John, Can you review my 1,000,000 portfolio?

John, Can you review my 1,000,000 portfolio?

Yes that was the request from Peter this week. The portfolio was 100% cash in one  bank which was offering above market rates to its  ‘Retention’ clients.

It was certainly  easy to agree with Peter that he appeared to be doing the right thing earning top interest.

We had a few initial thought bubbles.

What if interest rates fall further & Peter may have to come out of ‘hibernation’ & work to increase his income. Of course this is why Peter called us in the first place.

The government guarantee for bank deposits is only on the 1^st 250,000 per institution & hence it might be wise to deposit into say 5 different institutions.  Some cash under the mattress would be a suggestion although it doesn’t earn interest & Penny doesn’t like it.

{We read today a comparison between Iceland which did not support the banks & supported the tax payers & of Ireland which guaranteed the banks & hence not the taxpayers. Who is better off now?}

We also mentioned that because everyone including government wants his money then maybe a trust for protection  might be considered. However  he had closed his trust to simplify his life.

Peter is comfortable now so he says but his income has dropped over the year. Yes cash preserves your capital but it doesn’t preserve your income.

If Peter’s interest income has dropped  from earning 6% to 5 % then he has dropped 17% in income. If he was to diversify banks today he might get only 4.5%. That’s a 25% drop in income.

 No wonder Peter questioned Black Duck’s good news for Christmas. We heard similar questions to the Federal minister for Aging a month ago.

Today we read of lowest confidence readings & hence rates might be decreased further in February.

 i.e. anyone who needs interest income to support their needs, needs interest rates up.

Peter also pays taxx say 7,800p.a. or 650p.m. on his income which also reduces his lifestyle. This could be tuned up but requires further answering the what ifs?

No wonder Peter is in hibernation. However when he remerges then he may find he has acted too late.

What is a solution to Peter’s problem. He certainly can survive & remain as he is if rates don’t change.

However the only constant is change.

 If they go up then yes maybe he will manage. But higher rates are usually to contain inflation which means he is losing purchasing power by sitting on his hands. We are all very aware that governments  globally are attempting to inflate their way out of debt. Our power bill has increased to the extent we will have to share showers again.

Peter who travels for up to 3 months in the USA & a month in China is very aware that costs there are a third of what they are here. Why is this so?

If rates go down & they have been down in Japan for 20 years & are currently the lowest for 500 years in the UK & the lowest in 100 years for the USA then Peter really will be on struggle street. It may mean reduced prices of course.  Peter might then need to live abroad.

John Murray from Perennial  sent this now.

Honey Where's My Income?

As expected the RBA dropped rates by another 0.25% and the banks kept a little, with mortgage rates only declining by 0.20%. Non-mortgage holders are not rejoicing, with term deposits falling to well under 5.0%. So where to go to get income? The NAB provides an interesting example – you can invest in a term deposit at 4.40% or go up the risk scale and buy its listed income securities, currently yielding 6.33% but with a capital value determined by the stock market. Alternatively, an investor could look at buying NAB shares – a much riskier proposition, but with an attractive, high grossed up dividend yield. The dilemma for investors in terms of yield is illustrated by the following table.     Credit Rating Current Yield 1 Year Rate / Yield 5 Year Rate / Yield Low Risk         Commonwealth Government Bond AAA - 2.77% 2.70% Term Deposit Westpac AA- - 4.35% 4.65% Term Deposit NAB AA- - 4.40% 4.60% Listed / Hybrid         NAB Income Securities BBB+ 6.33% - - Macquarie Income Securities BBB- 7.66% - - Shares - Forecast June 13 Grossed up Annual Dividends*         ASX - 8.59% - - Telstra - 9.41% - - Westpac - 10.03% - - NAB - 11.26% - - Source: Bloomberg, Bank Web Sites, RBS, Perennial Value. Forecast Gross Dividends for Financial Year ending 30 June 2013. *Forecast return from June 2012 - June 2013.

Peter sold his property in 2010 as he anticipated correctly falls in house prices. He commented that his current rental property has dropped by 125,000 since he has moved in there. He has ‘no intention to own property again’ due to its costs & maintenance demands. ‘Rich Dad’ & others would agree with him.

We suggested that Peter consider a different allocation of his 1,000,000. I.e. not all 100% cash.

But into what & this means answering the what ifs.

There are too many what ifs & hence defining & countering these what if defines how his 1,000,000 is allocated.

Let’s not forget the what if of living too long. At the age of 52 then Peter could run out of capital & relaying on the government is not where anyone wants to go.

Peter  also commented on current Chinese thinking. I.e. all Westerners are from USA & Peter used the word ‘despise’ as the  Chinese attitude.  That certainly surprised us. He also pointed out the current indoctrination of the younger generation on Japan & how a Beijing  museum is being renovated to prove their arguments. That is a serious what if. That is completely different from the National Museum in Taipei.

{ This disagrees with an economist Jonathan Pain who correctly forecast the CFG in 2007 & his expectations this week on China  in 2013.} Email us for his article.

We also attended another seminar with Matt Sherwood  from Perpetual who manage 24 billion.

He compared the 5 asset classes i.e. cash, gold, property, listed property ,equities ..

Over any 20 year period equities produced 157 times the initial capital  using growth & income.

Cash produced only 25 times the original capital

LPT produced 78 times more.

Gold was the worst with 12 times as it didn’t provide an income & arguably therefore not an asset.

Residential property was 44 times the original capital.

Here is another what if. We read the Chinese want to own all the gold in 2020. Why? They want to be recognised as a reserve currency.

Many fund managers have an allocation between 5% & 10% gold. Why? It is Insurance.

Peter might view Matt’s  summary of the new investing environment as having 5 long term trends.

1.       Debt reduction

2.       Demographic  changes

3.       Energy consumers & producers changing

4.       Productivity & technical innovation

5.       Emergence of the BRICs

Hence the markets will be dominated by these long term trends

1.       Downsizing earning risk in advanced economies

2.       Decline in valuations

3.       Depreciating commodity prices.

4.       Emergence of income investing as source of wealth creation.

5.       Risk & return dynamics to change.

Matt is saying as the world has changed & hence the old rules which have worked in the past have changed.

Bill Gross from PIMCO does call it the ‘New Normal’.

Peter has plenty of what ifs & the answer is asset allocation. However his asset allocation must fit his view of the world which is his ‘risk profile’.  He can weigh his assets in the portfolio in many ways. Our suggestions is to tailor a model portfolio of fund managers from asset managers according to his currently very conservative profile.

 Of course term deposits & direct shares & most suggestions from Peter are available under the one umbrella which provides wholesale products & sophisticated record keeping.

An alternative is to use a specialist fund of fund managers after taking Peter’s risk profile into consideration.

We could discuss the Yale & Harvard endowment models & note from an email today  ‘During the past 10 years through 2009, including the crash, Yale's endowment managed average annual returns of 11.7%, allowing its endowment to reach $16 billion. That put Yale ahead of the top-performing U.S. mutual fund of the decade’.

Once you look under the hood, it's a relatively straightforward strategy of diversifying beyond a standard U.S. stock and bond portfolio into a broader range of asset classes like timber, private equity, real estate and global stocks and bonds.

 We just received this viewpoint via ‘Sovereign man’

‘a cockroach's portfolio "would be inflation resistant, deflation resistant, credit inflation resistant, credit deflation resistant... despite having 'no view' on which scenario was more likely at any one point in time." In short, a generalist approach.

It should be clear to any longstanding readers that we nurse grave fears for the future. So we have, at least, two choices--

We can vote in favour of the asset specialists who, putting the wrong end of the telescope to a blind eye, suggest that there are no problems ahead, and no bubbles visible.

Or we can vote in favour of a somewhat generalist strategy that allocates to a diversified array of disparate asset types (creditworthy bonds, defensive equities, real assets, uncorrelated funds) and that then attempts to pick value in those dusty, neglected corners where it might exist.

We are more worried about risk than we are greedy for return. And if that makes us cockroaches, we can certainly live with the label.’

 Yep that means fees but we certainly don’t want to look after our money 24 / 7/ 365. It’s a stress which we would rather pass on. He can do it himself  but we only master any trade after 20,000 hours.

Peter at some stage needs to act which is why he called us on 07 3848 1088. You may also email us.

 

John McAuliffe