8 June 2021

Exchange Traded Funds

Beware the proliferation of ETFs. Many of the newer ones have significantly higher management expense ratios (MERs) than the largest I Shares S&P 500 ETF (IVV) and the Vanguard US total markets (VTS), which are enormous have very low MERs and as they contain huge global companies are a cheap way of investing in international shares. However, this raises the question as to how much international exposure your SMSF already has.

Dangerously geared “ETFs”

The Australian Financial Review of 3 June 2021 reported that the Beta Shares GGUS and GEAR funds each “combine funds received from investors with borrowed funds and invest the proceeds in a broadly diversified share portfolio” made up of US and Australian large cap stocks respectively”.  Their gearing ratio expressed as a percentage of the total assets of the fund sits between 50 percent and 65 percent for both funds.

These are dangerously structured investment products based on what amounts to a margin loan financing strategy. In a rising market they have produced spectacular gains but in a market correction their equity can be wiped out or quickly diminished as their bankers sell down shares at falling prices to keep them within agreed equity to debt ratios. Magnified gains in a rising market can quickly turn into huge capital destruction in a falling market. It is the investor that bears the capital risk, not the ETF manager nor the bank margin lenders. Some ETFs are not what they may seem at first consideration.

Companies with International Businesses.

Be aware that a large number of well-performed Australian companies have substantial international operations. These include the following:

Amcor, Ansell, ARB, Brambles, BHP, Boral, Car Sales, Cochlear, CSL, Lynas, Magellan Financial Group, Macquarie Group, Reece, Ramsay Health Care, Rio Tinto, South 32, Seek, Transurban, Worley, Woodside Petroleum and Xero. 

This list is not intended to be complete. The chances are that, if you are placing direct investments into your SMSF, you likely have a number of these significant stocks. We hold a number of them in our family SMSF, as well as modest proportions of IVV and VTS.

Before you are persuaded to buy a number of international managed funds each with their own management expense ratio, consider carefully how much of your fund is already invested in international stocks. Go to the ASX200 or ASX300 then click on individual stocks and view annual and half yearly reports plus company announcements. Some of the above are mostly international in their operations, including Amcor, Brambles, Cochlear, CSL, Macquarie Group, Ramsay Health Care and Worley. All of the above have substantial international businesses. Remember it is essential to do a significant amount of your own research.

Be Aware

Be wary of advisers pushing your SMSF toward managed funds. The chances are that those advisers have too limited experience of analysing individual stocks or alternatively they have significant constraints placed upon them by the holder of the licence that they are working under. Sometimes these constraints are placed on the head licence holder by their professional indemnity insurer. 

I was fortunate to spend the greatest proportion of my financial career as a director/partner in a group which held their own financial services licences, and I had the freedom to advise as I saw fit—including spending a lot of time benchmarking dental and veterinary practices, analysing their financials in detail, and spending a vast and increasing amount of time analysing stock market listed companies. From 1995 onwards, freed from some significant constraints, I switched away from managed funds and into direct shares. The change was overwhelmingly beneficial, despite some mistakes along the way, and proved popular with clients. Nobody is immune from mistakes and even Warren Buffett regularly confesses to a few. 

While regulation fit, many reports from external advisers I have seen over the years lacked analysis of client’s overall financial situation since they had a strong tendency to be innocent of client business and professional practices. They often displayed insufficient awareness of direct shares and often invested their clients in a wide array of managed funds with high average MERs. It is doubtful if many advisers had other than shallow knowledge as to the content of the managed funds that they recommended to their clients.

Some Recent Company Announcements and Analyst Reports

ARB

Check their announcement of 3 May 2021 concerning the increased Ford relationship which expands on that announced on 31 March 2021. Also note its announcement of acquisition of UK Truckman Group of 4 March 2021 and letter to shareholders of 16 February 2021. All are available via ARB listing on ASX 200 site.

BHP

Ord Minnett research of 1 June 2021 predicts upside in its share price.

Lynas

Refer to investor presentation of 5 May 2021.

Mineral Resources

See presentation to Bank of America Metals, Mining and Steel conference 18 May 2021. 

Pact Group Holdings

Presentation to Macquarie conference 1 June 2021 and half year results announcement.

Most of the above are available by the respective companies ASX web pages.

Two Good Businesses ARB versus Bapcor

 The businesses of ARB and Bapcor tend to overlap to a modest degree.

Respective 1 year share performance to 4 June 2021

ARB $18.17 to $45.13 

Bapcor $6.18 to $8.10

10-year performances are a better comparison because they diminish short term random effects.

ARB $7.57 to $45.13

Bapcor $1.954 to $8.10

ARB has compound annual growth in share price of 19.55 percent compared with Bapcor 15.28 percent. The difference in growth over an extended period makes a huge compounding difference. 

We own ARB but don’t own Bapcor. While Bapcor has the attributes of a sound business, we would not reduce our holding of ARB to buy Bapcor.

Readers must do their own research.

Chinese Threat?

We need to take a deep breath and step back. Iron ore prices have rebounded strongly, and the Chinese steel mills lack alternative supply of iron ore in the quantities China needs. Modern construction is overwhelmingly based on steel reinforced concrete. The prices for both thermal coal and quality coking coal have rebounded.  China is buying coal elsewhere, but that creates alternate markets for Australian producers. Recently the Chinese leadership have moderated their tones.

Let us not forget that with US forces training in Northern Australia and the US having long term bases in Australia, any potential aggressor has to weigh up the fact that a direct attack on Australia will also be an attack on the USA. Such a scenario remains extremely unlikely. China and the West are in a global contest but that is likely to continue via trade and diplomacy. 

China has an ambition to reincorporate Taiwan but is unlikely to invade it for at least the next decade, if ever; rather, it is likely to continue to seek to isolate it diplomatically. An invasion might prove enormously costly. The US will continue to sell Taiwan with what it deems to be sufficient weapons to inflict a too high cost on an attacker but insufficient for it to become overly powerful. 

Both Napoleon and Hitler had huge armies which could have overwhelmed the much smaller British army were they able to cross the English Channel, but neither were able to gain control of that relatively small stretch of water to enable them to lodge an army in Britain. The Taiwan Strait poses huge costs on China were it to attempt to lodge an army in Taiwan. China undoubtedly has huge forces but is likely to be reluctant to pay the price of invasion.

China’s biggest economic threat is from an aging population which, due to the boomerang effect of its erstwhile one child policy, is irreversible for perhaps a couple of generations if at all.

Chinese immigrants have overwhelmingly become hard working model Australian citizens. Many have succeeded across our professions.

Failed Bank Wealth Management Strategy

The sale by the NAB to IOOF of its MLC wealth arm for $1.4 Billion, less than one third of the price of $4.5 Billion paid by NAB to Lendlease, is dramatic proof that wealth management is incompatible with the traditional, hugely profitable, banking business. Each of the four major banks have rushed to exit from wealth management. Wealth management businesses face a long-term squeeze between Industry superannuation funds and SMSFs. IOOF/MLC will find the future challenging

Commonwealth Bank Purchases Whitecoat 

An alert dentist sent me the statement that this had occurred. Whitecoat’s activities have been regarded with significant suspicion by dentists in the past. The CBA’s purchase is stated to be part of a strategy of providing end-to-end digital payments, claiming and directory solutions. It is intending to remove ratings and review functionality which may be a win for dentists and other healthcare providers. It is best to remain vigilant and see what actually occurs. From health professional’s point of view better that Whitecoat be owned by a lumbering giant, CBA, rather than by a health fund. Comments are invited from dentists.

General Advice

This newsletter contains general advice. Readers must do their own research and source additional advice and brokers reports as necessary. Those with advisers should do additional research of their own and become familiar with investing fundamentals before simply following advice.

I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.

Best wishes to all 

Graham Middleton