Q3 - Winners Losers and Emerging Themes - Julia Lee

With the 3rd quarter coming to an end, it's time to evaluate the winners, the losers and the emerging themes. Not only has Armageddon been avoided in the 3rd quarter but there have also been some stellar performances.

In the quarter to date, the benchmark S&P ASX 200 is down 4.5%. That's in line with the performance from Wall St with the Dow Jones Industrial Average down 4.4%.

The Australian market is currently 26.5% off its November 2007 high and the All Ordinaries Index continues to hover around the 5000 level, and starting to find support.

Equities - Top 5 Winners

DJS up 56%
RMD up 47%
FCL up 43%
PMP up 42%
COH up 36%

David Jones has been the top performing stock in the benchmark S&P ASX 200. Despite a tough consumer discretionary spending environment, David Jones lifted its profit forecasts for the full year. Full year net profit came in at $137.05 million which was a new record and above the company's forecast of $135-137 million.

Resmed came in second place and the performance in its share price was also on the back of a record financial result for the year ended 30 June, 2008.

Equities - Top 5 Losers

BBP down 81%
BNB down 77%
CER down 62%
MCR down 61%
MRE down 58%

Babcock and Brown Power continued its decline with a massive 81% decline in the quarter to date. That takes the total loss in its share price for the year to a loss of 95%. The parent company has also fared poorly with a 77% decline in share price for the quarter. Both companies plagued a cut in credit ratings and worries about its debt funded investment model.

Centro Retail has also been sold down heavily with a loss of 62% in the quarter. It's been trying to sell off assets to pay off debt which is something that the market is not taking kindly to at the moment.

Both Mincor and Minara are involved in nickel mining and exploration. Both these companies have lost value on the back of a plunge in nickel prices. Nickel prices have fallen by around 25% but the miners have lost more than double that in the same period.

It's been an extraordinary quarter both domestically and in the US. We've seen short selling banned on financial stocks in the US, UK and many countries around the world. In Australia, ASIC is concerned that current market conditions coupled with extensive short selling is causing unwarranted price fluctuations and has banned short selling on shares in Australia for 30 days with a few exceptions. It announced the changes on 21st September.

The US is looking at a bailout package which could cost $700 billion. Market watchers are hoping that its enough to restore confidence to the markets and to re-start liquidity in the credit markets.

In an economic sense, there's been little good news with the global property market continuing to fall. For the sharemarket, some people have started to call a bottom for the markets. While there does seem to be some light at the end of the tunnel, there are significant problems in the US economy to work through before an end is in sight.

For longer term investors, they can take comfort from Warren Buffett's actions. The world's most famous investor has taken a US$5 billion stake in Goldman Sachs and if the world's most famous investor is buying then surely some stocks are worth snapping up now.

Happy Investing!

Julia Lee - Equities Analyst - Bell Direct

To buy or sell shares from as little as $15 per trade, go to www.belldirect.com.au  

Bell Direct does not provide investment advice. This information is general information only. You should consider your own financial situation, particular needs and investment objectives before acting.

Creating a substantial property portfolio can be a lifetime's work, so serious investors need to know how to keep their assets safe. -  Michael Carman

You've lovingly accumulated your property portfolio, investing and borrowing while you're working, using capital growth and rental returns to build your empire. But there are a few storm clouds on the horizon: high interest rates and an increasingly litigious society to name a couple. The issue for you now as you contemplate transitioning to financial independence is not how to build wealth, but how to keep it.

Here we'll look at 10 ways to protect your wealth and keep your prized portfolio safe.

As many investors know, property investing is as much about managing cash and liquidity as it is about choosing properties, managing tenants and arranging finance. You need to ensure that you're able to access the cash needed to feed your portfolio and enable it to grow: this is a key wealth-building skill. The first few tips deal with your ability to manage cash so your portfolio can continue to appreciate and generate ongoing wealth for you.

1. Take out income protection insurance

If you're a negatively geared property investor who's self-employed or you work on contract, your salary doesn't have the same short or medium-term stability or security as a wage earner who's a permanent employee.

One risk-management strategy you can put in place to maintain the stability of your income is to take out income protection insurance. This ensures you continue to receive a certain amount of income if you suffer a decline or inability to work. Income protection insurance covers you for such things as illness or disability. It'd be hard to cop building a large, geared portfolio and then having your ownership of that portfolio threatened because your ability to service the loan repayments was undermined by a long illness. You want your property portfolio to be able to support you but until it does you need to be able to continue to support it!

A helpful aspect of income protection insurance is that the premium is deductible for tax purposes.

2. Take out landlord's insurance

We've all heard horror stories of tenants who trashed rental properties, were months behind on the rent and skipped the premises while still heavily in arrears. This not only causes costs for the investor in repairs and lost rent but also causes delays in collecting future rent because of the time required to get the property in order.

While prevention is obviously better than cure, in that good tenant selection is paramount, landlord's insurance offsets the cost (and some of the pain) of a bad tenant. This can mean the difference between a bad tenant causing only a minor disruption versus a huge cash hole.

As with income protection insurance the premium for landlord's insurance is tax deductible.

3. Keep a cash buffer

The most straightforward means of ensuring you can get cash quickly is to have some on standby.

Don't part with cash if you don't have to when making a property acquisition. To the greatest degree possible, let a bank or lender be satisfied with equity in the form of hard assets rather than cash so you can have cash on standby and under your control.

You can still have the cash working for you if you have it sitting in an offset account or line of credit.

There's no substitute for cash - it's the most liquid asset - and a ready supply is one of your best risk management measures.

4. Borrow more than you need

This may sound counter-intuitive since higher borrowing increases risk (other things being equal) but here we're just talking about an extension of number 3: when you buy a property, if your loan-to-value ratio (LVR) allows, your financing may permit taking out a few extra thousand dollars on top of the cost of the property and associated legal and purchase costs to keep on standby.

These extra borrowed funds don't need to add to your repayment costs: you can simply keep them in a line of credit, to be drawn down if you need to meet a sudden or unexpected expense.

5. Lock in your interest rate

It's something of a game for geared investors to try to beat the market by second-guessing future interest rate movements by locking in a fixed interest rate. The gamble is that the fixed rate you lock in will be lower than future variable rates for the period for which the rate is fixed.

Usually, long-term rates (i.e. those at which a rate is fixed) are higher than variable rates, with the longer the term the higher the rate. If you plotted interest rates from short term to longer term the line would slope upwards - this line is called the yield curve. The time to lock in a fixed rate is when you believe the yield curve will invert (i.e. the yield curve will slope downward rather than upward).

Betting on interest rate moves is a highly fraught (some would say speculative) venture. Trying to forecast future interest rates is far more difficult than choosing a good property investment.

Really, the benefit of fixing your interest rate lies in giving you certainty about your loan repayments for a given period of time - this is where its risk management value resides.

6. Make your loans stand alone

The usual means for a working property investor to accumulate a portfolio is by using the equity generated by the capital appreciation in one property as the security, or collateral, for a loan that is used to acquire another property.

This process, known as cross-collateralisation, means that the liabilities from one asset are in effect woven in with the liabilities from another. There's a whole tapestry of debt supporting the portfolio of assets.

This is fine in and of itself, and is a critical means of structuring finance to build a property portfolio for many investors. The problem arises when there's a cash shortfall in meeting the repayments on one loan, which then ripples through the debt structure, endangering the portfolio as a whole. Then, the tapestry of debt turns into a house of cards and the whole thing can collapse, meaning you lose the lot.

You can owe on a property loan even after assets are repossessed and sold if property values dropped below their purchase price and the bank didn't recoup the value of the loan. You'll be liable to pay the difference - a scary prospect.

How can you avoid a cash shortfall rippling through your whole liability structure? By releasing security and de-coupling your loans. Growth in equity enables this to happen because there may be sufficient value in one property that enables it to meet the loan to value requirements of the original loan, free from the requirement for equity from another property.

The loan structure would then be segregated: an asset that was tied to another would instead stand on its own. In effect the liability structure would be divided up and the (possible) house of cards subdivided (pardon the pun) into smaller, independent entities.

De-coupling a loan in this way means the liabilities are spread and dispersed and can therefore be more effectively managed because they're quarantined in smaller lumps.

The usual considerations would apply where security is to be released: bank valuations (or more correctly, revaluations) would be conducted, with mortgage insurance required if the 80 percent LVR requirement isn't met.

At first blush this strategy conflicts with what we noted earlier (in number 3) about using hard assets rather than cash to secure an investment loan. However these can be seen as different steps in the same process: a portfolio can be accumulated using cross-collateralisation, leaving cash free, and the loans can be de-coupled later once equity has grown.

The vigilant investor therefore has the ability to take advantage of the power of leverage to build a large equity-rich portfolio and to subsequently manage the liabilities used to finance this portfolio by splitting them up. It's a nice facet of equity growth that it not only builds wealth for an investor but also enables an investor to manage their liabilities by splitting those liabilities up.

7. Use a trust

In the same way that you can quarantine liabilities by de-coupling debt into smaller entities, as we've just seen, a trust can be used to quarantine liabilities.

A trust is a legal entity that can own property: it has beneficiaries who are the people or entities to whom the returns of the investment owned by the trust are distributed. A trust will also have a trustee who, in a discretionary trust, will distribute the investment returns as he or she sees fit. The trustee can be a person or company.

The protective benefit of a trust for a property investor is that if you have debt enforcement action taken out against you or you go bankrupt, assets in which you have an interest via a trust (including of course, properties) will be sheltered from such action.

Robin Evans, of solicitors Evans and Wislang, notes that because of this, if your property assets are owned by a trust, only the creditors of the trust - not the creditors of beneficiaries or the trustee - can lay claim to those assets.

"Effectively this takes the asset out of, say, a debtor's pool of assets which would be available to a creditor.

"Similarly," observes Evans, "creditors to the trust aren't able to claim against a beneficiary's assets for a debt of the trust.

"By the effective use of a trust a person can acquire assets which will not be available to his general creditors," Evans says.

The protective value of trusts was in the spotlight recently, particularly after the Westpoint case where the Australian Securities and Investments Commission was able to obtain injunctive orders in relation to assets in the hands of other legal entities (including trusts) in order to make the assets available to creditors.

However, Evans notes that where a trust acquires an asset for full value and there's no suggestion of any impropriety, that asset is protected under the trust from claim by unsecured creditors of the trustee or beneficiaries.

There are other benefits of a trust as well, most particularly the ability to distribute income on a basis to minimise tax liabilities. But from the asset protection point of view that we're interested in here the value of a trust is that the risk associated with the debt or liability used to acquire an asset can be managed by virtue of being quarantined within a trust structure.

8. Get a pre-nup

It's never a happy topic to consider but if you're getting married or in the early stages of a long-term relationship and want to ensure your property assets stay in your hands in the event of the breakdown of the relationship, a pre-nuptial agreement (or pre-nup) may be for you.

A pre-nup stipulates how assets will be divided if the marriage or relationship dissolves, before that event occurs (if it ever does).

Many lawyers recommend that asset-rich investors get a pre-nup, also known as a Binding Financial Agreement. On the other hand, many people don't like the idea of a pre-nup because it appears to them to pave the way for a break-up rather than supporting the idea that the relationship will endure.

In an ideal world, pre-nups wouldn't be needed, or at least both people in the relationship would want one. But for many, this ideal is not a reality.

The choice is yours. If you believe your relationship will last the distance and/or that your partner won't take you to the cleaners in the event of a breakdown, don't get a pre-nup. But if you want to ensure your ongoing ownership of your properties, push for a pre-nup. According to the statistics, the probability of a marriage ending in divorce is increasing over time (from around 28 per cent in 1985-1987 to 33 per cent in 2000-2002) so if you're able to get one you'd be well-advised to take it. Just ask Paul McCartney ...

9. Ensure you have an up-to-date will

This is as gloomy a topic as pre-nups but of even greater importance. No-one should be without a will - and this applies all the more so to property investors. You need a will to ensure your property and other assets are distributed after your death to whomever you've chosen.

Give yourself - and your intended heirs - peace of mind by ensuring there's clarity around who gets what.

Hopefully you won't need to use it for a long time. But it would be a terrible irony if the property assets that were supposed to bring you security and freedom brought your intended heirs conflict and insecurity.

Hope for the best but prepare for the worst.

10. Buy cheap

We're saving the best till last. It's an old investment cliché that you make your money when you buy rather then when you sell. However another aspect of this is that buying at a bargain price is also an excellent risk management measure.

This is for the obvious reason that you're parting with less capital, accumulating fewer liabilities and setting up the cash return from the investment at a higher yield relative to purchase price. Also, if you're able to buy at a discount to market you have, in effect, created immediate equity which has its own risk management value.

This is an aspect of the value investing approach adopted by the richest person in the world, famed investor Warren Buffett. For Buffett, risk and return can sometimes be positively correlated (as conventional finance theory states) - but not all the time. While many investors associate risk with volatility and price swings, the fact remains that if you buy an asset (whether a property, shares or a business) at a discount to its true value because of a price drop there is both less risk for you and greater potential for reward.

So kill two birds with one stone: do the research and the number-crunching to buy properties which are trading at a discount to their true worth (understood as the sum of their expected future rental return and capital growth) and get the benefit of higher returns. You'll not only be adding to your wealth, you'll be better insulated from cost increases or interest rate rises.

© Australian Property Investor magazine - www.apimagazine.com.au. Reproduced with permission.

This information is of a general nature only and does not constitute professional advice. You must seek professional advice in relation to your particular circumstances before acting. Please read our warning and disclaimer.

SMSF - New Annual Return streamlines reporting - Laura Menschik

This year is the first time self managed super funds (SMSFs) will use a new form entitled the "Self managed superannuation fund annual return".

This new return is only for use by SMSFs. The new SMSF annual return integrates the three previous reporting obligations into one streamlined form for:

• income tax
  
• regulatory
  
• member contributions

As with any new product there have been some issues around understanding how some of the new labels operate and the new integrity work being enforced for the first time. The ATO has published some tips on their website to help SMSF's complete the return as well as "Self managed superannuation fund annual return 2008 instructions", a 72 page booklet which is available as a PDF.

The ATO's tips provide clarification around various issues, including:

• member information - Section F & G and how to calculate member account closing balances.
  
  and
  
• accounting for rollover amounts across Section B (income), Section F & G (member information) and the relationship with the Rollover Benefit Statement.

For more information visit the ATO website at www.ato.gov.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 WLM Financial Services online wlm.com.au

The long view can be helpful when investing in volatile times - Andrew Page

An observer would not be surprised to think that the financial world is in ruin and that investors have been driven to destitution as a result of the worst correction in a generation.

We are undeniably in a bear market with a high level of volatility and the market has fallen 23% in the last 10 months, however taking a step back allows a broader perspective to be taken into account.

The correction that has occured in the last year is part of the cyclical nature of the market. It's entirely normal to see the market pull back from time to time. Usually there is a period of strong growth that precedes a downturn.

If we take a wider view and look at the market over the past 5 or even 20 years, the current downturn is put into context. The market has still gained around 60% since 2003 despite this correction.

If we step back, even further and look at the past 50 years we can see that the market has experienced a mixture of good and bad years.

The graph reveals that there is a ratio of approximately 2:1 of good years to bad years, and secondly the gains made in the good years are far more substantial than that of the decline in bad years. The average advance was approximately 21%, whereas the average decline was approximately 13%. The mean average growth rate over the entire period has seen an average capital appreciation of 9.4%. When you factor in dividends then the average annual return climbs to around 14%.

Not all that bad, when you consider that over this time period the market experienced the oil shock of the 1970s, the 1987 market crash, the Asian financial crisis, the 'tech wreck' and the current credit crisis.

The assumption with the previous history is that you bought at the start of each year and sold at the end of the year.

What if you had held your shares for 5 or 10 years?

It can be seen that historically it pays to have a longer term perspective. The 5 year investment horizon had an average return of over 50% while the 10 year time frame produced an average of over 120%. These figures do not include the effect of dividends.

It is not my intention to minimize the significance of the recent correction, it's very unpleasant to see your capital diminished to such an extent. The point I wish to make, is that we shouldn't view the last 12 months as proof that the market is a dangerous place to invest. The current pullback is not unprecendented, nor unusual.

If we take a view of 5 years or more we may find it easier to accept that while a market can be a volatile place in the shorter term, in the longer term the market has an excellent record.

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