Category Archives: Pro Finance

Elliott Jackson

Here we go again

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Let’s not talk up a recession

New Zealand, it seems, is leading the world in its handling of the Covid-19 crisis. Although none of us have a crystal ball, we are in a much better position than most nations, many of whom are suffering under the pressure of vast numbers of new cases and struggling economies.

Over the last few months I have observed economists, investors and market commentators sway between downright pessimism and euphoria. The happy medium is that there has been good growth in many asset classes during 2020, not least of which has been in the mortgage trust arena.

What now?

The Reserve Bank recently announced a funding for lending programme will be ready for the end of 2020. This will involve the Reserve Bank directly funding bank lending at a set low interest rate, which may add to the downward trend in bank lending and term deposit rates.

As house prices continue to rise it appears the Reserve Bank believes that it is better to over stimulate the economy than not. Ultimately more money is likely to flow into assets like residential property, shares and mortgage funds.

Although the global economy is slowing down, some economists believe that this does not necessarily mean that a financial crisis at home is looming and the Government, which is about to start its second term in office, has indicated that it will take extra steps to support the economy.

I firmly believe that we should not be talking ourselves into a recession. Let’s be honest here, people are spending their hard-earned cash; they are not travelling overseas because they can’t, but they are travelling domestically and do want to support local businesses and invest as asset prices continue to rise.

Pessimism in New Zealand seems to be easing. Kiwis are refocusing on their nest eggs and looking to the future, just as they should be. Many people have recognised that although our economy may take a few years to regain its full momentum there are still many opportunities to be had. Midland’s continues to fund various property orientated growth activities throughout the country.  There is good demand in the marketplace for lending products and as banks continue to reward their savers with meagre returns, we are seeing increasing interest in our fund.

In summary, I think we should all be looking firmly to the future, whilst understanding that there may be some challenges ahead. There is a continued trend of investors looking for reliable returns over and above bank deposit rates. The recent closure of Bonus Bonds has also fuelled interest in cash-type investments. Should you wish to discuss any of my thoughts detailed above, then please do not hesitate to get in touch.

Get your investments right from the start

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This article was written in early May.

In the last issue of the Profit, I used the term “market correction”, and boy oh boy, did we have one of those! Not for a second am I claiming a prediction of Covid-19 and the effect on the markets, but I will state that now more than ever real relationships with our clients are paramount.  Also, it’s important to do your homework on your investments before black swan events take place; we’ve now had two in the last 15 years.

But before we talk about that, let me say that I really feel for the businesses of Hawke’s Bay, many owned and operated by people whom I know personally, and the impact that Covid-19 is having.  New Zealand and to an extent Hawke’s Bay, as primary producing economies, will feel the effects of Covid-19 for some time to come.  Stimulus packages have tried to target employment retention and cash flow concerns but the real economy, effectively the flow of non-monetary factors, will struggle to get back to full pace in a short time.  I feel the real effects of Covid-19 are yet to be realised.

Thankfully, at Midlands our relatively vanilla offering to our conservative investors means that we have not experienced the volatility of other sectors – our strength is based on the quality of our lending book and the liquidity and management practices we have in place.  Sure, we’ve had to work with some borrowers regarding their debt serving abilities, but so far this has been done without any material adverse effect on the performance of the fund.  Being diversified around the country and having low Lending to Value Ratios (LVRs) has helped that profile.

Investors trust Midlands to give them a consistent and conservative return, over and above main bank rates.  They do not invest with Midlands with the intention of significant volatility.  But volatility is what investors got in many other sectors, including multi-sector solutions such as KiwiSaver.

I have written at length in the past about factors such as liquidity, volatility and getting an asset allocation that meets your needs and goals when looking to invest.  There is considerable material available in investment documents, such as Product Disclosure Statements (PDS), that assist in making these decisions. Your total asset allocation (all your investments) should be based on your needs, not just in fair weather, but over time and reviewed accordingly.  Past returns should be balanced with defensive factors, diversification of assets, when and if income is distributed etc.

So, I read with bemusement (and great worry) that many KiwiSaver investors switched to conservative or income funds when Covid-19 had violent effects on the market, mainly in late March and early April.  There is enough literature to say that financial professionals cannot time markets effectively, let alone the layman. So why do it? If you do not trust the manager of your funds to navigate what they can within their investment mandates, I would suggest you have chosen the wrong manager. Already we have seen markets correct back considerably meaning that those who switched have crystallised losses and have missed the considerable “bounce”.

I fear that Gen X and Gen Y will bear the main burden of the fiscal stimulus packages of Covid-19 for years to come, via taxation, estate duties (from the boomer generation), means testing of superannuation and many other vehicles yet to materialise. They should not be burning their long term nest eggs with poor investment and asset allocation decisions as well.

There are many factors that determine what you should invest in, especially in KiwiSaver as a “long” investment.  But time is one of the most vital considerations.  If you do not have the stomach for volatility, nor the time, then a more balanced or conservative type fund is more appropriate from the outset, not after the fact.

Looking ahead – what will change

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What are your predictions?

I can hardly claim this is a prediction, because it is well documented. But certainly, in the immediate term, we will continue to live in a low interest rate environment. For borrowers, this is good news. However, for savers and investors in income assets, it’s not so great.

One aspect of this is not fully understood. Post KiwiSaver, main street banks do not have to compete for the term deposit billboard rate as much as they used to. This is because within their own KiwiSaver products, they can assign the income end of the portfolios to their own instruments.
This effectively helps fund their domestic loan book by stealth, while charging a management fee to do so. When the organisation then sells you this as an investment solution, this is called “vertical integration”.

So better deposit rates at the bank billboard are a long way off. Time to think differently!

What’s likely to change in your sector?

More regulation and more compliance. On the lending front, the Credit Contracts and Consumer Finance Act (CCCFA) Amendment Bill is going to have some immediate implications come June 2020.

Here at Midlands, with both investing and lending, we are mature in our adoption of anti-money laundering (AML) considerations, as well as continuous disclosure, transparency, and our focus on good customer outcomes.

These changes mean that financial services providers like Midlands must get “closer” to clients. That requires investment into relationships and the delivering of soft skills if not actually giving financial advice per se. But we have to ask a lot of questions of our clients.

For this reason, I struggle with organisations moving away from genuine local relationship models and with “robo advice” or online lending models. To me, it’s an exploration in protecting margins and revenue without investing into customers and communities. Because we have had a very good run in investment returns, I do feel there are some fair-weather models being rolled out to investors that may be challenged in a market correction.

I also struggle with some passive management models for this same reason. Automated electronic trading based on macro asset allocation, with no micro company research really bothers me. Especially when you consider Environmental Social and Governance (ESG) factors.

But personally, I hope the powers that be do look further into “vertical integration” and if it is delivering better client outcomes. Certainly, the findings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry in Australia indicate it may not.

What opportunities do you see?

For us at Midlands, it’s pretty easy. Invest in our relationships and educate our investors and borrowers. We have a vanilla offering that suits our conservative investors.

We continue to significantly outperform bank deposit rates, while remaining fully liquid (no lock in of funds). We do this by close management of a quality first ranking security loans book across New Zealand.

While banks have reduced their lending and offer low interest rates to retail investors, we can continue growing as we are. We are proud to be non-bank.

What technology advancements will have an impact on how do business?

During our lending process, while we personally inspect every property we lend against, a lot of the initial discovery due diligence process can be done on-line now. This is important to ensure the quality of our lending book. This is only going to get better.

Regarding investments, the speed to market of online services used to be hamstrung by AML requirements. This gap has closed very quickly, and we are aware of this. Certainly, something we are looking into.

Shock and Orr Reserve Bank head prepared to make big calls

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Currently, it is very difficult to speak of anything but the low interest rates affecting savers and investors. At the time of writing1, the Reserve Bank of New Zealand has taken a breather with its September 2019 announcement and left the Official CashRate(OCR)at 1.00%.After the hefty movement of 0.50% “south” on August 7, this is welcomed in most sectors.

The OCR influences the price of borrowing money in New Zealand and provides the Reserve Bank with a means of influencing the level of economic activity and inflation. An OCR is a conventional tool by international standards.2 However, for many, it is seen as a blunt instrument that has far wider consequences. This includes directly affecting deposit rates, especially at main street banks.

Banks use domestically raised capital (term deposits) to help fund their lending book. Therefore, “the spread” between their deposit rates and their lending rates is effectively the margin off which they operate. This revenue, as well as transactional fee and service fee revenue, is the primary source of their well-published profits.

We, therefore, rely on competition in order to be able to shop around for better deals, but as rates remain so low, the main banks are starting to look rather homogenised.

It was widely reported3 recently, that the Financial Markets Authority (FMA) has found a further decline in interest rates on bank term deposits is causing more savers to consider alternative investments.

The financial watchdog said a survey of 195 term-deposit holders in August suggested 43 per cent were likely to invest less in term deposits because of low interest rates. Of those who were considering changing their investment strategy, a quarter were considering shifting savings in search of better returns.

Certainly, in our organisation, we are seeing a steady increase in queries about deposits as investors search for regular income and quality yield, without being locked in. More so than ever, investors and savers are asking questions about quality, liquidity and generally, “what do you do with my money”? I find this heartening, as for me it seems the message is filtering through that yield is important, but quality, management and liquidity are all factors that need to be considered.

Even though there is a search for yield, the preservation of capital is front of mind, as it should be.

The low-interest rate environment is currently forecast to continue, with little sign of an end any time soon. Investors and savers can no longer wait “for things to get better”. Mainly because the outlook is that it won’t, any time soon.

Like an English tabloid paper’s perpetual exploration of tacky metaphors, I read4 with great amusementthat the moniker “shock and Orr” is starting to be used.

Certainly, Reserve Bank Governor Adrian Orr (above) has ingrained himself in the financial services psyche of New Zealand. In a previous profession, I remember clearly learning of “shock and awe” in military doctrine with the words “overwhelming force from the outset” still ingrained in my mind 25 years later. In Mr Orr’s case, this cap certainly fits.

In my opinion, he’s a strong and bold Governor, not only for his large cut of the OCR in September, but also for his continued statements regarding bank conduct and all things economy. I am excited by the fact that we have visible economic leadership in New Zealand. The Reserve Bank Governor should be a “front of office” role. For this, personally, I applaud him.

Therefore, moving forward, we should watch Mr Orr with a deep fascination. He must navigate the country through what is largely uncharted waters. Interest rates are historically low and are forecast to remain so. The OCR is a blunt instrument and the biggest trick in his bag of tricks. I wonder how often he dares to play it.

One thing is for sure, this Governor is probably not offended by the term “shock and Orr”. He may even like it…

Making cents of the market

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It is the process of anticipating what could lie ahead, and the creation of methods and processes to help minimise the potential negative effects of future influence… but can you ever truly 100% futureproof a portfolio?

The truth is you can’t completely 100% future-proof any portfolio, because investment involves risk no matter how low, and the future is uncertain. But where we lack a crystal ball in life, we can still set a healthy projection for the future by identifying our personal objectives and re-evaluating our investment mix throughout our lives to make it as resilient to negative influence, as possible.

Over time, we’ll go through several investment lifecycles. Our goals and assets in our thirties will likely vary greatly to when we’re near or post retirement age and there are plenty of factors we need to consider at regular intervals over the years to ensure our investments evolve to reflect our lifestyle, risk profile and assets. We should also re-evaluate as markets fluctuate and threats or opportunities present themselves.

The identification and monitoring of our goals will ideally take into consideration a broad range of potential experiences in relation to what’s happening globally. In doing so we should consider how our future outcomes could be impacted by things like technology, political instability, boom and bust business cycles or environmental factors. We’re not talking fear or panic driven decision making, but mere logical consideration to how these factors may affect our goals. This helps us to work out how we should strategise so it aligns with our expectations.

When analysing our goals, it isn’t all cold numbers and projections. More and more we’re seeing the conscious investor looking into more ethical opportunities. Socially responsible investing acknowledges there’s an emotive side and behavioural biases when it comes to the choices we make in life, and it’s important to consider how this should affect the decisions you make with investing too.

Paying attention to our concerns or stance on certain subjects can help focus us on our journey, as well as the outcome, opening us up to take a more tailored, holistic approach. Our needs might be complex, but that doesn’t mean our investment strategy can’t harmonize with them.

MARKET THREATS AND OPPORTUNITES

When we discuss influences such as threats and opportunities in the market, we are trying to recognise that which we can’t yet see in full and anticipate what that could look like for ourselves. We mentioned political instability and BREXIT offers an example: it was a multifaceted disruption to the market that surprised many with its result. It reinforces the importance of recognising triggers early.

According to Statistics New Zealand “Over a fifth of New Zealand’s investment in the UK at the end of June 2016 was portfolio investment” including KiwiSaver investments. The UK is also mentioned as being 14% of New Zealand’s total investment overseas, which is no small fish by any means.

A political event like this pulls on our emotions and biases. Sterling driven assets are becoming less attractive to some and the current state of political turmoil has pushed spooked investors toward more defensive investments. That’s not to say there’s a rule book for this kind of political instability or how we invest. It depends on our individual aversion to risk, our biases, our asset allocation and our goals.

Using comfortable retirement as our hypothetical goal – a riskier investment might appeal to you if you were still receiving a steady income. But as the years pass by and you get closer to retirement you might feel less comfortable with the risk.

Utilising objectivity, our circumstances and projection as tools, we should be able to determine if it is in our interest to keep a hypothetical investment in the UK or whether to change it out for something more suited to our goals.

The takeaway is – though we might not be able to completely ‘futureproof’ our investments, we can get them close. Just keep in mind that as our circumstances, goals and stance change – our investments will likely need to change with us. Well researched and thought out diversification, with effective asset allocations aligned to your personal goals is the most effective tool we have when trying to protect your investments.

Diversifying more than your portfolio

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As many readers will know, as well as being a Hawkes Bay based financial adviser who has been servicing Bay clients for over 10 years, I also have a national role with AdviceFirst. Today, AdviceFirst includes the now rebranded Spicers business and has a strong presence with 15 offices throughout New Zealand.

As part of that amalgamation between Spicers and AdviceFirst, I was appointed into my role as Head of Wealth Management. I am privileged that a national organisation like AdviceFirst allows me to fulfil these responsibilities based from Hawkes Bay. Indeed it seems more and more that Bay based professionals are enjoying roles at a national level and working remotely, even at a senior level.

I have a strong duty of care and managerial responsibility for 35 Wealth Management Advisers across the country. The Profit therefore offers a great platform to discuss another regional and national aspect of duty of care to our respective industries that I feel should be top of mind for all professional disciplines: diversity.

So, I ask, what do you picture when I say financial adviser? You’re probably imagining a male of a particular age – which is often how financial advice has been commercially represented. That’s why securing and nurturing a diverse next generation of financial advisers is a top priority for our industry as we see our ranks of veteran financial advisers naturally decrease.

A knowledge gap is appearing, a gap which we need to fill with the transference of skills and expertise between peers to maintain the high standards for which our vocation is held. It’s our legacy.

AdviceFirst has been working hard to influence and promote diversity within our own organisation, setting a precedent for the next generation of Financial Advisers. Between 2016 and 2018 our percentage of advisers under forty years of age has increased by 13 %.

Along with benchmarking ourselves, building up the ranks of younger advisers, whose development is supported and mentored by our more seasoned financial advisers, is key to ensuring our clients’ needs for quality advice continues to be met competently and practically for years to come.

We’re not just closing the gap on bringing a fresh approach into the industry. Over the past three years we have been working to increase the percentage of female advisers in our business from 18% three years ago, and we have now reached 31% with over 150 years combined industry experience between them. Of course there is more to do, it is important to keep lifting our own standards in this way, nevertheless AdviceFirst is proud to be making good progress to ensure we have more diverse representation.

It’s also important to us that we represent positive change in financial advice and that our efforts mean we are well positioned to advise younger generation x and generation y investors, who are globally set to inherit assets in the trillions from their baby boomer parents (not to mention their own earnings) – and encourage the securing of those assets with accessible and smart financial advice.

We can do this while remaining true to our traditional values and an advice model that is very much relevant to our post war clients. Our clients don’t all have the same needs or background which is why it’s beneficial to work with an Adviser who can understand you and your goals while offering a flexible approach and choice.

As we evolve with social and cultural expectations, we’re building on the foundations that have been expertly set for us by our predecessors. Every time a new and younger generation grows, they bring with them a fresh approach that reflects their era, goals and preferences while remaining stabilised by the experience that helped raise them up.

One example of why we’re pushing for a more diverse offering relates to elderly clients. In this situation there can be a diminished capacity, often due to a passing of a loved one or pressing health concerns. In times of crisis or dealing with difficult decisions about a personal estate or investments, we need to be there for clients. In planning we can offer a level of experience and empathy that is more easily realised and provide our clients with an open and responsive relationship, improving the advice process. Trust is at the core of our value proposition and principles and that trust is better realised with the option for prudential stewardship.

Succession planning isn’t just for investors looking to the future. Succession planning is for all of us, AdviceFirst included. Our journey will continue…

When keeping calm and carrying on paid off

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Recently I had the pleasure of traveling around New Zealand with economic commentator and journalist Bernard Hickey’ where we have been presenting to AdviceFirst clients and local professionals about themes important to today.

We have also been joined by fund managers Fergus MacDonald of Nikko Asset Management and Craig Stent of Harbour Asset Management. Our event series included a Hawke’s Bay leg, at the Black Barn winery. Bernard has been sharing an important message which we think is timely today.

It was the darkest moment of the global recession. September 2008 and financial markets were on the brink of collapse. Economist Bernard Hickey was at a New Zealand Superannuation press conference expecting to learn how the fund was going to protect taxpayers’ money. Instead, what Adrian Orr, who at the time was the CEO of New Zealand Superannuation, said next would leave the economist shocked.

“Everybody was thinking it was end time for global markets,” said Hickey. “Lehman Brothers had collapsed. AIG had collapsed. The US Government was enacting giant bailouts for the banks and car companies. Financial markets had fallen 20 percent. Some people were saying it seemed like the end of capitalism.

“New Zealand superannuation had $14 billion funds under management, and we were on the eve of the new Government halting contributions to this fund. I fully expected Adrian Orr to announce counter measures for hunkering down and sitting it out.

“Instead he called the world a supermarket packed with discounts, and he was getting out the shopping trolley – they were going to run out and buy as much as they could.”

Speaking to the Christchurch leg of AdviceFirst’s Financial Markets Update roadshow, Hickey said that today the New Zealand Superannuation Fund – which has not benefited from any Government contributions for almost a decade – is worth $38 billion.

“The moral of the story is ‘keep calm and carry on’. The NZ Superannuation Fund had a long-term horizon. They knew that volatility is a fact of life and that all ups and downs can be navigated with a good plan and an eye for opportunity – all investors should keep this in mind.”

Hickey said the current volatility, including US President Donald Trump’s tax cuts, big spending and potential trade war with China, shouldn’t be a surprise because periods of peace are always followed by volatility and change.

“More than 250 years ago the invention of steam powered engines precipitated a period of growth and globalisation that ended with World War One. After the Second World War the world trucked along through a period of new technology and rebuilding, until the 1970s when we had the end of the gold standard, two oil shocks and the end of the Cold War.

“But even that period was followed by growth through the 1980s and late 1990s. Growth continues in the long run, particularly when new technology fuels a new surge in productivity.

“We’re now seeing a second industrial revolution that began with Steve Jobs’ introduction of the iPhone in January 2007. Like the steam powered engine, the technology that powers the iPhone is ushering in a new era of growth and globalisation

“This new industrial revolution will create a lot of value for some people, like investors in Netflix and Amazon, so it certainly isn’t time to be assuming it’s the end of the world or that things are going to get worse. If history shows us anything it’s that things always get better in the long run –our real challenge will be the fair distribution of that wealth.”

Hickey’s message?

Don’t be surprised by a return to volatility – decreases always seem more dramatic than increases – and don’t overthink things.

“Like Adrian Orr, learn to look past the headlines and the hype,” he said.

Do you want tulips with your bitcoin?

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The cryptocurrency bitcoin continues to make the news. What many New Zealanders don’t realise is that if they hold loyalty cards like Fly Buys or an air points card, they already own digital currencies.

However, when we read in December of a Wellington waterfront property for sale in bitcoin, and that bitcoin futures recently debuted on Wall Street, the subject of bitcoin and cryptocurrencies warrant consideration as a potential investment option.

What is a cryptocurrency?

Cryptocurrencies are digital currencies which use encryption techniques to regulate the generation of funds and the transfer of funds independently of a central bank.

What is bitcoin?

Bitcoin is one type of cryptocurrency that is produced and stored electronically. It has no intrinsic value – it cannot be redeemed for other commodities like gold – and it has no physical form because it exists only on a network of computers.

Bitcoin is not backed by any government or central bank, it is not regulated by any laws, and it is not universally accepted.

Bitcoin has a high profile because it was the first cryptocurrency. However, because they can be created with ease, as of writing there were more than 1,3001 other cryptocurrencies (including ethereum, ripple and litecoin) available on the internet.

Why is bitcoin valuable?

There is a cap on the number of bitcoins that can be created, limiting how much the currency can devalue through inflation. It can be seamlessly transferred between countries. A growing number of people are willing to accept it and to trade with it.

On a more sinister note, Bitcoin also enables crime and terrorist’s networks2, like ISIS, because it can be used for transactions that regular banks and governments would not allow.

How does bitcoin stack up as an investment?

Volatile is one of the first characteristics of bitcoin that comes to mind. The US Commodity Futures Trading Commission said in December that investors need to be cautious of an investment that surged more than 1,700% in 20173. Since the high of December 17, 2017, bitcoin was valued at $27,769 New Zealand Dollars. At the writing of this article (January 11, 2018), bitcoin devalued some 37% to $17,418 NZD on 22 December before going on to ‘recover’ to the current valuation of $20,776 NZD (9 Jan 2018) – still some 25% down on the earlier high4.

Dr Shane Oliver, AMP Capital’s Head of Investment Strategy and Chief Economist, labels bitcoin a bubble.

“To me, bitcoin has all the classic hallmarks of a bubble. It started off with some fundamental development, which is favourable, potentially revolutionising the payment system slashing the price of shipping money from around the world.

“But as the price goes higher and higher, investors are buying into it not because of the development but because it’s gone up… so it’s become very much a speculative bandwagon.”

Other financial speculators are now also drawing parallels to the Tulip Mania that gripped the Netherlands in the 17th Century, when some tulips sold for more than ten times the annual income of a skilled crafts worker, before dramatically collapsing.

What defines a good asset?

Before committing to bitcoin, or any other investment, ensure that it matches the definition of a good asset class. Ask yourself:

  1. Does it consistently earn on your behalf? e.g. interest bearing.
  2. Is it predictable? e.g. stable, not volatile.
  3. Is it widely accepted and in demand?
  4. Is it safe? For example, protected by regulation.
  5. Is it easy to buy or sell?

If the answer is no to some or all of these questions, talk first to an experienced financial adviser about what investments are best suited to your circumstances.

While investments that don’t have the above characteristics may provide opportunity for positive return, by and large, when dealing with peoples total combined wealth and financial goals, such investments fall more into the speculative and chance category, rather than forming the basis of considered and planned financial planning to meet one’s ultimate goals.

Tulips anyone?

Sources:
  1. https://fma.govt.nz/investors/ways-to-invest/cryptocurrencies/
  2. https://www.coindesk.com/u-s-think-tank-finds-rising-bitcoin-price-linked-terrorist- interest/
  3. http://fortune.com/2017/12/11/bitcoin-futures-contracts/
  4. https://www.cnbc.com/2018/01/08/cryptocurrency-ripple-crashes-30-percent-in-24- hours-bitcoin-also-dropping.html
  5. http://www.ampcapital.com.au/article-detail?alias=/site-assets/articles/insights- papers/2017/2017-11/all-aboard-the-bitcoin-bandwagon&audience=2

Goals-based Investing – A New Approach to an old Question

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When discussing a client’s financial planning needs, and specifically what portfolio to establish, an adviser is required to navigate through the client’s specific needs and goals. This is with an ultimate view to provide a portfolio from within the specific discipline and processes that will meet the client’s expectations, while importantly avoiding as much risk as possible.

While focusing on the growth of a portfolio is primarily what an adviser is often engaged to do, especially with historic low bank rates as we face now, a better and more client centric approach is to ensure the clients goals (fiscal or not) are incorporated into their financial plan.

Traditionally, this has been done by aligning these clients’ needs and goals to a risk profile. In turn, this risk profile is aligned with a Strategic Asset Allocation (SAA) where a mix of asset class sectors been applied.

For example, a balanced portfolio has 60% growth assets (shares etc) and 40% income assets (bonds and cash etc). Another layer on this is where fund managers see the market as it sits and apply tilts that underweight or overweight certain assets; this is called the Dynamic Asset Allocation (DAA). Again, for example, a Model Portfolio, for a Balanced Investor, has 57% growth assets and 43% income assets; in effect, a 3% variance.

This process has allowed financial planners and investment advisers to construct a portfolio that sits within their allowed variances of the SAA, while still trying to construct a portfolio with sub-asset classes to meet their goals. This also requires the adviser to be in tune with their client.

While many of these features can be achieved via the portfolio construction and the review / rebalance process, there is a ground swell of movement where such funds can build in the rebalancing function for the client. While these solutions may not make up the entire client portfolio, they certainly may be incorporated into the wider asset management structure.

What is also appealing for some investors, in some cases, are Absolute Return funds. Absolute Return is the return that an asset achieves over a certain period, expressed as a percentage that an asset achieves over a given period. Absolute Return differs from Relative Return because it is concerned with the return of an asset and does not compare it to any other measure or benchmark. Therefore, the saying “you can’t eat relative returns” rings true.

In practice, an Absolute Return fund invests into asset classes its sees appropriate for the time. While it may have an SAA, its DAA may vary totally and as such, it may be a highly traded fund.

Therefore Goals-based funds tend to have a lot more focus on protecting downside risk. This is particularly important for retirees because we all saw what happened in the Global Financial Crisis with more traditional balanced funds. They followed the market straight down . With the growth of KiwiSaver account balances to a point where they provide meaningful income levels for their clients, I see that Goal-based products will provide a natural transition out of the multi-sector funds once income is started to be drawn. This will form a part of the advice process and KiwiSaver Scheme and fund selection process.

While there has been a trend to low cost passive funds in what has been an extended bull market, we see clients now looking to better downside protection in an uncertain market.

In AMP Capital’s article – An Introduction to Goals Based Investing, they say that “The goals-based approach to investing is different as it represents a real shift in the way financial advice is given and the way investment solutions are designed. You could say it’s about turning financial advice and investment products on their head. However, it is important to note that the principles of diversification and risk management are still an important part of the portfolio construction process”.

Investing for sustainable, long-term wealth creation in a changing investment environment requires a different way of thinking. Success in today’s market calls for a more flexible approach and the ability to respond swiftly to change. This means a more dynamic approach to asset allocation and a focus on specific outcomes so investors can achieve their investment goals.

A good adviser will seek the appropriate mix for their client based on their goals. A Goals-based approach is built around helping people accomplish their goals, rather than focusing solely on investment management and performance. Therefore, you can assume that a goal-based fund may indeed be part of the appropriate mix for clients moving forward.

When your conservative portfolio is not so ‘conservative’

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The word ‘conservative’, particularly when it comes to conservative investment portfolios, usually suggests stable, slow-to-change and steady-as- she-goes, but in these changing times, there are early warning signs that a ‘conservative investment portfolio’ may no longer be the haven that it once was.

Most people who don’t have a huge appetite for risk, often because their earnings potential is declining due to age or because they need the income from their investments, will traditionally opt for a conservative investment portfolio. A conservative portfolio may be 75% bonds and cash, and just 25% of so-called riskier growth assets or shares – but the world is a different place from what it was five or ten years ago.

We are living in times of unprecedented and historic low-interest rates, not just here in New Zealand – where the Reserve Bank of New Zealand just recently left its official cash rate unchanged at 1.75% – but also in many of the world’s major economies. For example, the Bank of England last year cut interest rates to .25% for the first time in its 322-year history (it has since gone up to .50%).

Interest rates likely to rise

Essentially this means that cash investments are currently returning next to nothing, which puts pressure on people who rely on their investments for income. Meanwhile, inflationary pressures are increasing here in New Zealand and abroad – recent moderations in inflationary growth, due to a fall in energy prices, are unlikely to be long-term as low unemployment continues to exert upward pressure on wages and, as a consequence, prices.

The New Zealand Reserve Bank also needs to keep money flowing through our economy which, as it strengthens, may lead to rising interest rates to balance inflation.
On top of this, economists are also warning that we can expect to see higher interest rates due to positive growth outlooks, possibly early or mid-2018 here in New Zealand, while the Federal Reserve in the United States has already increased interest rates twice this year. At the moment, New Zealand’s banks are struggling to find cash to lend because the low-interest rate environment is deterring local investors from cash investments. As a result, local banks are having to source funds overseas, where rising interest rates are in turn making those funds more expensive. Ultimately, this will likely cause our banks to increase interest rates locally to attract ‘cheaper’ money. The upshot is that interest rates are likely to rise and, while this is good for cash investment returns, it’s not so good for the other half of your income portfolio, bonds.

Secondary market risks loom for bonds

Traditionally part of a portfolio to offer liquidity and flexibility, bonds can be defined as a ‘debt investment’, because when you buy bonds, you are essentially loaning money to an entity like a corporate or government e.g. government bonds.

Bonds can comprise around 40% to 75% of some conservative portfolios. When cash starts to outperform bonds, however, the latter ends up getting stuck on third base, resulting in a secondary market risk for investors with a large bond presence in their portfolios.

A good analogy for this is to think of your investment portfolio like a rental property. Think of your cash investment returns as the rental returns you would earn from a property. Bonds, on the other hand, are like the capital value of the property, which may decline as interest rates go up.

If your bonds are returning 4.5% interest and interest rates rise beyond 4.5%, you can no longer sell those bonds at their full value, (although you can sell at a marked down discount) because cash is worth more.

What’s more, you may be stuck with those low performing bonds until they mature years later, for example in 2020. We call this secondary market risk, and it is just such an eventuality that is making your traditionally conservative investment portfolio a riskier proposition than in the past – even for moderately conservative portfolios which consist of 60% income assets and 40% growth assets.

In summary, conservative investment portfolios may not be that conservative in a rising interest rate environment.

Time to challenge thinking about what’s conservative

Naturally, everybody’s needs are different, and each investment portfolio should be structured according to your individual goals and needs – based on professional investment advice – but perhaps it is time to challenge yourself with some ‘outside the square’ thinking when it comes to structuring your conservative investment portfolio. It is possible to achieve income and liquidity (traditionally viewed as the domain of bonds) from growth assets without being locked into low-yield returning deposits. Managed funds, for example, offer ways to achieve liquidity as well as solid returns, so long as you are prepared to take a portfolio-wide view of your investments.