30 March 2024

Don’t expect interest rates to fall in the near future.

With full employment in the USA and the US Federal Reserve looking likely to keep their interest rate setting above the Reserve Bank of Australia’s cash rate, the probability is no rate cut for at least 6 months, or more likely into 2025. Historically our cash rate has been above that of the Federal Reserve. In a perfect world our RBA would like to cut by less than the Federal Reserve to edge back toward the historical relationship.

Australia is suffering a per capita recession. 

The huge number of immigrants grows the overall economy but masks the fact that growth per individual Australian has been declining for the past four quarters. On average Australians are worse off, with many appreciably worse off than 12 months ago. Inevitably high immigration is making the housing shortage worse while planning control red tape is slowing the rate of new dwellings being constructed.

Rollovers of bank hybrid securities using ANZ security AN3PG as an example.

We own a variety of bank hybrid securities in our super fund issued by ANZ, CBA, Macquarie, NAB and Westpac.  Recently ANZ advised that it was offering a rollover to its replacement hybrid on the maturity of AN3PG. On notification of the rollover option by our broker, Ord Minette, we elected to accept the rollover as being the best option available. As is normal, we had to accept the rollover option within a relatively short time before the remainder of the issue was allocated to bidders. The interest rate on offer for the rollover was in the indicative range of 2.9 to 3.1 percent + BBSR (bank bill swap rate). BBSR is currently 4.295 percent. Assuming the lower of the indicative range of 2.9 + BBSR, the interest rate would be 7.195 percent on issue divided into 4 quarterly grossed up amounts of approximately 1.8 percent including franking credit. Note that if BBSR changes then the yield on all bank hybrid securities will change but there is not expected to be significant change. BBSR is normally slightly above the rate at which 10-year Australian Government bonds (Treasury notes) are traded in the money market. If interest rates fall, bank hybrid yields are expected to remain relatively higher than government bonds, albeit that our banks—although regarded as among the safest in the world—are considered to be slightly riskier than our government, which has the option of raising taxes to pay its interest bill. Bank hybrids being a mix of equity and interest-bearing securities are not risk free but are regarded as low risk. All our major banks are generating substantial profits and have a substantial margin of tier one equity.

Were there better investments available in equivalent long dated hybrid securities than the rollover option in respect of AN3PG?

I would expect superannuation fund advisers to give timely and accurate information to clients. While they might recommend that a hybrid security should or should not be rolled over, it is the client’s choice and they must be given this choice with ample time to consider and notify their decision. If an adviser is slow to notify their clients and it then becomes impractical to do the necessary rollover notifications or chase clients who may not have replied promptly, there is a temptation to cover themselves by saying that the rollover was not recommended! That is not good enough.

In my opinion there was not a closely comparable hybrid security which could be bought on market in preference to electing the AN3PG rollover option. Interest rates presently are lower than at the time of issue of AN3PG. The appropriate comparative measure is of long-dated recently-issued bank hybrid securities after taking care to correct for market timing of forthcoming quarterly payments. 

How are new issues of bank hybrids priced?

Each of our major banks have a variety of hybrid securities of varying dates of maturity. Replacement issues are partially funded by existing investors, who include a variety of large financial institutions electing to rollover and bids for stock by new investors. The process starts with an approach to institutional investors seeking guidance as to the price at which they would bid for stock and the amount they are seeking. The understanding is that those who make indicative bids at or above the final price will be offered firm stock after rollover requests have been allocated firm stock. The issuing bank normally restricts the target amount to be raised so that demand will exceed the amount of quantity issued. Buyers then bid for stock on the expectation that the issue will be oversubscribed.

Our super fund has bid for stock in a number of hybrid issues on the expectation that we might receive about 40 percent of the amount requested. The process ensures that the final interest margin above BBSR represents a fair market price and the new issue normally trades on the market at a tiny premium to issue price.

The best basis for comparison with other hybrids having similar low-risk characteristics is with long dated ones with similar conditions including franking. I note that the longest dated of ANZ’s other hybrids is AN3PK maturing in March 2030, which has a yield of BBSR plus 2.75 percent—i.e. lower than this new issue. On this basis accepting the rollover option for AN3PG was an appropriate choice.

Some ways to simplify self-managed superannuation fund investment and cut costs.

SMSF software has advanced in leaps and bounds and therefore accountants and superannuation administrators should be able to reduce fund administration fees.

Are you interested in heavy involvement in the share market or not?

As for investments decisions, either you have a significant knowledge of and interest in the share market or you do not.

If you are not interested in spending considerable time and energy trawling through the annual and half yearly reports of many companies listed on the stock market and are afraid of being baffled by investment advisers who may make investment appear a lot more complicated than it is, there are ways of getting near market return simply by investing the majority of your fund in the following three listed funds, chosen because of their size, spread of their investments and importantly their very low Management Expense Ratios (MERS). 

S&P 500 Exchange traded fund (ETF) code IVV.

This fund invests in the top 500 stocks listed on the New York Stock Exchange and NASDAQ, many of which are international in their operation (for example CSL and BHP) but also including Warren Buffett’s Berkshire Hathaway, whose huge insurance and re-insurance businesses have global tentacles. This fund also invest in the array of tech stocks referred to as the “Magnificent Seven”. A typical investment advisor might advise a range of North American, European and Asian etc., funds in the name of diversification but the S&P 500 ETF covers all these bases at a very low Management Expense Ratio (MER). So simply buy it and ignore the lesser ETFs.

For those who wish to invest in the Australian share market but don’t have sufficient interest to follow the market closely the two largest, long established listed investment companies with many billions of shareholder funds invested are:

1.     Australian Investment Company Ltd (code AFI) established in 1908, and

2.     Argo investments Ltd (code ARG) established in 1946.

Not only are they the largest but they have very low internal management expense ratios of 0.15 percent for Argo and 0.14 percent for AFIC. 

Be careful about other listed investment companies.

There are about 100 investment companies listed on the Australian Securities Exchange, known as LICs, but many of them—particularly the more recently established—are loaded with heavy fees. These include substantial “success fees” in the years in which the stock markets substantially increase their value, but they don’t give it back in down years. If you are not willing to research all of them stick to AFIC and Argo which are large, long established and invested in many major Australian companies.

Investment advisers tend to avoid AFIC and Argo because most investors in the know tick the dividend investment box and leave them in place long term. An adviser can quickly become near to being redundant. Stock broking analysts don’t report on them because they are not the sort of investments which are actively traded. They just sit quietly holding onto most company shares that they own indefinitely and quietly growing with their underlying investments and the dividend re-investment options taken by many of their shareholders.

Checking out the above ETF and major long term listed company funds.

If you are interested in checking out the above listed Exchange traded fund code IVV and the two long time listed Australian companies Argo and Australian Investment Company start by brings up the ASX 200 website. Then type in the code—be it IVV, AFI or ARG—and up will come a page of information. Look at the price chart and change the one-year chart to the 20-year chart. Then you can dial down through the one year and full year annual reports and announcements, if interested. As each of their 20-year charts show, they do fluctuate but not by as much as do most individual stocks and their long term trajectories have been up. 

Cash Management Accounts.

Most funds operate with a cash management account of which Macquarie Group’s has long been the industry leader and for those who like to carry lots of cash Macquarie’s parallel accelerator account pays higher interest.

What about interest bearing securities and Bank Hybrid Securities? 

The current 10-year Australian Government Bond yield, which is the yield at which they trade in money markets, is approximately 4.084 percent as at 22/03/2024. Higher yielding than government bonds are hybrid securities issued by banks. Our banks are among the safest in the world but are considered riskier than our government, which can adjust taxation to pay its debts. The hybrids rank below bank depositors, but ahead of ordinary shareholders. In the extreme circumstances of a bank making a loss, and the regulator APRA so demanding, a bank may not pay a dividend to ordinary shareholders or to hybrid securities but I note that Australian banks are considered to be well capitalized with all having tier one capital significantly greater than required. As hybrids rank ahead of bank ordinary shares we perceive them to be low risk. In our own superannuation fund we have an array of bank hybrids issued by the five major banks including Macquarie Group.  These hybrid securities are currently trading at a yield of slightly above 7 percent which includes franking credit. Be aware that their interest rates have a fixed component and a floating component known as BBSR (bank bill swap rate) which is currently 4.295 percent. BBSW is normally slightly above the 10-year Australian Government Bond yield. E.g. CBAPM hybrid pays a margin of 3.0 percent above the BBSW making current yield 7.3 percent. An investor seeking simplicity would simply buy one issued by each of say two or three of the major banks and stick to the longer dated ones, say AN3PK March 2030, CBAPM June 2030, NABPJ September 2030 and WBCPM September 2031. Normally at maturity date the issuing bank offers the investor a choice of whether to roll-over to replacement hybrid security at nil brokerage or receive their money back. The terms of the replacement will reflect the Hybrid premium to the bond market yield at the time. 

Why AFIC, ARGO and S& P 500 ETF are more suitable long-term investments than residential rental houses and rental units.

Their management expense ratio (MER) of 0.14-0.16 percent is miniscule compared to the landlord’s costs of ownership of residential rental properties which include:

·       Municipal and water authority rates

·       Building insurance.

·       Agent’s letting fees,

·       Ongoing management fees.

·       Property maintenance.

·       Land tax which Victoria has recently increased.

·       Additional accounting cost, particularly if owned through a trust.

·      There is risk of periodic tenancy damage which might not be easily recoverable.

Residential property has much higher transaction costs in the forms of stamp duty for buyers and agents’ commission on selling than do AFIC and ARGO or IVV which can be bought and sold for modest brokerage and added to via electing dividend re-investment at zero brokerage. By advising your tax file number dividends and franking account credits are automatically accessible to your registered tax accountant thereby eliminating your personal record keeping and simplifying accounting.

Clientele Investor Effect of residential rental property. 

Due to what academics refer to as “clientele investor effect”, owners of residential rental properties accept net income return well below what investors achieve on other forms of investment. The majority of residential rental properties are owned by people with modest, but reliable, incomes who negatively gear. Typical owners include school teachers, nurses, firefighters, police and public servants who having secure employment pass a key bank credit worthiness test. Most persons of significantly higher income/wealth invest quite differently, generally achieving much better investment returns with less procedural cost.

Do Argo, AFIC and S&P 500 give best returns? 

Those who are prepared to spend significant time repeatedly analyzing annual and half yearly reports of companies can achieve better returns than these three mega listed funds. However, they are much better and cheaper to manage than residential rental properties particularly for those who are time poor or aging with poor health.

Why real estate statistics are misleading in respect of residential rental property. 

Real estate statistics are deeply flawed because they mix up residential rental property with owner occupied housing. Between purchase and sale many of our homes have had substantial improvements including house extensions, installation of modern bathrooms and kitchens, internet connections, ducted heating and cooling, landscaped gardens etc. All of these improvements are buried in the statistics as capital appreciation. So when a real estate agent says that houses in our suburb have appreciated by an amount vastly above that of inflation I look up and down my street and notice that without exception all of the dwellings have had substantial capital improvements including some demolitions of old style houses and replacement with vastly improved modern houses with 4 bedrooms, multiple bathrooms, multiple car accommodation etc. All the statistics are measuring is the price at which titles changed hands and none of the capital insertion is measured.

By contrast many of the houses bought to rent have much less new capital spent on them. Who is going to pay a landscape gardener to beautify the building surrounds or spend a lot of money on a top of range replacement kitchen on a rental property? Because overall the houses which are owner occupied have a much greater amount of new capital expended compared to rental properties the common statistical measure creates a false impression of the capital appreciation on the rental properties.

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.                                                      

My Financial interest.

I have no financial interest in the advice I provided and seek no fee. I am secure financially and I seek no personal remuneration. If you find it worthwhile you are able to acknowledge it by making a tax-deductible donation to the registered charity which I support, the Delany Foundation who, I am confident, will apply it to worthy use.

Graham Middleton 0448 784 594

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.

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.

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

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