4 August 2023
Some industry super funds are carrying over valued property assets.
Industry superannuation funds continue to duck the matter of their holdings of large commercial office building investments carried at historical valuations which are far out of alignment with the change in values of listed real estate investment trusts (REITs). This change in value is due to working-from-home compression of office space, leading to a surplus of office space in major city central business districts. This means that some industry super funds have substantially overvalued assets which must correct; this will damage fund members relative to those who have recently made substantial withdrawals on retirement or who have transferred to a self-managed superannuation fund.
Advantages of and reducing the cost of self-managed superannuation funds.
Those with large amounts of superannuation are better suited to having SMSFs provided that they can source effective fund administration and advice at a reasonable price. Readers may avail themselves of a wide range of services. I personally use Heffron, a specialist super administrator, to administer our family superannuation fund with Campbell Thompson (0407 839 229) of Ord Minnett as adviser. He works closely with Heffron. This combination is cost effective and is a good place to begin seeking alternative quotes. I am not obliged to recommend anyone and receive no benefit for so doing. It is simply a place for readers who may be paying high fees for a mediocre service elsewhere to gain a comparative quote.
Rebuilding our electricity supply without fossil fuel?
If Australia is going to rely upon wind farms and solar panels to replace coal or gas fired electricity generation, imagine forests of wind farms and vast miles of solar panels spread across our hinterland. Then contemplate the thousands of miles of high voltage power lines connecting those areas to the electricity grids in major population and industrial centers. Those high voltage power lines need to cross farmland and forests. Farmers are resistant to having a series of huge power pylons spread through their fields and interfering with cropping. Power lines make aerial spraying of crops and spreading of fertilizer dangerous and significantly lower the value of land. Putting high voltage power lines underground is estimated to be between 4 and 10 times as expensive. Where they cross forest land, a huge amount of timber will need to be bulldozed to ensure that the bush fire hazard of power lines being too close to trees is eliminated. Regardless they will be hugely expensive and take many years to build to a scale that together with massive solar and wind farms will replace the energy generated by fossil fuel powered generators. An estimated 10,000 kilometers of high voltage transmission lines connecting huge solar farms located in remote areas to metropolitan distribution points will be required in the medium term and far more long term. Estimates are that building this infrastructure may take 20 years.
If nuclear power is used, then the nuclear plants would be built near existing coal fired generators and connect to the existing power distribution network. Opponents of nuclear power stations indicate their cost is several times gas powered generators but this does not take account of the enormous cost savings achieved by building them close to existing power generators and using the existing electricity distribution networks.
Former chief scientist Alan Finkel’s introduction to his new book outlines his vision of the future as follows:
“Think forests of wind farms carpeting hills and cliffs from sea to sky. Think endless arrays of solar panels disappearing like a mirage into the desert.”
Much of the capital cost of carpeting Australia with wind and solar panel farms will have to be found repeatedly because wind turbine forests and solar power arrays have a much shorter lifespan than baseload power alternatives.
The wind and solar solution also require massive firming power back up in the hours of darkness and on windless days.
Recently many industry experts have pointed to a virtual impossibility of Australia meeting 2030 targets to replace fossil fuel power generation with wind and solar.
The French experience!
We have a son who lives with his family at Cherbourg in France near to a nuclear power generator of which France has a number. Some adjacent countries also draw from the French electricity grid. The French cannot comprehend how Australia has shut its eyes to nuclear electricity generation.
Change Management.
The Voice debate is causing deep divisions regardless as to whether it passes or is defeated at referendum. It is risky to put such a referendum proposal without widespread (overwhelming) support. The 1967 referendum result on Aboriginal recognition was carried by a huge margin with cross party support and hence was a great step forward. The current debate has become bitter, and is likely to have a narrow result regardless as to whether Yes or No prevails. This is a formula for enduring division. Our political class may have been wiser to make the Voice a body established by parliament rather than constitutional referendum which goes as far as cross-party support can be agreed and can then be modified in years to come. Change management, when rushed, usually founders. Currently there are opposing former judges of the high court, opposing politicians and opposing prominent Aboriginals. The vast majority of referendums instigated by politicians have resulted in No votes. Contested referendums have usually resulted in No votes.
A Negative yield curve is indicative of recession. Risk of stagflation.
Recently the 90-day bank bill interest rate has been higher than ten-year bond yields. This is usually an indicator of a weakening economy leading to a possible recession. In a healthy economy, long term interest rates are higher than short term rates by a significant margin.
The Reserve Bank is desperate to head off high inflation and has been raising interest rates as well as pursuing quantitative tightening to contain the inflation bogey. A combination of high inflation and an economy in recession (stagflation) would be a disastrous outcome destroying a multitude of businesses, jobs and individual well-being. There is mounting evidence that segments of the population are tightening their belts with reduction in purchase of some items cited by Coles supermarket chain being a leading indicator. We may have only one—possibly two—interest rate increase(s) to come, after which the Reserve Bank would be expected to hold that rate for a time before slightly easing. Rates will then be unlikely to revert to the extreme low rates of the recent Covid era. Hence higher home mortgage rates are here to stay for the foreseeable future.
Investing for tougher times in our superannuation fund.
We have taken a conservative stance toward investment within our family superannuation fund with a large quantity of bank hybrid securities spread across various issues by the four major banks plus Macquarie Group as well as Macquarie accelerator account and cash together making up well above 50 percent of the fund and a select portfolio of shares with most having substantial unrealized capital gains. This is definitely not a time to be chasing small speculative stocks.
A number of bank hybrids are trading at around par with a grossed-up yield of around 3 percent plus Bank Bills Swap Rate (BBSR). BBSR is currently about 4.115 percent meaning that these securities are paying above 7 percent grossed up including franking credits. The recently issued Commonwealth Bank hybrid security, ASX code CBAPM was issued at 3 percent plus BBSR—i.e. 7.11 percent grossed up yield.
Bank hybrids are not guaranteed but rank ahead of bank ordinary shareholders and are therefore lower risk. A bank cannot pay a dividend to ordinary shareholders if it is unable to pay its hybrid security holders. By owning a wide selection of hybrids with different maturity dates and spread across the five major banks including Macquarie we spread the already low risk. We favor the big bank hybrids over the smaller regional banks.
No hybrids in non SMSF portfolio.
We do not own bank hybrid securities in our non-superannuation mix because that is better suited to long term investment in growth shares on the basis that realization of capital gains can be postponed long term.
Question. Why do banks pay higher yields on hybrids than they receive on home loans?
Answer: Banks must meet regulatory requirements. While much of their pool of funds is in the form of low interest and zero interest deposits, the Australian Prudential Regulating Authority (APRA), requires them to have a proportion of shareholders capital and long-term funding. The long-term funding is in the form of long-term bank bonds sold in wholesale markets and bank hybrids. These long-term securities are not subject to a short-term rush to withdraw deposits and underpin long term lending. The overall cost of funds is a blend of shareholders capital plus all forms of deposits, bank issued bonds of a variety of terms and bank hybrids. Hybrids are classified as tier one capital because under certain extreme circumstances banks can convert them into ordinary shares. The banks average cost of funds is usually about 2 percent below their home loan rates. Other forms of lending achieve higher rates. In a real emergency our banks can draw on the Reserve Bank. This facility is not available to non-bank financiers.
What about share ownership?
We hold a restricted selection of shares in our SMSF, nearly all of which have unrealized capital gain. Stock market codes of major held share holdings are: ARB, BHP, COH, CSL, GMG, HUB, LTR, MQG, NHC, QUB, REH, WDS, WES & WOW. Some of these are long term holds because of the amount of unrealized capital gain. Our family super fund includes two of our children, both in accumulation stage as well as members in part pension and part accumulation and hence has a blended tax situation.
Readers should be careful to research any shares that you consider buying for your super fund. There is no substitute for careful examination of a company’s financials over several preceding years together with annual reports and market updates. Take professional advice as necessary. Don’t accept share tips from the financial pages or internet blogs without doing your own research. Treat broker recommendations as being a starting point to analyze stocks further.
Unrealized gains on non-superannuation investments.
Shares held in a portfolio account outside of superannuation are exposed to owner’s personal tax rates which may result in substantially greater capital gains tax if sold depending on whether there are offsetting capital losses either concurrent or carried forward. Often it is best to carry forward unrealized capital gains and continue to receive dividends on capital, some of which would have been swallowed by taxation if sold. The world’s best known investor Warren Buffett (who heads Berkshire Hathaway) holds substantial long-term investments on the basis that it earns continuing income from that portion of the investments which would otherwise have been paid in capital gains.
Will the market turn as interest rates peak?
Historically the share market has been a predicter of central bank interest rate moves. With inflation showing signs of easing in the US the Federal Reserve is likely to be within one or two further interest rate increases before contemplating a slight easing after a pause. This may be taken as a positive signal by share markets. We are buying cautiously and have recently increased our super fund investment in the S&P 500 exchange traded fund code IVV and in SMSF administrative platform stock Hub 24, code HUB. Readers should take professional advice when making investment changes.
Chinese economy in freefall is bad news for BHP and Rio-Tinto.
The Evergrande property crash in China has turned into the biggest property failure of any property group in global history with losses of a magnitude that defy measurement. Vast numbers of investors have paid for or partly paid for apartments which have not been built or which show no possibility of being completed. Other property groups are also failed but overshadowed by Evergrande. Housing is the biggest investment of the Chinese and millions of Chinese investors are devastated. Chinese local governments are bankrupted as they depend on land sales for their finance. Currently major Chinese cities are reported to have youth unemployment of 20 percent and Chinese consumers with savings have gone on a spending strike fearful of economic devastation to come. Deflation has hit China at the same time as the Western world is battling inflation.
China’s population growth has turned negative earlier than anticipated with a substantial male to female population imbalance. Despite China rescinding it’s one child per family policy it is having no impact. Females are postponing marriage, while a mass of males cannot find partners. China is now threatened with a rapidly ageing population and a reduction in building/infrastructure development requiring less steel. The demand for Australian iron ore exports is falling, dragging down the price per ton.
It all adds up to troubled times as trade with China is a key economic growth generator.
Political parties responsible for destroying the availability of privately owned residential rental housing. Why I will not buy residential rental real estate.
There is a continuing squeeze on landlords with increasing land tax, in Victoria in particular. The Victorian government has been reported in the financial press of 24 July as considering rental controls.
Residential rental property investment makes little sense elsewhere in Australia and no sense in Victoria. Nor does it make the slightest sense to own residential rentals in a super fund. By comparison, investment in the share market does not carry the same onerous stamp duty and land tax imposts, does not risk bad tenancy and does not tie the beneficial owners down to repair schedules, agents letting fees and property management fees or the threat of rent control. Increasingly residential landlords, who are mainly people with modest incomes, are subject to onerous conditions which increasingly favor tenants. Unsurprisingly, landlords, many of them school teachers, nurses, police and others with modest incomes are selling their residential investment properties and reducing their own home mortgages. Since a significant proportion of new high-rise apartments have traditionally been bought to rent, this market is now hit hard. Off the plan sales by property developers are severely affected in Victoria and elsewhere. The Victorian Government’s policies in particular have contributed heavily to the emerging rental housing crisis. And unless significant changes are made will dramatically impede new high-rise development as developers rely heavily on investors off the plan sales to reach a point where there are sufficient sales to satisfy project lending by banks. The Victorian Government’s anti-residential landlord investors policies will make rental accommodation availability the worst of any state.
Revised superannuation limits. What to do?
The pension account cap for those who had not yet commenced a superannuation pension increased to $1,900,000 from 1 July 2023. This cap is indexed in a fairly clumsy way and increased from $1,700,000 last year. The overall cap including accumulation accounts will be set at $3 million per person from 1 July 2025 and is non-indexed. Those with excess balances above this figure will have the excess taxed at 30 percent including capital gains tax on unrealized capital gains. Effectively this will make the tax rate significantly greater than 30 percent on earnings on the excess amount above the $3 million in years in which fund investments increase in value by substantial amounts.
Retirees should consider removing individual superannuation amounts greater than $3 million from their superannuation funds. Many will have lower personal effective tax rates in retirement and will be advantaged by removing part of their Accumulation Account after commencing their superannuation pension from their Pension Account.
The benefits of assisting children’s mortgage repayment.
Many retirees with large balances will consider assisting children to reduce home mortgages effectively providing their children with a tax-free benefit equivalent to their home loan interest rate. An individual paying 6 percent interest on their home loan and having an income requiring a marginal tax and Medicare rate of 35 percent would need to earn 9.23 percent on a safe investment to achieve the same after-tax benefit as paying down their mortgage. Those with a marginal tax and Medicare rate of 47 percent and a home loan rate of 6.5 percent would need to achieve a return of 12.26 percent on a safe pre- tax investment to receive the same benefit as reducing their non-interest deductible home mortgage.
Readers should confirm their/their spouse’s average and marginal tax rates in retirement before making decisions to remove balances above $3 million from their superannuation fund and take accounting advice if uncertain. Those assisting their children should check their children’s mortgage interest rates, marginal tax rates and amount of mortgages. On a whole of family basis, those with large superannuation balances will give greater advantage to their children by assisting with mortgages at expensive life cycle points rather than leaving them large sums in their wills.
Investment advice from Industry superannuation funds, conflicted, unqualified and risky.
Recent news that industry superannuation funds are being permitted to provide financial advice without the rigorous qualifications and experience of financial planners opens up a high-risk Pandora’s Box likely to blow up in their faces at some future date when a royal commission similar to that of the banking royal commission peers into the consequences.
I personally provided financial and business advice for many years. My MBA qualification was heavy in economic, financial and accounting elective subjects. My undergraduate degree included units in economics and economic history. At various times changing regulations required me to sit exams in order to keep providing advice and there was a need to accrue monthly points through a recognized training provider. I spent many years analyzing the actual financials of a multitude of dental, veterinary and medical/medical specialist practice owners, writing books and magazine articles on the subject. I examined the need for practice owners to re-invest in their practices and pioneering dental and veterinary practice benchmarking including the building of data bases. I invariably examined the trade-off between paying down private non-deductible home loan debts, maintaining business tax-deductible debt and regularly advised on home upgrades. On many occasions I assisted clients by bidding for them at home auctions or valuing practices for sale or the entry or exit of a partner or dental associate. Nobody can be mistake free in advice but deeper knowledge gave me a significant advantage.
Invariably advice provided by superannuation funds will be conflicted.
Now it will become possible for employees of Industry Superannuation Funds to provide advice with a fraction of the knowledge, experience and qualification required. Inevitably this will be slanted toward maintaining Industry Super Fund balances and inflows and restricting the outflows. This will take precedence over the best options for the fund members even if many with modest balances will become better off by withdrawing superannuation and investing directly in husband-wife joint names, renovating their homes and assisting children to reduce their mortgages. The proposal to allow Industry Superannuation Funds to provide advice via underqualified employees is akin to authorizing foxes to guard the hen house.
Financial Success for Dentists
Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:
Understand key practice valuation criteria.
Learn how some dentists inadvertently reduce the value of their practice by $500,000
Avoid long term errors when purchasing your practice.
A complete and comprehensive career guide for mature and aspiring dentists.
Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.
—Merv Saultry, Founder Dental Innovations Network
There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value.
I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.
To Obtain a Copy:
Go to the Delany Foundation website at http://www.delanyfoundation.org.au
Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.
Email graham.george.middleton@gmail.com confirming that your donation has been made, as well as your name and mail address
A copy of the book will be mailed directly to you
All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.
The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.
Please Pass On
If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly at graham.george.middleton@gmail.com
Independence And Disclosure
I am not a representative of any accounting practice, financial planning firm, business or marketing consultancy. I spent 33 years as a business and financial adviser to mainly dental, medical and veterinary specialist and general practitioners. Since I retired as a director of a financial services group, of which I had been a founder, on 30 June 2020, I am no longer licensed as an investment adviser. Readers should treat the above as general advice and take professional advice as required.
General Advice
The above is ‘general advice’ and individuals are urged to undertake considerable personal research of companies in which they are investing as well as demanding of their advisers that they tailor advice toward their best outcome after demonstrating an understanding of their position in detail. Be cautious about accepting advice unless you are certain that your adviser has a thorough knowledge of your situation. If in doubt the best decision is often to make no investment changes.
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. My website is now available at grahammiddleton.com.
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 readers
Graham Middleton
