The dynamics around food are pretty straightforward: there are more and more people to feed, with less and less land available to grow food on. It’s a classic supply and demand imbalance. It is also an investment opportunity – but how to do it?

Until recently, it has been difficult for Australians to play the food industry, whether through soft commodities such as wheat and sugar, or through meat or fish. Oddly for a country that is a major producer of agricultural products and livestock, there are very few major listed companies that are exposed to those themes: the big exception used to be AWB, but in 2010 it was taken over by the Canadian group Agrium. There are still some out there – Goodman Fielder is a big example – but the dominance of the Australian market by banks and resource-linked companies is reflected in a relative paucity of food and agriculture stocks.

Yet the case for food investment is strong from both the long and short term perspective. To start with the bigger picture, the world population is today around seven billion; it only passed the three billion mark in 1960. Moreover, all those people are living longer. The proportion of the world aged over 65 – negligible as recently as the 1950s – is increasing fast. Just under eight people in every 100 on earth are over 65 today, and by 2050, it will be more than 16 in every 100. “The increased size and age of the population means we see additional demands for food, water, resources and everything else,” says Douglas Hansen-Luke, CEO for the Middle East at European fund manager Robeco, known for its work on the so-called megatrends that will shape our world over the coming decades. “It leads to scarcity.”

At a number of points over the last decade, food scarcity has become deeply problematic: there was an incident before the global financial crisis when Bangladesh, for example, was unable to secure rice at international auction because other countries were hoarding their own stocks. Had Bangladesh not had an excellent rice harvest that year, we could have seen severe shortages in a desperately poor country, and associated social unrest. Governments around the world are making food security a priority. “The absence of food security will make it much harder to pursue a broad range of other policy goals,” notes the UK-based Government Office for Science 2011 report on the future of food and farming. “It may also contribute to civil unrest or to failed states; it may stimulate economic migration or fuel international tensions.”

More pragmatically, that shortage suggests an investment case; UBS and Goldman Sachs are among the banks that have argued for a greater allocation towards soft commodities this year. Closer to home, a 2009 report from the Australian Agribusiness Group pointed out that less than 0.01 per cent of superannuation funds went into Australian agriculture, and that a greater proportion – as is common in international pension funds – would have insulated super funds from the global financial crisis. Soft commodities are a long term investment prospect and a diversifier too; and since food is usually a core part of inflation, they work as a hedge.

Shorter term, it’s trickier to be sure about the direction of any commodity in these uncertain times. “It’s not apples and apples,” says Ric Deverell, head of global commodities research at Credit Suisse, and a former Reserve Bank of Australia economist. “There are quite different balances in different markets: corn is fundamentally very tight, while wheat is nowhere near as tight.” But he says “the central tendency in most of these markets will be for markets to move sideways for the next year.”

That said, he says corn is “the tightest market we have seen since the 1970s; when it’s that tight, it only takes small changes in supply and demand to have very large movements in prices.” In that environment, weather patterns, a good or bad crop or some other macro consideration can have a major impact on prices. “If next year is an average season, some of the tension we saw because of crop failures fades away – but gee, it’s vulnerable.” And on top of that, he says the incremental global rate of corn consumption has doubled since 2003, partly because of its use in creating ethanol fuel – 40% of the US corn crop will be used in this way in 2012.

Also relevant are changing patterns in food consumption in emerging markets, and changing attitudes in different countries to self sufficiency. As always, China is a huge driver here: growing use of fish, meat and dairy products in the Chinese diet have had ripple effects all the way to Australian or South American pastoral businesses, while China’s decision to be self-sufficient in wheat and corn has had knock-on effects too – such as in soy, which it is now the biggest importer of, having reduced the amount of soy it grows domestically in order to achieve those wheat and corn ambitions. Clearly, seeing a way through all of these patterns and shift is enormously difficult, but the general long-term trend is up.

So how to play it? Late last year, it became much easier to invest in soft commodities when a series of new exchange-traded funds was launched by BetaShares. Exchange-traded funds behave like a share, in that you buy and sell them on a stock exchange, but they give you exposure to an index or an asset class, and so are a straightforward and low-cost diversifier.

BetaShares launched two new ETFs relevant to food: an agriculture product, and a commodities basket. The agriculture one tracks the performance of the S&P GSCI Agriculture Enhanced Select Index, which is made up of the big four commodities in agriculture: corn, wheat, soybeans and sugar. The commodities basket is broader, covering 24 separate commodities including energy and metals, but it also includes a wider range of food-related commodities: eight agricultural (the big four plus cotton, coffee, Kansas wheat and cocoa) and three livestock (live cattle, feeder cattle, and lean hogs). All of these commodities are established markets with a particularly long trading history in the United States.

Drew Corbett at BetaShares feels the new products fill a gap. “We’re trying to allow people access to different asset classes,” he says. “People have been able to invest in soft commodities overseas for 10 years now through access products [like ETFs], and now people here can access some assets they previously didn’t have a low cost solution to invest in.” He notes that in private portfolios, asset classes such as these can account for up to 10 to 15% of an overall portfolio, and argues retail investors in Australia should be allowed the same opportunity for diversity. And he also agrees with the macro point. “If you look at emerging market population growth, there is going to be substantial demand and pressure on food and agricultural commodities to keep up.”

One point to note about ETFs like this is that unlike a share index ETF, these can’t be backed by the underlying investments. Think about it: you’d have to have a vast warehouse full of corn and wheat that couldn’t be used (or, in the case of the oil ETF, a tanker) to back the fund. Instead, BetaShares backs its ETFs with cash, in order to reduce counterparty risk, a worry in some other ETFs.

CFD providers have watched the emergence of these ETFs with some interest, since they have provided the opportunity for investors to trade soft commodities for years without receiving a huge amount of takeup. At IG Markets, for example, you can trade cocoa (London or US), coffee (robusta or Arabica), orange juice, two kinds of sugar contract, cotton, lumber, oats, corn, soyabeans (including meal and oil), wheat (London, Chicago or milling), rough rice, live and feeder cattle, lean hogs or rapeseed. But, by and large, people don’t. “It’s not one of our most traded products, but more specialised investors will use it – we get a lot of farmers who trade these products, for example,” says Chris Weston at IG Markets.

He argues that anyone who is looking at ETFs should take a look at CFDs first. “CFDs are a much more cost effective way of trading commodities than ETFs,” he says. “They are cheaper, they track the spot or futures price more effectively than an ETF does, and we offer you a price identical to the futures price.” CFDs allow significant leverage, which magnifies both gains and losses.

Anyone who does invest in commodities needs to think about the currency. Commodities are generally quoted in US dollars, and as anyone who’s invested in gold in recent years will know, that can make all the difference if you have made your investment in Aussie dollars. The BetaShares products hedge for the currency. People using CFDs can add a currency hedge in a separate contract if they want to.

In this article we haven’t discussed the tax effective investment schemes that have sprung up around areas like wine, truffles and almonds; schemes like these tend to be used by investors for different reasons, chiefly tax. But in the big picture themes of agriculture and livestock (see box), expect more investment vehicles to emerge.

BOX: Beefing up

Alongside the grains and other soft commodities, a less-invested arm of the commodity world is livestock.

Alongside some of the ETF and CFD investments covered in the main story, a few other ways have been devised for Australians to gain exposure to this asset class.

There is a Beef Stock Market in Roma, Queensland, popular among people in the livestock industry but actually open to anyone with an Australian business number and an internet connection. The market sets a price, per kilo, to buy cattle, and also indicative prices for selling the cattle – one price for when a professional livestock manager suggests it be sold, and one for outside that period. Investors can buy a cow or a herd in this way.

During ownership, investors pay grazing fees – currently $1.15 per kilo gained, paid by direct debit every time your cattle are weighed – and at sale time, there’s an agent’s commission of 4% of the full sale amount, a compulsory industry levy of $5 a head and perhaps additional sales costs including transport to market and weighing. Whatever else is left – the difference between the buy and sell price, based largely on the weight gained in the meantime – goes to the investor.

The market provides this costed example of how it might work. You want to spend about $10,000 on cattle. The purchase price is $2.24 per kilo, and the average weight purchased 254.36 kilos, meaning you buy 16 head of cattle, weighing 4,069.76 kilos, for $9848.82. An invoice goes through for payment within 48 hours. While you own the cattle, every few months they are weighed and the portfolio updated with current weights, while your weight based grazing fee is charged to your account. Let’s say the average weight gain is 195.37 kilos and fees $1.14 a kilo; your grazing fees will be $3,594.81.

Then the livestock manager tells you the animals are in sale condition at an average of 449.73 kilos apiece. If you agree to go at this – the ‘finished sale price’ – the livestock manager goes ahead. Let’s say they sell at $2.22 per kilo, with no additional marketing or transport costs (a farm-gate sale); the portfolio of animals would have been sold for $15,974.41. Once levies, commissions and so forth are taken out, the bottom line is a return of $1,811.80 on your just under $10,000 initial investment, or a return of around 18%, which would have taken about a year to achieve. Clearly, though, there are a lot of unpredictable variables involved; this is just a costed example.

One of the leading producers of sheep and cattle in Australia is Macquarie, which is understood to have about 220,000 cattle and 240,000 sheep across more than three million hectares of land, all of it held as a method of giving investors exposure to Australian livestock. This tends to be the preserve of private or institutional investors; an example of a completed fund backed by Macquarie is Paraway Pastoral, formed in 2007, which runs 18 large-scale sheep and cattle stations across New South Wales, Queensland and the Northern Territory.

While Macquarie declined to comment on any specific funds, citing regulator issues, executive director Tim Hornibrook explains the broader investment case. In some cases, it’s similar to that for other foodstuffs around the world: too many people. “The investment case is a fairly simple one: we’ve got more people in the world eating more food but less land to produce that food on,” he says. “That is causing a structural imbalance between demand and supply, causing a shift in agriculture prices above their long term average. Over the last 40 years arable land available for agricultural production has basically halved. So whereas once upon a time we used to each have a football field we could go and farm on, today we have two fifths of a football field.”

On top of that are changes in what people eat and can afford. “There are not only more people, but those people are getting wealthier, and there is a strong correlation between wealth and diet,” he says. “As you get wealthier, you tend to consume more proteins, and that once again puts pressure on demand and supply.” To meet demand, animals are tending to be produced more intensively – pigs in piggeries, cattle in feed locks – which in turn puts further pressure on the grain and oilseeds used to feed the animals.

But some elements of livestock in Australia are very distinct to this country. “Australia is in a fortunate position,” says Hornibrook. While it ranks second as an exporter of beef globally, behind Brazil, it ranks first by value, “because we get a higher price in recognition of being a consistent provider of high-quality, disease-free meat.” Most cattle in Australia are grass-fed, which is cheaper than the feedlock system common in the US and also considered more humane, and also reduces linkages to rising grain prices. Australia has a lot of land to allow a pasture-based system; it is closer to the key Asian markets than Brazil, with cost and time benefits; and more than anything else, it is disease-free, without ever having suffered an outbreak of an export-restricting disease, a function of being an isolated island with strict quarantine and a national livestock identification system. “Once a cow leaves a farm in Australia it has to wear an electronic ear tag,” he says. “You could be anywhere in the world and order an Australian steak and I could trace it back to the paddock where it was born.”

All of these things make Australian beef (and lamb) a very compelling investment case, but for retail it’s still very hard to play. Macquarie does, though, have a track record of starting out with somewhat esoteric investment classes with institutions and private wealth, then gradually offering retail exposure to them, so that may change in future. In the meantime, the most obvious exposure is through listed companies, the principle example being Australian Agricultural Company, Australia’s biggest exporter of live cattle to Indonesia.

When the enabling legislation to allow Australian banks to issue covered bonds passed through Canberra’s parliament in October, expectations were high. For banks, there was the prospect of a new, cost-effective, diversifying funding source. And US and European investors would get exposure to one of the most secure, steady and reliable banking sectors in the world – in the agreeably high-ranking form of a covered security.

But it didn’t quite work out like that. In November ANZ became the first Australian bank to launch a covered bond, swiftly followed by Westpac, and from the issuer perspective they were successful: they raised $2.25 billion between them at attractive terms. But within 10 days, both deals were being bid 30 basis points outside their reoffer. Granted, markets were exceptionally difficult, but there was also a sense that the Aussies, galvanised by their strong domestic standing, had demand pricing that was too tight for their role as vanguards of a whole new market. In the fallout, Commonwealth Bank of Australia cancelled a planned deal in euros; National Australia Bank, the first of the four to roadshow and announce a planned deal, has still not even formally mandated one.

There has consequently been a great deal of finger-pointing among the issuers and their lead managers (ANZ, Citi, Nomura and UBS on the ANZ deal; Barclays, Bank of America Merrill Lynch and Westpac on the Westpac deal). Some blame the issuers, others the bookrunners.

“Investors were disappointed by the spread widening seen after the launch of the first Australian covered bond issues,” says Ted Lord, managing director at Barclays Capital. “These investors have strong confidence in the Australian banking system, but they thought that the pricing pushed the envelope a bit too much – especially for inaugural covered bond deals from an inaugural covered bond market.”

There’s also a sense of Australians not having properly conveyed the strength of their own system to investors who are used to troubled European banks. Australian banks weathered the financial crisis better than any developed nation bar Canada; they still pay dividends and have a great economic story underpinning them. But that’s not obvious to European investors.

In particular, there is a feeling that Australian banks were so intent on beating each other on pricing that they missed the broader point: a favourable start to a new market will that will important to all of them. “The investor market really wants to have a very strong successful Australian covered bond market, because people feel comfortable about the country, the banks and the future. But they want the process of creating this to be much more collaborative,” says Lord. “That’s the message.”

The prize is potentially very big. The Australian Prudential Regulatory Authority (APRA) limits covered bond issuance to 8% of total system resident assets for each bank. “That could equate to about A$160 billion for the major Australian banks overall if they maxed out capacity,” says Fergus Blackstock, head of debt capital markets at UBS in Sydney. “Everyone will maintain a slight buffer inside that, which brings it down to about $120 billion. Most issuers are probably going to try to build up to that and not do it all at once, but you could still expect to see about A$5 billion per major bank per annum.” For banks, there’s every reason to participate in this market as fully as they can. “Covered bonds will form a core part of funding,” Blackstock says. “They will still do senior deals and RMBS, but covered bonds will be another string to the bow.”

From his perspective, having worked on the ANZ deal, he put the reception down to the fact that “the markets were tough, and just getting tougher. We were pleased with the way the ANZ transaction went: the initial primary subscription was strong, we were oversubscribed with $1.45 billion in the book, and the performance immediately on the break was pretty strong. But then the market deteriorated.” In his view, all regular comparables issuers – the Scandinavians, the Canadians – were under similar pressure. “Timing was unfortunate; legislation came through at the point when markets were really turning, and ANZ managed to hit what turned out to be a very small window.”

Blackstock accepts that “with the underperformance of the initial bonds, we need to make sure, as the market stabilises, that performance can come back. New deals will have a chance to perform in a better market and put the product back on track.” But he adds: “there’s not a material hole in the covered bond product that needs addressing.”

Is it realistic to expect a group of banks who compete vigorously among themselves to collaborate in building a successful funding market? Lord points to Germany, Sweden and the UK as examples of places where this has happened. When markets stabilise and shelved deals return, it will be interesting to see whether issuers are prepared to leave a little more on the table for the greater good.

It’s certainly in their interests to have happy investors – and not just because of the established European and American buyers. “Several Asian central banks are now finalising plans to invest in covered bonds for the first time,” says Lord. “Australian issuers will probably enhance that, because Asian investors – whether banks, pension funds, insurers or central banks – have a good and comfortable knowledge of Australia.”

As another banker, not involved in either of the first two trade, succinctly puts it: “It would be nice if they don’t screw up the market before it’s even started.”

Asia is widely accepted as the most enticing market for asset management growth in the coming decade and beyond. It’s little surprise, then, that the region also hosts a vibrant market for M&A transactions.

This can take a number of forms. One is international businesses seeking to acquire local enterprises, or – where regulation requires – to form joint ventures with them, as is most commonly the case in China. Alternatively, local businesses often acquire one another, or conduct mergers of equals, in order to achieve scale – something that is prominent among the Australian industry funds landscape, for example. Drivers of M&A can include regulatory change and the framework of the institutional investment industry that these fund managers seek to support.

China and Australia dominate M&A in asset management, and China generates by far the most attention.

There are several reasons for this. Firstly, China is obviously the region’s main prize, not so much for the market it represents today but what it is likely to turn into tomorrow. Even after considerable slippage since 2007, the public mutual fund industry in China had RMB2.027 trillion under management at the end of the third quarter, and in brighter economic circumstances is likely to soar. It’s still very clearly an important industry to have a foothold in. Retail mutual funds represent only about 3% of retail investor portfolios, according to research group Z-Ben.

Plenty, though, have already done more than secure footholds. When Essence FMC was established in November, it became the 69^th fund management company active in China. For anyone new seeking to get involved, they must wait for a new licence, and, although six have been established this year (only one of them a JV), it is very hard to know how many more will be licensed and at what pace. A rule of thumb is to wait three years for a new business to be licensed and launched. For foreigners, it can make more sense to find an existing joint venture (there are 36 active) with a foreign partner who wants to exit.

On top of that, regulatory change has driven M&A activity. No domestic fund management company can be 100% owned by one company (although a local company can hold more than 49% in a Sino-foreign JV, in some cases going as high as 80%). Instead, no shareholder can own more than 49% of a domestic fund manager. Consequently many of the bigger local groups have had to sell stakes – either domestically or internationally – and in some cases have opted to change their structure to a JV.

These three trends (potential scale, need to enter an established industry, and regulatory change) are what has made China such fertile ground for M&A.

Perhaps the most striking in 2011 involved China AMC, the biggest local asset manager with almost 10% of all industry assets under management, owned by CITIC Securities. Being the biggest made the China AMC stake difficult to sell, and for some time CITIC found itself in violation of local law because of the size of its shareholding. Eventually, China AMC was banned from new launches until it redressed the problem.

So in 2011, it created five tranches for auction. First, 10% went to Shandong Rural Economy Development and Investment Company, for RMB1.6 billion, and then an 11% stake to South Industry Asset Management Company for RMB1.76 billion. But the most significant sale was the third, in August, since it went to Power Corp, a Canadian financial services firm, for CAD276 million (which at the time was RMB1.78 billion) for a 10% stake. This sale to a foreign house has turned China AMC into another joint venture.

While China AMC, as the biggest, is the most striking example of Chinese M&A, there have been many others besides. Bohai International Trust bought an 18% stake in Orient FMC in 2010, while ICBC announced that Cosco – a shareholder in the ICBC Credit Suisse joint venture – would sell its 20% stake to the bank, with Credit Suisse selling 5 of its 25% stake. The 20% piece cost RMB258.2 million. Southwest Securities, based in Chongqing, bought a 20% stake in Yinhua, another fund management company. Analysts expect other bank-backed JVs, such as CCB Principal, Bank of Communications Schroders and ABC-CA, to see the banks try to up their holdings in future.

The following charts look at the composition of the joint venture businesses in Chinese asset management today.

[Contact Cerulli to see version with charts]

In Australia, one of the main drivers is the pension fund (or superannuation) industry, and in particular industry funds. In an open and highly competitive market for funds, there is a clear need for scale. In early 2011, five separate industry fund mergers were underway simultaneously: First State Super with Health Super, AustralianSuper with Westscheme, LGSuper with City Super, Equip Super with Vision Super, and Non-Government Schools Superannuation Fund with Cue Super. There have been others besides.

While the quest for scale is understandable, it may not always be in the best interests of members. Russell Investments launched a paper in August saying that the cost efficiencies and economies of scale from mergers are not necessarily serving the members of the fund. Issues raised by the paper include ensuring member equity in addressing differing exposure to liquid and illiquid assets between merging funds. Handling varying member balances and managing transparency and accountability principles also raise difficulties. Members are often not given a detailed analysis of expected costs, so can’t then hold their trustees accountable.

Outside these two markets, M&A volumes are lower, but there are several interesting trends underway. India deserves close scrutiny, partly because its own asset management industry has similar demographic potential to China. Here, acquirers of stakes in local businesses, or creators of new joint ventures, have been a widespread group in recent years, from homegrown ambitious businesses like Religare to international heavyweights like Robeco, Nomura, T Rowe Price and most recently Goldman Sachs.

The chart below demonstrates how many of the leaders in international asset management are well represented in ventures of various forms in India today. As with China, a number of different approaches are possible. Some entities carry the name joint venture but are in fact 100% foreign owned, such as those established by Morgan Stanley, Franklin Templeton, ING, HSBC, BNP Paribas, Fidelity and JP Morgan, though the last of those was set up in 2006. Since then, full foreign ownership has also been possible, but they are now termed private sector entities: this approach describes the ventures owned by AIG, Mirae, Daiwa and Goldman Sachs, among others. Still others are true JVs in which the foreign partner ties up with a local, sometimes in a majority stake, sometimes a minority; this is the approach for BlackRock (tied with former Merrill Lynch partner DSP), Sun Life (with Birla), Standard Life (with HDFC), Prudential (with ICICI), and Nomura. Finally groups like T Rowe Price – which holds 26% of a venture called UTI Asset Management – and Robeco and Pioneer (with stakes alongside Canara and Bank of Baroda respectively) have taken a model termed bank-sponsored.

As with China, movements in stakes in these businesses can often be driven by events outside of India. So, for example, Daiwa Asset Management is there not because Daiwa bought in but because it acquired fellow Korean Shinsei Asset Management in 2010. Others change hands because of mergers elsewhere; just as BNP found itself with stakes in three Chinese JVs and was obliged to sell out of two of them following its various financial crisis-era mergers and acquisitions, in India it ended up with two and had to sell its stake in Sundaram BNP Paribas in October 2010.

There is not scope in this article to go into Taiwan and Korea in detail, but both are also important markets for M&A, as the charts below demonstrate.

That’s the backdrop. But should a foreign party acquire a business, or a stake in one, rather than building organically?

There are clear arguments on both sides. It can be extremely hard to launch a greenfield business in many emerging markets. The process of licensing can be opaque and time-consuming, and, once achieved, it is very difficult to start from scratch in an intensely competitive field – none more so than China, but also in established markets like Korea and Taiwan. That’s a clear argument for buying into a business or JV: access to existing client base, infrastructure, and local knowledge, with the opportunity to revamp or improve an existing product range, rather than having to launch and market a whole new one.

On the negative side, it can be frustrating to be the minority partner in a joint venture – and in several markets, China among them, that’s as good as it’s going to get in the near term. There is no opportunity to exercise leadership and to drive the direction of a business. That’s not so much of a problem if the local partner has the right strategy. But no venture ever takes place without some internal friction. Additionally, in competitive markets like China, the costs of acquisition are getting steadily higher, as the China AMC sales show; in a slowing market, no matter how much potential it has, that’s a difficult situation in which to thrive.

ROADTEST

Clime Australian Value Fund

Who runs the fund? Clime Asset Management, a value investor. John Abernethy is the chief investment officer and founded Clime in 1996 after 10 years as head of equities at NRMA Investments.

The basics: Looks for good value Australian stocks in order to deliver consistent capital growth and growing income over three to five years.

The process: Underpinned by three key beliefs: preservation of capital; sustainable return on equity determines value; and the value of a company will be reflected by its share price in the medium term (in other words, be patient and value will be delivered). Holds a concentrated portfolio of around 20 stocks. An easily understood business model, well funded balance sheet, absence of heavy debt, and high dividend yields are also attractive.

The bottom line: Looks truly exceptional lately. In the last three years to October 31 it is up 17.74% a year, according to Morningstar, more than 3.5 percentage points higher than its nearest value-style rival. It’s also the top performer in its field over the last 12 months (up 4.76%) and five years (6.63%).

Fees: 1.03% for retail, 0.87% for wholesale, plus a performance fee of 15.38% of outperformance above of benchmark of 12% per year. That is a much higher benchmark than many fund managers apply.

Verdict: Consistently excellent results for the last five years just can’t be argued with.

NEW FUND

Mutual Cash Terms Deposits and Bank Bills Fund

What is it?

Basically a cash fund.

Sounds boring.

In this environment, boring is good. All it aims to do is outperform the UBS Australian Bank Bill Index, and at a time when equity markets are either plunging or volatile, that will do some people very nicely, thankyou.

How does it invest?

Looks for the best term deposits offered by the major Australian banks and authorised deposit-taking institutions, including credit unions and building societies, provided they qualify for the Commonwealth Government ADI Guarantee. It can’t use gearing, or derivatives – it keeps it very simple.

How much can I expect to make from that?

When last disclosed on September 30, the weighted average yield of the portfolio was 5.84%. Almost all of the fund was invested in four deposits at that stage, through CBA, Westpac, NAB and Bank of Queensland.

And what do I get charged?

A 0.4% management fee.

What if I need to get my money out in a hurry? In the last financial crisis there were ‘enhanced cash’ products that got cash-locked.

The fund pledges access to liquidity within seven days without an interest rate penalty.

Is it a good time to be in cash?

It is exceptionally difficult to call the likely direction of stock markets at the moment, and not particularly easy to draw conclusions about bonds either. That is the sort of environment that very much favours cash. You might miss investing at the bottom of share markets but you also won’t lose money.

What do analysts think?

Zenith calls it “a very safe and high quality investment.”

GIZMO

Fujitsu Stylistic Q550

Having buckled and bought an iPad recently, I’m impressed, but couldn’t countenance it replacing a laptop on business trips yet – the biggest reason being I’m so married to Microsoft Office, for better or worse.

So I was interested to find this new product from Fujitsu which looks a lot like an iPad – it’s a slim tablet of similar size and weight – but is equipped with Windows 7 Professional and can handle all the usual Microsoft Office documents and functions. You can still use it for games apparently, and play music, but that’s not really the point of the device: it’s meant to be an iPad that you can work with on a trip. Indeed, Fujitsu even markets it as “for professionals only”.

For me, the lack of a keyboard is still a problem, but I think I’m in a minority there, so for those who want the portability of an iPad with the programs they use in the office, this is worth a look.

FUND WATCH

Trust Company Imputation Fund

Ouch. Everyone knows these are testing days for fund managers but this fund is suffering worse than the market, particularly over the last 12 months. Part of the problem is that, as an imputation fund, its strategy is chiefly around stable stocks that pay a good healthy dividend; but in recent years, dividend payouts have been under a lot of pressure, particularly at the banks.

In terms of sector breakdown and top stocks, the fund looks a lot like the broader market: almost 40% of the fund in financials, much of the rest in basic materials and consumer defensives. The fund is keeping the faith with the big four banks; they occupy four of the five biggest holdings in the fund, after BHP. A fund like this will thrive in brighter times when dividend security is restored and the steady stable heavyweights lead the way out of market problems. But those days could be some distance away.

Australia’s financial advice industry is going through the greatest period of change in its history. As market participants prepare for a host of new measures that will start to take effect next year, it’s already clear that reforms targeted at superannuation and financial planners will have knock-on effects on the whole distribution sector of the asset management industry.

To recap, three separate streams of reform have been happening together: the Future of Financial Advice (FOFA) reforms on financial planning; the Henry review, which seeks to streamline tax; and the Cooper review, which is a re-evaluation of the country’s powerful superannuation (pension) industry. The FOFA and Cooper reviews, the ones most relevant to fund managers and distributors, have both now reached the point of draft legislation and have undergone detailed periods of consultation and review.

FOFA will be the first to come into effect, largely applying from July 1 2012. Chiefly this affects the way that financial planners are remunerated for their advice, and the way that fund managers and investment platforms reward those planners for distribution. It will, for example, ban commissions from product manufacturers to financial planners in exchange for recommending their products; it will ban volume-based payments; and will introduce a compulsory, annual or bi-annual renewal notice for all advice clients, requiring them to opt in for financial advice rather than it just rolling from year to year.

One argument is that this favours vertically integrated companies – those that, within a single institution, combine product management and a financial advisory force, since they have greater flexibility in how they remunerate. Nomura, for example, argues this favours IOOF Holdings, whose companies and brands include investment management (Perennial Investment Partners, IOOF Multimix), financial advice (Bridges, Ord Minnett, Lonsdale), platform management and distribution (AustChoice, IOOF Pursuit, Spectrum Super) and estate planning and trustee services.

Another argument is that it favours those groups that have long seen the writing on the wall for commissions and removed them from their approach to distribution. MLC, the asset management arm of National Australia Bank, has been taking this approach for about a decade and is therefore well placed for the new environment.

For individual fund managers, the hope is that they will find their way on to the menus of investment platforms based purely on merit and returns, rather than a relationship – however contrived – with a financial planner or distribution arm. One positive way of looking at this is to see how exchange-traded funds, which have never paid commission, have taken off since the advice industry has started to move towards fee-for-service; previously they would rarely be recommended because there was no monetary sense in planners doing so. Any objective view would suggest this is a good thing; ETFs have a useful role to play in a client portfolio but were previously impeded from doing so because of advice remuneration structures. Perhaps the same can happen more broadly with managed funds.

Set against that, there’s still a feeling that this is a move that helps the big get bigger, in terms of distribution platforms; anything that streamlines tends to favour those with scale. The distribution industry has been consolidating for years anyway – there are over 60 platforms in Australia but almost all the business resides within the top 10, and the vast majority the top five.

Within the grass-roots advisory industry itself, though, it’s clear that the changes will have a significant impact. The research group Investment Trends, which this year surveyed almost 1,400 financial planners, found that 45% of them had received soft-dollar benefits from third parties in the last year, and that 16% had received both financial and non-financial incentives to recommend their licensees’ products. The most common soft-dollar benefits may seem rather anodyne – they included professional development (58% of advisers), technical services (43%) and compliance services (22%), compared to just 7% who said they have received cash, gifts or entertainment valued at over A$300 from third parties. But there’s still going to be a significant period of adjustment in the industry model.

There is no shortage of dissenting views in the advice industry about these changes; many feel unfairly targeted, and one particularly controversial element has been a proposed ban on commissions related to insurance in superannuation, with people arguing the ban will discourage people from taking up insurance at all. There is some debate about costs, too; actuaries Rice Warner calculated that the opt-in provisions, for example, would cost $11 per client per year, a calculation widely broadcast by the government in supporting the measures. Rice Warner, which was swiftly belittled by the financial planning industry for understating the cost, has since rushed out a clarification saying this represents the ongoing cost and excludes opt-in implementation costs or any other cost related to FOFA. Its clarification said that a dealer group would on average face $105,000 of one-off costs and $110,000 ongoing per year; and that a product provider would face $1.4 million and $450,000 of costs respectively, bringing an industry total of $46 million in one-off costs followed by $22 million per annum. The $11 figure came from dividing that $22 million figure by the number of people who receive advice every year – estimated at 2 million.

Alongside FOFA, there are potentially more influential changes afoot in the superannuation industry. A previous column has looked at the so-called stronger super reforms; the key measure is the introduction of the MySuper product, which is a low-fee, no-frills superannuation option that will be the default fund for most Australians if they do not specifically opt to be in something else. A host of different MySuper products will be developed by funds, which will come into effect from October 2013, with balances required to be migrated to them by July 2017; they are all likely to look rather similar, offering a balanced portfolio with a lot of the exposure delivered passively in order to keep costs down.

SuperRatings, a research group in Sydney, has estimated that 80% of superannuants fall into the default option, so clearly building a successful MySuper product must be a priority for super funds and the manufacturers they engage. There’s not going to be much room for fees in these things – SuperRatings estimates the average fee will fall to about 1 per cent, whereas many people today pay twice that – but then again the economies of scale should be considerable.

A third change, also highly significant for the funds management industry, is the Superannuation Guarantee (Administration) Amendment Bill, which entered the House of Representatives – one of the two halves of Australia’s parliamentary system – in November. The key measure this will implement, if passed, is to increase the superannuation guarantee (the proportion of salary that an employer must put into super directly for an employee) to 12% from 9% today. This would take place in 0.25 percentage point increments between July 1 2013 and 2020. It will also abolish the age limit for superannuation contributions, again potentially increasing the inflows of assets into the industry.

It’s no surprise that the bodies representing funds are fully behind these changes. The Association of Superannuation Funds of Australia has been swift to urge parliament to pass the legislation. The move would clearly increase retirement savings for most Australian workers – the Treasury reckons a worker aged 30 on A$70,000 a year would have an extra A$108,000 in retirement with the new rate – but it would clearly also boost assets under management in superannuation, which at A$1.3 trillion already represent one of the largest asset pools in the world, all the more so as the Australian dollar continues to climb against the greenback.

ASFA tells Cerulli that each on quarter of a percentage point increase will generate about $1 billion extra in superannuation contributions each year, based on current contributions of about $45 billion a year. So 12% versus 9% means an additional $15 billion per year – or, by 2020, likely $22 billion a year, ASFA says. It estimates that total superannuation assets could increase by 17% of GDP by 2028 as a result of the increase; if that’s right, there will be a total of $450 billion more in assets as a consequence of the rule change.

One interesting impact of all of these reforms is that for many funds and advisors, member retention – particularly at retirement – has become the most pressing issue, more so than engaging new clients in the first place. Some groups will clearly thrive and find new business in this revised environment, but the impression today is of a great urgency for funds and firms to hang on to what they’ve already got.

ROADTEST

Platinum European Fund

Who runs the fund? Platinum Asset Management, Australia-based global investors.

The basics: Invests in European companies’ listed securities. It defines Europe as “all countries from the UK to the Ural mountains”, which means it includes Russia and the various former Soviet republics.

The process: Holds 50 to 100 securities Platinum believes to be undervalued. It can go to cash, and it can also sell short, meaning it benefits from falling share prices.

The bottom line: We looked at European equities because this asset class has been so enormously beleaguered this year, stricken by problems with eurozone sovereign debt. We wondered if any of the available European equity funds in Australia had stayed positive over three years; this is the only one that had, though like most of its peers it was down more than 13% in the six months to September 30. Over seven years, it’s up 4.79% a year. It may have performed better than the herd because of its ability to short sell and go to cash; also, not all European funds can invest in Russia as this one does.

Fees: 1.54% management expense ratio, including GST and administration costs.

Verdict: When you believe European markets have hit the bottom – a very difficult call – this will be a good option to catch the rebound.

NEW FUND

Blackrock Australian Equity Opportunities Fund

What is it?

A new Australian equities fund

Great. There’s only about 300 of them already. What’s special about this one?

It invests into units of the BlackRock Equitised Long Short Fund, which in turn puts most of its money into the BlackRock Australian Equity Market Neutral Fund, with some in swaps or futures on the Australian share market.

So when you peel all those layers off, does that all mean it’s a hedge fund?

Yes, a long-short fund, which means it can make money from declines in stocks as well as climbs. Blackrock has a bold ambition for this fund – 8% per year over the S&P/ASX200 Accumulation Index over three-year periods – and seeks to do so through an investment process that includes investor behaviour around earnings forecasts, relative value, earnings quality, market signals, and dividend reinvestment plans, among other things.

How much can it short?

The underlying hedge fund has a maximum exposure to long equity positions of one times net asset value, and the same for short positions, which means it can fully express a view on whether a stock will go up or down.

And how has that underlying fund done?

Very well. By the end of August, it was up 16.03% per year since inception, and crucially was up 12.18% a year over the volatile last five years. Normally, that’s an institutional fund; the point of this new version is that retail investors can access it.

What will the fees be?

Very heavily linked to performance. The management fee is just 0.3%, lower than some index funds, but the performance fee is 30% of outperformance over the benchmark. That is one of the highest performance fees we’ve heard of, but also the lowest base fee, and if you’re paying out a lot in fees you’ll also be receiving good performance.

GIZMO

Wacom Bamboo Stylus

What’s the one big problem with our new iPad and iPhone-fuelled lives? Battery life? No. Walking under buses while playing? OK, you can make a case for that. But what bugs me is that our fingers are wholly unsuited for touchscreen swiping. We leave dirty great fingerprints (last week I witnessed the unhappy combination of yak meat grease and an iPad 2, and believe me, it wasn’t pretty) and our screens become unsightly and somewhat unhygienic.

The best gizmos bring the absolute basics to technology, and there’s nothing more basic than a pen.  The bamboo stylus is specifically designed for iPads, and looks like a classy fountain pen with rubber on the end; it has a pen’s weighted feel too. This clearly excels using applications where you need to write or draw, but even when just playing Angry Birds, it’s an appealing difference. From www.wacom.eu

FUND WATCH

Cromwell Phoenix Property Securities

It’s relatively early days for this fund, but so far it has dodged the shoals and pitfalls for listed property to create a decent return in difficult circumstances. Where the benchmark has lost an average of almost 12% a year for three years – and worse for five – Cromwell is at least flat since September 2008 and up over 7% over the last year.

How? While the top positions are inevitably in Westfield, they are underweight positions relative to the benchmark (in fact, there is a 20% ceiling on any stock); the fund is not constrained by benchmarks and takes a value approach to stock selection. Cromwell (and underlying manager Phoenix) won an award from Lonsec for the best Australian property securities fund manager this year.

Smart Investor, December 2011

How should a novice approach contracts for difference? For speculation or for hedging? Quick gains or safety? To find out, Chris Wright took a trail of a CFD platform during the most volatile month since the GFC

Monday September 5

It’s been a characteristically miserable day in the markets: the ASX 200 down 2.2% at lunchtime, Asian markets faring worse. The market chat is about miserable US economic data while the fate of European sovereign debt lurks in the background like a hangover. It’s against this backdrop that I key in my password and login to IG Markets for a month-long trial. I’ve been given $20,000 of mock capital (“regrettably, it’s not real”, IG’s Chris Weston tells me as he sets up the account) and I will paper trade until I think I’ve figured it all out.

To see the article as it ran, click here: diary1 diary2 diary3

As I log in my first impression is of a data-heavy page with some regular flashing red and blue lights. Closer inspection shows the flashing is next to buy and sell prices on AUD/USD FX rates, the spot gold price, the FTSE 100 (it’s late in the day and London is in session) and crude oil. I look at the various menus and within seconds realise I need some training.

IG has also given me access to its TradeSense training modules, and I’ve decided my job for the first few days will be to get through this six-part series before trying even a paper trade. The modules, in PDF form, are well ordered and filled with examples; the early emphasis tends to be on unfamiliar things like short positions, which makes sense since most people using this will already have bought shares in the traditional manner beforehand.

In real life, you’d also be making a decision on whether to pay extra for live data fees, which depends on just how closely you want to follow the market.

Thursday September 8

I’ve gone through the six training modules in the TradeSense scheme. A lot of it is about risk management, and I like the bluntness of some of the advice: “Do not trade for fun. Do not trade because you are bored. Do not trade because you are scared of missing out.” And: “Leave your ego at the door and admit when you are wrong.” The CFD trading process seems straightforward: there is a lot of explanation around stop losses, and I’ve decided I will use them (or a limit order) on every single trade I make.

In the time I’ve been going through these, the world has gone through yet more tortuous ructions: the Swiss central bank has set a ceiling (or floor, depending on which way you’re looking at it) for the Swiss franc against the euro and the fear in world markets now is of a currency war. It doesn’t look good.

For various reasons tedious and unfortunate, I own a ton of bank stocks which are a mile underwater. Had I had a CFD account earlier, I could have taken a short position against banks in order to hedge. It’s too late to insulate those losses, but frankly it looks like things will get worse before they get better, so I decide to short Macquarie as a hedge. The way I see it, if I’m wrong, then at least my other bank shares will be rising. Part of me can’t help but feel that this is cutting off my nose to spite my face, and that I should just have the courage of my convictions; the other half of me thinks it’s prudent risk management and if I’d done this ages ago I’d be living in a larger house.

Conducting a trade is very simple: pop the code into the Finder window, do any research you want to do in another window (charts, Reuters info, etc), set the size of your trade, put a stop loss on if you want to, and press buy or sell. I decide to sell 100 Macquarie shares, which are worth $2,380, roughly 10% of my opening account.

But I’ve forgotten just how powerful leverage is in a CFD platform. You only need to put down a fairly modest amount in order to effect a major exposure. So having made what, to a usually long-only investor, appears a reasonably significant trade, I notice that I still have A$19,992 of funds left, and have spent just A$87.49. My initial reaction is: oh, I should make it a much bigger trade. And then I realise I’ve learned my first lesson about CFDs. The power of leverage is great, amplifying good and bad calls equally, and just because you have the ability to use it doesn’t automatically mean you should.

I leave Macquarie as it is but also decide to short the European market. Nothing in recent weeks has made me think anyone has the faintest idea how to fix the European sovereign debt problems and that things are going to get worse before they get better. Again, there’s a logical hedge here: while I don’t own many European stocks I do have lots of stocks that fall when there are global macro worries – indeed, it’s hard to think of any that don’t. So I find that, without really thinking about it, I’m using CFDs as a hedging tool rather than a money grabbing exercise.

So I go to the indices panel and pick the EU 50. I take a bigger position here, and now I’ve used a total of A$2,000 of margin. Once again I’ve used a stoploss so, if I’ve understood the system correctly, the trade will close out at a point where my maximum losses are about A$4,000. While I wouldn’t normally want to lose that in real life, I comfort myself with the fact that if it happens, then probably my other shares (the ones I really own in this bitter reality) have been going up.

Within seconds I’m down about $500. I log off and get some work done.

Friday, September 8

Next day, I find myself up about $2,000. Suitably galvanised, I decide it’s time to try FX.

Being only a share trader by background, this is new to me, and it takes me a little while to work out which way I ought to be betting (let’s be honest, with forex, it’s all betting) to express my view. I have a theory, you see, and want to try it out: Switzerland pegged of Swiss franc, to support its exporters, is another bit of news that’s not great for the euro. Also, people are going to be looking for another safe haven currency if the Swiss franc can’t move; everyone’s talking about the Singapore dollar, but why not the Aussie? What could be safer and more supported than our very own Aussie dollar? So I take a long position on the Aussie-euro cross-rate. I notice that just one lot requires more than A$1,000 of margin – that’s a reflection of the leverage involved in CFDs. I decide to put my stop loss in 30 pips below the trade, which means that if the exchange rate falls from the 76.30 cents where I’ve bought in to below 76, the trade will close. On reflection I realise that’s probably too close to be sensible in a volatile market – just 0.3 cents! But I’m a bit paranoid about the leverage and the potentially bottomless pit of getting my call wrong.

Watching the FX screen is like a 70s disco: all flashing red and blue lights moving around. All it needs is a mirrorball. The FX market moves so exceptionally fast I can see why most people leave it to the professionals.

Monday September 12

After I turn off my computer on Friday, the chief economist at the European Central Bank resigns; the European market reacts as it does to anything with a hint of negativity about it and plunges. When I turn my computer back on on Monday morning, my short position on European stocks is in profit to the tune of Eu13,000; I instantly close my position. To my astonishment my A$20,000 of equity now stands at A$36,240. Clearly I’m a genius.

After this initial moment of euphoria subsides (it is, after all, pretend money) I analyse why I’ve just acted as I have. My view that European markets are going to get worse is considered and, I think, well thought out. It’s a reasonably long term view. So why have I just closed my position barely two days after opening it? To preserve profits, sure, but if I believed in that position, why not let it run?

I realise I have brought some preconceptions to CFDs and am acting accordingly. I have read that most people who use CFDs have their positions open for only a couple of days, sometimes even hours, and so I’m behaving in the same way. But the truth is, if you’re really going to use a CFD platform for hedging, there’s no reason to do that.

The very next day, I will regret this: Greece defaults and European markets plunge. Pretty much every day for the rest of the week something utterly miserable happens in Europe, culminating with a rogue trader losing US$2 billion of UBS’s money at the end of the week. Had I stuck by my convictions I’d have made more than twice as much – but, then again, I’m still ahead.

What next? I’m not generally using the platform to buy stocks I hope will go up – it’s easy enough to do that with my usual online broker. The novelty of a CFD is to trade things I can’t normally trade. So next, I decide to take a look at oil. IG Markets hosts a range of different oil contracts (Brent, US light), in a variety of amounts and durations. I’ve decided that if the world is in a mess then probably demand for oil will decline, plus the Middle East seems to be getting a bit calmer, so I take a short position on US Light Crude. I think about doing something similar with other commodities but can’t decide what I actually think and so, lacking an intelligent reason to trade, I don’t.

Next day, I find that both my FX trade and oil trade moved too far against me and hit stop losses. I lost a bit, but not too much, and am still well ahead overall; I’ve decided I like stop losses. In CFDs, putting in a stop loss also reduces the amount of margin you have to commit.

I’ve been having a think about gold. It’s at an all time high and there is more and more talk of a bubble. But I don’t see any reason for a decline in the near future. So I go long the spot gold price. This, I promise myself, will be a longer trade. I also go long the Aussie dollar against the US dollar, since it has retreated a bit lately and I can’t really see why.

Friday September 16

Swamped by deadlines, I take my eye off the ball for a few days, and it costs me. Both my trades from Monday – long gold, and long Aussie dollars – go against me and hit their stop loss positions. Worse, I realise I’ve miscalculated the margin on the FX trade and lost twice as much as I thought I would – wiping out the gains on shorting the European stock markets. I’m back pretty much where I started. It’s an expensive mistake, except for the fact that it’s not a real trade – and I am reminded again just how important it is to try paper trading first. Next time, when trading with real money, I won’t make the same miscalculation.

The following week I have to go to America and will rarely be anywhere near the system during trading hours. The only sensible thing to do is to hedge existing positions – which, again, means going short stock markets.

Tuesday, September 27, 2011

My week in America, attending the World Bank/IMF annual meetings, is an apocalyptic series of press conferences and meetings among the leaders who are supposed to bring the world away from the threat of recession and Eurozone collapse. To say that they don’t inspire much confidence is like saying the Titanic had a slightly disappointing maiden voyage. The markets, unimpressed, crash; the Dow loses almost 400 points in a single day on the Thursday.

So with my short positions on world stock markets, I must have made a fortune, right? Wrong. Although my call on stock markets declining has been entirely correct, I manage instead to lose half my money because I have failed to take into account volatility. On the way down, markets bounce and wobble, and my stop losses are too close to the level I bought at – so I get wiped out, despite having actually been right. This happens twice.

Seeing this, I then go short again, with a wider stop loss, and this time eventually get it right. By the end of the month, and the end of my four week trial, I have ended up just short of where I started out.

It takes some kind of incompetence to go short during a market rout and still lose money. Still, I have learned some valuable lessons, and am newly convinced of the merits of CFDs. Were I to start from scratch with real money, having learned about the pitfalls involved, I think I’d do reasonably well.

Postscript

Since the money is not real, I don’t close out the trades on the day I stop trading to file this article; I see what they’re worth that day, take that as my closing balance, and leave them. Two weeks later, out of curiosity, I open the system again to see if the account is still active; markets have rallied and all the capital has been wiped out. Of course this isn’t real, since in reality I would have closed the positions when I wanted the money. But it’s a cautionary tale: never leave your positions unmonitored and forgotten!

So what have I learned?

1. Spend a month paper trading! You may think you know what you’re doing with a new system but you’re very likely to find a couple of areas along the way where you mis-step because you’re unfamiliar with the program and its processes. There’s no harm in taking a few weeks getting to know the ropes.
2. Know your strategy. It may be, for example, that you want CFDs in order to hedge your stock exposure, or to take a position on particular asset classes you can’t normally get exposed to. But don’t just dip in and out like it’s a sweet shop: know what you want to do and execute it calmly.
3. Stop losses are great. It would be rash to use CFDs without them.
4. BUT, be careful where exactly you put that stop loss. On three separate occasions I took a position, which within a week was correct, but instead lost money because my stop loss was hit in the volatility.
5. Be sure your understanding of leverage, margin and exposure is correct. This is another thing I got wrong to my (theoretical) cost, taking a much more leveraged exposure on a foreign exchange position than I had intended to. No harm done in paper trading – that’s what it’s for, to iron out these mistakes before they matter – but you wouldn’t want to make an error like that in real life. Leverage on FX contracts can be very, very high.

A short while ago, we received a letter from a reader. “I would like to ask if Smart Investor can explore the financial road map for investors,” the reader said. He asked if we could tell readers how to develop their own financial roadmap, “and get their financial house in order and then keep it that way.”

It’s an intriguing idea: how do you prepare your finances for the many watershed moments of your life? So we set out to do it. But just remember: if you’re going to get any good use out of a map, you need to know what destination you’re trying to reach with it.

To see this article as it ran, click here: financial roadmap 1 financial roadmap 2 financial roadmap 3

“Your requirements do change,” notes Sergio Arcaini, a financial planner at Chiltern Peak, part of Genesys Wealth, in Kew, Victoria. “While the regulator can keep talking about risk and return, I think the focus of people should be to create a budget and try to stick to it. Once you have done that, you can work out what your goals are and what you would like to achieve in life. One problem we have as an industry today is we don’t teach clients to set goals and stick to them.”

“Anything you lie awake at dreaming about, anything you want so badly you can taste it, you can find ways of making it happen if you are prepared to make the sacrifices to achieve that goal,” he says. A practical example: “It is much more important to say I would like to get a Porsche than to say I would like to have $250,000,” says Arcaini. “If you are dreaming about a Porsche, it becomes a powerful motivating factor. If it’s just a figure, it doesn’t have the same power.”

Goals can be anything: the property on the beach. A family; or education for that family. Early retirement. A part-time existence for much of your life. A return to study. Or simply breaking even and providing as best you can for your dependents. But it’s only with the goals in place that you can build a roadmap towards them. With that done, here are some typical life stages and the issues they tend to raise.

GETTING STARTED

The first big life stage for most of us in financial terms is leaving home, starting work, and just trying to make some progress.

The priority of many young people, having bought their first home, is to pay down the mortgage as much as possible, and there’s nothing wrong with that: after all, home loan debt is not deductable. Planners recognize that saving at this age is more easily said than done, but they recommend if there are any surpluses, they be put aside in a savings or investment plan.

Many Australians, when they first do begin to accumulate money, opt for the tried-and-tested route of an investment property. That has pros and cons: on the plus side, if everything goes in your favour, it’s a great way of growing your assets over the long fun, as a tenant pays down your mortgage, your equity increases, and hopefully the property itself increases in value. On the downside, there’s a big up-front cost, and issues around what happens if it is not tenanted: can you still pay the mortgage?

It’s a big ask to try to get very young people to put money into super, though planners do suggest salary sacrifice where appropriate to build for the future; the earlier you put money in, the greater the power of compounding returns over time. Others recognize that there are likely to be short-term requirements to liquidate investments when young, for a first house or to upgrade to a bigger one, and therefore suggest managed funds or exchange-traded funds.

Since this age bracket is largely about accumulation of assets from a low base, some recommend borrowing to invest, but remember this is a double edged sword: leverage increases rewards when things go well, and losses when they go badly. Borrowing to invest has a tax benefit, but that should never be the main reason you do it.

Another important component of this bit of the roadmap is insurance: particularly income protection. If your greatest asset is your ability to earn income, then that’s worth protecting.

THE KIDS

Let’s be honest: you didn’t have kids to improve your wealth. For at least a couple of decades they are a strictly one-way street when it comes to cashflow.

When kids come along they present both a need for long-term saving and a barrier against doing exactly that, particularly if you’re paying Sydney or Melbourne childcare rates. If you’re in state schools, they become considerably cheaper once they’ve started primary school.

Saving for the kids depends on what you proposed to do for them. If you want to put them through private education, and have a rough idea where you will do so, then you can look ahead to the likely costs and build a savings plan to be ready when the time comes. Likewise if you want to pay Uni fees rather than the kids paying them back from HECS, then that can be planned and saved for, as can the living expenses for that time if they won’t be living at home.

Some families, such as in one of our case studies, help their kids by buying investment properties and allowing their children to live in them with subsidized or no rent while they find their feet. This isn’t an option for everyone; it means another mortgage without income coming in to service it. But it does mean an investment in an asset which will hopefully enjoy capital growth.

SELLING A BUSINESS

Another of our case studies revolves around this: selling out after 20 years of hard work and pondering what to do with the income, and indeed the next 20 years.

Andrew Buchan of HLB Mann Judd in Brisbane, the financial advisor for Martin Meek in our case study, notes that people who have built a business can have different needs and priorities. “Martin’s wealth is his ability in business,” Buchan says. “It doesn’t matter if I could get him a 5% or 10% return on an investment. His real ability is his business nouse.” Buchan believes this applies equally to, say, a sports star with a brand name: wealth management for people like this is not just about the split between equity, bonds and property, but encouraging an individual’s attributes and their assets as a person.

People like this are natural candidates for self-managed super funds, so that they can match their expertise and enthusiasms with self-directed investments.  Buchan says for an entrepreneur figure there are three phases. “Phase one was the wealth protection prior to building the business. Phase two is wealth generation during the business. Phase three is the business sale and the investment of the proceeds for income and growth.” Involving an accountant on the tax side is crucial.

APPROACHING RETIREMENT

One of the biggest moments in all of our lives is retirement, and this of course is where your financial roadmap has been aiming. But fewer and fewer of us suddenly shift from full-time to retirement one day; we’re more likely to reduce hours, do part-time work for a few years, and potentially continue to do a bit of work while drawing on super for many more years.

Either way, when the day approaches, transition to retirement rules become important. Once you reach preservation age, between 55 and 60 depending on when you were born, you can reduce your working hours and top up whatever income you get from your part-time job with an income stream from your super. Planners generally urge people in this age bracket to get as much money into the most tax-effective vehicle possible (super), then into an account-based pension. Minimising tax is naturally a crucial consideration now: having spent your whole life building wealth there’s no sense in giving any more than necessary to the taxman. Again, salary sacrifice can make a lot of sense at this age.

If they haven’t done it already, people in this group should make sure their estate planning, wills and insurance arrangements are in order. Who is the beneficiary on your super, for example?

It’s also common for people approaching retirement to reduce their risk profile: a bit less in equities, a bit more in bonds, for example. Not everyone agrees with this capital preservation approach; some feel that this is the time to increase wealth to the greatest degree before retirement.

CASE STUDY: Rob and Jan Burdon

Rob and Jan Burdon are retired now, living comfortably in Port Macquarie. They’re smart people who have always known the importance of putting money to one side. “We were always conscious that you need to try and save something somewhere,” says Jan. But like all of us, their financial roadmap has had to change over the years according to the events that take place in our lives along the way.

Rob worked for Qantas in Sydney for 26 years; during that time, financial planning was fairly straightforward. Qantas at that time had a good superannuation scheme, and allowed its employees to make the best of it. “Sometimes if he got a small raise, instead of taking it into the pay packet, he would put it into super,” Jan says. “In those days we didn’t have all the fringe benefits you have now: if you stopped work to have children you didn’t get assistance, or Centrelink; you had to save for it,” she says. Jan stepped out of the workforce for some time, not returning until the youngest of her three children was 14, but even so they put money aside where they could.

So far so good. But then change started to come to Qantas and the airline offered voluntary packages for redundancy; Rob opted to take one, and to retire. It’s one of those pivotal moments that changes the way your life will go, and the way your finances will evolve, and this was when Jan and Rob first took financial advice. “My husband’s question was, if I take this early retirement, do I have to go back to work or live on what I’ve got?” Jan recalls. “They [the planners] said yes, you can live on what you have. So he stayed at home for maybe a year – I was working and earning good money – but then Ansett came looking for him and he worked for them, and then the NRMA. It was a matter of something to do.”

Along the way in Sydney they had saved enough outside of super to buy two investment properties, sometimes allowing their three daughters to live in them and subsidising the rent as they got their own lives underway. This, too, is a life stage that changes the family economics for many of us: kids finishing education, leaving home, but perhaps needing help to get started in an entry-level job in an expensive city.

The next big change came with semi-retirement, when the two moved to Port Macquarie. They sold the Sydney properties in 2000 – “I wasn’t comfortable with having property there and not being able to keep an eye on it,” Jan says – and bought an investment property on the coast. They did some casual work for a time, but options were limited and they decided to retire completely. They sold the investment property, turned the money over to their new financial advisor, Port Macquarie-based Julie Berry, bought a caravan, and hit the road. “We travel four or five months a year with the van,” Jan says.

They have now both reached the age where they can access their superannuation (Jan is 69, Rob 67). They place a lot of trust in their financial advisor. “She changes things for us as she thinks is necessary, and notifies us,” Jan says.

Life is pretty good for Jan and Rob: two of their three daughters and their families are now also in Port Macquarie, and the third on Queensland’s Sunshine Coast. “I think we’ll be all right,” Jan says. “I don’t think we would go for a holiday on the Queen Mary, but being able to have time away in the caravan, and knowing we’ve been able to help our children along the way, we’re reasonably comfortable.”

So what’s the secret of navigating the different things that life throws at you? “Start saving when you’re young,” Jan says. “It doesn’t matter if it’s only a couple of dollars a week set aside: it’s growing and compounding if you put it somewhere.” And encouragingly, she thinks she’s passed some of this onto the next generation too. “Our eldest daughter has wiped the floor with us with what she’s saved.”

CASE STUDY: MARTIN MEEK

Martin Meek is an example of an entrepreneur with a clear goal. Like many successful businessmen, he got his big break from an unexpected route.

A teacher at first, Meek’s wife’s family was in retail. One day over dinner he disagreed with his father-in-law about plans for a new store. “Do you think you could do better?” the older man asked. “Yes I could,” said Meek. He redesigned the store, then gave up teaching to build it, and finally ended up running it.

Two years on, Meek reached the next life-changing moment. Looking at having children, he looked at his financial prospects and decided he wanted to buy in to the business. “I didn’t have any money,” he says. “But I had a house. So I sold it and bought in. That was 20 years ago.”

It was a bold move not all of us would make, but that’s entrepreneurs for you; and it worked. Along the way Meek and his father-in-law shifted from a previous model – build a health food store and sell it – to a franchising model in which buyers could use the name. This became Flannerys Natural Grocers, which thrived for two decades and was sold in 2008.

This, of course, was the next pivotal life moment: the windfall from a working lifetime’s effort. But Meek was still young; even today he has only just turned 46. So he had to decide on the next step. He had signed a non-compete clause, so retained two stores and ran those as a franchisee until the clause ran out two years later, and then sold the stores. Now, he’s setting up a new organic commodities import-export business. “I’m moving up the food chain, supplying to the people I used to be competing with,” he says. Noting his risk profile has diminished as he has got older, the new business is structured to have low costs. “The upside is good, but if things don’t work out I can fire sale the stock and walk away having dropped 10 or 20 grand and a bit of time,” he says. “As I get older, I look more at the possibility of: what if it goes wrong. When you’re young you think you’re indestructible. You don’t have that fear. Now I’m older, I’ve got more to lose; I don’t want to have to start again at 46.”

Meek is a canny operator and has appointed advisors who understand that his main asset in building wealth is his own skill as an entrepreneur. (Andrew Buchan, his financial planner, is quoted in the main text). They haven’t tried to push him towards a traditional portfolio model, but have accepted his expertise and enthusiasms and worked around them. Unsurprisingly for a man who has built and run stores all his life, Meek has a familiarity with property, and that represents the main pool of his assets today: he has two warehouses on the Gold Coast (“No-nonsense, easy, give a good return for a low amount of outlay”) and a residential property in Brisbane that is a double block development zoned for townhouses.

It should be no surprise to learn that Meek has a self-managed super fund; the vehicle was invented for people like him. “I enjoy research,” he says. “I’m a little bit of a control freak.” He’s built it to produce income. He holds quite a large sum in shares, having been quite lucky with the circumstances of his pay-out in 2008; it took him 12 months to get the money from his business sale, which was irritating at the time, but in fact saved him from investing into the share market immediately before the financial crisis.

Having reached one key life stage moment with the sale of the business and readied himself for the next, Meek and his advisor sat down and came up with a number. They worked out how much money he wanted to have, per day, upon retirement, and then worked back to establish what that total figure needed to be. It was a big number. “It was a scary thought. But a good scary thought to have,” he says. “It made me more proactive on: this is what I need. When looking at things and making decisions, I ask: does this get me closer or further away from that number? It really simplifies things. I would encourage people to have a number.”

ROADTEST

Pimco Australian Bond Fund

Who runs the fund? Pimco, one of the biggest and most well-regarded fixed income managers in the world. In Australia the fund is offered through Equity Trustees.

The basics: Invests in government, semi-government, corporate, mortgage and other fixed interest securities in Australian and New Zealand dollars.

The process: In practice, though any Aussie bonds are fair game, the bulk of it is pretty conservative: 56% in AAA assets, 23% in AA, 14% in A and only 7% below that level.  That gives just enough zest to put the estimated yield above high-yielding cash accounts; as of June 30 it was 6.7%. On a world scale, that’s pretty impressive, given that any fund that holds US Treasuries as its conservative anchor is no longer doing it with AAA-rated assets – one of the many reasons Australia is increasingly being seen as a safe haven for global money.

The bottom line: Doing very well. According to Morningstar it is the best Australian bond fund available over the three years to August 31, logging 10.99% a year. One year numbers, at 6.99%, are more the middle of the pack but Pimco is consistently impressive no matter how far you look back: it’s also the best in the industry over seven years, at 7.19%.

Fees: Bought using the Equity Trustees version, management costs are 0.72% per year.

Verdict: Consistently impressive and steady. Looks a good choice for the longer term.

NEW FUND

Bennelong Avoca Emerging Leaders Fund

What is it?

A small-cap and mid-cap equity fund.

Who runs it?

Avoca Investment Management does the stock picking. It’s a new group formed by John Campbell and Jeremy Bendeich, both of whom were portfolio managers on UBS’s small companies fund. They have set up in partnership with Bennelong Funds Management, a boutique manager formed in 2001, originally to run the Bennelong group’s commercial property and equity interests, and now an Aussie equity/absolute return fund manager in its own right.

What’s the strategy?

Holds 30 to 50 stocks usually, and a maximum of 70. Uses deep fundamental investment research – that is, studying individual companies and their valuations closely.  Also has sector and stock concentration rules which are designed to minimise volatility of returns, but also presumably means there’s a limit to how strongly managers can express a view.

Is it a good time to be in small caps?

In volatile markets like these, the prevailing wisdom is usually to stick with the big, robust, defensive names; small caps usually get hit hardest during choppy times. That said, they also tend to fall far enough to create bigger opportunities for investors – if they’re clued up enough to spot them.

What are the costs?

1.25% per year management fee plus a hefty 17.5% performance fee based on returns above that 1.25% over the benchmark (the S&P/ASX Small Ordinaries Accumulation Index).

GIZMO

Buffalo MiniStation

This month we acknowledge the research of Jonathan Margolis, author of the influential Technopolis guide to all things gizmo-related. He recently set out to find the best external hard drive, for back up while on the road, and this is what he came up with.

Buffalo – distributed in Australia through Uniden and through retailers including Bing Lee, Myer and RetraVision – makes light, sleek and very brainy portable back-up drives most of which come in 500GB, 1TB or even 1.5TB sizes. The HD-PCU2, for example, which is much nicer looking than its ugly name would suggest, weighs just 210 grams and measures 11.4 x 7.7 x 1.7 cm. A new extra-durable Ministation Plus was launched in the US in July for US$111.99; ask your retailer if they can stock it.

FUND WATCH

UBS Australian Share Fund

This fund is following five years of outperformance with a bit of a shocker in 2011. Long-term numbers are what matter – and an almost 4% per year outperformance over the last three years is impressive – but being almost 4% behind the benchmark over the last 12 months is less good news.

Why should that be? The fund’s top 10 positions look very similar to any other regular Aussie equities fund: big positions in miners and financials. 36% of the fund in financial services is a big chunk and that is probably dragging the fund back in current market turmoil; a lowish allocation to consumer defensives is also likely taking away from the downside insulation.

Australian investors are spoiled for choice when it comes to online brokers. Data provider Canstar Cannex tracks no less than 35 different accounts from 15 different providers; Infochoice covers 29 from 17. It can be bewildering for the novice.

The key to thinning the field is to know exactly what you want from your broker. There is a wide variety of service available from no-frills low-cost, to platforms that provide a wealth of research and charting tools. Some have different accounts available according to how much you’re likely to trade.

Let’s start by working out how often you’re likely to trade. Log on to Bell Direct’s web site and look at its ‘trading style’ menu for an example of how online brokers offer different platforms, with different costs, according to how much you’re likely to use them.

In Bell Direct’s case, there are three available versions: silver, gold, and WebIRESS. Silver is the low-cost option – in fact, the membership itself is free (you still pay brokerage of course). Your ASX quotes will be 20 minutes delayed – meaning you’re not getting up to the minute information – which, for most investors, won’t really matter: you’re probably not a day trader seeking to get in and out quickly, and hopefully you’re investing for the long term. You still get access to research reports.

If you opt for gold, you’ll pay $10 per month as a membership fee, but there are several benefits: your ASX quotes will be live, along with various other market information; you can use charting tools with that live data; and as with silver, you get access to market reports. And if you’re really a frequent trader – a semi-professional – you can opt for WebIRESS, which Bell describes as Australia’s most powerful web-trading tool. For $79 a month, you will get a host of live and dynamic information available, putting you on a par with the professionals for immediacy of information with very advanced technical analysis tools. It’s all about the type of trader you are.

Many other providers also offer varied accounts according to your trading behaviour:  examples are CommSec, E*Trade, NAB OnLine Trading and Amscot Discount Stockbroking.

[Subhead]How low can you go?

Now you’ve narrowed the field to a single product from each provider, what else separates one from another? An obvious place to start is brokerage cost.

Low costs aren’t everything, but they’re certainly welcome. Trades vary from $9.90 apiece to as much as $33, but be sure to look closely at the small print about how exactly trades vary. Take E*Trade, for example: on their normal service, the headline rate for your first trade of the month is $19.95. But that’s only true in orders up to $5,000. Up to $10,000 it’s $24.95, and up to $28,000 it’s $29.95; beyond that it turns to a percentage (this is common at trading platforms) of 0.11%. For your second and subsequent trades, it’s a flat $19.95 and then 0.11% for orders over $18,000.

Sticking with E*Trade, you’ll also notice that on the more active services, heavy trading will be reflected in other perks. E*Trade’s Active Traders system charges you a $79.90 monthly fee to use its sophisticated platforms. But the more you trade, the more your subscription cost comes down, until it is made free with your 10^th trade of the month.

The current leader in the low-cost stakes is CMC Markets, which dropped its headline brokerage rate to $9.90 per trade in August 2010, easily the lowest in the market; some other brokers (E*Trade among them) subsequently dropped their own headline rates. It clearly worked: CMC’s turnover went up 40% in a year, as the rate attracted the more active traders in the market. Regular traders, says Louis Cooper, head of CMC Markets, “are very price sensitive, and the more they trade, brokerage becomes a far bigger aspect of their trading, in terms of what it takes away from their profits.”

Cooper and CMC are at pains to point out that they’re not just about cost; CMC still gives traders a lot of other options, among them free unlimited conditional orders, charting, and fast order processing, as well as education packages. But it’s a key marketing point. Generally, the more frequently you trade, the more brokerage is obviously going to mount up; but then again, if you trade more frequently, you may need comprehensive research and access to real-time data that tends to come at the more expensive places. It’s a trade-off everyone will need to make their own decision on.

In addition to brokerage costs, the more sophisticated platforms that use the WebIRESS platform, like the Bell Direct product we discussed earlier, carry a monthly fee (again, this may be diluted according to how often you trade). Costs for these platforms are typically around $80 per month; for example CommSec’s IRESS platform costs $82.50, St George’s directshares Power $79.90, Amscot’s traderRate product $77, and NAB OnLine Trading’s Professional version costs $77. More costly services are at Trader Dealer ($90 for its Market Analyser and Market Analyser Pro Trader services), $93.50 at First Prudential Markets for its webIRESS service, and $110 for Morrison Securities’ own webIRESS product.

[Subhead]What do you want to trade?

Beyond cost, the next thing to look at might be the sort of securities that are available to trade. Naturally, every broker in the market allows you to trade ASX-listed shares. Beyond that, most allow you to trade ASX exchange-traded options and warrants. Very few allow you to trade the futures and options from the Sydney Futures Exchange (Morrison is an example). Some allow you to invest in other derivatives, managed funds, or directly in stock market floats. The data tables available online for free at Infochoice are a useful place to start researching this.

Another big differentiator is the ability to trade in foreign markets through your broker. Westpac Online Investing, E*Trade, CommSec, Interactive Brokers and St George’s directshares, for example, allows investment in stocks in Asia, Europe and the UK. Brokerage will usually cost a lot more to do this, so be sure to check that too.

Another thing to consider is the way you make your order, and the processes available around it. Some people just want to put an order out there and pay whatever a stock costs on the market at the time; others want to be more specific. ‘At limit’ orders set a price at which you are prepared to buy a stock, and don’t trade until it’s hit. Stop losses are another useful tool: when you buy a stock, you set a limit, and if the stock falls below that limit the broker will automatically close the trade for you, so you know exactly how much you stand to lose. Most brokers allow both of these approaches now, but do check associated costs.

Next: research. How do you trade? Do you want broker research before you make a decision? Do you want to build your own charts? Or do you come to your online broker after already having educated yourself through the newspapers and public sources? This will also impact which broker you opt for. Again, brokers typically offer different research options according to what package you buy. Westpac, for example, has a standard research package, and an advanced one which is free of charge to anyone who trades twice or more per month. It covers news feeds, from Reuters and Dow Jones to specialists like Morningstar and Lexus Nexus. Westpac’s own research, and that of affiliate fund manager Advance, are available, and there are regular videos giving opinion on financial markets.

If you are a charting fan, you probably have your own personal views about the tools and systems you like; most brokers, before you subscribe, will have a demo that shows some of the available charting methods, but you may want to ask directly whether your particular enthusiasms are catered for. Again, Infochoice has a page of its online broker category dedicated to charting; typical packages allow candlestick charting off historical data, and in more expensive platforms, charting with live data.

Finally, check that your broker has a training module available to show you how to use the platform. It’s not much use having bells and whistles available if nobody’s showing you how they work.

In future, probably more and more people will make brokerage decisions based on whether they can access the platform through their phones or handhelds. James Staltari at Westpac says that the mobile phone application it offers with its brokerage package is experiencing “month on month double digit growth”. It allows you to buy and sell, access research, and mange your portfolio. Some day all brokers will do this – all the greater reason not to leave your phone in a taxi.

BREAKOUT: Jargon Buster

Stop loss: When you place a trade, you also place a limit. If the share drops below that level, your broker sells out automatically. That way, you know what the maximum you can lose is.

At market/market order: This means you put an order in to buy a share at the best available price on the market at that time. This is different to a limit order, which says only to buy at a certain price or better.

Warrants: Most warrants give you the right to buy or sell something (usually a share, sometimes an ETF) at a particular price. ASX warrants trade on the stock market. If you buy a BHP warrant, for example, you get exposure to the stock and dividends, but don’t have to pay out as much as you would buying the shares.

ETF: Exchange-traded fund. Behaves like any other share, but it represents something much bigger – like a whole market index, or a commodity. A way of diversifying cheaply and easily.

Dynamic online trading: Some brokers have a platform service which is faster than the norm, with real-time streamed data, and other services like enhanced charting tools. For active traders.

BREAKOUT: Next steps

• Decide what you need from an online broker. Is it chiefly a low cost? Are you going to use charting tools? How much research do you need access to?
• Based on that, see which of the many available platforms has the best match to your needs.
• Setting up an account is then usually straightforward: fill in a form, provide some ID, and you’re ready to go.
• Do NOTHING in terms of real trading until you’ve done all the available training that comes with your membership.
• Consider linking your brokerage account to a cash account – for some people, this is what determines their choice of broker in the first place.