Thursday, 29 November 2012

What are the most efficient ways of using your credit cards awards points?

Credit card awards schemes are one of those nice to have features of a credit card however it should not be central in your decision to choose one credit card over another.  The fact is that the points are worth so little that unless it is an 'added benefit' for the same cost you probably should not bother.

Most people realise this.  Indeed, when post people work out that it costs them ~$14,000 - $18,000 worth of expenditure to get $100 worth of value most people stop worrying about the points and then redeem them every time they realise that they have a decent balance.  However although the seem to have such little value, there are still ways you can optimise the value you get from them - also this post is to  remind everyone that uses these rewards systems that the points can and do depreciate in value so it is best to use them reasonably quickly.

Gift cards are almost always the best value option

I have done a post on this before which spells this out in more detail but I thought I would outline again why gift cards and vouchers are always the best option.

You should never use your points to buy products.  Go online and see how much the product actually costs and then work out how many points it is costing you and you will see that it can be double or triple the regular price using your points.

Using your points to get cash is also a terrible idea.  The difference in the number of points it takes to get $50 worth of cash versus a $50 gift card to buy groceries is astounding!  Getting cash or reduction in your credit card bills are almost as bad value as getting products.

A better way to get the items you want is to redeem your points for gift cards and use these to buy products

If there is a particular product you want then go and see what stores you can buy this item from and get a gift card from that store - it will work out much cheaper than using your points.  However if you really want to maximise your points and the value for money you get then you should do the following:

  1. Work out what the cheapest gift card is
    • Gift cards do not all cost the same amount of points.  Cards for supermarkets tend to cost less than cards from other retailers (this is not always the case so make sure you check with your rewards provider)
  2. Buy the cheapest card from a store you regularly go to (it does not have to be the one you want the item from)
    • If you shop at a particular supermarket often and this has the cheapest card then you should go for this
    • Alternatively fuel cards are often very cheap as well and if you have a car you are always going to use it
  3. Use the cash you save from this other store to buy the item you want
    • In this way you are getting the item you want for effectively the best points value that you can get
You tend to get better value when you redeem more points at once...BUT don't wait for too long

With most rewards systems the amount of value you get from gift cards tends to increase the more points you accumulate.  Typically speaking if it costs you 8,000 points to get $50 worth of value it should cost you less than 16,000 points to get $100 worth of value.

Credit card companies and rewards programmes do this deliberately for several reasons.  Firstly they make more money if they don't have to pay out the cash as often and and secondly every so often they increase the number of points it takes to redeem a certain amount of value so they win when they charge you more points to get the same amount of money.

The best thing for you to do is to strike a compromise.  Know how much money you typically spend on a credit card and if it is going to take you an extra year to get from a $250 gift card to a $500 gift card and you are only saving 500 points then it is probably better for you to get a $250 gift card each year.  You may lose a little bit in terms of the points it costs you but you have the benefit of getting the first amount earlier and the risk that your points reduce in value is diminished.

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Tuesday, 27 November 2012

Investing in property: How much will you pay for non-interest expenses?

Recently a reader of this blog asked to me do a post on what the expenses associated with running an investment property were like.  This post will deal with that issue.

It will not, however deal with interest expenses.  Although this is the biggest expense associated with an investment property it is too hard to generalise about because it all depends on:

  • How much you pay for the property
  • What sort of gearing you use (i.e. a higher gearing will result in a higher interest cost)
  • The interest rate you are charged on the loan
  • How fast you pay the loan down
All of the above are not related to the property per se but rather with how you finance it and repay your loan.

While other charges will also typically be related to the individual property (e.g. the age of the property and the condition that it is in will determine what your maintenance expenses are) it is much easier to generalise about this and the costs associated with these.

When I discuss the costs below I will talk about them as a percentage of the rent I receive.  Note that this is only indicative and what I receive for my investment property and you should remember that every property will be slightly different.

Property management expenses (7% of gross rental)

This amount is a negotiated rate and includes GST.  I have posted before on how you can negotiate this rate with your agent down.  Note that this is the total amount that I paid to my agent - some people think they are paying a certain percentage but then end up getting stung on things like advertising, leasing and other miscellaneous fees.  

Paying between 5.5% and 8% is pretty standard for a property management fee.  If you are thinking about investing in property and are looking to add up all the expenses go down to your local real estate agent and find out what they charge.  It will always be a percentage of gross rent.

Maintenance expenses (~1%)

This will vary drastically from year to year. I have been pretty lucky, however and have had few issues.  This however was a function of the property I bought - I was willing to pay a little more for a property with few issues and then deal with all the relevant problems upfront before I leased it out.

In a previous post I recommend doing all the necessary maintenance up front and working out what can be left for later.  If you're thinking about how much maintenance expenses will cost you I would not assume something this low - I would choose a number more like 5% of gross income per annum. 

Rates and council fees (~9%)

As a landlord you will be paying the council rates as well as the water rates associated with the property (note that you do not pay for the water usage but rather the connection charges).  This will vary from property to property and from council to council.  My charges have been pretty steady at 9% so I feel confident using this number to forecast into the future.

If you are thinking about calculating this for yourself remember that your council fees are dependent on the value of your property.  If you are buying a high value, low yield property then this charge will be higher as a percentage of rent than if you bought a cheap, high yield property. 

Insurance (~4%)

Insurance costs me about 4% of my gross income.  The price you pay for this can vary greatly and it is always worth negotiating every time it comes up for renewal - I save hundreds of dollars by doing this every year.

I have done posts before on how to negotiate your home insurance and why it increases so much.  Modelling for 4% or 5% insurance costs is an appropriate number to use.

Total cash expenses (~21% of gross rent)

My total cash expenses for the last financial year came to 21% of my gross rent.  Note that this number is a 'run rate' type of percentage.  That is your expenses will typically be much higher in your first year of ownership because you are bringing the property up to scratch and have things like legal fees that increase your expenses

I should re-iterate that your interest cost will totally dominate your expense line.  However many people when thinking about property investment totally forget that there are a fair few expenses associated with running it and that you really only have 75% - 80% of your gross rent to help pay it.

Why didn't I include depreciation? 

You may have noticed that one of the big expense line items that I didn't include above was depreciation (which for me is ~20% of gross rent).  This is because it is a non cash expense - you do not pay anything when you claim it (however you receive the tax benefit of the deduction).  

The tax deduction component of depreciation could almost be considered in the income line because you do receive this money back from the government however I have been conservative and not included it.

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Monday, 26 November 2012

GetUp's poker machine proposal for Woolworths fails

Over the last few months I have been following the Woolworths versus GetUp! saga whereby GetUp! was trying to get Woolworth's to introduce legislation through an EGM whereby Woolworths would be seriously curtailed in the way that it was allowed to operate it's poker machines.  After thinking through the implications and issues quite carefully I was against the resolution for various reasons which I have outlined in previous posts.

Last Thursday Woolworth's put the issue to a vote at an Extraordinary General Meeting (which also doubled up with their Annual General Meeting) and the proposal failed.  This is not surprising however if you look at the statistics and breakdowns in the vote there are some interesting features.

The proposal was resoundingly defeated by submitted proxies well before the actual vote

If you look at slide 14 of the Woolworths EGM presentation you can see what the status of the vote was before the open votes on the day were cast.

  • 2.47% of the shares voted for the proposal
  • 95.41% of the shares voted against the proposal
  • 3.14% were open to be voted at the general meeting
If you look at the final results (see the final page of this document) you can see that most of the shares voted at the meeting were actually against the proposal.  The final count of shareholders voting for and against the GetUp! EGM resolution was:
  • For: 2.53%
  • Against: 97.47%
The resounding defeat means that either retail shareholders didn't turn out OR they were against the proposal

There is often the perception by participants in the market place that institutions are somehow more 'ruthless' than individual shareholders.  GetUp! made a big play about having motivated the retail shareholder base at Woolworths to vote for the proposal.

Retail shareholders make up approximately 30% of WOW's shareholder base (I will tell you how to calculate this in a later post).  As only ~2.5% of shareholders voted for the EGM proposal this means that retail shareholders either voted against the proposal or they simply did not turn up.  I have posted before about the apathy of retail shareholders when it comes to voting.  

Unfortunately it is hard to see which one of these that it is however it is hard to think of a motion that they are more likely to understand or be encouraged to vote for.

It is unclear whether any institutions voted for the proposal

GetUp! tried to get their members to send letters to their superannuation funds to encourage them to vote for the proposal.  Indeed they even had a standard form letter on their website that you could send to them.  However based on the vote count it does not look like there are any institutions that voted for the proposal (though I could be wrong).

I find this actually very comforting - I like to think that my superannuation fund would vote in a way which protected all of their security holders and not just the ones who are particularly vocal.

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Friday, 23 November 2012

AGM season in full swing...and I couldn't care less

Just before the Annual General Meeting season started for Australian companies I did a series of posts on how voting at AGMs was the one time that shareholders had to influence the way in which a company was run.  I also pointed out that retail shareholders do not vote and the companies therefore made decisions which typically favoured institutions.

I decided that one mini-crusade that I would go on would be to inform retail shareholders how important their vote was and how they should vote to protect their shareholding.  For this first AGM season, therefore I committed to doing my small part and actually voting in every AGM in which I was entitled to and I discovered something - I just did not have a good enough understanding of what I was voting on to care.

Voting on remuneration reports

This is the one area that people typically get worked up about - executives get paid too much money and this is a chance to vote that remuneration report down.  However there are several problems
  1. The remuneration reports take a fair bit of effort to go through properly
    • What you should be interested in is not only the absolute levels of incentives but also how these incentives are structured and how the vesting works for each of these
    • Most retail investors do not have the knowledge or know how to go through these reports
    • Even if you do have the knowledge and know how they take a fair bit of effort and if you try and do it for any more than about 5 stocks you typically get bored out of your brain
  2. Typically remuneration report voting is linked to how well the shares have performed NOT how the remuneration is structured
    • You see this all the time - a company that is performing well can pay their senior management almost anything and incentivize them terribly and shareholders will still vote for the report
    • Conversely  shareholders will vote against a report which compensates managers in an appropriate way if the shares are performing badly
    • This doesn't make sense but it is the only real option that shareholders often have to vent their frustration at the company
Voting for directors

This is the bit I got most stuck on (and I cared the least about).  I simply did not know WHO these directors were, whether they were good or bad, what sort of decisions they voted on and how informed they were. 

The strange thing about investing in companies is that you are constantly exposed to the management team - the CEO, CFO and other senior personnel through conference calls, news reports etc but as a shareholder you get no say over the management team.  You get to pick the guys who pick the management team however you know nothing about these people and how active they are on the board and how much the actually contribute.

I found myself voting for board members if I liked the senior executives and against them if I didn't.  There has to be a better way.  Companies should start providing information on what these board members are actually adding.

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Thursday, 22 November 2012

When to buck the trend and ignore the share market

Often times as an investor, especially in listed securities, you will find an investment 'going bad'.  The market will has significantly against you and the temptation is to cut your losses and get out.  This post will be about when to hold your nerve and what you should be telling yourself when your are doing that.

I have posted before about how one of the hardest thing to do as an investor is to sell shares when they have increased in price significantly or very suddenly because greed takes over.  This is the converse case - it is about how it is hard to hold onto you shares when fear takes over.

However I should stress from the start that you should not always hold onto your shares.  There ARE times when you should cut your losses and get out.  There are, however, a very specific set of circumstances in which you should ignore the market and buck the trend

What are the specific circumstances where you should ignore the market?

For you to ignore what is going on in the market, in your own mind you should be very clear about certain things:

  1. Is your valuation of the company up to date and do you believe in it?
    • This means you should have included ALL relevant information that has been released and you need to be comfortable that your valuation is as accurate as it can be
    • If you think that you are right and the market is wrong - this is where you can make real profits
  2. What is causing the share price drop and is this relevant?
    • Share prices fluctuate quite a bit and sometimes they do so for valid reasons (e.g. the company is decreasing in profitability, there is a new, better competitor, they have too much debt) however sometimes it has nothing to do with the company itself (e.g. a company that doesn't have any exposure to Europe falls on concerns about Greek debt)
    • If it is relevant news (or even rumours) then you should be putting these into your valuations as discussed in point 1.  Your valuation is not a static document - it should constantly be updated
  3. What DON'T you know?
    • The hardest thing about being an outsider investing in a company is that you will never know everything
    • You always need to consider therefore what may or may not be happening that you do not know
Assuming your valuation is up to date, the factors causing the share price to drop are irrelevant or temporary and you have accounted for those things you don't THEN DON'T SELL

If you have done everything that you can and you trust your valuation and you understand what is moving the share price then you should have the confidence in your own investment analysis to hold out against the market.

The thing about investing is that you have to be able to ignore what is happening day to day with your stock investments.  They will go up and down and as long as you are tracking the fundamentals and they still look good to you then you should hold out until your valuation not the market tells you to sell  

In these circumstances I have often seen investors double up their bets and take advantage of the lower prices.  I am typically not one of those investors.  If I still trust my original investment then I stick with that amount.

Note that there is always the risk that you are wrong.  There is the risk that there is something that you didn't know that comes and bites you and unfortunately there is nothing you can do about this other than to keep a very close eye on the investments that you do have - especially those that seem under pressure - and constantly be trying to work out what is driving the share price.

A (current) personal example

I thought I would include a quick example that was currently affecting me.  Recently I mentioned that I bought into (in quite a large way) the FKP rights offer.  In fact I was very happy when I got allocated much more than I was expecting

Because I have hold periods associated with any stock that I buy, I have been unable to sell these and the stock has dipped well below my average buying price (and the offer price).  I have more than I am usually comfortable with invested in this particular stock.  

The reason I am holding onto it is as follows (please do not go out and buy this stock because I am saying I think it's good - I'm not giving investment advice - just describing the principle):
  1. I am comfortable with my valuation of the stock and this has not changed as the stock price has been falling
  2. I think I know why the price has fallen so aggressively - I think the underwriters are selling the stock they got issued when FKP screwed their retail shareholders (I hope they are making a loss)
  3. I think there are things I don't know - but I have allowed for those specific items in my valuation
I'll provide an update on how this goes but hopefully the price recovers around the time I want to sell it so I can reduce my exposure a little bit.

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Wednesday, 21 November 2012

Employee shares - Avoiding high transaction costs on the way out

In a recent post I mentioned that I had been stung pretty badly when selling my employee share plan shares.  The operator of the share registry that my company uses knows that most people will sell their shares directly through them and will often charge outrageous fees which employees think that they have to pay.  This post will show you how to save a lot of that money.

Who typically gets stung the worst by the share registry fees?

Typically the people that get stung the worst are employees that live in one country but get issued shares in another one (i.e. on a foreign stock exchange).  This is pretty common for those working for large US corporations but who do not live in the US.

The shares that are issued to them are typically listed on a US stock exchange and held with a share registry company that specialises in employee share plans.  A very common registry for US stocks is BNY Mellon (which is now owned by Computershare).

The fees that a foreign shareholder normally gets stung with include

  • A transaction (trade) fee:  This is normally quite reasonable and everyone gets charged this
  • A foreign wire transfer fee:  This costs $25 and is a little annoying but not over the top
  • A spread on the foreign currency:  This is where they really sting you badly.  The rate that BNY gives you is much worse than the actual wholesale rate.  In the case of the AUD there was a 2% difference between that rate and the rate they gave me - this meant that I automatically lost 2% of my profits through this cost.
In most cases you will not be able to avoid the first fee and it is a reasonable one to pay however you should  NOT be paying the second and third fees (or if you do pay them they should be much lower).  Below I have outlined some strategies to save on the fees.

Saving on the foreign currency fee

If you sit back and think about how much that foreign currency fee is actually costing you - you will be outraged.  If you assume that you are allocated $20,000 of stock in a year (not out of the ball park if you have variable compensation and an employee share plan) and you sell this stock you are getting hit with $400 in foreign currency fees which is outrageous!

Here are some ways to save on the fee charged by these share registries
  • Do a position transfer to a broker like Interactive Brokers which and sell through them instead - they do not charge an FX spread
    • What you are doing here is actually transferring the stock itself to Interactive Brokers - you are not selling it through the share registry.  This should not cost anything.
    • Sell the shares through interactive brokers - their trading costs for US stocks are very cheap (generally you want to be trading US stocks through a US broker not through your home country broker)
    • Interactive Brokers does not charge an FX spread - they charge you a flat percentage of the currency conversion cost which is 1bp - i.e. 0.01%
      • Instead of paying $400 in currency costs you will therefore only pay $2.50 (the minimum trade value)
  • Sell the shares through the share registry but set up a multi-currency account
    • There are some banks (like Citi and HSBC) that offer multi-currency accounts
    • They also offer exchange rates that are better than those offered by the share registries
    • You sell the stock through the share registry and then transfer the funds to these accounts to be converted into your home currency
    • These accounts typically have minimum balances and have reasonably high fees however they are worth considering if you get a lot of stock in foreign currencies or travel a lot
Saving on the wire transfer fee

The wire transfer fee is not a large amount ($25) however it is an annoying amount that I really believe that you should not have to pay.  Here are some ways that you can get around it.
  • Transfer the funds to a US based (multi-currency) account
    • If you can do an in country bank transfer instead of a wire transfer then you do not have to pay this fee
    • Multi-currency accounts typically have branches in several countries and so you do not get charged the wire transfer fee for bringing it back to your home country
  • Use a broker to sell you shares that does not charge a wire transfer fee
    • Interactive Brokers (mentioned above) does not charge a wire transfer fee for Australian accounts.  This is because they have an account based in Australia so what they actually do is an in country bank transfer to your account
  • Request the proceeds in a check
    • The share registries normally give you the option to receive your proceeds as a check.  If you do this it will take a little longer to get to you but you are not paying a pointless fee to receive it
    • You can then deposit this into your local bank or your multi-currency account
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Tuesday, 20 November 2012

A few updates on the personal finance front - November 2012

There were several small updates that I've been meaning to write for a while but they have not been sufficiently important for me to dedicate whole posts to so I have decided to do one posts which will cover several of these smaller issues.

Employee share investment plan - shares finally sold

In several of my previous posts I outlined that many companies offer employee share plans to their staff and how it can be a way to make free money.  I also had a post in which I said that there were several strategies one could take when it came to selling the shares when they were allocated to you.  At the time I had said that I would sell these as soon as they were allocated to me.

In fact I let them run for ~4 months and got a very good return out of doing this (~35%). Where I did get shafted though was on the exchange rate which cost me hundreds of dollars more than it should have. I will do a post on avoiding these exchange rate fees soon.

Annual bonus hit the account - I had already mentally pre-spent the amount so benefit is only passing

In my 2012 financial goals at the start of the year I said that one of my goals was to buy a sports car when I was young and carefree enough to throw away a bit of money.  I realised that this would not help me financially however not all things in life can be driven by finance.

Although my bonus was in line with what I expected, I had mentally catered for too much tax so on an after tax basis I actually got more than I expected. In addition I have picked the model / year of car that I want and this was cheaper than I had originally budgeted for too.

I am therefore using the excess as my spending money for my overseas holiday. In my October 2012 net worth post I mentioned that I would need to start putting away money for this but it turns out that I wont have to.

Until I actually spend the money it will appear in my net worth but this is only transitory and will not count in the long run.

Tax return is finally done and MUCH better than expected

I will cover this more thoroughly in my next net worth post however I could not believe the amount I got back on tax (~$20,000) - it turns out that I really did pay too much tax over the year   This amount I will save and it is going to increase my net worth over the long run.

I have STILL not started my business

I confess between my last post and this one that I have still not got around to starting my business.  Several things (and life) have gotten in the way.  It is still one of my goals however I do not have a time frame on it because at the moment I cannot find a decent amount of time to dedicate to it.  If this actually gets off the ground in the next few months I will be pleasantly surprised.

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Monday, 19 November 2012

What is NAV (Net Asset Value)?

NAV, or Net Asset Value is typically a term used in investment funds (both listed and unlisted).  It is the assessed value of the funds assets, normally by the management of the company and approved by independent valuers (though not always).

NAV is also sometimes referred to as NTA, or net tangible assets however I think this term is incorrectly used as NTA is used for all types of companies and does not necessarily refer to this independent valuation of assets process

What types of entities disclose NAV?

NAV is typically disclosed where it is hard for investors to see or discern the value of the assets.  This is often used for investments where the exact composition of the portfolio is unknown or where the assets are inherently illiquid and so assessing an actual value from regular valuation methods becomes difficult for investors.

There are many types of entities that disclose NAV however some of the most common ones are:

  • Property trusts (both listed and unlisted)
    • Property of all types is inherently illiquid.  As investors we know that the value of properties are changing however without the full information about all the properties held in the trust it is pretty hard to know how the valuation of these trusts are moving year to year
    • Property trusts normally revalue their assets on an annual (or sometimes semi annual basis) so that investors know what the theoretical value of the assets within the trust are worth
  • Equity funds
    • Equity funds normally disclose their NAV on a daily basis.  It is very easy for them to calculate however very hard for outside investors to work out because they do not know the exact composition of the portfolio
    • For equity funds the NAV represents the valuation of all the shares within the fund (and you divide this by the number of units to get the per unit NAV
  • Infrastructure funds
    • Infrastructure funds also typically disclose a NAV for the same reasons as property trusts
    • They typically hold more than one asset and investors find it hard to value these assets from an external perspective.
  • Companies with minority stakes in several unlisted assets
    • Where a company does not have a controlling shareholding in several assets they often disclose NAV because it is almost impossible from regulatory filings and presentations to work out what these assets are worth
  • Externally managed vehicles
    • I have written before on the corporate governance related to externally managed vehicles
    • External managers are often compensated based on the value of the assets under management. In order for investors to understand the fees being paid to external managers they often provide a valuation of the company and it's assets to justify the fees.
Why do companies trade at a discount or premium to NAV?

For listed funds and companies you will notice that they very rarely trade at NAV (the exception to this is listed equity funds which never really deviate far from NAV).  This seems counter intuitive - if you know the value of the assets then why would you see for less than they are worth and conversely why would you buy for more than they are worth?

The answer is quite simple - the NAV is always

Friday, 16 November 2012

Click Frenzy - A chance to do your Christmas shopping in one hit

Click Frenzy is this coming Tuesday starting at 7pm and running for 24 hours.  It gives shoppers the opportunity to buy goods at 15 - 90% off (only) for that 24 hour period.

I think this is a great opportunity for everyone to do their Christmas shopping early and in one massive hit and possible get some good deals but you do need to prepare!

What is Click Frenzy?

Click Frenzy is the Australian version of Cyber Monday which was is a US day of crazy online sales where everything online is heavily discounted.  It is like the online version of the boxing day sales.

This is the first time it is being done in Australia as Australia has been very far behind in terms of major retailers having an effective web presence and Australians have been much slower than their US counterparts in taking up the online buying phenomenon.

When is it?  It starts at 7pm on  Tuesday 20 November and runs for 24 hours.

What stores are participating in Click Frenzy?

Not all the major retailers are participating but so far there are a really good list of retailers that are participating including Myer, Dick Smith, Target, Dan Murphys, Masters, Microsoft, Saba and many others.

You can find a more extensive list here.

What should you do before Click Frenzy?

There are several things you should do before the start of the sales.  These include

  1. Make sure you have access to a good Internet connection.  
    • My home Internet tends to be extremely slow during times of high use (you wouldn't think that about broadband but unfortunately it is the case) so I am using my corporate connection and will be staying at work.
  2. Work out what you want to buy before the sales
    • The chances are the stock you want to buy will be relatively limited and if you are going for something popular you want to head there straight away
  3. Make sure you know your prices before Click Frenzy
    • The worst thing you can do is to buy an over-priced product which has then been nominally marked down so if you have your list of products you want to buy - make sure you know the cheapest price you can get it elsewhere
  4. Know what stores sell the product you want
    • There are real worries that the Australian retailers' online stores are not up to the volume of traffic that will be received on Tuesday and you want to be able to get into the store you want and purchase your product before it goes down
Are the deals really going to be that good?

This is the big question and the fact is that no one really knows.  I think the retailers will offer really really good deals in this first year to hype up the day and get it off the ground so this may be the year where you get the best deals.  In any event I have freed up a couple of hours that night and have made my list of things that I want.  

Hopefully my Christmas shopping works out a lot cheaper than I had originally budgeted for!

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Thursday, 15 November 2012

Should you vote for the GetUp! proposal at Woolworth's AGM?

In a previous post I had touched briefly on shareholder activism, how you defined shareholders interests and used the Woolworths battle with activist group GetUp! as an example of when activists work to promote their agenda which may not necessarily be in the broader shareholder interest.  At the time the issue was put off until the Woolworths AGM.

As this AGM gets closer - it is now only a week away (on Thursday 22 November 2012) Woolworths shareholders need to seriously consider how they are going to vote on this issue.  There are several things to consider which I have addressed below.

What are the proposals?

There are three proposals being put forward by shareholders that form the vote that will take place at the Extraordinary General Meeting (which is being held at the same time as the Woolworths Annual General Meeting).  The proposals are summarised below.  It essentially changes the constitution of Woolworths such that from 2016

  • The company limits it's Electronic Gaming Machines (Poker Machines) to a maximum bet of $1 per push;
  • Limit the profit each machine can make to $120 per hour; and
  • The machines are only allowed to operate for 18 hours in any 24 hour period

Is this motion in the best interests of the company and shareholders?

The first thing you need to remember as a shareholder in Woolworths is that this is a real investment for you and this is real money that you stand to gain or lose as a result of this investment. Therefore, while it should not be the only consideration, you need to think about whether voting for this resolution will be good or bad for the company in the long run.

From this framework I would consider the following

  • Woolworths is naturally going to lose profitability if you limit the money they can make from these poker machines
  • The argument is that they will get some sort of social benefit, or rather avoid a social cost by being seen as a responsible operator
  • I do not find it convincing that the benefit (or lack of cost) that they will receive from implementing these measures will outweigh the actual money they will be losing through implementing these measures
I actually find this case analogous to the selling of cigarettes.  Everyone knows that smoking is bad for you and creates real social harm however it is a legal thing to do and therefore stores (including Woolworths through their shopping centres) are allowed to sell them as long as they obey the law.  The idea that people will not want to invest or shop at a store that operates gaming venues seems strange to me because they are more than happy to invest and shop at one which sells cigarettes.

Will the measures work to stop problem gambling?

In this area I think both sides have been a bit disingenuous.  Woolworths has downplayed the Productivity Commission's reports on gambling and in their letter to shareholders was quite misleading on several aspects of this.

However GetUp! is also being a bit sly about it's motives.  It keeps talking about how Woolworths is the largest operator of poker machines in Australia, which may be true however they still only have 6% of the market and GetUp! is obviously targeting Woolworths because they are a soft target (unlike a casino or the actual manufacturer of the gaming machines themselves, Aristocrat, which is also a listed company).

I think the reason that GetUp! is targeting Woolworths is because if they can force Woolworths to operate in a certain way then Woolworths will lobby the government to ensure that everyone operates in the same way.  There is currently very limited political will to implement such measures and GetUp! wants an influential player pushing for rules they want.

Do I think problem gambling is a problem and do I think this is the solution?

I absolutely do think problem gambling is a problem and although it does not affect a large proportion of the population, it is devastating to those who it does affect.

Having said that - I do not believe this is the solution.  I believe that this problem needs to be dealt with by policy makers in this country.  I believe that to really tackle the problem that everyone should be playing by the same rules with the aim of reducing problem gambling.

I think that the Woolworths vote will not do anything to curb problem gambling, will cause Woolworths shareholders to be worse off and therefore do not believe shareholders should vote for this measure.

If you have an opinion on this matter or if you think I am wrong please comment below

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Wednesday, 14 November 2012

What is Private Equity?

Almost everyone would have heard about the Private Equity industry in some form or another.  If you are young and interested in finance, the chances are that you have seen it mentioned on message boards as the holy grail of jobs to get.  If you are a bit older you may have seen many businesses that you worked for, that were listed on the stock exchange or that you patronise being bought out and changed by private equity firms.

This post will take a very high level look at the private equity industry - what they do, where they come from and how they make money.

What are private equity firms?

Private equity firms are essentially fund managers that, instead of buying shares in publicly traded companies, buy whole companies (whether public or private) using a significant amount of leverage (debt) and then pay down the debt from the operations of the business and then on sell the company at a later date.

Private equity firms typically raise their funds from pension or superannuation funds, who give the funds to the private equity business for ~5 years to make a return.  Although the structures vary, it is relatively normal for the private equity firm to have a 2/20 type model.  They charge 2% of the funds under management and 20% above a certain benchmark return rate (much like hedge funds).

Who typically works at private equity firms?

The core of private equity firms are usually ex-investment bankers or management consultants (depending on the firm).  Because the main feature of private equity is the way in which the business is financed when it is taken private they will often have significant experience when it comes to both capital and debt markets.

Although employees of private equity firms will always sit on the boards of companies they own and control, they will almost never get involved in the management of the business.  When they buy a business, private equity firms normally use one of two management approaches

  1. They buy the business with existing management (often called a Management Buy-Out) in which case the existing management stays in place
    • There are a few reasons why private equity firms will not change the management that is in place
      • If it is a well run company there is no reason to.  Why would you change the way a cash generating successful business is run if you do not have to?
      • Those participating in the management buy out are particularly well rewarded and so management has an incentive to help the private equity firm take over the company through the provision of detailed information and data rooms as well as business plans
  2. They replace the existing management with a 'first in class' management team
    • If the business is a cash cow but not particularly well run then it is quite common for Private Equity firms to hire the best operators in the world to run the business
    • They attract these people because of the pay opportunities and upside they offer them
How exactly do they make money?

At it's core the private equity model is relatively simple (although the execution of this can get particularly complex).  Below is a pretty standard way for a private equity firm to make money:
  1. Private Equity firm buys business A for $100 which represents a 10x multiple on their free cash flow ($10)
  2. They finance the acquisition with $20 of equity and $80 of debt at a debt cost of 8% (i.e. the debt costs them $6.40 per year)
  3. They cut costs brutally in the business and all non essential capital expenditure is removed to improve the free cash flow position of the business.  The free cash flow of the business is now $12.50.
  4. Every year the private equity firm uses the free cash flow to pay down the debt in the business. Assume they hold this business for 5 years
    • In year 1 they pay $6.40 in interest and pay off $6.10 in debt
    • In year 2 they pay $5.91 in interest [(80-6.1)*8%] and pay off $6.59 in debt
    • In year 3 they pay $5.38 in interest [(73.9-6.59)*8%] and pay off $7.12 in debt
    • In year 4 they pay $4.82 in interest and pay off $7.68 in debt
    • In year 5 they pay $4.20 in interest and pay off $8.30 in debt
  5. At the end of year 5 they have a business that is still making $12.50 a year but because they have been paying down this debt so aggressively they only have $44.21 in debt left
  6. They sell this business at exactly the same free cash flow multiple they bought it at however they get more money for it because they cut so many costs out.  They also have much less debt than they started with
    • They receive $12.50 * 10.0x = $125
    • They repay the $44.21 in debt
    • They are left with $80.79 for investors
  7. The return they earned on their invested capital is (80.79 / 20)^(1/5)-1 = 32.2% p.a.
As competition for these high cash flow

Monday, 12 November 2012

Yellow Brick Road's 1.15% discount is good...but not a game changer

There as a splash recently in both the financial and regular press about a 'fifth pillar' entering the Australian banking system.  The press lauded the entry of this competitor as great for consumers and finally providing some competition to the big four Australian banks.

Who is this new competitor?

The new competitor was Yellow Brick Road, a financial services company with 130 retail stores across Australia, which had recently struck a deal with Macquarie, an Australian based investment bank to use it's balance sheet to provide funding for Australians looking for home loans.  Their headline rate seems staggering - they are offering a 1.15% discount to the standard variable rate which is a discount rate almost unheard of in the Australian banking environment.

Yellow Brick Road is a company founded by Mark Bouris, the host of Australian's version of The Apprentice.  He was also the founder of Wizard Home Loans, a mortgage provider he later sold to GE Money for A$500 million.  With Macquarie's balance sheet backing him this venture is unlikely to be a 'here today, gone tomorrow' type operation so it should be something that those looking for a loan should consider.

However there are risks of a new competitor like this which you need to consider BEFORE you refinance you loan with them

Although the deal seems great, there are actually several draw backs and 'false' comparisons which many hyping this product have failed to point out.  These include

  • The 1.15% discount is for the first year only.  This then reverts to a 0.86% discount.
    • Generally promotional or 'sweet heart' rates are targeted at those who only look at the first year and do not consider what rate they are likely to be paying later on.  Given that home loans last for 20 to 30 years, it is the 'normalised' rate that you should be considering - not the sweetheart rate
    • To be fair to Yellow Brick Road - they do provide what the rate will be over the life of the loan on their comparison table
  • The comparison table is flawed - ALL banks offer significant discounts if you ask for it
    • The standard discount on a loan of more than $250,000 is 0.70%.  This table does not take into account this discount
    • For example they have the NAB rate at 6.08% however I am only paying 5.91% on my loan (which is not very different to the 5.79% offered by YBR)
  • Although you get a discount to the Standard Variable Rate (SVR), you do not know whether YBR will reprice their SVR to a rate higher than the other major banks
    • There is no 'standard SVR' - banks can make this whatever they like
    • Over time you can see that the major banks track their SVR's relatively close to each other however there is no such proof for a new competitor.  If they want to increase their profits they can increase this SVR to a point where they are actually charging you more than the major banks even if your discount is larger
  • There are no ongoing fees BUT this is a very basic product so you do not get many of the bells and whistles that are standard on other banking products
    • Banks often charge a 'package fee' for the loan that they provide.  Mine is $120 p.a. and for that I get an offset account linked to me loan, fee-free credit cards and discounts on significant other products
    • The YBR does not charge the fee but you have NO option to have an offset account, they do not offer fee free credit cards or any of the other benefits that come with having a 'package deal'
    • For me, the offset account is one of the most critical tools that I have in managing my finances so personally this is what killed the idea for me straight away
  • As this is a basic product you should compare apples with apples
    • As mentioned above YBR's comparison table compares it against the major banks and their standard home loans.  
    • However this is a

Thursday, 8 November 2012

No guaranteed 9% return, some major draw backs...but not as bad as originally imagined

In a previous post I had questioned the validity of a 9% guaranteed return being offered by Collins & Kent International (CKI) for an investment in art.  From their advertising and after trawling their site quite thoroughly I could not work out how this investment worked - this is never a good sign.

I had received several questions about this investment for several months after I uploaded my original post but it was only a recently that a reader sent me the relevant contracts which set out how the arrangements actually work.  Those documents very clearly outlined how the arrangement worked and I am happy to say that this investment is not as bad as it first seemed - but the advertising is still misleading and there is no way they are guaranteeing a 9% return

So how does it work?

The investment proposition is actually rather simple:
  1. You either buy a piece of artwork from CKI (or presumably you can bring along a collection of your own - I did not see anything in the contracts restricting this to art works sold by CKI)
  2. They assign the artwork a value
  3. You get a fixed percentage return on this initial valuation for the life of the agreement
  4. CKI then loans this asset to their clients making a spread on the rate they lend it out at
It is actually just a simple rental / loan type agreement where you are providing the asset and in turn you are being compensated for this (much the same as a return on a rental property).  

Why do I think the advertising is misleading?

The original advertisement that I had seen had, as the most prominent part of the advertisement a guaranteed 9% return.  In reality what you are getting from this arrangement is a rate of interest on a predetermined art work for a predetermined period of time with.

What is wrong with this?
  • As an investor in art (or indeed any other type of investment) the rental yield is not your only form of return.  Indeed in property and art it is typically not your primary form of return.
  • The primary form of return is the change in capital value associated with the asset
  • There is no guarantee in this arrangement as to capital value and so the investor is not getting a 9% rate of return on their investment - in fact it is almost guaranteed NOT to be 9%
    • This is because if the value of the investment moves your effective yield is moving; and
    • This capital value movement forms part of your return

What are the other drawbacks?

There are several other drawbacks from this type of investment (and also from the contracts that I had a look at)
  1. There is always a risk that you overpay for an asset when you are buying it as part of a 'bundled' return 
    • There is a risk (although I am not saying they do this) that CKI offers the high rate of return on an inflated price in order to 'prove' the value of the original price they sell the asset for
    • I do not know if art dealers typically do this however it is quite common in commercial real estate where you are buying a piece of property from a party that is going to be your tenant for a specified period of time - there is a risk that you capitalise too high a number
    • Again I have no insight into how objective their valuation and pricing process is so this is just outlining a risk
  2. For someone inexperienced in art - their forgery provisions seem quite onerous
    • I know nothing about art and I would be trusting that an art gallery was selling me the real deal when I was investing with them
    • However when you buy a piece of art from CKI you have less than a month to get it evaluated by two separate independent experts to see whether it is a forgery to get a refund from CKI
    • I have no idea whether this is industry standard or not but from an outsiders point of view it seemed quite onerous
  3. It does not de-risk art investment - but some may assume that it does
    • The biggest risks around art investment is around paying too much for something that is in vogue which then loses capital value
    • CKI provides no protection against this so their scheme is not for 'beginners' investing in art
  4. No rent escalation clauses
    • The rent is not linked in any way to the capital value so in the event that your artwork's value shoots through the roof you are not getting an appropriate rental for it - the original rent stays the same for the life of the agreement

However - this scheme CAN be handy for those who were looking to invest in art ANYWAY

The more I thought about this investment proposition I realised that it would be very useful for those who

Monday, 5 November 2012

Playing the lottery - Is it your ticket to dream?

I have never been much of a gambler.  Went I went to Macau for a weekend I was content to stop playing the tables when I had won enough to cover my boat ride back to Hong Kong.  It came as somewhat of a surprise to me, when I found myself entering (for only the second time in my life) the lottery for tomorrow's draw (Oz Lotto).

The amount of ordinarily rational people that play the lotteries astounds me - one investment banker repeated that old catch line of 'you have to be in it to win it' while explaining that he bought a ticket every week.  While strictly speaking this is true everyone knows that the odds are truly stacked against you.  However the more I thought about it, the more I realised that in big draws your expected value may actually be greater than 1.

That is for every dollar you invest in the lottery, purely statistically speaking you should expect to receive something greater than one in return.  Below are the calculations:

  • For every entry you have a 1 in 45,379,620 chance of winning
  • The cost per entry is $1.20
  • To buy up every single possible combination it would cost you $54,455,544
  • The jackpot is $100 million (you will see soon why this only works for the big prizes)
  • Therefore your expected return is
    • Sum of the probabilities * expected outcomes
    • 1 / 45,379,620 * $100,000,000 
    • $2.20036
  • If you then subtract the cost of entry you get your expected winning
    • $2.20036 - $1.20
    • $1.00036
However before you rush out and buy all the tickets remember that your potential winnings are diluted the more people enter the game.  You need to reduce this expected return by the proportion of people that are expected to win the jackpot.  To know this you need to know the number of tickets sold which they do not disclose.

Also you need to remember that this is a purely theoretical exercise - your chances of actually winning are still only 1 in 45 million.  As an exercise while writing this post I got the ticket I had bought which had 36 different entries.  I then went to last weeks draw to see how many of my combinations even got close to the winning combination - in none of my picks did I get more than 2 of the drawn numbers.  People who play expecting to win the lottery should keep track of how successful they are every week and then perhaps spend less money on it.

However having bought a ticket this time around I realised that the advertising folks may have got it right - I know I'm not going to win but I keep imagining what I would do if I won the $100m.  It most definitely is your ticket to dream - though what the advertising people do not include is that after you dream you have to wake up and get back to your normal life and finances.

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Friday, 2 November 2012

October 2012 Expenditure Tracker

ItemOct 2012Target (new)Over/(Under)
Share Investments+$1,032+$3,100-$2,068
Offset Acct.+$2,700+$1,300+$1,400
Personal expenditure+$2,757+$2,000+$757

This will be the first time that I provide my performance according to my reset expectations only.  Although I am still not meeting all of my expenditure goals I am moving towards them as I am more conscious about controlling my expenditure and am breaking some of the bad habits that I had previously.

In terms of share investments, I invested a significant amount of money in the FKP rights issue (as discussed several times before), however as the funds for this were already held in my share trading cash account the amount allocated to share trading did not change at all for the purposes of the expenditure tracker.  I also continued to contribute to my employee share plan which made up the bulk of the net investment this month. Although it looks like I under invested in shares this month I am still well ahead of my objective as can be seen from the cumulative table below.

I over allocated funds to my offset account this month to account for the fact that I am well below where I want to be due to the allocation of funds from this account to my share account.  As interest rates in Australia continue to decrease the effective return I earn on these funds decreases and so I am comfortable with this state of affairs.

The big story for me this month was around personal expenditure.  This is the first month where I overspent less than $1,000.  Although the overspend was still well above my limit,  regular readers would know that I regularly blow through this amount very easily and so I was very happy not to this month.  This was a combination of several factors
  • Spending less money on taking lunches to work
  • No major expenses during the month
  • No major events (such as weddings or gifts) during the month
November 2012 is likely to be a very positive month but this is due mainly to significantly increased income due to my bonus being paid and receiving my tax return.  However in this month I will be:
  • Transferring a significant amount of unused share capital from my share trading account back into my offset account
  • Paying for my car servicing bill 
  • Starting to purchase Christmas gifts
Below I have included the cumulative expenditure performance (from July 2012 only)

ItemJul 12 - Oct 12Target (new)Over/(Under)
Share Investments+$54,432+$12,400+$42,032
Offset Acct.-$40,872+$5,200-$46,072
Personal expenditure+$13,676+$8,000+$5,676

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Thursday, 1 November 2012

October 2012 Net Worth: $268,000 (+2.8%)

Value% Change
Net worth$268,000+2.8%

Once again I was very happy with my absolute performance this month as some of my investment strategies started to pay off and I managed to keep my expenses well under control this month.  However as with my September and August Net Worth posts I noticed that the value of my investment portfolio always seems to be lowest at month's end - I'm not sure what the reason for this is but it certain impacts how I think I am going every month.

This month was impacted by a few large events.  Some of them were quite positive and others were mildly negative. These included:

  • Being allocated more shares than I expected under the FKP rights issue
    • I have posted about this before in detail but what it did was reduce significantly the loss I was carrying forward on these shares
    • At the moment I am 5% below my weighted average purchase price for these shares however they are very depressed at the moment so I am holding onto them
    • This was the biggest positive impact for this month
  • I held onto my ESIP shares a little longer than I should have
    • I am still holding on to my ESIP shares which I had originally meant to sell very quickly
    • These shares reached all time highs however have now come off quite a bit.  The decision to hold makes sense but if either the currency or share price moves back in my favour I'm going to take the cash and run
    • This had a marginal positive impact over the whole month but probably a mildly negative one over the last few days of the month
  • My expenditure was as controlled as it has ever been
    • I will provide more detail on this in my expenditure tracker post tomorrow but this month I somehow did not end up spending much money at all (even though I did a weekend away)
For those who read this series from month to month there are several items that were pretty consistent
  • My monthly allocations to my employee share plan and my superannuation increased my savings without me having to think about it
  • My home loan offset account increased as I started to rebuild my balance post significant transfers to my share trading account
  • Start putting aside money for my overseas holiday over Christmas - I totally forgot about this so have not done it
  • Doing my taxes for the 2012 financial year.  I have booked in an appointment with my accountant for next week so I should get the refund in November
For November 2012 I forecast that my Net Worth will be affected by the following
  1. I gave my car in for servicing which cost my $700.  I have yet to pay this bill but this will have to be paid this month.
  2. I should get my 2012 bonus paid into my account this month which will should see a significant increase in my net worth.  Note though that I had already set aside the majority of this for my new sports car which I plan on purchasing
  3. I should get my tax return for the 2012 financial year
  4. I am going to edit the way in which my net worth is calculated to take into account future tax payable on unrealised gains in my share portfolio - this will give a more accurate picture of my net worth
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October 2012 Expenditure Tracker - Still to come