Market Volatility - it can be difficult to keep a cool head - Julia Lee

In times of market volatility, it can be difficult to keep a cool head and ride out the storm. Volatility often scares inexperienced investors and it can be difficult to see your shares rise and then plummet for seemingly little reason day to day.

While it is much easier watching shares rise and rise and rise, a bit of market volatility might be just what's needed to pick up some bargain shares. So keep your cool, and make some money.

Market volatility happens when uncertainty creeps into the sharemarket such as the volatility that we are seeing due to instability in the US financial sector. Firstly, we need to determine the cause of the volatility and secondly the impact it is likely to have on the future business environment.

The cause of the current volatility in the market is the US housing slump and the problems in the credit market. At the moment, it looks like this may lead to a recession in the US and hence a slowdown in global growth. While Australia is somewhat immune to a slowdown in the US, if it starts to affect China, then it will in turn flow on to Australia.

So how do we ride out this volatility? For some people, the answer will be to wait on the sidelines in cash until things become rosier. For others, this is a chance to pick up quality businesses at cheaper prices. There is a danger of being out of the sharemarket altogether, because it is so hard to time the market accurately and shares historically are the best asset class to create long term wealth.

Sectors that are high yielding with solid cash flows are usually called defensive stocks. They are called defensive because they ride out downturns in the market much better than other stocks. Benjamin Graham said it well when he said that dividends act as a buffer in bear markets. It's because regardless of what the share price is doing, you will still usually get dividend payments.

Defensive sectors on the Australian sharemarket are usually the industrial and property trust sectors. Their high yields often act as a buffer to a fall in share prices. Beware of highly geared stocks, as these stocks usually are more risky.

In the end the sharemarket is a market full of businesses. As long as the business is improving profitability, then the business value should increase and hence the share price will also increase in the longer term. Volatility is about short term market reaction and when the market settles down, it will focus on what companies are really valued at.

I consider confusion a great time to make profits for those that keep sound logic. The key is to look at the underlying business, as opposed to the share price noise. Some of my best trades have been when everyone else is running out of shares. It is fundamentally easy to make money in the sharemarket - buy low and sell high. Unfortunately for most beginners the opposite occurs. They buy at the top of the market when everyone is making money and then sell at the bottom of the market when everyone is selling through fear.

There are always shares to steer clear of when the market is volatile. They are the businesses which aren't making profit yet. These are usually the shares hardest to fall when fear sets into the markets.

Remember the sharemarket is a market full of businesses and if you can pick up a good business at a cheap price, it's a cause for celebration rather than fear. Evaluate shares on the underlying business and not the greed and fear that drives markets.

Happy Investing!

The real cost of buying and owning a property can come as a bit of a shock to many first homebuyers - Jeremy Gough

WITH considerations such as stamp duty, loan establishment fees, pest and building inspections, and conveyancing costs, there's a lot more to buying a property than simply arranging the finance to meet the agreed sale price. These extras can blow out to make a real mess of your budget and that's before you get into ongoing costs such as rates and insurance. Experts like Mark Armstrong, a director of Property Planning Australia, say it's vital all first homebuyers go into the market with their eyes wide open. "People should make sure they speak to their financial adviser to get a clear picture of their cash flow and financial commitments," he says, "and they need to think carefully about the selection of their asset... First homebuyers certainly don't want to push themselves to the line to afford a property and then discover they can't make the payments and have to sell the asset for less than they paid." Traditionally, the biggest one-off extra expense a purchaser faces is stamp duty. This is a tax charged by all state and territory governments based on the amount borrowed and the purchase price of the property. The rates vary between states but can add 3, 4 or 5 per cent to the cost of an average home.

The good news, however, is that first homebuyers are commonly entitled to a concession on stamp duty. For example, in New South Wales first homebuyers who qualify are exempt from stamp duty on properties under $500,000 and receive concessions on properties of $500,000 to $600,000. The concession isn't necessarily as generous in other states so first homebuyers should seek advice about the concessions in their area. Armstrong says borrowers also need to be aware of the loan establishment fees charged by banks or other lenders that generally start around the $500 mark. And then, he says, there's the small matter of paying the interest on the loan. For those who don't go for a fixed mortgage, the repayments can move up and down with interest rates. "People really need to factor possible interest rates rises in," Armstrong says. "They need a buffer to ensure they can still afford to meet their commitments if interest rates were to continue to rise. I would think that a 1 per cent buffer would be enough at the moment."

Then there's insurance. Most financial institutions lending a high percentage of a property's value will require lenders mortgage insurance (LMI). Many banks require LMI if they lend more than 80 per cent of the value of the property for standard full doc loans, or 60 per cent for low doc loans. The cost of this is added to the loan.

This offers buyers the opportunity to purchase a property with a smaller deposit, but should they default and the property is sold for less than the outstanding amount on the loan, LMI protects the lender, not the borrower.

Armstrong says mortgage insurance can come to $5000 or even $10,000 depending on what percentage of the property's value you're borrowing. Most lenders will also insist you take out building insurance. Contents insurance and income insurance are also recommended.

Armstrong is a firm believer in potential purchasers paying a professional to peruse any contract before committing to buy. "This may cost you around $50 to $100 but in my view it is absolutely essential," he says. "This is particularly true if you're buying at auction as there's no get-out... naivety is no excuse when you find out there's a great easement going through the property that you knew nothing about."

As the sale proceeds, purchasers need to factor in the legal costs. Buyers may undertake conveyancing themselves but generally a solicitor or licensed conveyancer is engaged. Conveyancing fees can vary dramatically, depending on the type and number of searches required and the property's location. You pay for the costs of the searches as well as a fee for the professional's time. The legal fee can be as little as $250 but is generally far closer to $1000. A couple of key things a conveyancer or solicitor will arrange to have done are a building inspection and a pest inspection. These will each cost around $300 to $600, depending on the size of the property and what is being checked for. Obviously, these are expenses that can potentially save buyers a small fortune so are well worth incurring.

You can also expect to pay land transfer and mortgage registration fees. These are state government fees and can vary significantly depending on where you are. Check the cost with the appropriate authority.

But wait, there's more.

You probably also have to factor in gas, water, electricity and telephone connection fees. You may also have to pay to have your mail redirected from your old address for a while. And there are moving costs and the ongoing costs. While some people prefer to hire or borrow a truck or van to move their goods and shackles themselves, for most it's worth spending a few hundred dollars to save the stress and hassle.

In terms of ongoing costs, council rates can add up to a couple of thousand dollars or more each year and, if you're buying a unit, you'll also have the body corporate fees to consider. Then once you move in you'll have the costs of maintaining the property. It all adds up to the best part of a tidy sum but Armstrong returns to the theme that, apart from making sure they can afford the payments, the most important thing that homebuyers can do is select their asset wisely.

"First homebuyers need to know the investment potential of their property," he says. "They're not generally buying their dream home... they're buying a stepping stone to bigger and better things." He says the cost of making sure they're making the right decision is comparatively minimal compared to the possible gains, advising that the difference between 5 per cent capital growth and 10 per cent capital growth over a few years is huge.

"First homebuyers who may be under financial pressure should be very careful about the selection of their asset," Armstrong says. "If they do find themselves in difficulties, they want to be able to sell it easily. They have to think about the worst-case scenario and look at underlying demand to their property and be sure there isn't an oversupply of that sort of property."

"I certainly believe it pays to get some independent advice from a valuer or buyers agent to obtain a real idea of a property's value... this may cost $500 to $1000 but, in my opinion, it's money very well spent."

Jeremy Gough - Australian Property Investor magazine

© Australian Property Investor magazine - www.apimagazine.com.au  

LICS - Understand your Portfolio investment options - Angelo Veschetti

There are currently 196 Listed Managed Investments (LMI) listed on the ASX with a surprising market capitalisation of some $164.6 billion.

There are six broad LMI categories; Listed Investment Companies (LICs), Exchange-Traded Funds (ETFs), Listed Property Trusts (LPTs), Infrastructure Funds, Pooled Development Funds (PDFs) and Absolute-Return Funds.

Here we're covering LICs, which we believe give the investor another tool to build a portfolio with some diversified market exposure.

What are they?

A LIC is a company listed on the ASX, whose role it is to buy and sell shares. LICs allow investors to build a diversified share exposure simply by buying shares in the LIC. You would use them over managed funds to save fees, to speed up the investment process (buying or selling) and for transparency in price to value (NTA is discussed below).

Look before you leap

Generally, you could choose LICs as you would managed funds. There is however a couple of extra things to think about before you sell out of your managed funds in favour of these assets.

Fees. Historically, performance fees were generally the domain of LICs. Investors could therefore be forgiven for having no idea of how these work. Today though several fund managers use them as a means of lowering their general management fee in a bid to align their wealth with the investor's. We agree with this - in principle! While most managers are getting it about right, we still think investors ought carefully assess the performance fee in light of the total fee. The presence of a performance fee should drive a reduction in the general management fee (aka the management expense ratio (MER)). If it doesn't, then have a look elsewhere as there are plenty to choose from. We also believe that there should be a good hurdle rate linked to the market that the LIC invests in and a high water mark to ensure that performance consistency is rewarded (or otherwise).

Taxation. LICs pay tax on income and realised gains at the company tax rate and are not forced to distribute any of this to shareholders. If they do make a payment to shareholders it is usually done as a franked dividend. This means that managed funds, which distribute all of their income and realised gains, may not be as tax-efficient as LICs.

Pricing. Is the price reflective of the underlying value of the portfolio? Can you, like Warren Buffett (the world's most famous investor), buy a dollar's worth of assets for fifty cents? LICs actually publish a figure called "Net Tangible Asset backing - NTA" which helps answer these questions. In its simplest form, NTA is the total value of all the shares/investments that the LIC owns divided by the number of shares on offer. For example, if a LIC that has 10 shares on offer owns one BHP share and one CBA share with a total market value of say $100, then the NTA of the LIC is $10 (=$100/10 shares). So if this LIC happens to be trading at say $5 per share, a deep discount to NTA, then you could literally buy a dollar's worth of assets for fifty cents. But beware of simply buying LICs based on NTA relative to share price! It's akin to simply buying normal shares using a Price/Earnings (PE) ratio. The premium/discount to NTA varies according to the market's perception of management quality, the structure and quality of the underlying portfolio and also the market cycle. A good rule of thumb is to establish a fair value price range by defining a long term trend range for price to NTA. This method can serve as a conservative guide for whether the NTA premium/discount is reasonable at any given offer price.

SWOT analysis

We believe that an effective way to determine whether or not to use a product is to conduct a SWOT analysis, analysing Strengths, Weakness, Opportunities and Threats. As you will see, some aspects sit across categories, depending on each investor's view.

Strengths

• Are actually managed. A good manager can add real long term value over the benchmark.
  
• Benchmarked. They're usually benchmarked, hence tell you what comparator to use.
  
• Diversification. Represent a diversified portfolio of holdings wrapped up in a single asset.
  
• Liquidity. Listed on the ASX hence can be easily bought or sold.
  
• Open-ended. Some managed funds close (stop accepting new funds), whereas LICs do not.
  
• Fees. Are usually cheaper than managed funds.
  

Weaknesses

• Are actually managed, so there's risk in terms of the manager making mistakes.
  
• Can trade at discount to NTA for a long period of time.
  
• Can sometimes trade at premium to NTA for a long period of time giving little opportunity to top up an investment.
  
• Have performance fees, which may not be totally transparent.
  

Opportunities

• Can be bought at discount to NTA.
  
• Generally better for tax paying investors as they generally retain and reinvest realised capital gains.
  

Threats

• NTA valuation assumes that the market is valuing all of the investments held in a portfolio correctly. We note that the market can be a fickle place, changing valuations wildly on little more than sentiment at times.
  
• Some may be carrying large unrealised capital gains that could be realised in your investment timeframe, which may give rise to additional taxable income.
  
• Might have to be sold at a discount to NTA.
  

So long as you look before you leap and appreciate that cheap is not necessarily cheap then we generally believe that many investors can get some good, low cost exposure to certain asset classes through the careful selection of a few LICs.

Australian Foundation Investment Company Ltd (AFI)

Benchmark: S&P/ASX 200 Accumulation Index.
Investment style: value based, large capitalisation stocks, investing for the medium to long term.
MER: 0.13%.
Australia's largest LIC.

Argo Investments Ltd (ARG)

Benchmark: All Ordinaries Index.
Investment style: value based and its portfolio is diversified within both large and small capitalisation stocks.
MER: 0.2%.
Australia's second largest LIC.

Global Mining investments Ltd (GMI)

Benchmark: HSBC Global Mining Index
Investment style: GMI invests in natural resource companies across global markets.
Objectives: gain exposure to a diverse portfolio of natural resource companies across global equity markets.
Manger: Bell Potter Funds Management Limited delegate investment decisions to Merrill Lynch Investment Managers Ltd UK.
Management fee: 1.25% p.a.
Performance fee: 15% of outperformance.

Century Australia Investments Ltd (CYA)

Benchmark: S&P ASX300 Accumulation Index
Investment style: active, bottom up approach with a 5 year management agreement with 452 Capital.
Manager: 452 Capital under Peter Morgan.
Management fee: 1.00% p.a.
Performance fee: 10% of outperformance in excess of 3% above S&P/ASX 300 Accumulation.

Hunter Hall Global Value Ltd (HHV)

Benchmark: MSCI World Accumulation Net Return Index in A$
Objective: to achieve substantial growth in the value of each share through ownership of a portfolio of undervalued international and Australian equities, augmented by a tax efficient capital management policy.
Manager: Hunter Hall Investment Management.
HHV has a policy of acquiring and cancelling the ordinary shares at around a 10% discount to the post-tax NTA.
Management fee: 1.5% p.a.
Performance fee: 15% of outperformance.

Contango Microcap Ltd (CTN)

Benchmark: S&P ASX All ordinaries Accumulation Index
Investment style: uses the business cycle approach to stock selection based on the fact that macro economic factors influence the relative performance of both industries and stocks. It holds a medium to long term portfolio of shares in companies that are in the micro cap sector of the ASX.
Manager: Contango Asset Management.
Management fee: 1.25% of net assets.
Performance fee: 15%.
Senior staff own 50% of the company.

Be careful when moving assets other than cash into self-managed superannuation funds - Laura Menschik

Although 'Simpler Super' was brought in recently to make things easier for some of those concerned, it is not much simpler for trustees of SMSF's. The Australian Tax Office (ATO) releases information, alerts, notices, and rules for the establishment and ongoing administration of SMSF's which may escape the notice of some trustees.

Some recent releases are outlined below:

A taxpayer alert on non-cash contributions to superannuation funds has been issued.

The ATO has released a Taxpayer Alert warning trustees to be careful when moving assets other than cash into self-managed superannuation funds.

The alert highlights the ATO's concerns about certain transactions designed to manipulate contribution limits and avoid excess contributions tax.

Some key points from this alert are:

• when assets other than cash are transferred to a fund, trustees must make sure the fund accurately reports the market value of the assets and considers any other relevant superannuation regulatory issues.
  
• people paying expenses on behalf of their fund or improving the value of their fund's asset may be making a contribution which needs to be reported for the purposes of the excess contributions tax.
  
• both trustees and members need to consider any income, capital gains and fringe benefit tax when transferring assets.

New reporting requirements for self managed superannuation funds.

From the 2007-08 income year, trustees of self managed superannuation funds (SMSFs) will lodge the new self managed superannuation fund annual return 2008 (NAT 71226).

• The new SMSF annual return replaces the old fund income tax and regulatory return and member contribution statements (MCS).
  
• This new annual return can be used only by SMSFs. All other funds must use the Fund income tax return 2008 (NAT 71287), the 2008 SMSF annual return and fund income tax return will be available in June.
  

The new SMSF annual return reflects changes made to the superannuation system that apply from 1 July 2007. Consequently, there is information trustees will need to provide for the first time.

• Trustees can refer to the examples and tables provided by the ATO on their website.
  
• On the other hand, the ATO no longer require some information that was required to be provided in the past.
  

The ATO used the feedback they received from tax professionals to make design changes and rename some items to align with common industry terminology.

Some changes aim to streamline reporting and simplify the process, include:

• report all member information on the SMSF annual return, including members who have not made contributions.
  
• the annual $150 supervisory levy is included in the income tax calculation and on the notice of assessment.
  

To make it easier for trustees to calculate the SMSFs tax liability, the ATO have simplified how they report private company dividends and excessive non-arm's length income (previously referred to as 'special income') so trustees can separate the amounts that are subject to the higher tax rate.

Questions & Answers.

I have been receiving some questions from Money.com.au readers which I will try to address next month. Please feel free to email me with your questions at lm@wlm.com.au with the reference: "Q&A for Money.com.au".

As with all aspects of your financial affairs, and especially in regards to SMSF's, ensure that you are not beaching any rules, plan accordingly and appropriately and always seek professional advice in areas for which you are uncertain or have less expertise.

Laura Menschik
Director and Authorised Representative
WLM Financial Services Pty Ltd.
CERTIFIED FINANCIAL PLANNER TM - SMSF SPECIALIST ADVISER TM
Visit the WLM Financial Group online wlm.com.au

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