Importance of diversification to get the best investment returns

If you’re an Oasis fan you’ll know who Liam Gallagher is. If not, at one stage Liam and his brother Noel fronted one of the biggest bands on the planet – Oasis.

Due to creative differences (regular punch ups), Oasis broke up in 2009 with the brothers going their separate ways. While the pair have still been making music, things haven’t been as lucrative for various reasons.

This was recently highlighted in a video clip posted online by the BBC to promote a documentary. While making tea, Mr Gallagher mockingly explained (between swear words) that he used to employ four people to make his tea in the 90’s. One running the kettle and the other three presumably dunking the bag, putting the sugar in and stirring the spoon.

However, he noted times had changed. Today he had to make his own tea because no one buys records anymore – they download them for nothing. As he found out, business models change while consumer habits demand change. Ignoring this fact is a huge risk for investors or anyone relying on an income from one specific source.

Take the taxi industry as an example.

Five years ago, you could have had a conversation with many taxi license plate holders who’d tell you a taxi plate was the best investment you could find – and with little risk. The number of plates was controlled by government, they offered high yield (leasing fees were great) and had offered steady capital growth on a secondary market.

Then the ride sharing services Uber and Lyft took off, while some state governments issued cheap new leases which undercut the rates plate holders were leasing their plates for. All this new supply took a hammer to the values of taxi plates.

At one-point taxi plates were reaching over $500,000 in various Australian states, this year they’ve been reported to be selling in the low six figure range. With plate owners being quoted in the media saying they’d bought the plates “as investments” and their “superannuation” it’s a sad state of affairs for these plate owners.

Unfortunately for the plate owners, the uncomfortable reality was the value of their plates was always being maintained by the discretion of the government of the day – our old friend legislative risk. And the value of the plates was inflated on a secondary market away from government issuance – it was speculation by any buyer that the value of a plate would hold or increase.

With this in mind, half a million dollars is an extremely large sum of money for any one investment. And with stories suggesting some plate owners have been forced to now apply for the age pension, it seems these particular owners were woefully undiversified. Life savings should never be ploughed into any one asset, especially not on the basis of conventional wisdom like “taxi plates have always gone up and provided income”.

Business innovation doesn’t stop and it affects everyone, whether you’re a taxi driver or rock star. The lesson for investors is to remain diversified because today’s rock star can quickly become tomorrow’s tea lady.

Ethical Organisations and Individuals - You must have both!

I saw a presentation from Major General Jim Molan yesterday about ethical leadership. Amongst many other things, Jim Molan was the Chief of Operations for the multinational Forces in Iraq in 2004. As you can imagine, leading forces in Iraq posed many management and ethical issues.

One of his key statements was that for ethical conduct to be assured, an ethical view must be held by both the organisation and the individuals within it. If either fail, the outcome will be compromised.

From a financial planning point of view I take two things from this:

1.       The importance of our organisation being actively and visibly ethical to ensure the people within it can and will act in our clients’ best interests at all times, and

2.       That regardless of how dedicated and pure of heart an individual planner is, if they work for an organisation that rewards bad behaviour in order to achieve it's own goals, that is what you are going get.

 

As a privately owned financial planning company, we tend to go on and on about being ‘non-conflicted’. This means we are one of the 15% of financial planners in Australia (and Bathurst) that aren’t controlled by the big four banks or AMP. This means we don’t have sales targets, we don’t share ownership with any fund managers, platform providers or insurance companies. We don’t have a share price to think about and no-one exerts any pressure on us in terms of volume or revenue. We answer to no-one but our clients. This makes an enormous difference in the advice we give.

 

Thanks Jim!

Boom Boom Goes Bust Bust

If you are old enough, you’ll remember him winning Wimbledon as a 17-year-old. Three decades later you may have heard the news about him going bankrupt as a 49-year-old.

The man in question is Boris ‘Boom Boom’ Becker. In the wake of his bankruptcy there have been lifetime earnings figures tossed around from the tens of millions to just over 100 million. While the exact figure remains unclear, it is clear he earned a lot and a lot of that money has now departed.

Like Johnny Depp earlier in the year, it seems Becker’s financial decision making isn’t the best. Although we’ll defer on casting too much judgement on Capt. Jack Sparrow, as there’s some conjecture about missing funds. Though if that’s the case, it does prompt the reminder – get good advice!

In Becker’s case, it appears he’s prepared to accept he’s the architect of his own demise, but like all these stories there seems to be some poor investment advice.

Now there are the well reported stories about his luxury lifestyle and his wandering eye, which resulted in multiple financial settlements and large child support payments. There were also his noted problems with German tax authorities whether his residence was in Germany or Monte Carlo which also resulted in a fine in the millions – clearly something that also required some good advice.

However, something not reported in English language media, but reported in Germany, was back in 2013 Becker had apparently been investing in the Nigerian oil and gas industry.

Nigerian prince jokes aside, Becker was said to have holdings of $10 million in just one of the investments.

The oil price has taken a very negative turn in the years since 2013 and Nigeria isn’t noted as the most stable of investment destinations. It has suffered constant interruptions to its oil production and export capacity due to an ongoing conflict with the Niger Delta Avengers bombing their oil and gas facilities.

There’s no mention of how long Becker held any of these investments, but given his track record in other financial matters and the state of the oil industry in Nigeria, we could assume they also didn’t turn out well.

Becker had found himself holding this exotic and volatile investment mix thanks to advice from an associate. The associate in question had links to a Canadian investment bank with a focus on oil and mining.

We’ve noticed over the years that that celebrity associates, managers and advisers never seem to recommend basic portfolios!

But what if Boris had done something else with his money? Let’s take the hypothetical scenario of Warren Buffett’s 90/10 portfolio, with 90% in the US S&P 500 and 10% in fixed interest. It’s certainly not our ideal, but it’s easy to construct and Boris is a man of the world so maybe he wouldn’t mind a US based portfolio.

Going back to 1985, after winning Wimbledon, Boris gets his winner’s cheque of £130,000 British pound and decides to invest. Take off 50% for his taxes and other expenses (yes, we know he’s not noted for paying taxes) and Boris is left with £65,000. We’ll invest in US dollars for him and given the exchange rate at the time it would give him $91,000 to invest.

Here’s the result.

BeckerBuffett.jpg

 

Half of that Wimbledon winner’s cheque in 1985 (a fraction of his reported career earnings) would have grown to $2.289 million by July 2017. You could only imagine his wealth had he made more choices like this over his career.

During bankruptcy proceedings held recently London, Becker’s lawyer, told the court: “He is not a sophisticated individual when it comes to finances.”

And it seems some of Becker’s advisers and associates were a little too sophisticated for his own good! Markets in developed economies have long offered decent risk/return opportunities, there’s no need to hunt exotic deals in extremely volatile provinces!

Channel Ten in administration, and what you can learn from it

In 2009 with the All Ordinaries at about 3,700 I bought a number of parcels of Australian shares. I used to be an avid ‘stock-picker’. I would read the paper and listen to the news. I would follow particular commentators and economists and even subscribed to a stock-picking service.

One of the quality stocks I purchased at that time was Channel Ten. I purchased the stock at the same time Lachlan Murdoch acquired a significant interest in the company. “If it’s good enough for Lachlan, it’s good enough for me” I thought.

I don’t own the stock any more, having cut my losses some years ago and evolved past the folly of individual stock picking, but there is still an ‘in joke’ with some of my friends that ends in “Don’t start me on Channel Ten!”. A few factors have contributed to the poor performance and eventual administration of Channel Ten over the last eight years. Some are obvious, some are not so obvious.

It’s a tough time for all media right now; at Fairfax, another round of reporters have taken redundancies as private equity circles. News Corp have been bleeding money and laying off photographers and subeditors, while remaining staff were reportedly told the company “is in a fight for its life”.

Most recently, Channel Ten went into administration when the major shareholders Lachlan Murdoch and Bruce Gordon refused to guarantee a new loan for the company. This likely won’t spell curtains for Ten as a whole but it will likely spell curtains for Ten’s smaller shareholders. And those smaller shareholders could be a little cynical given those larger shareholders have since made a bid to acquire the company themselves.

After the share price tumbled 82% this year. After they refused to guarantee Ten’s debt. After they watched Ten go into administration. To be fair, these are business decisions. My only interest in Channel Ten was to make money and it would be hypocritical for me to think others shouldn't view the company the same way. We would all rather acquire assets at a serious discount verses paying top dollar.

The lesson? The interests of large shareholders don’t always align with smaller individual shareholders. Sometimes our hard-earned capital is considered expendable because we have little else we can bring to the table – being significantly more capital to invest or political weight to influence outcomes for the business.

Ten itself hasn’t been the most stable of companies through the years, even before the recent difficulties for media companies. The internet has disrupted the flow of advertising dollars to traditional media companies and delivery methods, such as streaming, have more recently eaten away at traditional TV audience figures.

Competition and technological change have pressured companies to be better, get bigger or simply fail for hundreds of years. Investors don’t always see these changes coming and the right management may not be on hand to ensure companies respond adequately.

The lesson? Being a shareholder of any company means full exposure to the ongoing market disruptions and challenges that company faces. This means higher levels of risk and most certainly higher volatility than you would experience owning one of our diversified portfolios that contain small pieces of thousands of companies.

What does the AFL draft have in common with stock picking?

We’re now mid-way through the AFL season and football fans are enjoying the entertainment. For non-football fans it’s been 3 months of wondering why this circus takes up so much time on the news.

If you’re of the second persuasion, keep reading because the AFL still has some lessons for anyone who thinks humans are adept at turning the art of selection into future success.

At the end of every season the AFL runs its yearly draft, where teams select the best available junior (and some mature age) talent from around the country. Generally, the draft order runs from the worst to best teams in the just completed season – the team finishing last receives the first pick in the draft etc. Though picks can be traded prior to the draft for existing players.

In the year leading up to the draft prospects are watched by talent scouts, they and their families are interviewed by clubs and in the month prior to the draft there’s a draft combine where the top talent are tested for their psychical attributes. Every team has access to tests on speed, agility, endurance, kicking accuracy, jumping and ball handling. Afterwards, potential draftees are interviewed by team psychologists.

With all this time and money spent analysing and evaluating the top junior players, you would think that clubs would be nailing their selections and would have worked out who will be a great AFL player. You would be wrong.  With all this analysis, there is still no great degree of success.

And when you think about it, all this analysis is little different to all the analysis that goes into picking stocks. A bunch of experts pore over listed companies to come up with their best picks for the year ahead and frequently produce more losers than winners. There are no shortage of examples highlighting how poor stock pickers are at their jobs.

If they’re being honest, both AFL clubs and stock analysts, would have to admit there is a significant amount of luck involved in getting it right – a higher position in the draft and more picks should help with success, but often it doesn’t.

Looking at the most dominant teams of the past decade, Hawthorn (4 premierships) and Geelong (3 premierships), they have had varying success when it comes to their drafting, but interestingly fewer top picks than a less successful team like Richmond who haven’t won anything.

Since 2000 (we’re looking beyond just the last decade as drafting takes time to evaluate) Hawthorn has had eight selections within the top 10 picks at the draft, but only half of those picks became important players for the club. In the same period Geelong had five selections within the top 10, with three of those genuinely contributing to their success.

The most notable at Geelong, Joel Selwood, came at selection seven in 2006. There were no questions over Selwood’s ability, but medical reports said his bad knee would degenerate quickly. Many of the six clubs before Geelong’s selection agonised over this advice, eventually passing on Selwood. The irony? A decade later Selwood has played more games than any other player drafted in 2006, has been a crucial part of Geelong’s success and has never been hindered by his suspect knee.

Finally, there’s Richmond. Proof that more top picks aren’t a guarantee of anything. Since 2000 Richmond have had nine top ten selections. Famously, with two of those selections Richmond overlooked Buddy Franklin and Jarryd Roughead in 2004. Both were then taken by Hawthorn and played in multiple premierships for the club. We won’t continue to rub it in for Richmond fans, maybe 2017 will be their year.

It’s understandable people believe scouts and analysts who devote significant time and effort evaluating the best individual AFL prospects and individual companies could ensure success. Surely all that effort most come to something. However, the records of both are less than impressive.

The reality is the future is hard to predict and luck regularly plays a part. The difference for investors is they don’t have to depend on luck. Proper asset allocation and diversification ensures they can still enjoy growth from the year’s best performers while ensuring the worst performers won’t leave their portfolio with the wooden spoon.