2 October 2024
The continuing funds management shakeout.
In the 1980s large fund management businesses were the lords of the investment world but their ascendency proved to be temporary. From 30 June 1983 when taxation deductions for superannuation contributions became far more generous, funds management businesses like Bankers Trust and Rothschild & Co took on the traditional life insurance businesses including the AMP and National Mutual which had armies of life insurance agents selling their policies on exorbitant commission. This quickly sparked competition and a race to the bottom. The financial world shakeout has continued to this day. National Mutual collapsed in value and was taken over. AMP has been in near continuous decline since its demutualization and ASX listing in 1997.
Two main superannuation pillars.
There are now two huge superannuation pillars; the industry superannuation funds are one. The other is the self-managed superannuation funds sector. Caught in between are traditional funds managers who continue to shed market share.
Our four major banks have quit the superannuation and investment business.
Funds management has been massively disrupted by the introduction of Exchange Traded Funds (ETFs) which enable ordinary investors and their SMSFs to cheaply buy into global markets via products such as the Standard and Poors 500 ETF (code IVV) covering the 500 largest listed companies on the New York Stock Exchange and NASDAQ, being companies with global reach. The US total markets fund (code VTS) is a close clone.
The decline of traditional superannuation fund managers.
Traditional fund managers such as Perpetual have steadily lost investment mandates and assets under management as have others. They and their ilk are experiencing a steady downward spiral.
Listed Investment companies.
There are a number of listed investment companies (LICs) claiming to be champion stock pickers, some spicing up their message by being hedge funds i.e. betting on the market direction by short selling or purchasing put options. The Global Financial Crisis of 2007 saw a huge number of hedge funds wiped out as liquidity disappeared from the market. This demonstrated the fatal weakness of hedge funds, despite their boasting that they knew how to make money in a falling market! Observations over many years show that very few fund managers beat market returns on a long-term basis.
Those that do for a short time have substantial success fees in their good years but don’t give back in their bad years. Because of their overall costs, most won’t beat the ASX 200 index over a sustained period. Changes to investment regulation following the banking enquiry mean that new LIC start-ups are unlikely, nor are large capital raisings by existing LICs other than dividend reinvestment. They are far less attractive than the better exchange traded funds.
The best value for money among investment companies lies in the long-established Argo and AFIC because of their comparatively low management expense ratios (MERs) i.e. low internal fees compared to many more recently established LICs. They are very long-term holders of stocks but being company structured rather than trust structured they too will be at a long-term disadvantage compared to ETFs.
Are Melbourne housing prices the lowest of Australian capital cities? The statistics may be misleading.
Recent publicity suggesting that Melbourne house values are falling is based on median sale prices. The impact of Victorian Government plundering of residential landlords—including sharp increases to land tax on rental dwellings and legislation heavily favoring tenant’s rights over landlords—has initiated a wave of selling of rental housing in Melbourne. Since rental property is worth less on average than is owner occupied housing, the impact of this wave of selling off of rental property is to lower the median price of Melbourne house sales overall. We don’t actually know whether Melbourne housing overall is the cheapest of Australian capital cities. We will gain a better perspective in a couple of years when the sell off of rental properties has dwindled and there is a normal pattern of housing sales.
Wild horses would not persuade me to buy an investment house or apartment in Victoria.
Why Stockland cannot make apartments pay.
Huge property fund and developer Stockland has recently indicated that it cannot develop high rise residential rentals because costs make the process uneconomic. It continues to develop stand alone housing and has long been involved in land banking with a view to development.
High rise developers traditionally relied on off-the-plan sales to kick start a project. Bankers will not finance the actual build until sufficient binding ‘off-the-plan’ sales with deposits, usually of 10 percent have occurred. Typically, they demand 70 percent pre-sales before advancing finance to build. Since traditionally most high-rise developments have been 50 percent ‘buy to rent’ investments, recent anti land-lord legislation and land tax imposts have now made selling to this segment of the market extremely difficult. Hence it is now extremely difficult to finance the building of high-rise apartment complexes. The rental housing shortage will grow worse under the current government policy settings.
The Greens attack on large company profits is actually an attack on the value of our superannuation funds.
Recent announcement by Greens leader Adam Bandt indicating the Greens’ policy of vastly increasing taxes on our major companies would, if implemented, trash the share price of these companies. Since their shares are mainly owned by industry and self-managed superannuation funds this would substantially reduce the superannuation value of millions of Australians. Economic stunts like this demonstrate the irresponsibility and lack of credibility of the Greens.
Adgemis loses control of another five Sydney pubs.
Debt of the wider Adgemis collection of 24 pubs had been reconstructed with US lender Muzinich becoming the first secured lender over one group of five Sydney pubs. Adgemis had been relying on very high-cost private debt and his overly ambitious plan to become a pub baron has been rent asunder. There have been a series of reports concerning the financial difficulties of the group. In these circumstances lenders seek to secure the top-ranking charge over a defined group of assets not connected to the remainder of the group. Muzinich, having secured top ranking debt over a group of five pubs, is in a position to play hard-ball and is reported as having blocked an approach by Archibald Capital to buy the pubs and repay Muzinich’s debt. It is near certain that Muzinich’s loans have punitive penalty interest rates in the event of default. If it judged the asset values to be substantially greater than its loan it would be to its longer-term advantage to let the interest penalties pile up until it judged that it has reached an optimum time to push the assets and their operating company into liquidation. Under these circumstances, lower ranking debt of other creditors is wiped out. It is likely that Muzinich will significantly benefit from the demise of this part of Adgemis’s pub collection.
Sanjeev Gupta’s Whyalla steelworks business difficulties.
English/Indian businessman Sanjeev Gupta’ GPG alliance, which has been involved in a string of troubled business deals in Britain and Europe, is reported as being behind in bill payments to suppliers and has cut staff in its Whyalla Steel enterprise. GPG Alliance has been struggling for years to repay massive debts to collapsed Australian financier Greensill.
Greensill lent against the invoices of struggling businesses including GPG Alliance. It was a high-risk lender to risky businesses and collapsed when it could no longer obtain insurance cover. Its debts now belong to its trustee in liquidation who has the task of collecting them to make payments to its creditors.
There is doubt about the survival of the Whyalla Steelworks after GPG Alliance had announced a two-year delay for the proposed $500 million upgrade.
Off market takeover offer for Pacific Smiles.
Pacific Smiles has terminated an agreement to facilitate an off-market bid via a scheme of arrangement with NDC Ltd. Following this, another bidder has entered the race. Genesis Capital which has bid $1.90 in a mixture of cash and share scrip. This is below Pacific Smiles recent share price high but it remains to be seen what Genisis Capital’s final offer price will be.
I regard Pacific Smiles share price as being well above its true value. It is impossible for dental corporates to be as efficient as well run privately owned and operated dental practices because of the additional layers of management and administration of the corporate. If I had been a shareholder in Pacific Smiles, which I am not, I would treat corporate takeover proposals as creating an opportunity to sell my shares.
As for Genesis Capital. One large, relatively inefficient, dental corporate making a takeover bid for another large, relatively inefficient, dental corporate reminds me of the 1980’s corporate games of Bond, Skase, Elliott, Spalvins and others which ended disastrously for them and to the detriment of vast numbers of innocent shareholders.
No talented dental graduate will be near as financially successful over their career working for a corporate as they can be by owning their own practice and following the path to the personal quad of owning:
1. Their dental practice
2. Their long-term family home
3. Their family superannuation fund, and
4. Their practice premises.
No corporate contractor/employer can promise talented dentists as much financial success as they can achieve in private practice.
The Ukraine War.
What Russian Leader Vladimir Putin assumed would be an easy and virtually bloodless victory over Ukraine has turned out to be a difficult prolonged struggle into its third year which has highlighted many Russian weaknesses. It is unlikely that Ukraine can actually win given Russia’s much larger population and resources but there have been many embarrassments for Putin with ammunition stockpiles being successfully targeted and Russia’s Black Sea fleet suffering big losses. Ultimately there will be huge losses on both sides with neither side emerging as a winner after counting the cost of their losses both human and material.
Israel, Hamas and Hezbollah.
The Hamas orchestrated atrocities of 7 October 2023 were clearly a declaration of war against Israel just as Japan’s attack on Pearl Harbor amounted to a declaration of war against the United States. Hamas is armed by Iran. It is unimaginable that an Australian Government could ignore an attack of that magnitude on Australian citizens.
The Hezbollah action of attacking Israel with 8,000 rockets in support of Hamas is of similar character. Both Hamas and Hezbollah are armed by Iran even though Hamas’s followers are Sunni Muslims and Hezbollah’s followers are Shiite Muslims. Israel’s government had no choice but to attack both Hamas the government of Gaza and Hezbollah which, although not the government of Lebanon, has created a force so powerful that the actual government of Lebanon is powerless to control it.
Sadly, there have been continuing incidents of antisemitism in Australia and our government leadership has been far too muted in condemning it. Foreign Minister Penny Wong visited Israel and failed to visit the October 7 site and her urging of Israel to cease its defensive responses appears to be pandering to Muslim minorities in several Labor held Western Sydney seats rather than forthrightly condemning Hamas and Hezbollah’s attacks on Israel.
Negative gearing nonsense.
Periodically fringe politicians seeking headlines try to whip up a storm against negative gearing of investment housing. Negative gearing was briefly discontinued by the Hawke Government in 1985; this was found to do more harm than good and the decision was cancelled in 1987. Overlooked is the fact that governments, both state and commonwealth, have disinvested in rental housing with all the management and tenancy issues involved such that the proportion of public housing has declined. The Commonwealth for example sold off its portfolio of Defense housing to external investors who then rented back the houses for occupation by members of the ADF.
Government policies, particularly in Victoria, have caused investors to sell off rental properties by imposing steep increases in land tax. If negative gearing were to be abolished there will inevitably be a further decline in investing in residential rental property. Government actions have deterred investors from buy to rent investments making selling high rise units off the plan difficult in the extreme. Simultaneously huge government ‘big build’ projects have taken building trades away from the housing sector. It is a series of actions by governments which have caused the increase in the housing shortage.
Capital gains tax discount. Understanding the facts not media distortions.
When the Hawke Government introduced capital gains tax in 1985 it indexed the capital base so that the tax was applied to real gains, not inflation induced gains, which would have amounted to partial property confiscation. In 2000 the Howard Government gave into pressure and announced a review of capital gains tax. The committee ostensibly led by a prominent retired businessman, hence known as the “Ralph Review” was, in reality, controlled by its Treasury Department secretariat and had the riding instruction that the outcome was to be revenue neutral.
In due course it dispensed with the Hawke Governments indexation of the capital base, instead halving the amount of gain to be taxed on assets owned for more than twelve months. The results turned out to be revenue neutral but individuals were better or worse off depending on how long they had owned assets and whether their gains on sale resulted in more or less tax than would have been the case under the indexation method.
The main losers from the change were actually long-term property investors! Those who gained were those lucky enough to make short term speculative gains, for example those lucky enough to purchase shares in a company which had a large gain in its share price which was cashed in after 12 months.
Consumer Price Index numbers:
The June 2024 CPI number was 138.8.
The June 2000 CPI number was 70.2
Consider a rental property purchased for $150,000 including stamp duty and conveyancing cost in June 2000 its indexed cost as at 1 July 2024 is $296,581. If sold for $350,000 net of selling costs on 1 July 2024 there is a nominal gain of $200,000. Under the previous indexation of base-cost the gain would be the amount above the indexed selling price of $296,581 i.e. $53,419 which would be taxed at the seller’s marginal tax rate.
Under the replacement taxation method of taxing half of the gain the $200,000 is halved and the seller is taxed on $100,000. This is significantly larger than what the tax would have been under the indexation method. Hence to a large extent capital gains tax on sale of long held assets, even after halving of the taxable amount is really a tax on inflation. Property tends to be a class of assets held longer than shares. Hence the result of the Ralph Review was to materially increase the overall tax on sale of property but lower the tax on shares sold after owning for a little more than 12 months. Some financial writers, who should know better, ignore the cessation of indexation and hence write misleading articles.
The winners were short term speculators able to turn a quick profit, having held an asset for a little more than 12 months and for whom the halving of the gain outweighs the change in CPI over a short period. The change was calculated to be revenue neutral but almost certainly resulted in a higher tax yield to the Treasury. Those parroting on about the halving of capital gains are only telling half of the truth.
Phasing out of bank hybrids. Hidden agendas?
Bank hybrid investments will be phased out with the last maturing in 2032. They have been popular with SMSF investors chiefly due to the franking component. They have been useful to the banks who can utilize their stores of unused franking credits. The regulator, APRA has announced that they will be phased out apparently due to its concern over system risk to banks source of funding. That is a complex issue because banks working capital has multiple sources including ordinary deposits, shareholders capital including retained profits and long-term borrowings in bond markets. I suspect that there is a hidden agenda, by Commonwealth Treasury, to force banks to retain more of their franking credits rather than apply them to hybrids. In the short-term hybrid investors might consider selling hybrids maturing in the short term, say in 2025, and buying longer dated ones maturing in 2031 or 2032.
Best wishes to all
Graham Middleton
For archive of articles including ones by Graham Middleton go to website at grahammiddleton.com. Watch for detailed article on Dental Practice valuation in two parts appearing shortly.
General advice and need to confirm.
As I sold out of an accounting and financial services group, of which I had been a founding partner, on 30 June 2020 I am no longer licensed. The above is general advice and should be confirmed with a currently licensed investment adviser. One I would recommend to you is Campbell Thompson at Ord Minette who is both courteous and experienced. His number is 0407 839 229. His assistant Simone Shelton 0402 085 892 is a helpful person also. If you are after simple transaction advice, they are ideal. I use them but have absolutely no financial interest in any services that they provide to others.
