money management (october 13, 2011)

www.moneymanagement.com.au

The publication for the personal investment professional

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By Chris Kennedy

THERE has been unprecedent-ed activity over the past 12 to18 months in terms of practicesales, and it is possible theclarity provided by the latestFuture of Financial Advice(FOFA) announcements couldprompt a further pick-upleading into the 1 July 2012implementation date.

Director of practice salesbroker Forte Asset Solutions,Stephen Prendeville, said thatwith that aspect of FOFA dealtwith, there may be more confi-dence for practices to moveahead, with increased activityaround the acquisition ofdealer groups and practices.

He said Forte had experi-enced a 100 per cent increase

in the number of businesses ‘inmarket’ in the 2010-11 financialyear against any other periodover the past eight years, withthe major contributor being

financial stress.Most f inancial planning

businesses are operating at 20 per cent below their 2007-8highs, with little to no newbusiness being written asidefrom cash – yet most financialplanning businesses are stilloperating with the samepersonnel and infrastructure of2008, on diminished turnover,according to Prendeville.

He said there had been a realspike in demand for books ofbusiness that can easily be putinto the existing structure orpractice. There is also demandfor businesses that can beacquired, that are using thesame platform as the acquiringbusiness, saving on the transi-tioning of clients.

Prendeville said it is still not

clear how grandfather ingprovisions will apply to booksof business being sold,meaning there could be almosta hyper level of activity runningup to 30 June 2012 as practiceslook to lock that business inbefore the FOFA cut-off.

Despite the increase in activ-ity, pricing has remained steadyfor practices at around 3.3times recurring revenue for thepast two years, with clientbooks currently valued ataround three times recurringrevenue, Prendeville said.

However, the principal ofpractice sales consultancy firmRadar Results, John Birt, said hehad noticed a significant drop-off in activity recently, after alsoexperiencing high levels of inter-est in the past 12 to 18 months.

This is unexpected given thecurrent round of FOFA reforms,and he said he would haveexpected a pick-up in sales ifanything. He added the reasonmay be that many practicesthat would be looking to sellhave now been sold, leaving alack of supply.

Some advisers may also wantto sit on the sideline untilmarkets improve, and there isalso currently a disparity in priceexpectation between buyers andsellers, with vendor expectationssignificantly higher than marketpricing, he said.

“The problem is gettingadvisers to embrace [purchas-es] at the prices they’re asking,”he said.

By Tim Stewart

THE Financial Ombudsman Service(FOS) has played down concerns itwill have little legal guidance oncethe Future of Financial Advice ‘bestinterests’ duties become law.

Responding to claims by ArgyleLawyers principal Peter Bobbin that alack of legal precedent relating to thechanged laws would see the ombuds-man effectively “swimming in the dark”,FOS ombudsman for investments, lifeinsurance and superannuation AlisonMaynard said FOS was well preparedfor the new environment.

Legal principles were one of fourfactors the ombudsman took intoaccount when determining what was“fair in all the circumstances”, May-nard said. FOS also considers appli-cable industry codes, good industrypractice, and previous relevant deci-sions of FOS or a predecessorscheme, she added.

“When legal precedent is created,of course we’ll be looking at it. Butit’s only a very small part of theequation,” Maynard said.

F inancia l ser v ice prov idersalready have a requirement to oper-ate efficiently, honestly and fairly

under the Corporations Act, and thenew best interests duties containedin FOFA would just be an “additionaloverlay” to the current require-ments, she added.

FOS has been involved in the FOFAconsultation process, and will beguided by the Australian Securitiesand Investments Commission's(ASIC's) regulatory guidance when itis released, Maynard said.

While Bobbin agreed with May-nard for the most part, he took hercomments as an admission that FOSwould be taking a pragmaticapproach and forming its own viewon FOFA as soon as an issue relatingto the new laws was brought beforethe ombudsman.

“That’s one of the issues foranyone who finds they’re involvedwith FOS. It’s not a strict applicationof the pure law – it’s what is per-ceived to be ‘fair’. And that has beenFOS’s standard throughout,” he said.

Bobbin labelled the willingness ofFOS to rely on ASIC guidance as“scary”, because the courts wereunlikely to interpret the new laws thesame way as ASIC.

FOFA could increase practice sales further

Continued on page 3

We are ready forFOFA, says FOS

PERPETUAL PLATFORM DEAL: Page 6 | REGIONAL FINANCIAL PLANNING: 4

Continued on page 3

Vol.25 No.39 | October 13, 2011 | $6.95 INC GST

THE manner in which regional plannersoperate their businesses is somewhat dif-ferent to city planners. The adviser/clientrelationship is rather intimate; they largelyservice ‘C’ and ‘D’ clients, and havebecome the fabric of the community.

However, there are significant down-sides. Since regional planners are soheavily involved in their clients’ lives, theyfind it almost impossible to move on andspecialise.

In addition, the introduction of the fee-for-service remuneration model will proveto be a tough sell to clients outside of bigcities, which could result in many prac-tices going up for sale. Because smallfamily practices mainly operate in ruralareas, regional planners find it generallymore difficult than city planners to bearthe costs of increased professionalindemnity insurance premiums andtougher business lending standards.

However, technology and increasedsupport services coming from large finan-cial services institutions could save theday.

For more on trends in regional financialplanning, turn to page 14.

The unseen spectre

REGIONAL PLANNING

Stephen Prendeville

Repeating historic mistakes?

Those who cannot rememberthe past are condemned torepeat it. Those words, attrib-uted to George Santayana at

the beginning of last century, would beringing alarm bells for the FederalGovernment if only it were to closelyexamine the full range of consequencesflowing from its Future of FinancialAdvice (FOFA) changes.

If the Government had cared toundertake a full regulatory impactanalysis of its new legislation it mighthave quickly concluded that, in manyrespects, it was turning back the clockby as much as two decades. It mighthave recalled a time when financialplanning was dominated by the majorbanks and insurers utilising tied agencyarrangements.

Assuming the Government succeedsin navigating all of its FOFA changesthrough the Parliament, the industryafter 2012/13 will look very much likethe one which existed in the early 1980s,but with an additional player in themajor institutional space – the industrysuperannuation funds.

In developing its FOFA legislation theGovernment has, as it should, examined

a number of the impacts. But the regula-tory consequences remain to be illumi-nated – and this is despite long-standingCommonwealth best practice arrange-ments which recommend regulatoryimpact analyses attaching to the imple-mentation of major policy decisions.

According to the Department ofFinance and Deregulation, RegulatoryImpact Analysis (RIA) is the process ofexamining the l ikely impacts of aproposed regulation and a range ofalternative options which could meetthe government’s policy objectives.

The department says the AustralianGovernment’s RIA requirements areintended to achieve better regulationby supporting:

• Sound analysis. The case for actingin response to a perceived problem,including addressing the fundamentalquestion of whether regulatory actionis required, needs to be demonstrated.The analysis should also outline thedesired objective of the response, arange of alternative options to achievethe objective, and an assessment of theimpact of each option, and should beinformed by effective consultation.

• Informed decision-making. To help

decision makers understand the impli-cations of options for achieving thegovernment’s objectives, they should beinformed about the likely impacts oftheir decision, at the time they aremaking that decision.

• Transparency. The information onwhich government regulatory decisionsare based should be publicly available.

So far as Money Management is aware,the Government has not yet published anRIA with respect to its FOFA changes, butit seems likely that financial planners willbe intensely interested in the findingswhen and if such a document is finallymade available.

Even before the Government’s legisla-tive changes are introduced, there areclear signs of industry consolidation andthe re-emergence of product manufac-turers – the banks, insurance companiesand industry funds – as dominant playersin the financial planning landscape.

An RIA may not avert any of the unin-tended consequences of FOFA, but itwould certainly make clear whether thefinancial planning industry is beingcondemned to repeat the past.

– Mike TaylorABN 80 132 719 861 ACN 000 146 921

This is general information only and does not take into account any individual objectives, financial situation or needs. Investors should consider the relevant PDS available from us

before making an investment decision. *Source: Wealth Insights 2011 Platform Service Level Report and survey of 867 aligned and non-aligned advisers, conducted Mar/Apr 2011.

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2 — Money Management October 13, 2011 www.moneymanagement.com.au

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Average Net DistributionPeriod ending March '1110,207

By Milana Pokrajac

ASTERON-owned dealer group GuardianFinancial Planning has changed its nameto Guardian Advice as part of a broaderrebrand, and will reposition itself as arisk-focused boutique, the group hasannounced.

The new name, colour palette and logofollowed a strategic review of Guardian’sbrand eight months ago, when executivemanager Simon Harris came on board.

“When we looked at our offering in thebusiness and the marketplace, and thetypes of advisers that we’re trying toattract, we realised our brand hadn’t keptpace with our business,” Harris said.

Harris added the dealer group current-ly had a 150-strong financial adviser

network, and was planning to expandthat number to around 200 advisers overthe next three years.

“This represents about 10 per centannual growth in adviser numbers; we’retalking about organic growth, and advis-ers seeking to join us because of ourgrowth strategy,” Harris said.

Guardian Advice will remain a holisticfinancial planning business, but will havea special focus on risk, he said.

Speaking at the launch of the newbrand last week, Harris acknowledged theupcoming regulatory change, as well asadviser anxiety associated with it.

“Many advisers are feeling the pres-sures associated with change,” Harrissaid. “However, it is important to ensurethat we don’t get bogged down in the

negative aspects of the changing regula-tory environment, or the perilous stateof the global economy.”

The rebrand also came followingGuardian’s launch of free statements ofadvice to its advisers, the Guardian Busi-ness Academy and other tools, whichHarris said reaffirmed the group’s focuson risk advice businesses targeting growth.

Guardian Advice has worked with anexternal brand consultancy for the pastfour months, but the rebrand will not befollowed by an advertising campaign,Harris said.

“We’ll use a social media strategyrather than a traditional advertisingcampaign.”

The new name was launched after thegroup marked its 10th birthday this month.

www.moneymanagement.com.au October 13, 2011 Money Management — 3

News

Guardian FP rebrands for growth

FOFA could increasepractice sales further

Multiples of earnings before interest and tax for largerpractices used to be as high as seven times, but havedropped to six, then five, and can now be as low as four.

“So someone’s offering them $3 million for a practice,and they think it’s worth nearly $4 million,” he said.

Premium Wealth Management general managerPaul Harding-Davis said his group continues to keepan eye out for like-minded practices and doubts theflurry of acquisitions has finished, but added that anypractices thinking of selling up because of FOFA wouldlikely have done so already, rather than waiting forfinal details of the legislation.

“Various individualswithin ASIC have displayedtheir colours and their dis-taste for financial planningin the past. As a regulatorof financial planning, ASICis all about regulation –and less so about thesmooth operation of theindustry,” Bobbin said.

Gold Seal Risk Manage-ment Services managingdirector Claire Wivell Plateragreed with Maynard thatthe onset of the FOFAregime was unlikely topresent FOS with signifi-cant problems.

“The legislation providesmore guidance to FOSthan they’ve ever had inthe past,” she said.

She added that theFOFA legislation was verydescr ipt ive, and boremany similarities to the

Financial Planning Asso-ciation’s Code of Profes-sional Practice.

“[The Government has]almost written a mini codeof practice or standard forthe adviser, which is some-thing you’d tend to seefrom an industry associa-tion rather than a regula-tor,” she said.

We are ready forFOFA, says FOSContinued from page 1

Continued from page 1

Simon Harris

Alison Maynard


News

Planners still ahotspot of demandBy Milana Pokrajac

FINANCIAL planners andparaplanners remain anongoing hotspot of demandas the wealth managementindustry continues to battlecandidate shortages, accord-ing to the latest report by HaysRecruitment.

Hays Quarterly Reportnoted that fewer peopleentered the advice market in2008 and 2009 when theindustry’s reputation suffered,the consequence of which isa shortage of talented wealthprofessionals today.

Hay’s Recruitment expectsthe proposed Future of Finan-cial Advice reforms to lead toan increase in adviser use asa whole, with the knock-on

effect of the talent vacuumincreasing.

“These advice reforms willnaturally create a need forcompliance professionals asthe industry fights to regulateand restore consumer confi-dence,” the report stated.

Furthermore, headhuntingis increasing for financialplanners. The traditionaldealer group model of on-boarding trainee advisors intothe network is once againbecoming prevalent and retailbanks are launching similarschemes.

“In all other areas of thebanking and financial servic-es sector hiring intentions aremore reserved, particularly onthe permanent side,” thereport said.

Tax changes must encourage retirement savings: FPABy Chris Kennedy

THE Government should amend thetax system to help Australians buildtheir retirement savings, FinancialPlanning Association (FPA) chief exec-utive Mark Rantall has said in anaddress to the Tax Forum.

Rantall’s core recommendationswere that the Government introduceincentives to encourage Australiansto seek financial advice; and improvetax and superannuation laws toencourage the development of moreinnovative products to counterlongevity risk.

Cost is currently a significant barrierfor low to middle-income earnersseeking financial advice, and improv-ing their access to advice would helpboost their retirement savings andtake pressure off the age pension, hesaid.

The Government’s Intergenera-tional Report published last yearprojected that by 2050, 6.1 million

Australians aged over 65 would bereceiving a full or part age pen-sion, which highlights the need tobridge the advice gap for pension-ers, he said.

The Government could improve

access to advice by allowing Aus-tralians to pay for advice with pre-tax dollars via salary sacrificing;introducing tax deductibility forfinancial planning fees; using a per-centage of the current superannua-tion co-contribution payment to funda ‘one-off’ superannuation advicefee; and directly subsidising finan-cial advice for low-to-middle incomeearners, according to Rantall.

The development of better retire-ment income products has been ham-pered by the current superannuationand tax legislation which overly restrictsthe definition of ‘income stream’ andthe eligibility of certain pension assetsfor tax relief, he added.

“In particular, the FPA would liketo see legislation amended to allowproviders to develop ‘deferred annu-ities’ and other ‘longevity protec-tion’-style income streams, whereindividuals can choose when tobegin retirement income pay-ments,” Rantall said

Online SoAs ‘won’t replace advisers’: AustralianSuper

Positive report card for Aussie equitiesBOTH big brand and boutiqueAustralian equity managers haveperformed well overall in thelatest Standard & Poor’s (S&P)Fund Services Australian equitiessector review, with the quality ofresearch singled out for praise.

This is a result of the strongcompetitive forces at play withinthe Australian equity sector andthe tough environment for retailflows, S&P stated.

The six managers to receivethe top five star rating were:Schroders, which was upgraded;Fidelity; BT; Perpetual's IndustrialShare Fund; and the flagshipofferings of Perennial Value andTyndall.

Overall, the report covered104 capabilities offered by 57managers, wi th e ight fundsacross five underlying managersupgraded and nine funds acrosseight managers downgraded.The only strategies currently 'onhold' are four INGIM strategies,

as a result of the UBS acquisi-tion announcement.

“The volatile market conditionswe are currently experiencing aregenerally very favourable to activemanagement, with compressedvaluations creating opportunitiesfor managers to purchase qualitystocks at attractive valuationlevels,” said S&P Fund Servicesanalyst James Gunn.

The report also found mostmanagers continued to espousea bottom-up approach, but with agreater acceptance of macroissues and the value of informedtop-down analysis.

S&P predicted high-prof i ledepar tures and leadershipchanges would cont inue tooccur, and stated the rapidgrowth of the boutique businessmodel over the past five yearsand the response by mainstreammanagers to shore up their keystock p ickers had general lyimproved retention.

By Tim Stewart

AUSTRALIANSUPER hasannounced the launch of anonline advice offering for itsmembers, which the bigindustry fund says will helppeople ‘self-start’ their super.

The super fund’s generalmanager of marketing andcommunications James Coylesaid online advice was muchcheaper to produce than face-to-face planning, although headded that online Statementsof Advice wouldn’t replaceadvisers.

“At any point in the processthe member can stop andthen re-engage later or put ina call to our phone-basedsuperannuation advisers, whocan access the histor y ofadvice provided and pick upwhere the online advice toolleft off,” Coyle said.

Austral ianSuper’s new

advice offering was developedwith Provisio Technologies,and will provide memberswith access to advice oncontributions, transition toretirement and setting up apension account.

“ The goal was to helpmembers make moreinformed decisions abouttheir financial future by takingaway as many barr iers toengagement as possible,” saidCoyle. He added thatAustralianSuper’s new advicetools would utilise members’account information to makeadvice available “24 hours aday, seven days a week”.

The online offering includesaccess to the fund’s existingretirement calculator, which isalso available on mobile devices.

Provisio Technologiesdirector Jye Tucker said the AustralianSuper websitealso included “teaser-style

widgets” that acted as a call toaction for members, showingthem how long their superwould last in retirement.

“To really engage membersAustralianSuper needed adepar ture from previousretirement modeling, calcula-tors and so on. By shifting thefocus to projected retirementincome AustralianSuper ispainting a picture of whatsuper will actually mean tomembers,” Tucker said.

Mark Rantall

Jye Tucker


News

By Chris Kennedy

SNOWBALL chief executive TonyMcDonald will depart the companyon 4 October 2012 as part of the inte-gration between Snowball and Shad-forth, the company announced.

Until that time, McDonald will focuson integration and related initiatives,according to a statement to theAustralian Securities Exchange.

McDonald’s new role as executivedirector, integrat ion projects,includes assist ing the group tomanage the responses to Future ofFinancial Advice reforms, Snowballstated.

The group also announced chair-man Eric Dodd was being appoint-ed chair of Shadforth FinancialGroup, non-executive directorGraham Maloney would chair port-

folio management business Offici-um Capital and fel low directorJohn Gannon would chair affiliatelicensee advice business WesternPacific.

The company will also seek share-holder approval at the 29 Novemberannual general meeting to changethe group’s name to SFG Australia.

Dodd said the integration wasproceeding on schedule.

Global smallcaps can playdiversifying role

By Tim Stewart

GLOBAL small cap fundscan provide significant diver-sification benefits to a bal-anced portfolio, but the strat-egy’s inherent volatility canmake more conservativeinvestors uncomfortable,according to Morningstar.

In its wrap-up of the WorldSmall Cap fund category,Morningstar reviewed eightstrategies that make up 94per cent of the sector. Noneof the eight funds reviewedreceived a ‘highly recom-mended’ rating, but threefunds – Hunter Hall GlobalEthical, Hunter Hall ValueGrowth and Schroder GlobalSmaller Companies – werenamed ‘recommended’ byMorningstar.

Investors should examinetheir portfolio’s market capand style characteristicsbefore adding a global smallcaps strategy, to ensurethere is no duplication,according to the Morningstaranalysis.

“Investors and advisersneed to consider carefullywhether exposure to aninherently volatile assetclass such as global smallcaps matches the investor’stime horizon and risk toler-ance,” said Morningstar.

The BlackRock GlobalSmall Cap fund also holdslarger cap stocks, which willpotentially undo some of thediversification benefits forinvestors, according thereview.

Hedged global small capshave produced betterreturns than unhedgedfunds in the category, butthey have done so at thecost of greater volatility –making them inferior on arisk/return basis, accordingto Morningstar.

McDonald departs in Snowball integration


News

Perpetual to outsource administration platformBy Chris Kennedy

PERPETUAL has announced itwill outsource third party provi-sion of portfolio and fiduciaryadministration services forPrivate Wealth clients toMacquarie InvestmentManagement, to be launchedin late 2012.

Macquarie will add Perpetu-al-specific functionality to anexisting third party systems andadministration solution, withadditional features and infra-structure, Perpetual stated.

Perpetual will decommissionits older platform administrationsystem (PACT) and transfer a

significant level of IT develop-ment requirements to Macquar-ie, the group stated.

Perpetual’s group executiveprivate wealth and head of retailsales, Geoff Lloyd, said the groupneeded to improve on the func-tionality of its platform offeringin line with an evolving businessand client servicing model.

The new solution will allowPerpetual to widen the range ofproducts and assets offered,support a multi-platform envi-ronment, and ensure Perpetualcan target specific customersegments in a more efficient way,Lloyd said.

Perpetual will be able to offer

additional products, such as aSuper Wrap (which Perpetualexpects to be available by thethird quarter of calendar 2012),and build a full spectrum of advi-sory, investment and fiduciarysolutions, the group stated.

Perpetual managing directorand chief executive Chris Ryansaid the decision was in keepingwith efforts to reduce thecompany’s cost base and redirectresources towards growth oppor-tunities.

The outsourcing deal avoidsongoing system spend, and moreclosely aligns operating costs toactual revenues, Ryan said.

“In the context of possible

regulatory changes and rapidlyevolving client needs, the cost ofmaintaining PACT’s functional-ity at required levels would havebeen prohibitive,” he said.

Perpetual expected the dealto incur one-off costs of $5.5million before tax in the current2012 financial year, and $11million of costs before tax in the2013 financial year, of which$6.6 million are expected to benon-recurring.

Perpetual anticipated a posi-tive profit contribution from the2014 financial year, with positivenet present value over five yearsdue to the combination ofrevenue and expense benefits.

Online traction for FPA campaignA RECENTLY-launched advertisingcampaign from the Financial Plan-ning Association (FPA) is yieldingpositive results online after lessthan three weeks, according to theFPA.

Among the measurable onlineresults, the campaign has generat-ed nearly 2,000 clicks through to the FPA website at fpadiffer-ence.com.au; more than 6,000click-throughs from Googlesearches; a 20 per cent increase inusage of the FPA’s online Find aFinancial Planner tool to 700searches per day; and an increasefrom around 600 to around 1,000unique visitors per day to the FPAwebsite.

The FPA’s general manager ofmarketing Lindy Jones said thatin total the campaign had reachedover 230,000 unique individuals,with each person seeing theadvertising more than four timeson average.

The online results are muchmore easily measurable in the shortterm than the television campaignbut the FPA had done some marketresearch before the campaign

started to gauge consumer aware-ness of the FPA and their attitudestowards it, and would repeat theresearch after the campaign wascompleted to measure its effective-ness, Jones said.

“After the campaign it will be aquestion of where to from here,”Jones said.

“We’re hoping members willcontinue to support the campaign.We’ll see how this one goes and

look for feedback at the nationalconference [in Brisbane in Novem-ber],” she said.

There had already been signifi-cant member feedback, of whicharound 80 per cent was positiveand 20 per cent was neutral orconstructive, she said.

The overwhelming messagefrom members was one of “at lastit’s here”, particularly with toughtimes in the markets and lowconsumer confidence which canmake it difficult for planners, shesaid. That also makes it the righttime to be telling consumers wherethey can get trusted advice, sheadded.

Some members have suggestedthey’d like the Certified FinancialPlanner (CFP) designation to bepromoted, but with the FPA not yeta household name, research hasshown that talking about the CFPas well effectively halves theamount of brand awareness anddilutes the message, Jones said.That may be something to look atincluding in the next campaignonce awareness had been raised,she added.

Cost a catalyst tolow advice uptake By Milana Pokrajac

FINANCIAL advice fees are themost commonly mentionedbarrier to consumers takingup financial advice, accordingto CoreData’s latest shadowshopping exercise conductedamong super fund financialplanning arms.

After seeing an adviser,more than half of shoppers(53.8 per cent) thought theproposed fees were too high,although before seeing one avast majority felt adviserscould improve their financialwellbeing.

CoreData’s head of advice,wealth and super Kristen Turn-bull said this does not seemtoo radical a concept, giventhe reported gap betweenwhat consumers are preparedto pay for advice and whatadvisers are charging.

“Industry research has putthe cost of holistic or compre-hensive advice at between

$1,400 and $3,500 depend-ing on the complexity, yet con-sumers often baulk at payingless than half this for financialadvice,” Turnbull said.

She said the main reasonfor lack of advice take-upwasn’t, as many might haveexpected, the failure to articu-late the value of advice.

“Although consumersbaulked at the cost of advice,they were very positive aboutthe planner’s ability to finan-cially assist them ahead of theirinitial meeting,” Turnbull added.

Nearly nine in 10 con-sumers thought adviserscould assist them with thingslike investment strategies,market development andaccessing research on latestmarket events.

CoreData noted the pricingof financial planning firms thatwere shopped varied broadly,but as a general trend theannual fees increased withthe size of the portfolio.

Geoff Lloyd

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In-specie transfer ban forSMSFs more ‘red tape’THE proposed Stronger Super ban on off-market relatedparty transfers for self-managed superannuation funds(SMSFs) “goes against the grain of a simplified superannu-ation system,” according to Hewison Private Wealth chiefexecutive John Hewison.

The Government’s proposal, contained in the recentStronger Super changes, would see SMSFs prevented fromcompleting in-specie asset transfers. Instead, DIY funds wouldhave to carry out the transaction through a recognised marketsuch as the Australian Securities Exchange, said Hewison.

“Using shares as an example, this means the investor mustsell the asset on the share market, wait four days for trade tosettle, transfer the cash into their super fund and rebuy theshares – taking up to a week to complete the transaction,”Hewison said.

The Government’s changes were a response to specula-tion under the Cooper Review that SMSFs were using off-market transactions to minimise capital gains tax by choos-ing a transfer date to coincide with a low price for theasset, he added.

Rather than adding further “red tape” to the system (andthereby defeating the purpose of Stronger Super) Hewisonargued that a better solution would have been to tighten thetimeframe for the lodgement of transfer documents.

“There is no logical reason to have singled out SMSFs,which are audited, when there is little evidence to suggestSMSFs are using in-specie transfers to avoid capital gains andone could argue that institutional investors would have a fargreater impact in this regard,” Hewison said.


News

Bendigo enters retailsuperannuation marketBy Tim Stewart

BENDIGO Wealth is targeting fee-for-service inde-pendent financial advisers (IFAs) with the launch of alow-cost, ‘true-to-label’ superannuation productcalled SmartStart Super.

Bendigo Wealth head of wealth markets AlexandraTullio said SmartStart was Future of Financial Advice“ready” because it was fee-for-service and dollar-based.

“Advisers in the IFA market are small businesspeople who have all the pressures and stress of legis-lation and margin squeeze. From their perspectiveSmartStart fits with a fee-based model,” Tullio said.

Bendigo Wealth would also support planners whenit came to back-office functions such as super consol-idation and analysis work, Tullio said.

SmartStart offers 10 investment options – five activeand five indexed – with annual fees ranging from 0.39per cent to 0.99 per cent. There is also an annualadministration fee of $98.

“A lot of products out there purport to be transpar-ent and very cost-conscious, but there is an asterisk ontransaction-type fees. With this product we don't have

any of those fees,” Tullio said.Bendigo Wealth has partnered with TAL to provide

life insurance through SmartStart. The offeringincludes ‘Life Events’ cover that allows customers toincrease their death and total and permanent disabil-ity cover after a significant event, along with incomeprotection up to age 65.

Vanguard is the major investment manager for theproduct, and is joined by many other managers. IOOFwill provide the administration for SmartStart, andSandhurst Trustees (part of Bendigo Wealth) willoversee the product.

Along with the IFA market, the other main channelfor the product will be Bendigo and Adelaide Bank’s(BAB’s) 1.4 million customers, who Tullio said “have ahigh level of trust in us”.

As evidence of that trust, BAB recently ranked equalfirst in a customer loyalty benchmarking studyconducted by Brisbane consulting firm EngagedMarketing. According to the findings, customers ofBendigo and Adelaide bank are more likely to recom-mend the bank to their friends and family thancustomers of other banks.

Core-satellite strategy can reduce riskA DYNAMIC core-satellite invest-ment approach can control riskwhile boosting portfolio returns,according to research conductedby the EDHEC-Risk Institute.

The research, produced as partof the Amundi ETF research chairon ‘Core-Satellite and ETF Invest-ment’, was built on the knowledgethat momentum and value are theideal strategies for managersseeking outperformance. Whiledynamic asset allocation strate-gies can produce superior returns,they also carry a high risk, accord-ing to the research. However, therisk can be tempered through the

use of a core-satellite strategy.The authors found that

exchange-traded funds (ETFs)were the best investment vehiclefor the strategy, because they offerbroad exposure to the market, are

highly liquid, and adapt well tothe frequent rebalancing requiredin a dynamic core-satel l i teapproach.

Additionally, the use of ETFsthat target sectors rather thanspecific stocks can keep a checkon downside risk, according to theEDHEC-Risk Institute study.

The research was conducted byElie Charbit, Jean Rene Giraud,Felix Goltz and Lin Tang of theEDHEC-Risk Institute, one ofEurope’s leading business schools.

Amundi ETF offers over 100 ETFsand had $9.9 billion in assets undermanagement as of 31 July 2011.

The Lonsec Limited (‘Lonsec’) ABN 56 061 751 102 rating (assigned May 2011) presented in this document is limited to ‘General Advice’ and based solely on consideration of the investment merits ofthe financial product(s). It is not a recommendation to purchase, sell or hold the relevant product(s), and you should seek independent financial advice before investing in this product(s). The ratingis subject to change without notice and Lonsec assumes no obligation to update this document following publication. Lonsec receives a fee from the Fund Manager for rating the product(s) using comprehensive and objective criteria.Challenger Managed Investments Limited ABN 94 002 835 592, AFSL 234 668 (CMIL) is the responsible entity and issuer of interests in the Five Oceans World Fund ARSN 117 060 769 (Fund). Thisadvertisement is not intended to be financial product advice and does not take into account any person’s investment objectives, financial situation or needs. Accordingly, investors should considerthese matters, the Fund’s product disclosure statement (PDS) and its appropriateness to them before making an investment decision. The PDS is available from www.challenger.com.au and should beconsidered prior to making an investment decision. Five Oceans Asset Management Pty Limited ABN 90 113 453 160 , AFSL 290 540 is the Fund’s appointed investment manager.12

614/

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For information on the Five Oceans World Fund visit www.5oam.com

1. Aims to deliver strong, consistent performance.2. Benchmark unaware investment approach.3. Reduced volatility via hedging.4. Active currency management.5. Diverse investment ideas.

Five clear reasons to investinternationally with Five Oceans

John Hewison


News

By Milana Pokrajac

ELIXIR Consulting has launched afollow-up survey to its Adviser PricingModels Research which looks atobstacles and methods used byfinancial planners in creating a fee-based remuneration model.

Many advisers are still in the darkabout the appropriate pricing foradvice, as the industry continues to

get clarification on the upcomingFuture of Financial Advice (FOFA)reforms package.

Elixir Consulting managing direc-tor Sue Viskovic said the researchaimed to unveil some of the myster-ies and challenges faced by businessowners when creating a fee model.

“We want to understand what themajority of businesses are doing andalso delve deeper with those who

have already implemented fees intheir business in order to assist advis-ers around the country to improve,update or maintain their own pricingmodels,” Viskovic said.

The report, first conducted in 2009,will also see the expansion of theresearch into increased focus on riskand stockbroking pricing models.

The company is conductingAdviser Pricing Models Research for

the first time since the announce-ment of FOFA, as part of which alladvisers will have to dump a commis-sion-based remuneration model andswitch to fee-for-service by July 2012.

Elixir Consulting is calling finan-cial advisers to participate in thesurvey, which involves legal agree-ments protecting the identity ofparticipants and the informationthey provide.

Elixir launches advice pricing research

Praemiumrestructures toreduce costsBy Tim Stewart

FOLLOWING a successful $5 mil-lion capital raising earlier thismonth, portfolio administrationspecialist Praemium hasannounced an organisationalrestructure and cost-reductionprogram to “improve efficienciesand eliminate expenditures”.

The restructure followed areview of Praemium’s opera-tions which sought to eliminateexpenditures that were “not jus-tified by near-term revenueexpectations”.

The cost-reduction measureswill see Praemium incur a one-off cost of $1.5 million in the2011-12 financial year, and willresult in continuing savings ofbetween $2 million and $3 mil-lion in ongoing years, accord-ing to the company.

The restructure will befunded by a $5 million capitalraising that was announced tothe ASX on 8 September. Theplacement was mainly takenup by larger Praemium share-holders, new institutionalinvestors, three of the com-pany’s directors and its chiefexecutive, Michael Ohanessian.

Praemium announced on 28September that Ohanessianand Praemium chairman BruceParncutt would both be advanc-ing the company $500,000 onan unsecured basis.

The advanced funds “willensure the Company’s cashbalances remain above mini-mum regulatory, contractualand operating requirementsprior to the settlement of the$5 million equity placement”,according to a Praemiumannouncement.

“We remain committed to pro-tecting our core business. Forour clients it is business as usualas we continue to deliver ourhigh-quality services. For ourinvestors the priority remains forus to improve bottom-line per-formance,” said Ohanessian.

Sue Viskovic


News

AMP launches secondwalk-in planning centreBy Chris Kennedy

AMP has launched its secondretail financial planning centre inthe Melbourne suburb of Camber-wel l , just over a year afterlaunching its first centre in Parra-matta, Western Sydney.

The new centre wi l l br ingtogether 18 new and experiencedself-employed financial plannersin one AMP-branded premises,AMP stated.

The centre has 10 plannerssigned up already, includingformer Richmond AFL playerMichael Roach, with another fourdue to start in October, accordingto AMP.

AMP Financial Services manag-ing director Craig Meller saidCamberwell was a great centralhub for the people AMP wantedto reach, and expected the centreto mirror the success of the Parra-matta centre.

In its first year, the Parramattacentre received around 11,500calls and met with close to 1,500customers, AMP stated.

As with the Parramatta centre,the Camberwell centre features anon-site AMP specialist supportteam to look after practicemanagement and administration,and will be led by AMP businesspartnership manager Frank Welsh,AMP stated.

Economic growth not linkedto equity returns: VanguardBy Tim Stewart

THERE is no correlation between a coun-try’s gross domestic product (GDP) growthand the real returns of its stock market,according to Vanguard chief investmentofficer Gus Sauter.

The current enthusiasm among investorsfor emerging markets can be put down totwo major factors, according to Sauter: atendency to “look in the rear-view mirror”,and a mistaken impression that GDPgrowth is linked to stock market returns.

“The problem we have with that is finan-cial theory mentions nothing about eco-nomic growth. Equity returns are notrelated to economic growth,” Sauter said.

As evidence, he pointed to Vanguardresearch that compared geometric realstock returns with real GDP per capitagrowth rates between 1988 and 2010. Thecorrelation between the two was 0.0176for developed markets, and 0.003 foremerging markets.

“When we invest we’re buying compa-nies, not countries. Even if China is growingat an extraordinarily rapid rate, it doesn’tmean Chinese companies’ earnings willgrow at an extraordinarily rapid rate,”Sauter said.

If the earnings of those companies didrise quickly, competition from overseaswould quickly drive those excess profitsaway, Sauter added.

“You won’t be compensated for higher eco-nomic growth in the [emerging market] region,but you will be compensated for higher risk. If

there is a premium, it’s due to volatility, noteconomic growth,” Sauter said.

The lack of correlation between stockreturns and GDP growth was also evident indeveloped markets, Sauter said. He citedUS and UK GDP growth per capita over the20th century: 3.2 per cent and 1.8 percent, respectively. Compounded out, theUS grew 17-fold between 1900 and 2000,and the UK grew 7-fold – but the equityreturns in both countries was 10.1 per centper year.

“You weren’t rewarded for extra eco-nomic growth in the US. You were beingcompensated for the risk and volatility inboth marketplaces,” Sauter said.

Gus Sauter

Craig Meller

Investors turn to defensive stocks as confidence slumpsBy Andrew Tsanadis

THE search for safety amidglobal market downturns hasheralded the return to moreconservative asset classes,according to EPFR Global FundFlows and Allocations Data.

A possible Greek default andmultiple sovereign downgradesalso created an uncertain climate

for fixed income investors duringthe third quarter.

The data revealed that thefinal week of September sawEPFR global-tracked US bondsfunds, utilities sector funds andmunicipal bond funds postincreased levels of inflow.

Meanwhile, any fund groupassociated with Europe sawheightened levels of outflow,

with Europe bond funds postingoutflows 11 out of the past 13weeks, the data stated.

Emerging market bond fundscontinued to attract investorsdespite a break in inflows in earlyAugust. Emerging Asia was aclear front-runner in terms ofregional preference and localcurrency mandates, but the lastweek of September saw a record

outflow of $3.19 billion from theemerging market bonds sector,the data found.

Meanwhile, October sawmunicipal bond funds andmortgage-backed bond fundsattract steady inflows, whilefunds specialising in dividendpaying stocks absorbed nearly$6 billion during a period wheninvestors pulled out over $100

billion from equity funds as awhole, the data revealed.

According to EPFR, utilitiessector funds extended theircurrent inflow streak to sevenconsecutive weeks going intoOctober, and commoditiessector funds benefited fromadditional f lows into fundsspecialising in gold andprecious metals.

News

Demand for equityincome funds on the upBy Tim Stewart

WITH traditional income-yield-ing investments such as govern-ment bonds delivering pooryields, there has been significantgrowth in the number of incomefunds that are based on equities,according to van Eyk.

In its second review of the equityincome sector, research house vanEyk has found the number of fundsin the sector has grown from fourin 2008 to 16 today.

Considering that the number ofpeople aged between 65 and 84 isexpected to double between nowand 2050, the demand for income-producing investments is rising,according to van Eyk head ofratings Matthew Olsen.

“The relatively reliable and highyields of income funds combinedwith typically more conservativeinvestment strategies haveemerged as an alternative to fixedinterest securities,” Olsen said.

Thirteen of the 16 equity incomefunds in the sector agreed to

participate in van Eyk’s reviewprocess. The funds typically favourstocks that pay high dividends, butseveral of the funds use optionsover the stocks to increase thepotential yield. However, the useof options made van Eyk reluctantto award any of the funds an ‘AA’rating, due to concerns about illiq-uidity – whether the options were

over-the-counter or exchange-traded options.

“We were cautious of managersusing derivatives, and generallyassigned a higher risk rating tothose strategies,” Olsen said.

The review found the idealinvestment for income managerswas “a quality firm that grows earn-ings and fully franked dividends”,citing banks and consumer staplesas good examples. Stocks in theutilities sector were less attractive,because while they paid a reason-ably high dividend the frankingcredits were low, the review said.

Van Eyk awarded three ‘A’ratings, six ‘BB’ ratings and two ‘B’ratings to the funds in the sector.

The research house added thatequity income funds were bestsuited to investors on a tax rate ofzero to 15 per cent. The optionsstrategies employed by some of thefunds protect investors frommarket falls, but they can alsocause investors to miss out oncapital gains in rising markets, vanEyk said.

Reinsurers still good for business in AustraliaBy Milana Pokrajac

BUSINESS capacity for global reinsurers remains strongin Australia and New Zealand despite the losses fromthe 2010/11 natural catastrophes, according to AonBenfield’s chief executive officer Malcolm Steingold.

Of $25.6 billion in combined losses from theQueensland floods, Cyclone Yasi, the Perth hailstormand the New Zealand ear thquakes, insurersrecouped an estimated $16 billion from reinsurers.

According to Aon Benfield, the renewal of reinsur-

ance programs at 1 July 2011 was orderly followingsignificant catastrophe loss activity over the past12 to 18 months.

“The insurance industry performed as intendedand drew upon its significant capital resources toprotect insurer balance sheets and earnings so thatinsurers could continue to help their customersrebuild homes and businesses,” Steingold said.

While pricing in the region was higher at renewal,insurers continued to find the capacity they required,he added.


The more things change...Investors are anxious about the present turmoil around the world.

Yet, for all the economic disruptions over the last 100 years,which included two world wars and a profusion of regional confl icts,

equities have eclipsed infl ation by a sound margin.

www.platinum.com.au | 1300 726 700

3CPAMM06

Higher dividends forinvestors: RussellInvestmentsTHE market has delivered a 9 per cent increase in divi-dends to investors thisreporting season, accordingto data released by RussellInvestments’ high dividendand high value indexes.

In the per iod of lowergrowth forecasts and height-ened volatility, companiesare taking the pr udentapproach and retur ningcapital to shareholdersinstead of reinvesting incash, according to RussellInvestments por tfol io

manager, Scott Bennett.Apart from the mining

giants, Telstra and Westfield,the big four banking groupswere found amongst the top 10holdings in Russell’s high valueand high dividend indexes.

Bennett added thecompany’s high value indexfound value in resources, asfinancials lost their “cheap”appeal.

“In stock movements, thistranslates into buys of BHPand Rio and selling down thebanks,” he said.

IOOF Advice addstwo WA practicesTWO Western Australian financial planning practices havejoined the IOOF Advice Division.

The practices will join IOOF via its Wealth ManagersLicence. The two practices are Kings Park Securities, basedin Perth and operated by Warren Killen; and Coastal Wealthmanagement, based in Geraldton and run by Allan Roseand Craig Woodman.

Both practices were formerly under the Financial Ser-vices Partners umbrella and have a combined funds undermanagement of $400 million.

“What has attracted us to the IOOF Advice licence is theirstrong compliance systems, the quality of the in-houseresearch team, their understanding of direct equities andtrading capabilities through Bridges Stockbroking, togetherwith better access to estate planning support,” said Killen.

IOOF Advice Division head Michael Carter said theimpending Future of Financial Advice environment wouldresult in more practices moving to realign with dealer groupswith strong infrastructure and additional service offerings.

Over 650 financial planners operate under IOOF.

Matthew Olsen


SMSF WeeklySG – a tax by any other nameBy Mike Taylor

THE recent High Court deci-sion upholding the consti-tutional validity of thecompulsory superannuationguarantee also validated thefact that it is a tax.

In examining the decision,law firm Blake Dawsonpointed out that a key elementin the High Court’s decisionwas its status as a tax.

It said the focus of RoyMorgan's special leave appli-

cation to the High Court wasthe distinction between apublic purpose and a privatepurpose, on the basis that thesuperannuation guaranteecharge is not a tax undersection 51(ii) of the Constitu-tion as it is not imposed forpublic purposes.

However, the law firm’sanalysis said the majority ofthe High Court considered theSGC to be a valid tax on thebasis that:

• the shortfall amounts

payable by the Commission-er of Taxation for the benefitof the employee are payableout of the ConsolidatedRevenue Fund and this isconclusive evidence that theSGC is imposed for "publicpurposes"; and

• when an employer paysthe SGC into the Consolidat-ed Revenue Fund, the identi-ty of the moneys is lost and thefunds may be appropriated bythe Commonwealth for anylawful purpose.

Jury out on SMSF asset allocationBy Damon Taylor

WHILE self-managedsuper funds have beenviewed favourably inrecent years for how welltheir asset allocationshave weathered marketvolatility, chief executive ofthe Association of Super-annuation Funds of Aus-tralia, Pauline Vamos,believes the question ofwhether those allocationshave matured is one onwhich the jury is still out.

“The latest figures

don’t seem to indicatethat,” she said. “Andthere is no doubt that, asinvestors, they do investin a narrower class ofassets.

“The question for uslies in the fact that whilethey are a growing por-tion of the super industrypie, their ability to investin ‘whole of economy’asset – or at least acrossall asset classes – is lim-ited,” Vamos continued.“The question to beasked is what that

means for the expectedrole of the superannua-tion pool?”

Vamos said one of thekey economic benefits ofthe Australian superan-nuation pool was its abil-ity to “give back” to theAustralian economy.

“It invests back into thewhole economy, andthrough that investment,drives economic growth,”she said. “And obviously inthe end, that providesbetter returns to every-body.”

Accountants move to cement audit changes

A ‘TICK the box mentality’ by auditors isnot the right way to assess independ-ence and runs the very real risk that indi-vidual circumstances of a potential auditengagement may be ignored, accordingto Institute of Chartered Accountantssuperannuation specialist Liz Westover.

Commenting on recent Governmentannouncements on self-managedsuperannuation fund (SMSF) auditorregistration, Westover said althoughuncertainty still surrounded theprocesses, the Government’s announce-ment had represented a positiveoutcome for the accounting and audit

industries around SMSFauditor independence.

She said the Institutehad been advocating forsome time that appropri-ate standards for auditindependence already existin APES 110, the Code ofEthics for accountantsdeveloped by the Account-ing Professional andEthical Standards Board.

Westover pointed outthat APES 110 alreadyapplied to members of the

three professional accounting bodieswho currently undertook around 95 percent of all SMSF audits.

She said these same standards wouldnow be applied across the board for allSMSF auditors.

“Independence is a critical compo-nent of all audit engagements,” she said.“The same principles of independenceare just as applicable to an SMSF auditas they would be for the audit of a listedcompany. Therefore, the same princi-ples that apply for the broader auditindustry should apply to the SMSFindustry as well.”

SMSF growth presents planning opportunitiesTHE strong growth in the self-managed superan-nuation fund (SMSF) sector is presenting bothopportunities and challenges for the financialplanning industry, according to the recentlyreleased Vanguard / Investment Trends 2011SMSF Planner Report.

According to the survey, total annual industryrevenue generated by SMSFs for plannersexceeded $1 billion for the first time – and withalmost half of advisers surveyed expecting to be rec-ommending the use of SMSFs more often in thefuture, it seems that growth is likely to continue.

Commenting on the financial planning indus-try’s challenges specifically, Robin Bowerman,head of corporate affairs and market develop-ment at Vanguard Investments, said the com-plexities associated with managing and advisingSMSFs had also been highlighted.

“Since 2009 the average number of challengescited by planner respondents in relation to servicingthe SMSF market has grown year-on-year from 3.9each in 2009 to 4.4 in 2011,” he said.

Bowerman said falling caps on concessionalcontributions had been the biggest challengeidentified this year, but other commonly citedchallenges included educating clients about theirresponsibilities, administration and keeping feescompetitive.

“The survey results illustrate a number ofissues that planners and the broader industryshould be addressing if they are to be successfulservicing this sector,” Bowerman added.

Yet while the growing importance of SMSFsto financial planner business is clear, the Van-guard / Investment Trends Report also showedthat growth from SMSF clients had not matched

planners’ past expectations.However, Mark Johnston, principal of Invest-

ment Trends, said it was clear that SMSFs contin-ued to offer strong opportunities for bothinvestors and planners, and there was no sign ofthat growth abating.

“Planners need to look at the reasons underly-ing the lag in the expected growth and perhapsconsider a different approach to servicing thismarket,” he said. “The investor research showsthat they favour more of a partnership or coach-ing approach.

“Competitive fees and a clearly articulatedvalue proposition remain areas where plannersthemselves understand that the industry haswork to do. However, there is no doubt that plan-ners can and will play a significant role in thecontinued growth in the sector.”

Robin Bowerman

Amid all the discussion around theimplications of the Government’sFuture of Financial Advice (FOFA)changes and the influence the

legislation will hand industry superannua-tion funds, it is worth reflecting upon howsuperannuation funds have utilised thefreedom granted to them to provide intra-fund advice.

When the former Rudd Labor Governmentgave the green light for class order relief to begranted to superannuation funds to deliverintra-fund advice to their members, therewere many in the financial planning indus-try who believed it represented the thin endof the wedge.

At least a part of the reason for the plan-ning industry’s concern was the vigour withwhich the issue had been pursued by thepolitical lobbying arm of the industry super-annuation funds – the Industry SuperNetwork (ISN). Indeed, it is arguable the ISNpursued intra-fund advice with almost thesame vigour with which it is now pursuingelements of the FOFA changes.

Now, more than three years later, it hasbecome obvious that few superannuationfunds actually chose to fully utilise intra-fundadvice, preferring instead to pursue the moreconventional route requiring the holding ofan Australian Financial Services License(AFSL) or the outsourcing of advisory servic-es to an AFSL holder.

At least a part of the reason for the low util-isation of intra-fund advice is probably owed tothe realisation by superannuation fund trusteeboards that the class order relief fell well shortof providing them with the ability to develop acommercial advice model.

The reality of the rules surrounding theprovision of intra-fund advice is that they werealways going to provide a very narrow remit.

The narrowness of this remit was made clearin a recent Association of SuperannuationFunds of Australia (ASFA) submission to theTreasury dealing with the FOFA proposalswhich outlined the boundaries of intra-fundadvice as being:

• Intra-fund advice can include personal

advice – subject to the limitations contained inthese principles.

• Advice that may be provided by a calcula-tor (such as benefit projections) can be includ-ed in intra-fund advice but areas outside intra-fund cannot. For example, calculators thatcompare two products cannot be funded out ofthe administration fee of a fund.

• The provision of intra-fund advice mustmeet the sole purpose test.

• Areas of advice that are potentially conflict-ed (such as advice to switch money fromanother fund), cannot be included in intra-fund advice.

• Intra-fund advice must be available to allmembers in the fund and the trustee must takereasonable steps to ensure all members areaware that the service is available.

• Members must be made aware of thelimited scope of the intra-fund advice beingprovided.

• Trustees must have a documented policyon how it provides intra-fund advice and thismust be published on the fund’s website.

The second point made in the ASFA submis-sion, referencing what can be paid for out ofthe administration fee of a fund, is possibly themost important in terms of explaining why sofew funds opted to strongly leverage intra-fundadvice.

The third point referencing the sole purposetest is equally important because it sits at theheart of the debate about what ought to beregarded as the core activities of superannua-tion funds and whether national televisionadvertising campaigns and sporting sponsor-

ships actually fall within that criteria.Indeed, the points outlined in the ASFA

submission would seem to raise a number ofissues for the Australian Prudential RegulationAuthority (APRA) in terms of the manner inwhich superannuation funds have structuredthe delivery of their financial advice modelsand how those models are being funded.

What is clear from the manner in whichintra-fund advice was handled and how theGovernment is approaching its FOFA changesis that while that part of the SuperannuationIndustry (Supervision) Act (SIS Act) which dealswith the sole purpose test may not need to berewritten, it may need to be suitably re-inter-preted.

The commonly accepted interpretation ofthe sole purpose test is that it prohibits a trusteeof a superannuation fund from maintaining afund for purposes other than the provision ofthe benefits specified in section 62(1) of the SISAct.

In that section, there are two permissiblepurposes, as follows:

• core purposes – mainly for the provision ofbenefits relating to retirement or death bene-fits for, or in relation to, a member; and

• ancillary purposes – mainly for the provi-sion of benefits on the cessation of a member’semployment, or other death benefits andapproved benefits not specified in the corepurposes.

When the SIS Act was drafted in the early1990s no one envisaged that superannuationfunds would be providing financial advice, andit is unlikely that anyone conceived that indus-try superannuation funds would be fundingmulti-million dollar advertising campaigns andsigning up to large sporting sponsorships.

While the ISN has signalled its willingnessto work with the Government on some of thefine detail of the FOFA changes, it might be ofvalue to the financial planning industry to offerits assistance in dealing with any new interpre-tations around the sole purpose test.

At the very least, both the Government andAPRA must provide a detailed and legallysustainable explanation of how the SIS Act andthe sole purpose test are to be interpreted in anew FOFA world.

InFocus


“The reality of the rulessurrounding the provision ofintra-fund advice is that theywere always going to provide avery narrow remit.”

Repurposing the solepurpose test post-FOFA Platform and Wrap

Managed Funds Snapshot

SPAA – Technical Update &Latest Regulatory Impact20 October 2011 NSW Leagues Club, Sydneywww.spaa.asn.au

AIST – RG146 Refresher4 November 2011CBD, SydneyMore information provided aweek prior to the eventwww.aist.asn.au

ASFA National Conference &Super Expo9-11 November 2011Brisbane Convention &Exhibition Centrewww.superannuation.asn.au

FPA 2011 NationalConference16-18 November 2011Brisbane Convention &Exhibition Centrewww.fpaconference.com.au

Australian SecuritisationForum Conference21-22 November 2011Hilton, Sydneywww.abs2011sydney.com.au/

Analysis of Wrap, Platform and Master

Trust Managed Funds at 30 June 2011

Source: Plan For Life Actuaries and

Researchers

+6.6% to $428.4b FUM

What’s on

PLATFORMSNAPSHOT

Master fund market at June 2011

+5.8% to $148.5b FUMWraps at June 2011

+6.9% to $215.2b FUM

Platforms at June 2011

The sole purpose test has governed the operations of Australiansuperannuation funds for nearly two decades but, as Mike Taylor reports, itmay require some reinterpretation if it is to accommodate the role ofsuperannuation funds in the Government’s new FOFA world.

ONE of the greatest advantagesregional planners have over

their city counterparts is theircloseness with the community. While theindustr y as a whole grapples withwinning back consumer trust, plannersin regional areas are really at grassroots,and often enjoy stronger client relation-ships. Chief executive of the Associationof Financial Advisers (AFA), RichardKlipin, says the adviser/client relation-ship is a more intimate experiencebecause the adviser tends to be part ofthe fabric of the community.

As a regional planner, you “live andbreathe in the community”, says GregSchmidt, principal of Regional FinancialPlanning in Rockhampton, Queensland.

“It’s nothing against city planners,” headds, “but if you live in the city youprobably lose that sense of community.The care factor may be higher if you livein a smaller community as you have tomeet cl ients head-on and have noregrets.”

However, there is a downside to thiscloseness, Schmidt admits.

“I would like to specialise, but thestronger the relationship with the client,


Regional Planning

Regional planners find it difficult tospecialise.Fees a difficult proposition for regionalclients.Succession planning challenges alreadyapparent.Additional financing challenges forregional planners.

Key points

Theunseenspectre

The financial planning industry isin a state of flux – althougharguably, regional planners have ita bit tougher in some areas, such assuccession planning, financing andadapting to the FOFA reforms,writes Caroline Munro.

the more things they want you to dealwith.”

Being a generalist practitioner hasother implications on the business,which may make it difficult to adapt ina FOFA world.

FOFABoth tranches of FOFA have beenannounced, yet the AFA has vowed tokeep fighting against key elements of thereforms. Klipin feels that the impact ofFOFA is likely to be more pronounced inthe regions, particularly when it comesto opt-in and the pricing issues that thereforms create.

“By their nature, regional advisers aregeneral practitioners, seeing both highvalue and low value clients,” he explains.“What FOFA will drive is the increase inthe cost of advice, impacting the afford-ability of advice in middle and lowermiddle income Australia.”

David Harris, principal of RegionalFinancial Solutions in Guyra, New SouthWales, is not against regulation – as longas it is implemented in the right way.

“We need to get some integrity backinto the industry and take the short-term view out,” he says. “Regulation isrequired, but the way that FOFA is going,it will not do that. It is just going to shiftthe balance away from the clients andinto different profit areas.”

Sandy Hopps of Strategic Partners inToowoomba, Queensland, says everyadviser is concerned about the adminis-trative burden of FOFA.

“ We’re predominantly a fee-for-service practice anyway, and most of ourclients are used to it being hands on,”she says. However, for those C and Dclients that are less active there is likelyto be an increased administrationburden, she adds.

Fees are a difficult proposition forpeople in the regions as they tend to bemore price sensitive, Hopps said, addingthat her business was unlikely to receivethe same level of fees as city planners.

Harris says his business will be ableto adapt to the reforms, although it willbe more expensive to look after clientsand will therefore push up fees.

“The concern for us in a regional areais that we provide advice to everybody,including people that don’t have a lot ofmoney,” he explains. “I’m worried that

they wil l end up going to the non-advised union sector. While they may geta reasonable product, they won’t get thesame quality of advice.”

If FOFA comes in as i t has beendrafted, Harris will reduce the number ofclients his business can service morethoroughly.

Concerned about the impact of FOFAon their businesses, regional plannersare looking to their local governmentrepresentatives. Klipin says they have noless of a voice than their city counter-parts.

“There are specific nuances aroundadvisers in the regions, and that’s aconversation we’ve had regularly withboth the Government and Opposition,”he says.

He notes that a number of independ-ents represent the regions, includingRob Oakeshott in Port Macquarie andTony Windsor in Tamworth.

“I don’t think regional based advisersare being disenfranchised, but certain-ly at a political level it is important tooutline and explain the nuances anddifferences, because the community thatRob Oakeshott represents is a verydifferent community to what Bil lShorten represents.”

Selling upWith a bit more clarity on the directionof FOFA, more businesses are starting tocome to market, although Alan Kenyon

of mergers and acquisitions specialistsKenyon Partners states that supply is stillnot meeting demand. He says businessowners who were preparing to sell in thelead up to the global financial crisis(GFC) and consequently held off theirplans may now feel that it is time tocome back to market. Yet those advisersfrustrated with an increasing compli-ance burden are also looking to leave,he adds.

Schmidt agrees that more businessesare coming onto the market as a result ofan aging adviser demographic. However,he adds that more feel that FOFA will

make it too hard to do business.“I know advisers who are probably five

years away from retirement, but havebasically brought that forward due tocurrent market conditions, FOFA, andconstant regulation of the industry,” saysSchmidt.

But it wil l not be an easy sell , asprices are under pressure and buyersare scrutinising businesses. Kenyonnotes that, in general , pr icing hasbecome more complicated as buyersanalyse closely the sources of revenueand refuse to go anywhere near toxicassets, high levels of gearing, and exoticinvestments or strategies. Prices arealso down as a result of different multi-ples being applied to different revenuesources, he adds.

Harris recently sold one of his prac-tices, yet notes that buyers areconcerned about FOFA and are steeringclear of practices with a large number ofclients. This may be worrying for region-al practices with a large and diverseclient base.

“Under the new FOFA rules, it will bevery difficult to service a large number ofclients to the level that is required by therules,” Harris says, adding that eveninstitutions are less interested in ‘C’ and‘D’ clients.

The succession planning concerns ofregional planners, exacerbated by a skillsshortage, are well known. So what of thetraditional plan of passing on the business

through the family? Financial PlanningAssociation (FPA) general manager forprofessionalism, Deen Sanders, says eventhis avenue is under threat.

“We have heard from a number ofexperienced financial planners thatwhile things are volatile, they don’tnecessarily want their children to followin their footsteps,” he says, adding theydon’t have the same confidence in busi-ness models.

Dealer groups are well aware of thesuccession planning challenges alladvisers face, and are addressing thisarea as part of their own value proposi-tion. Getting advisers to move into theregional areas is part of AMP’s recruit-ment strategy, says AMP Financial Plan-ning managing director MichaelGuggenheimer. He adds that the groupalso has a facility to connect buyers andsellers.

ANZ Wealth recently announced anonline facility for advisers looking to buyor sell a practice.

“When you have close to 2,000 plan-ners in your network, the mergers andacquisitions activity should be able tomake a compelling competitive advan-tage,” says ANZ general manager adviceand distribution, Paul Barrett.

Kenyon says some advisers can lookto the regional peculiarities of their busi-ness models. In Queensland, for


Regional Planning

Continued on page 16

Paul Barrett

“More up-and-comingbusinesses that choose to bein a regional area will lookat having multiplelocations.” – Alan Kenyon


Regional Planning

example, it is common for an adviser towork out of multiple locations.

“More up-and-coming businessesthat choose to be in a regional area willlook at having multiple locations,” hesays. “Part of the solution for successionplanning there, will be to make the busi-ness highly attractive to someone whoseown business is a three-hour driveaway.”

FinancingWhile planners have the appetite forbuying practices or committing togrowth, do they have the actual meansto do so?

Regional practices are not viewed anydifferently from city practices when itcomes to lending criteria, says NABFinancial Planner Banking nationalmanager, Shane Kirsch.

“Our risk assessment is exactly thesame. We focus on the exact samefundamentals, being the key risks in thatbusiness and its ability to service a levelof debt.”

Kirsch acknowledges the generalcomplaints that financing became a bitmore difficult post-GFC, but he saysfrom NAB’s perspective, underwritingstandards and policies have notchanged.

The only difference for banks now isthey need to ensure they understand thebusiness fully, and may ask more ques-tions around the type of business, thesustainability of its revenue streams, andhow it can support the debt, says Kirsch.He adds that FOFA and changing busi-ness models may mean that all financialplanners will have to work a bit harder incommunicating what changes they willhave to make in their businesses.

Kenyon says banks are not as focusedon numbers as they are on the business’chances of success. Lenders are alsolooking closely at the critical issues in aplanner’s geographical area of business,Kenyon adds – for example, whether itis supported by a large industry and thepossibility of it closing down.

Klipin says that by their nature ofbusiness, regional planners may haveadditional challenges in getting a loan.

Because regional planners’ client basestend to be a lot wider, the revenue perclient will often have different marketeconomics to practices in the cities, heexplains.

“It impacts on all business profitabil-ity indicators, because on the one handthe adviser may be dealing with Centre-link clients, and then on the other handthey will be dealing with local smallbusiness operators, and then they willdo ever ything in between. So thesustainability of income and clients is awhole lot more variable in the regions.”

Regardless of the issues, finance ismost successful when the planner workswith a lender that understands theindustry, Kenyon says.

“Unfortunately, there are not toomany specialist bankers in regionalareas,” he notes.

Sanders argues that lenders generallyhave a lack of understanding around thecomplexities of a financial planningbusiness, regardless of where it is situat-ed. Klipin disagrees. While he acknowl-edges that most specialist lending teamsare in the capital cities, he says the goodbanks take the time to understand thenuances and differences inside the clientbase.

“Regional advisers are not disadvan-taged, but it’s important for them tounderstand what the banks are lookingfor in terms of their risk managementcriteria,” Klipin says.

Well-structured proposals are the keyin any business, according to Kenyon.

“You need to demonstrate, give themthe information, and give them thechance to say yes. More importantly, youneed to think through what you aregoing to do to be successful.”

Sanders says while lending criteria istightening in different areas, it is encour-aging to see a changing competitivedynamic.

“A number of institutions have beenquite public about being open for busi-ness,” he says. “It is reasonable to expectthat regional practices may have a bitmore explaining to do to educatelenders about their business models.”

Hopps says her business is looking toacquire a practice, and she felt that the

lender was not asking more of her thanthey would a city planner. But she isconcerned about the downward pres-sure on valuations since FOFA came out.

“If we are working on a multiplerevenue basis, regional practices areworth slightly less than city practices,”she says. “That has to come into thefinancing equation at some point.”

Harris felt quite positive about financ-ing, noting that while CBA pulled out,ANZ has come back to the market.

“From a finance perspective, it is nottoo bad at the moment because it isgoing to be based on EBIT rather thanmultiples of recurring revenue,” hesays, adding that it will be a more busi-ness-orientated way of looking at thepractice.

Barrett notes that ANZ’s lending crite-ria is developed to support regionalpractices, however, i t is becomingincreasingly important for dealer groupsto support all their advisers, he adds.

“The challenge for licensees, particu-larly in a FOFA world, is to make surethat they are building compelling offer-ings for their advisers. We are trying toaddress the issues, which for all plan-ners are opt-in, succession planning,and access to funding. There’s no doubtthat in a FOFA world not only do advis-ers find themselves having to work thatlittle bit harder, so too do the licensees,”Barrett says.

Support servicesPlanners are under pressure and arelooking to their sources of support,whether that be their associations ordealer groups. The FPA has noted anincrease in enquiries from regional plan-ners for its services.

Hopps has clients across Australia andsays, like everyone else, she is fearfulthat FOFA will increase operating costs.

“We think we know what some of thereforms are going to look like, but thereare some things that haven’t been ironedout yet.”

Schmidt says it is difficult to knowhow FOFA will impact on financial plan-ning practices, although his businesswas already putting in new systems andprocesses, and improving its overallvalue proposition before the regulators

decided to step in.“The problem is that some business-

es can’t afford those additional resourcesand hours. You have single adviser prac-tices, with one adviser and one supportstaff, and it’s quite difficult for them tointroduce measures that regulationsexpect them to meet.”

Schmidt’s practice is licensed by theGarvan Financial Planning dealer group,and he says that being part of a stronggroup has helped his business adapt tochange. He says Garvan has increasedsupport services in recent years as itsfocus shifted from product.

“But it goes back to the size of yourpractice and the resources you’ve intro-duced to make your business more effi-cient,” he adds. “For any adviser, thereare three important issues to get right tomeet any challenges the industry throwsup: efficient processes and systems,good staff and an innovative andsupportive licensee.”

Harris agrees that more advisersunder pressure will look to the biggerdealer groups for support.

AMP has also recognised the impor-tance of supporting regional planners.Guggenheimer says as part of its growthplan AMP has decided to locate infieldsupport in regional areas.

Barrett says another way groups willdemonstrate their value proposition isby enhancing eff iciencies throughimproved technology.

“We are looking closely at the relation-

ship between the financial planningsoftware and product systems thatfinancial planners use to ensure thatwherever possible it is as integrated asit can possibly be,” he says.

He adds that paraplanning, research,and compliance services are also areasthat need to be reviewed to ensure thatadvisers experiencing margin pressurecan be as successful as possible. ANZWealth also recently announced aphone-based adviser service, whichBarrett says will be particularly helpfulfor regional planners struggling withoperating costs, and those keen toprovide holistic as well as limited advice.

Education is another area that mostdealer groups are investing in, and

Continued from page 15

“There’s no doubt that in aFOFA world not only doadvisers find themselveshaving to work that little bitharder, so too do thelicensees. ” – Paul Barrett

Richard Klipin

Deen Sanders

“Regional advisers are notdisadvantaged, but it’simportant for them tounderstand what the banksare looking for in terms oftheir risk managementcriteria.” – Richard Klipin


Regional Planning

online capabilities are removing thetravelling, cost, and time constraints forregional planners.

“The advent of online technologymeans that it is a whole lot easier interms of getting information,” saysKlipin. “While it is difficult to get theright people, training is very accessible.”

It is not just the dealer groups lookingto up their services in regional areas.Kirsch says NAB’s model supportsregional practices, in that accreditedbankers are dotted all over Australia.

“Ours is a localised distr ibutionmodel, in that we have special istbankers in regional areas to supportadvisers,” he says. “And we are actuallygrowing our distribution and puttingbankers in more regional locations.”

PI InsuranceConcerns around the cost of profession-al indemnity (PI) insurance can befound across the financial planningindustr y, although this may be yetanother pressure for regional plannerswith smaller practices.

The FPA has for some timecomplained about the lack of competi-tion in the sector and the cost of premi-ums. Yet an increase in claims post-GFChas only exacerbated the situation.

Sanders says regional planners maybe particularly impacted because thesize and nature of the business mayaffect the affordability of PI insurance.He feels that the PI industry does notunderstand the dynamics of regionalbusinesses, asserting that in otherprofessional f ields there may bediscounts for regional practitioners lesslikely to be exposed to corporate scandalthat one might see in the metro areas.

“I think that is understood in somemarkets, but not in the financial plan-ning market; and I think certainlyregional planners are probably disad-vantaged by many of their ser viceproviders that have a lack of under-standing about the different businessmodels or environments that they workin,” says Sanders.

For now, it seems that all planners arepaying for the misdemeanours of a fewbad apples. Vero head of casualty AlexGreen says they still receive up to 100claims a month.

“I accept that there are individualsthat feel they are unfairly paying forothers’ faults,” he says. “We have beentrying to constrain the level of increas-es, but overall, premiums are still wellunder claims costs at the moment. It isactually costing us to insure financialplanners, which is why premiums aregoing up and will continue to do so untilthey reach a stable level.”

Green says regional practices are notviewed differently to their city counter-parts. And although he recognises thatthere are some differences, ultimately,he does not think regional practiceshave much lower risk than planners inother areas.

“But we’re always open to understand-ing the risk as well as we can, and for asmall practice which is owner-run andhas a good track record through theGFC, we will definitely look on themmore favourably,” says Green. “Theydeserve to be treated separately.” MM

Will the next change to the

credit rating of US debt bedown or up? According toStandard & Poor’s (S&P),

AAA means ‘extremely strong ability tomeet financial commitments; highestrating’.

Howards Marks, chairman of OaktreeCapital (Memos From Our ChairmanSeptember 7, 2011) notes that “the US canprint money, so they presumably do havean extremely strong ability to meet theircommitments. But do they deserve the

highest rating? If the USA was AAA in 2000when running a surplus, its national debtwas far smaller and Washington func-tioned more constructively, mightn’t itdeserve a lower rating today?”

Undoubtedly, Switzerland, China,Australia and New Zealand each havematerially stronger ability to meet theircommitments than the USA, if we lookat capacity to pay measured by debt asa percentage of the gross domesticproduct (GDP).

But what about America’s capacity to

print money? Virtually every nation canprint unlimited amounts of money, exceptthe poor Europeans shackled to the Euro.If capacity to create money is sufficientto qualify for an AAA rating, then almostevery country would deserve it – includ-ing Zimbabwe, which has thoroughlyproven its skills in money creation.

Recognising this, we must concludethat credit ratings need to take intoaccount more than the ability to printoneself out of disaster (or into it, inZimbabwe’s case.) On these grounds it

does seem reasonable to remove thehighest rating from the US.

Ratings AgenciesS&P unfairly got the credit – or blame –for downgrading the US to AA, yet it wasonly the second ratings organisation todo so. Egan Jones Ratings (EJR) led S&Pin downgrading Uncle Sam.

The business model of the mainresearch houses has been much criti-cised as ratings are paid for by thoserated. This is claimed to have


The Messenger

Rating the USA – credit where credit’s due?

Robert Keavney agrees that theUSA should be stripped of its AAArating – and wonders whether itcould be downgraded further.

contributed to many inappropriateoutcomes, from the ridiculous grantingof AAA to low grade collateralised debtobligations (CDOs) which contributedto the subprime bubble, to maintainingEnron’s triple AAA rating until four daysbefore it filed for bankruptcy.

EJR is paid by its clients (ie subscribersfor their service), not by the entities theyrate. This business model avoids conflictsof interest. In my view, all ratings andresearch organisations should operatethis way, just as financial advisers should.

Research by academics and the FederalReserve have found that 95 per cent ofupgrades/downgrades by EJR tend to befollowed by S&P, Moody’s and/or Fitch.Examples of EJR recognising problemsbefore other ratings agencies actedinclude its work on New Century, home-builders and the monolines in the recentbubble, and Enron and WorldCom in theprevious cycle.

Given the widespread concern aboutthe business models of rating agenciesin the wake of the sub-prime debacle, itis encouraging that a new breed of rateris emerging, and seemingly doing abetter job.

In the case in point, the downgrade ofUS debt, EJR was first to do so. This waslargely missed by the world’s media.

US Junk Bonds?However, Grant’s Interest Rate Observer,a US-based subscription newsletter in its29th year, can perhaps claim to have beenfirst to identify the risk of US debt beingrerated. (Incidentally, Grant’s was also thefirst publication, to my knowledge, todetail the faults with CDOs and predicttheir catastrophic future, before the finan-cial crisis.)

From 1985 to 2010, Grant’s has“presented the financial condition of theUS government in the form of a (seriesof ) junk bond prospectus.” In otherwords, Grant’s sets out the financial posi-tion of the USA as it might look toprospective purchasers of governmentbonds, under a requirement for full andfrank disclosure.

Grant’s notes that “invariably we havefound negative cash flow, high and risingcontingent liabilities and a worryingcrutch in the reserve-currency privi-lege”(Grant’s August 12, 2011).

In the foreword to its most recent‘prospectus’ dated March 5, 2010, Grant’sobserved:

“For its exemption from the reportingrequirements of the 1933 Securities Act,the US Treasury may thank its lucky stars.”

Under the various risk factors itemisedas applying to the USA is the followingprescient assessment:

“Ratings agencies may withdraw ordowngrade the US governments currentAAA rating without notice,” and adds “theincrease in government debt as a resultof the financial crisis may lead to greaterconcern over sovereign risk”. This waspublished more than a year before theratings downgrade.

Other risks for US Treasury investmentdescribed in the prospectus included(note all figures are for financial year 2009,the last data available at the time ofGrant’s publication):

• The US economy is heavily indebtedat all levels. Total debt represents 369 percent of GDP.

• The government faces growingmandatory commitments for retirementinsurance and health care. Treasury esti-mates that the net present value of thesefuture obligations was $46 trillion;

• The government is exposed to largecontingent liabilities from its interven-tion on behalf of numerous financial insti-tutions during the global financial crisis.

These include Fannie, Freddy, FederalDeposit Insurance Corporation and theFederal Housing Authority. “Interventionssince the start of the crisis have totalledUS$8 trillion or 55 per cent of GDP…It isunlikely that private risk can be continu-ously transferred onto public balancesheets without eventually impairing thecredit worthiness of the government”;

• US states and municipalities are expe-riencing severe economic distress andmay require federal intervention;

• The Federal Reserve Bank is exposedto significant credit risk as a result ofassets taken onto its balance sheet since2007. Both the government and US bankscould be impacted negatively by prob-lems in the Fed’s portfolio;

• Approximately 50 per cent of USgovernment debt is held by foreign offi-cial institutions. Therefore demand forthe greenback is largely in the hands offoreigners. Thus the exchange rate coulddepend materially on their action;

• The US has substantial overseascommitments including involvement intwo wars, plus 716 overseas sites in 38foreign countries. It is also committed byalliances as the de facto defender formany nations and could be drawn intoconflicts. It is also de facto guarantor ofshipping lanes in the Panama Canal, RedSea, Persian Gulf and Strait of Malacca.Historically, the financing of militaryconflicts has imposed stress on sovereignfinances;

• The Government AccountabilityOffice audits the finances of the USA andhas declined to offer an opinion on theiraccuracy, due to identifying 38 materialweaknesses in 24 government agencies.(Incidentally, this is the 14th year in a rowthat it has declined to offer an opinion);

• Improper or erroneous payments

were made by certain federal departmentstotalling approximately $100 billion, or 5per cent of the outlays of the relevantdepartments. This amount is double theamount two years earlier; and

• Elected officials may not take steps toensure long-term debt sustainably andmay take actions counter to the interestsof bondholders.

Imagine the reaction of investors to aprospectus, offered by a corporation,which revealed heavy indebtedness, over-laid with massive future obligations pluslarge potential contingent liabilities inseveral areas, whose accounts are ofdubious accuracy and whose directorsmay act counter to investors’ interests.And which yields only 2 per cent.

Junk bonds (though lacking a junkbond yield) is how Grant’s describes it,with tongue only half in cheek.

Only ownership of the dollar printingpress provides reassurance that Americawill be able to finance the growing debt pile.Yet, as Grants notes, printing money may(not will) deflate the value of the dollars,and may cause exchange rate losses.

There is another risk flowing from allthis. If the US is fundamentally weakened,and the greenback becomes less sound,it could even become possible that USdollars might lose their role as the world’sreserve. This seems unthinkable, just asit may have been unimaginable early inthe 20th Century that the pound sterlingwould cease to be the reserve currency.Reserve currencies have come and goneover the centuries. World demand fordollars would plunge, should it ever ceaseto be the reserve currency.

This is a non-trivial list of risks.

Round the twistMeanwhile, the Fed continues its danger-ous hyper-activity. The underlyingproblem in America is over-indebtedness.The Fed can’t fix this. Thus all actions bythe Fed will fail to produce the desiredresult. Yet it can, and in the case of quan-titative easing already has, produce nega-tive consequences. This, however, won’tstop them.

The first phase of the Fed’s OperationTwist resulted (at date of writing) in a yieldon five year Treasuries of 0.85 per centwhile the rate for three months is -0.01per cent.

As if American banks weren’t weakenedalready. Lending institutions make theirprofits largely by borrowing short andlending long at a higher rate. However,with a margin of only 0.86 per cent, beforecosts, from borrowing for three monthsand lending for five years, this activity willbe far less profitable.

I’ll close on the subject I began with.Guess which country has the highestgovernment debt as a percentage of GDP,among the USA, Portugal and Spain: notPortugal or Spain. I do not mean tosuggest that the US is actually worse offthan the Iberian nations – but it is a strik-ing statistic.

So will the next change in US creditrating be up or down? We shall see.

Robert Keavney is an industrycommentator.

“Guess which country hasthe highest governmentdebt as a percentage of GDP,among the USA, Portugaland Spain: not Portugal orSpain. ”


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leading fundRESEARCH HOUSEShave in common?

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On a recent trip to China, Iarrived with a cautious atti-tude, only to leave with arenewed sense of comfort in

the country’s long-term growth story.From a macro perspective, there is no

doubt that monetary tightening, highercommodity prices and electricity shortagesare slowing China’s gross domestic product(GDP) growth. Credit tightening is having aserious impact on small and medium-sizedcompanies, which will inevitably lead tomore non-performing loans in the bankingsector.

Automobile sales are weak due togovernment measures, housing sales aredropping, and a weak domestic stockmarket points towards tightening liquidity.There is no question that China’s stimulusprograms of 2009-10 led to some signifi-cant misallocation of capital, and proba-bly brought forward some commoditydemand.

However, to my mind, all this suggestsan engineered cyclical slowdown in thepace of growth, designed to control infla-tionary pressures, rather than signposts ona path to structural decline as some of theChina bears would have you believe.

First – a few words on growth. HSBCrecently published an interesting timelinethat puts the development of various emerg-ing markets into historical context by placingthem on a timeline of US economic devel-opment1. On this basis, China stands aboutwhere the US was in 1941. (Die-hardcommodity bulls will notice that India iswhere the US was in 1882.)

However, what is even more interestingis that China is achieving in a decade whatit took the United States 50 years to achieve.

This rapid pace of innovation andproductivity growth was apparent duringmy trip. For example, the Chinese haveworked hard to increase the domesticsupply of some resources and to bringdown costs. In commodities like alumini-um, bauxite, nickel and stainless steel,Chinese companies are innovating, and are– in some cases – more competitive thanWestern companies. In manufacturing, thesignificant size of the domestic marketagain gives Chinese companies a signifi-cant scale advantage, allowing them toinvest more in research and development.

Property and consumptionMuch has been written about thesupposed property bubble in China. Myview is slightly more nuanced than someof the recent commentary. It is true thatproperty prices are towards the top endof their rising trend, in real terms, and thehouse-price-to-income ratio is high. Theamount of floor space under construc-tion has soared in the past decade, and itis argued that prices need to drop to clearsupply.

However, the strong counter-argumentis that the total housing stock in China isstill short of demand (according to someestimates, by almost 80 million units). Mostof the supply has been at the top end andhas been absorbed by investors paying cash(given a lack of other domestic investmentalternatives in an era of negative real inter-est rates), leaving a real shortage in themiddle and at the bottom end of themarket. The Government – through itssocial housing initiative – is trying to setthis imbalance right, and over time, thiswill support commodity demand.

Domestic consumption is also expectedto rise significantly, and should thereforeremain a positive driver of demand forsome commodities. The Chinese Govern-ment has made it clear in its latest five-yearplan that it wants to boost domesticconsumption and increase levels of socialharmony via growth in wages and improve-ments to the social welfare system. Weshould see wage increases across Chinafrom the industrialised coastal areas to therural areas. Notably, the salary increase inrural areas and second tier or third tier citieswill be proportionately higher, as these aregrowing from a lower base.

Hence, my preference overall remains tobe invested in commodities that benefitfrom consumption over capex spending.Copper, energy and potash fit this bill,whilst I find aluminium, steel and iron oreless interesting. It is also worth noting thatif one looks at inventories, unlike 2008,there is limited inventory in the system.Historically, China has behaved counter-

cyclically to the West, and hence, if you seea slowdown in western world commoditydemand as commodity prices come off,you could see a restocking in China.

Copper looks to be a beneficiary longerterm, thanks to its importance in, forexample, air conditioning and car manu-facturing. China remains committed toinnovation and renewable technologies.New electric cars, for example, use up tothree times as much copper as traditionalones. Cars are largely bought for cash inChina, and with fewer than 60 cars per1,000 people (compared with 750 in the USand an average of 150 in the world), thegrowth road stretches a long way into thefuture. At the same time, copper minesupply remains constrained with highdecline rates and significant increases inthe cost of mining/production along withenvironmental/‘not in my backyard’concerns delaying new supply.

So for me, the main insights from myrecent trip were, firstly, that China remainson a structural growth path – even as it triesto navigate a near-term engineered, cycli-cal slow-down to combat inflation.

The second was that innovation andproductivity remain strong, and while risinglabour inflation is a worry, increased GDPper capita will drive the economy moretowards consumption-driven growth.

Thirdly, as China moves towards becom-ing a consumption-driven economy (asopposed to the investment-driven growththat it has experienced over the past 10years), the outlook for consumptioncommodities (energy, platinum, potash,

oil) will be superior to those driven prima-rily by investment spending (steel, alumini-um, iron ore, etc).

For investors, there will be great invest-ment opportunities going forward. Clearly,some of the winners of rising domesticconsumption will be local companies whosestrong understanding of the local market andthe distinctive needs of Chinese consumerswill provide them with a competitive advan-tage. However, I also expect some foreignbusinesses to gain from this. For instance,commodity producers mining the raw mate-rials needed to make the goods Chineseconsumers are after, stand to benefit – partic-ularly if the materials are in short supply.Global consumer names with recognisedbrands – such as Unilever, BMW, or someof the luxury brands such as LVMH – arelikely to continue to see significant revenuegrowth from this part of the world, asemerging middle classes aspire to newlifestyles. This is why I think taking a globalapproach to investing makes a lot of sensenowadays. It ensures that one can capitaliseon the investment opportunities present-ed by, for instance, the emergence of neweconomic superpowers like China – but notjust through local/regional stocks wherecorporate governance may sometimes bean issue, or where shares may be relativelyexpensive.

1HSBC. The Southern Silk Road – StephenKing, June 2011.

Amit Lodha is a portfolio manager of theFidelity Global Equities Fund.

OpinionChina


Having recently travelled to China, portfolio manager Amit Lodha examines whether the countrypresents a sustainable investment opportunity, or if it’s just heading for a hard landing.

Heading for a hard landing?


The razor’s edge for Australian investorsAs China transforms itself into a domestic consumption-driven economy, energy and resources-intensive industries will slow. Australian investors need to tilt their equities exposures to growingindustries, explains Diane Lin.

The extent and velocity of China’srecent economic development isunprecedented. Benefiting fromlow labour costs and the influx of

foreign investment looking for lower manu-facturing costs, China has experiencedextraordinary growth over the last threedecades. Gross domestic product (GDP) percapita grew from US$239 in 1978 to overUS$3,659 in 2009. China’s global prominencehas surged as its economy has achievedsignificant scale, overtaking Japan as theworld’s second largest economy in 2010, withannual GDP of US$5,878 billion.

Despite this phenomenal progress,China's GDP per capita is ranked just 91stglobally. The Chinese government’s long-term economic target is to reach GDP percapita of US$10,000 over the next five toseven years, based on the assumption thatthe economy will continue to grow at adouble-digit rate in nominal terms and thatits currency will appreciate against the USdollar (by an expected 5 per cent per annum).

However, China’s rapid growth has thrownup some structural issues and these mayjeopardize future development. Over the last10 years, China’s economic growth has beendriven predominantly by capital investment.Fixed asset investment, including govern-ment spending on infrastructure and privatesector housing investment, accounted fornearly 50 per cent of growth on average inthe 2000-2009 period, compared to about 30per cent in the previous decade. In 2010,China’s capital investment accounted for 47per cent of GDP, compared to Japan’s peakof 39 per cent in 1970.

When an economy goes through the initialstages of industrialisation, it is not uncommonto see economic activity driven by capitalformation as there will be a significant needto build (social) infrastructure. Building suchan infrastructure relies on an increase ofproduction facilities in heavy industries suchas petrochemical, steel and cement.

China is to an extent exceptional in thatits economy is even more reliant on capitalinvestment than any other industrialisedeconomy has been in the past. There are twomain reasons:

• Firstly, the reform of China’s housingmarket in the late 1990s as private housingownership was introduced, for the first timesince 1949, triggered a wave of housinginvestment by the private sector; and,

• Secondly, the entry of China into theWorld Trade Organization (WTO) in 2001 sawChina’s government initiate large-scaleconstruction of port, road and airport infra-structure.

The combination of housing investmentand transport infrastructure constructiondrove fixed asset investment to levels unseenhistorically. The resulting strong demand forbuilding materials also led to substantialcapacity expansion in heavy industries

throughout the 2000s. China today holdsover 50 per cent of the world’s capacity inmost building materials, including steel,cement and glass – and China now accountsfor a large proportion of global consumptionof most metals and materials.

However, after decades of phenomenalgrowth, China has become extremely energyand resources intensive and inefficient. Inorder to create new economic growth driversand achieve sustainable growth longer term,a structural change is needed to develop new,less energy-intensive industries.

In addition, changing demographics arealso driving the need for structural change.The proportion of China’s working age (15-64) to total population bottomed out in the1970s and rose over the last 30 years, givingChina access to an ever-increasing supply oflabour. This is starting to reverse as a conse-quence of the introduction in the 1980s of aone-child policy to address populationgrowth concerns. The resulting birth ratedecline is now, 30 years later, starting to affectlabour supply, while the most recent popu-lation census (2010) paints a picture of asociety about to age significantly. The propor-tion of the population aged below 14 (thefuture labour force) as a percentage of totalpopulation has declined to a historic low of16.6 per cent from 23 per cent 10 years ago.The proportion of those 65 or older hasincreased to 9 per cent from 7 per cent, a

record high. The ratio of working populationto total population reached 74 per cent in2010, a likely peak before a decline from2013/2015 onwards – the end of China’s long-standing labour dividend.

In addition, the increasing number of well-educated and highly skilled workers is alsostarting to have an influence on economicstructures. The number of university gradu-ates has increased from 1.2 million in 2002 to6.4 million in 2010.

These structural changes in demograph-ic patterns have two main implications.First, the government’s future spendingwill have to reallocate some of its previousinfrastructure spend to building a socialsafety net and covering pension andhealthcare for the rising number of retirees.Simultaneously, as the benefits of lowlabour costs start to disappear and the poolof high skilled labour grows, corporateChina will have to focus on productivitygrowth and move up the value chain.

In order to reduce the need for higheconomic growth to achieve full employ-ment, create the type of jobs needed toabsorb surplus highly skilled workers and,ultimately, maintain social stability goingforward, China’s government will focus onquality rather than quantity of growth. Indoing so, it will support the development ofhigh value-add industries such as health-care, IT and machine tools.

Sectors that will benefit from China’sfuture structural transformation include:

• Energy efficiency: renewable energy suchas wind, solar and nuclear power, and emis-sion reduction technology

• Private consumption and internet: tech-nology companies across the region as wellas Chinese IT software and service compa-nies; and,

• High value-add manufacturing: capitalgoods companies across the region, espe-cially component suppliers in Japan, bene-fiting from Chinese companies moving upthe value chain.

Sectors that will face headwinds fromChina’s structural changes include industrieswith high energy and resources intensitysuch as steel, cement and coal across theregion. Nearly half of Australia’s exports goto two single countries: China and Japan. Asimilar percentage of our exports consists ofjust two commodities: iron ore and coal, inthe latter case also spread amongst othercountries such as South Korea. This depend-ence on a narrow commodity base is onlygrowing, with expansion already underwayin the two base commodities. Fortescue isplanning to increase its output of iron ore tomatch that of BHP Billiton and Rio Tinto, andthere is significant capacity growth inconventional liquefied natural gas, as well ascoal-seam methane.

Meanwhile, other major ‘export’ indus-tries such as tourism and education areshrinking, certainly in relative, but most likelyalso in absolute terms, as a consequence ofthe extraordinary rise of the Australian dollar.

If China successfully transforms itself froma capital investment to a domestic consump-tion-driven economy, energy and resourcesintensive industries will experience slowergrowth. This will negatively impact Australia’seconomy if it fails to reduce its dependenceon the mining industry as a growth driver.

To hedge this risk, investing in Asian equi-ties with a tilt towards structurally growingindustries that Australian equities do notprovide exposure to – for example, IT, health-care and consumer – is essential forAustralian investors who are currentlyexposed to China’s economy directly andthrough equity exposure tied to the fortunesof resources. Both have driven wealth intandem and could turn in tandem. Asianequities can help ensure such a turn doesnot slash investors’ wealth irrevocably.

This is an abridged extract from a paperpresented at the 2011 PortfolioConstructionForum Conference. The full paper is avail-able at www.PortfolioConstruction.com.au

Diane Lin is the lead fund manager atPengana Asian Equities Fund, PenganaCapital.

ResearchReview

In association with


Research ReviewResearch Review is compiled by PortfolioConstruction Forum, in association with MoneyManagement, to help practitioners assess the robustness and disclosure of each fund researchhouse compared with one another– given the transparency they expect of those they rate.This month PortfolioConstruction Forum asked the research houses: Given the dichotomybetween high growth emerging markets and low-growth developed markets, should all portfoliosbe ‘overweight’ to emerging market equities? If so, overweight to what?

LONSECEmerging markets are an acknowledgedsource of long-term investment growth.While currently 13 per cent of world equitymarket capitalisation, emerging marketsare forecast to be the engine room ofglobal growth for the foreseeable future,contributing over 40 per cent of globalgrowth, according to the InternationalMonetary Fund.

However, it is important to recognisethat strong economic growth alone is notsufficient to support strong equity marketreturns in emerging markets. For example,Lonsec has analysed the relationshipbetween gross domestic product (GDP) ofthe major BRIC economies (Brazil, Russia,India and China) and the annualisedperformance of each country‘s stockmarket on a rolling quarterly basis. The

results show that there are definitely manyperiods where positive GDP has beenaccompanied by positive market returns,but that has not always been the case. Theresults for China are particularly interest-ing. Despite annual GDP growth of 6 percent or more between 1993 and 2010, therehave been numerous periods when thestock market has declined dramatically,sometimes by 50 per cent per annum.Therefore, strong economic growth inemerging markets may not necessarilytranslate into consistently positive returnson emerging market equity investments.

Nonetheless, Lonsec believes thereremains a compelling case for includingemerging markets within a diversified port-folio for growth-oriented investors. Wesuggest that a 10-to-20 per cent allocationto emerging markets within the overall

global equities allocation may be appropri-ate for clients with the appropriate riskorientation. A 20 per cent allocation repre-sents an overweight to emerging marketswhen compared to both the MSCI Worldindex (0 per cent emerging markets expo-sure) and the MSCI All Countries index(circa 13 per cent). However, when deter-mining an appropriate level of exposure toemerging markets, it is important toremember that emerging markets shouldonly be used within a portfolio as a returnenhancer, not as a diversifier/risk reductionstrategy. That is, investing in emergingmarkets will increase the risk of the totalportfolio, albeit with a commensurateincrease in expected return.

Investors should also be mindful of thesources of indirect exposure to emergingmarkets within a portfolio. Firstly, many

global equities managers have scope toinvest in emerging markets. Secondly,investors may already be exposed to emerg-ing markets’ themes via their Australianequities allocation, in particular, resources.

China’s rapid urbanisation has fuelleddemand for Australia‘s resources, withAustralian mining stocks the clear benefi-ciaries. The Australian equity market alsoshares characteristics with many of thelarger economies in the MSCI EmergingMarkets Index, which by their compositionare also exposed to the fortunes ofcommodities (eg Brazil, South Africa andRussia, which are 16 per cent, 8 per cent and6 per cent of the MSCI Emerging Marketsindex respectively). Therefore, any addition-al direct emerging markets allocation mayresult in an unintended doubling up ofemerging markets exposure.


ResearchReview

MORNINGSTAREmerging markets are no longer considered toorisky or fraught with corruption, so a migrationis underway as investment managers reach outfor areas of growth and distance themselvesfrom subsiding developed economies. Thereality is, though, that investors’ growth assetexposures are likely to already be significantlyhigher to this theme than would first appear.

What does overweight mean? That dependson the benchmark to which you’re comparing.The MSCI World benchmark has no emergingmarkets exposure, so any holding in emergingmarkets versus that benchmark would consti-tute an overweight position. A number ofmanagers have moved to using the MSCI AllCountry World Index as their benchmark, whichhas an allocation to emerging nations of nearly15 per cent. That’s the easy part to see.

However, investors may already unknowing-ly have invested in emerging markets. Forinstance, global equity managers own multi-national companies with profits increasinglysourced from up and coming regions. Forexample, the Magellan Global Equity fund ownshigh quality companies listed in the developedworld, such as YUM Brands (KFC/Pizza Hut),Colgate, and Unilever. According to Magellan’sanalysis, in 2010 these three companies gener-ated over 50 per cent of their total sales fromemerging nations. Accurately assessing the indi-rect exposure of a portfolio to emerging marketsis not easy. In our 2011 Global Equity SectorReview, we note portfolio managers themselvesfind it very difficult to accurately assess a break-down of earnings by country, as most companiesdon’t disclose this detail and instead often only

make known revenue by region (eg Asia Pacific).A global equity portfolio with indirect expo-

sure to emerging market companies via ahandful of stocks listed on emerging marketexchanges, when combined with a dedicatedemerging market manager, reveals a largeemerging market footprint. Morningstarbelieves most Australian investors are also moreleveraged (and therefore overweight) to emerg-ing markets than they may already realise.Further to the above global equity example, theAustralian equity market has a higher correla-tion to emerging markets than to global devel-oped markets such as Europe and the US. Mostinvestors have a hefty allocation to large-capAustralian equities and through this, will becompounding their indirect emerging markets’exposure. This was shown by the abrupt sell-offof the Australian sharemarket in 2008, and thenagain in recent months. All of a suddenAustralian investors have found themselves withan intrinsic play on emerging market growthwithout having to do anything differently.

Overall, Morningstar believes it is best to usededicated emerging market strategies in moder-ation. We suggest blending that with a broaderdeveloped world allocation. For instance, atypical growth investor with a 30 to 40 per centallocated to international equities could incor-porate an emerging markets investment as asubset of the broader global equities exposure.And, while investors could select a dedicatedemerging markets fund, they should first consid-er any potential indirect exposures they mayhave as a result of owning Australian and globalequities. Many will find they are already welloverweight.

MERCERIt’s important to keep in mind thatmarket capitalisation benchmarks arebiased to past success and can becomeexcessively concentrated. The overseasequities sector is a wide investmentuniverse, providing opportunities tobuild more efficient strategic allocationsacross the different sources of equitybeta. Mercer adjusts market capitalisa-tion benchmarks by over-allocating toareas of the global equity universe thatwe expect to outperform over the longerterm – both small caps and globalemerging markets – but with a lowervolatility equity component to offset theadditional risk.

We believe that there is a strong struc-tural story for increasing the weight toemerging market equities. Emergingmarket economies offer faster econom-ic growth potential than developedmarkets. Arguably, this growth differen-tial has been exacerbated by the globalfinancial crisis and the need for devel-oped economies to delever.

While academic studies report a weakassociation between GDP growth andequity returns, Mercer expects relativelyhigher earnings growth in emergingmarkets and the prospect of higherreturns. Of course, this will depend on theentry price. Emerging market equitiescome at a cost of higher risk, and it’s fair toassume historic volatility of 25 per annumwill continue. We seek to mitigate thishigher risk elsewhere in the portfolio.

The attraction of emerging marketsisn’t restricted to beta. These marketsare relatively inefficient and highlydiverse, unlike developed markets wherecountry indices tend to move in timewith one another. Potential for alpha ishigh, and emerging market managershave a strong track record of alphageneration. Mercer expects this alpha toexceed that achievable in developedmarkets.

As is always the case, some fine tuningmay be required to get the balance rightat total portfolio level. In constructingan overseas equity model portfolio, weadvocate an overweight allocation toemerging market equities, relative to theMSCI All Country World Index. An allo-cation of up to 20 per cent to emergingmarket equities within the total over-seas equity allocation is appropriate inmore growth-orientated, diversifiedmodel portfolios. In more conservativediversified model portfolios, we recom-mend lower allocations to higher volatil-ity, growth-oriented strategies such asemerging market equities.

In summary, an overweight positionto emerging market equities offers thepotential of higher returns from both abeta and alpha perspective, and astrategic overweight position relativeto market cap weighted benchmarksis appropriate. However, this comeswith higher risk, which can be offsetby incorporating a lower volatilityequity component.


STANDARD & POOR’S In addressing this question, we make the followingassumptions. Firstly, other equities in the growthasset component of a portfolio are used forcomparison to assess emerging market (EM) equi-ties performance. Secondly, EM equities are listedshares in companies that derive themajority/significant proportion of their revenuesfrom emerging market countries, irrespective oftheir domicile.

Emerging economies are growing faster thandeveloped ones. But is this reflected in the perform-ance of their respective equity markets? Yes, it is.The MSCI Emerging Markets Net Return Indexreturned 8.06 per cent per annum for the 10 yearsto 31 August 2011, substantially outperforming theMSCI All Country World Index (ACWI) with a netreturn of -2.62 per cent per annum, and slightlyahead of the S&P/ASX 300 Accumulation Indexwith 7.23 per cent per annum. Of course, in achiev-ing this return, some constituent markets in theMSCI EM Index will have outperformed and othersunderperformed, highlighting both the risk andthe opportunity of exposure to EM equities.

The relatively high correlation of the MSCI EMNR Index with the S&P/ASX 300 AccumulationIndex (0.75 per cent over the period) raises theissue of just how much EM exposure anAustralian investor has simply by owning a diver-sified portfolio of Australian equities. Typically,the equity component of most Australianinvestors’ portfolios is at least 50 per cent weight-ed to Australian equities. Interestingly, while thetotal return experience has a high correlation,there are differentiated sources of return betweenmarkets – for example, industry sector exposuresand dividend yields is approximately 4 per cent

per annum for the S&P/ASX 300 versus 2.7 percent per annum for the MSCI EM NR Index.

All things being equal, EM appears a moreattractive long-term opportunity than developedworld equities in the current environment.However, despite this prima facie attractiveness,investing requires adequate compensation forrisk assumed. Historically, there is a range ofpolitical, regulatory, cultural, market and envi-ronmental risks in EM for which an investorshould be compensated in order to support thecase for investment and subsequent considera-tion of an overweight position.

So, for Australian investors, what constitutesa benchmark weight to EM relative to globalequities? As at 30 June 2011, EM and constitut-ed 1 per cent of the MSCI ACWI (projected to be19 per cent by 2020), 28 per cent of global marketcapitalisation (projected to be 44 per cent by2020) and 35 per cent of global GDP in US dollars(projected to be 49 per cent by 2020). As an arbi-trary level, adopting the global market capitali-sation weight appears prudent.

To conclude, it is rational to have a prudent andinformed overweight allocation to the higher risk-adjusted returns available in EM equities. However,in a portfolio construction context, there is a rangeof factors to consider before arriving at benchmarkor greater exposure. These include the exposurethat should be attributed to Australian equities,and which industry sectors, themes, geographies,and markets will provide the better risk-adjustedportfolio outcome. Also, consideration should begiven to the degree of EM exposure derived indi-rectly via companies listed in developed marketsbut which source significant revenues from theemerging markets.

VAN EYKMost Australians may not realise just how much exposure they already have to emergingmarkets – through the local economy, by extension through exposure to the local stockmarket, the increasing share of revenue accruing to multi-nationals in the overseas portfo-lio, and the Australian dollar. It’s even possible to mount an argument that the value of ourhouses is inextricably linked to the fortunes of emerging Asia. Australians will be very comfort-able in a world where the importance of emerging and newly emerged countries continues.On the other hand, Australia has the potential to trip badly if Asia (read China) stumbles.

On that basis, it could be argued that Australians already have too much exposure to emerg-ing markets – not because high growth, emerging markets and low growth, developed, debt-ridden markets have become synonymous with good and bad prospects. This ignores the factthat ‘high growth’ in this case also involves high economic volatility, political instability andembryonic shareholder governance. It also ignores the fact that markets are continually pricingin these factors. The recent divergence in growth and growth prospects means that emergingmarket companies now trade at similar valuations to developed country companies despitethese factors.

The real issue is therefore not whether we are witnessing the spectacular rise of many largeemerging nations or whether they are likely to enjoy above average growth (all of which seemsmore likely than not). Rather, the focus should be on how best to benefit from that trend froma portfolio perspective – taking into account expected returns (given current valuations) andpotential political, economic and market risks (and not forgetting that it is perfectly possiblefor shareholders to largely miss out on the benefits of economic growth under certainunfavourable conditions). Furthermore, there are deep-seated structural problems withrunning an emerging markets fund and this is probably what has led to the underperfor-mance of most funds compared with index benchmarks. For instance, an emerging marketsanalyst who is a national of a particular country (and arguably therefore brings a local’s knowl-edge) is likely to be biased in favour of their home country. On the other hand, analysts thatcover many different countries from the comfort of New York or London may find it tough tocompete with the insights of locals.

It is also important to acknowledge that benchmarks can give rise to arbitrary exposures tocertain markets. An investor using benchmark-unaware overseas equity managers (or eventhose benchmarked to the MSCI All Countries Index) might view the question differently fromone whose exposure is largely determined by the MSCI World Index given the latter lacks expo-sure to emerging markets and even some developed economies such as South Korea.

For all these reasons, van Eyk has long held a large and explicit strategic weighting to emerg-ing markets. However, at present, we are somewhat cautious and therefore underweight ourstrategic allocation to emerging markets, while using highly-rated managers that have the flex-ibility to invest in emerging markets when valuations warrant.

ZENITH INVESTMENT PARTNERSThere is no doubt that portfolios shouldhave a significant and overweight expo-sure to emerging markets equitieswithin the growth component of theportfolio. However, it’s important to besensible about how this is achieved asthere are a number of considerationsto be taken into account when achiev-ing this overweight exposure. Theseconsiderations include:

• The Australian sharemarket has ahigh exposure to emerging marketsgrowth via the heavy weight to resource-and commodity-based companies.Virtually all Australian portfolios arestrongly overweight Australian equities;

• Many globally diverse companies(eg Coca Cola, Philip Morris, GeneralElectric, Johnson & Johnson) generatelarge proportions of their overall revenueand profitability from their operationsand/or sales in emerging markets;

• Emerging markets equities are histor-ically more volatile than developedmarket equities and therefore investors’capital value can be more volatile;

• Emerging markets companies canbe a lot less liquid than developedmarkets equities and therefore fundmanagers may not be able to sellsmaller illiquid stocks in times ofmarket crisis; and,

• Equity markets and equity marketreturns do not always directly reflect thefortunes of the underlying economies inwhich they operate. So, the fact that

emerging markets economies are set togrow longer term will not automaticallylead to constant positive returns foremerging markets equities. There will betimes when emerging markets equitieswill be overvalued and therefore sensi-tive to corrections.

As such, Zenith believes the optimalway to achieve an overweight exposureto emerging markets equities is to:

• Include a quality, actively managedAustralian equities large cap fund in theportfolio;

• Include a quality, actively managedglobal resources or commodities fundin the portfolio;

• Use truly active global equitiesmanagers whose portfolios do notreflect high weightings to developedmarkets and/or which invest in globalcompanies with high exposures toemerging markets’ economies; and,

• Use a quality, active diversifiedemerging markets equity fund or region-al fund (if you want to slant the portfo-lio to a particular emerging marketsregion) in the portfolio.

The weightings to each fund will varydepending by the portfolio type orinvestor risk profile but will achieve bothan overweight exposure from a MSCIWorld Index weighting perspective, aswell as a strong exposure to the under-lying emerging markets economies.

In association with

In the recently released draft selfmanaged superannuation funds(SMSF) ruling SMSFR 2011/D1, theAustralian Taxation Office (ATO) has

provided welcome clarification on anumber of key issues relating to limitedrecourse borrowing arrangements (LRBAs).By softening their stance on some of theseissues, the ATO has opened up greateropportunities for SMSF trustees consider-ing LRBAs and allowed them to invest withgreater certainty.

The draft ruling provides clarification ona number of areas:

• Meaning of a single acquirable asset;• Difference between maintaining,

repairing and improving an asset; and• When an original asset becomes a

different asset.

Meaning of a single acquirable assetUnder an LBRA, a SMSF trustee is restrictedto acquiring a single asset or a collection ofidentical assets that are treated as a singleasset, such as company shares or units in aunit trust. For the average SMSF trustee,direct share investment may be impracticaldue to diversification issues, the cost of multi-ple borrowing arrangements and the require-ment to buy and sell shares in one parcel. Asa result LBRAs in a SMSF have largely beenrestricted to property investments.

The ATO view on real property investmenthas been clear since the legislation wasamended on 7 July 2010; real property heldon separate titles was not allowed under asingle borrowing arrangement. In the draftruling, the ATO has conceded it may be possi-ble to acquire a single property asset that isheld over two or more legal titles.

Example: Factory complex on more thanone title

A SMSF wants to enter into a LRBA toacquire a factory complex that is coveredby three separate legal titles. As there is aphysical impediment to selling each legaltitle separately, the factory complex isconsidered to be a single acquirable assetand can be acquired under one LRBA.

This arrangement may only be possiblewhere the property can be distinctly iden-tifiable as a single asset. If there is no phys-ical or legal impediment to each individualproperty title being acquired separately, theproperty will be considered as multipleassets and will require multiple borrowingarrangements.

Example: Farmland on multiple titlesA SMSF wants to enter into a LRBA toacquire a farm that is covered by two sepa-rate legal titles. While the farm has alwaysbeen conducted as a single primaryproduction business there is no physical orlegal impediment to each farm title beingsold separately. As a consequence, the farmis considered to be two separate assets and

would require two LRBAs. The draft ruling has also provided confir-

mation that an ‘off the plan’ propertypurchase can be acquired by an SMSF usinga LRBA. The initial deposit is paid by theSMSF using existing funds to secure theproperty and an LRBA is used to finalise thepurchase when the property has beencompleted.

Difference between maintaining,repairing and improving an assetRecent natural disasters throughout Australiaserved to highlight the importance of theconcepts ‘maintaining’, ‘repairing’ and‘improving’ an asset when it comes to LRBAs.

Maintaining an asset involves theprevention of damage or deterioration toan asset and ensures the functional effi-ciency of the asset is maintained in itscurrent state. Repairing an asset restoresthe functional efficiency to its former statewithout changing its character. It general-ly involves the replacement of somethingthat has been worn out or damagedthrough natural wear and tear. An improve-ment to an asset increases the value andfunctional efficiency of the asset throughnew additions and features that substan-tially alter the nature of the asset. Theseimprovements would provide benefits overand above the value of a general repair.

For example, restoring the damaged partof a kitchen that has been destroyed by firewould constitute a repair. Extending thehouse to install a new kitchen of greater sizeand functionality would be an improvement.

Legislation allows money borrowedunder an LRBA to be used in connectionwith maintaining or repairing an asset, butnot improving an asset. This is because theimprovement of an asset would fundamen-tally alter the character and value of theasset used as security by the lender, poten-tially increasing the risk to the fund.

In what is being seen as a departure from

previous views, the ATO has indicated viathe draft ruling that improvements to anasset are only restricted when funded fromborrowed monies. Improvements to fundassets using existing SMSF resources isconsidered acceptable and would notbreach LRBA rules provided the improve-ments do not result in the original assetbecoming a different asset.

Example: Renovation of propertyA SMSF enters into an LRBA to purchase aresidential property. The fund renovates theproperty, adding a second storey to thehouse using borrowings under the LRBA.The addition of a second storey improvesthe value of the asset, and as borrowedmoney was used, the arrangement nolonger satisfies the requirements of theLRBA provisions. If the renovations hadbeen funded from a source other thanborrowings, the improvements would bepermissible.

When an original asset becomes adifferent assetThere are very limited circumstances inwhich an asset may be replaced and thesegenerally relate to investments in sharesand unit trusts. It is therefore importantto consider whether any improvements tothe original property result in a differentasset being held on trust under the LRBA.If the character of the original acquirableasset is fundamentally changed andreplaced by a different asset, the arrange-ment ceases to satisfy the requirements ofthe LRBA provisions.

Example: Subdivision of landAn SMSF enters into a LRBA to acquire avacant block of land. The land is subse-quently subdivided into two separate titles.The original asset has now been replacedwith two separate assets and the LRBAprovisions are no longer satisfied.

Example:Reconstruction of house damagedby fireA fire destroys a four-bedroom house heldunder a LRBA. A new four-bedroom houseis constructed using the proceeds from aninsurance policy. Rebuilding the house issimply restoring the asset to what it wasprior to the fire and does not fundamen-tally change the character of the asset. Thearrangement continues to satisfy therequirements of the LRBA provisions.

The draft ruling is welcome in an areathat is increasingly seen by many to be arelatively restricted field of investment forSMSF trustees. However, it is important tokeep in mind that that the SMSF ruling isstill in draft form and may be subject tochange when finalised.

Stephen Bone is OnePath’s technicalservices manager.


ATO clarifies SMSF borrowing

Toolbox

The Australian Taxation Office has recently provided moreclarification on borrowing arrangements for SMSFs. StephenBone puts into context three major areas of the draft ruling.

BriefsAMP Limited has launched its first Victorianretail planning centre in Victoria.

The company announced last week that thenew retail centre had been launched in theMelbourne suburb of Camberwell followingthe successful launch of the first centre inSydney’s Parramatta.

It said the purpose-built centre would bringtogether 18 new and experienced self-employed financial planners in one AMP-branded premises.

AMP Financial Services managing directorCraig Meller said the centre’s opening wasaimed at making quality financial advicemore accessible and affordable to people inMelbourne.

“The launch of the new centre in Camber-well helps remove some of the barriers togiving people access to quality, affordablefinancial advice and experiencing the differ-ence it can make in their lives,” he said. “Weselected Camberwell because it’s a great cen-tral hub for the people we want to reach.”

Mr Meller said he is expecting the Camber-well centre to mirror the success of the centrein Parramatta. In its first year, planners at theParramatta centre received around 11,500calls and met with close to 1,500 Australians,with both customers and planners benefitingfrom the flexible approach to planning.

THE CFA Institute has launched a mobile appaimed at allowing investment professionals tostay up to date with key trends and researchon finance and investing.

The CFA Institute Mobile App was devel-oped in partnership with WillowTree Apps,and according to CFA managing director ofstrategic products and technology Jan Squiresit represents a free and convenient way tostay up to date no matter where you are inthe world.

“Given the widespread use of mobiledevices in our industry, apps like this provideimportant new channels for delivering high-value educational content and services to CFAInstitute members, candidates and other con-stituents,” he said.

The APP is available in the Apple iTunesStore and Android Marketplace. It deliversaudio and video podcast interviews with lead-ing investment practitioners as well as provid-ing access to CFA Digest summaries.

AIA Australia has won a number of insuranceindustry awards across its Priority Protectionproduct range.

The company announced last week thatit had received Canstar Cannex awards forLife Insurance - Outstanding Value, and forIncome Protection - Outstanding Value. It alsowon best Life Cover Plan with Asset Innova-tion and best Business Overheads productwith Money Management’s 2011 AdviserChoice Risk Awards.

Commenting on the awards, AIA Australia’sHead of Adviser Services Pina Sciarrone saidthey were the result of a strong commitment toproduct development over the past 12 months.

“We have focused heavily on marketresearch to better understand the needs ofour customers and have designed productbenefits accordingly to meet those needs,”she said.

“The draft ruling iswelcome in an area that isincreasingly seen by manyto be a relatively restrictedfield of investment forSMSF trustees.”

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Opportunities For more information on these jobs and to apply,please go to www.moneymanagement.com.au/jobs

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You will have a solid understanding ofcredit risk and the ability to manage longterm relationships.

The applicant should be either living orwilling to relocate to regional centresacross Australia.

To find out more and to apply, visitwww.moneymanagement.com.au/jobs orcontact Emily at Terrington Consulting –0422918177 / 84234444,[email protected]

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This role would be suited to those in theearly stages of their financial planningcareer or currently in the banking andfinancial services industry with a minimumrg146 qualification.

You will have experience meetingperformance objectives possibly in awealth management customer serviceenvironment where you have beenproviding advice to clients regardingmanaged investments, life insurance andsuperannuation.

For more information, visitwww.moneymanagement.com.au/jobs orcontact Liz Medwin at AllianceRecruitment – 8319 7888,[email protected]

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The applicant will have the opportunityto build a successful business with the fullsupport of an established and successfulteam.

The successful candidate will also have

the opportunity to either purchase anexisting book or service the book with aview of building equity over time.

You will have experience working withinstitutional clients and providing advice on afee for service basis. You must also possess asound knowledge of risk, transition toretirement and investment strategies.

To find out more , visitwww.moneymanagement.com.au/jobs orcontact Emily at Terrington Consulting –0422918177 / 84234444,[email protected]

REGIONAL MANAGERLocation: AdelaideCompany: Terrington ConsultingDescription: A major Australian bank isseeking a regional manager with pastexperience managing and developingteams within the financial services sector.

You will possess a powerful combinationof strategic sales, operational and creditrisk skills, with a strong focus on sales andservice.

You will be required to travel to regionalSouth Australia as well as metropolitanAdelaide so a willingness to spend timeaway from home is essential.

Your role will involve generatingcommercial and agricultural leads

independently so strong businessdevelopment skills are desirable.

For more information, visitwww.moneymanagement.com.au/jobs orcontact Emily at Terrington Consulting –0422918177 / 84234444,[email protected]

SENIOR ANALYST – COMMERCIALLocation: AdelaideCompany: Terrington Consulting Description: A financial services firm isseeking a senior analyst – commercial toprovide risk and credit support to a majorclient group portfolio.

You will be based in Adelaide CBD andjoin a team of professional bankers tomaintain a significant portfolio of clients.

As part of your role you will be responsiblefor preparing credit submissions, liasing withexisting clients, conducting reviews andidentifying opportunities to improve existingportfolio service levels.

You will have previousaccounting/auditing and credit experiencewithin the SME or commercial sector.

To find out more and to apply, visitwww.moneymanagement.com.au/jobs, orcontact Emily at Terrington Consulting –0422918177 / 84234444,[email protected]

COMMINSURE has appointedLachlan MacDonald as StateManager, Queensland.

CommInsure generalmanager, retail advice TimBrowne said MacDonald’sappointment was in line with thecompany’s focus on long-termprofitable growth and maintain-ing their support for the value ofadvice amidst Future of Finan-cial Advice reforms.

MacDonald joins CommIn-sure from CommonwealthFinancial Planning, where hespent two and a half years as afinancial planning managercovering north Brisbane and theSunshine Coast.

He was previously a businessdevelopment manager at bothColonial First State and Chal-lenger Financial, overseeingoperations in Queensland,Northern Territory and North-ern Rivers.

MacDonald was also anadviser development managerat BT Financial Group and afinancial planner with WestpacBanking Corporation.

MacDonald commences hisnew role on 31 October.

AUSTRALIAN Unity Invest-ments (AUI) has appointedthree former Investa staffers tosenior positions following acompany restructure.

Ma rk Lu m by has beenappointed to the newly-created role of head of officeand industrial property fundsat AUI. Previously Investa’sgeneral manager for retai lfunds, Lumby has over 18 yearsexperience in funds manage-ment, including work at Stock-land and Trafalgar CorporateGroup , where he helped toestabl ish and manageAustralia’s first geared proper-ty security fund.

Grant Nichols will take onthe property portfolio manager

role for AUI’s property fundsbusiness. Nichols previouslyworked for the then listed AMPO f f i c e Tr u s t , fol lowed byalmost eight years with Investaas asset manager, and later,fund manager.

Si m o n B e a k e has beenrecruited as a senior analyst atAUI. Beake was previously anaccountant and analyst forBiwater Group and CascalS e r v i c e s L i m i t e d beforebecoming an Investa fundanalyst.

NATIONAL Australia Bank(NAB) has announced theappointment of Dr Ken Henry

AC to the role of non-executivedirector, effective from 1 Novem-ber 2011.

NAB chairman MichaelChaney said Henry’s experiencein both domestic and interna-tional finance sector policywould be an asset to the board.

Henry was previously theformer secretary to the Depart-ment of the Treasury, and wasawarded Companion of theOrder of Australia (AC) for hisservices in developing andimplementing economic andtaxation policy to the Australianfinance sector.

CHARTERED accounting and

advisory firm William Buck hasappointed Malcolm Wright asdirector of tax services.

Wright has over 30 yearsexperience as a tax specialist.Managing director Ja m i eMcKeough said Wright’s rolewill strengthen the tax capabil-ity of William Buck in Adelaide,and nationally.

Wright started his careerwith William Buck 17 yearsearlier, before working as a taxspecialist at other firms.

Malcolm has been involvedwith the Taxation Institute ofAustralia, having been a pastchair man of the S A St a t eCo u n c i l a n d E d u c a t i o nCommittee.

Move of the weekANZ Wealth has once again expanded its manage-ment team with the appointment of RaeleneSeales to the role of head of advice delivery.

Seales will be responsible for establishing andleading the advice delivery area of ANZ Wealth.In her role she will provide dealership services tothe company’s advice businesses, said ANZWealth general manager, advice and distribution,Paul Barrett.

Seales – a former National Australia Bank/MLCstaffer – will be based in Sydney and start her newrole in early November. Raelene Seales

Lachlan MacDonald

““ALTHOUGH Outsider indulges himselfin a good television show every now andthen, he will go on record saying he is nota particular fan of the so called ‘realitytelevision’ genre.

He cringes at the mention of big broth-ers, survivors, renovators, extrememakeovers and the Kardashians (althoughOutsider might have watched a minute ortwo because he enjoys appraisingtheir…ahem…assets).

However, there is one show returning toAustralia’s small screens which caughtOutsider’s attention – particularly becauseit features a financial services figure, YellowBrick Road executive chairman MarkBouris. Having a financial services figureappear on TV for reasons unrelated tobeing criticised for commissions is a rareoccasion in itself; financial services appar-ently make for boring TV.

Of course, Outsider is talking about the

Australian version of The Apprentice – afranchise owned and hosted (in the US)by US business magnate Donald Trump.

Which begs the question: is Mark Bourisreally our equivalent of Donald Trump,who, amongst other things, owns the MissUniverse Organization? And does Bouris

aspire to become Australia’s king of thecomb-over?

All in all, Outsider hopes Bouris – whohas recently tapped into the financial plan-ning space – can achieve the desiredratings this time around or he, himself, willhear the words “you’re fired!”.

Outsider


“Investment is one place where

you don’t get what you pay for.”

Higher fees mean a lower net

return, according to Vanguard chief

investment officer Gus Sauter.

“The investment market’s the

only place you can put

something on sale, and people

want to sell it instead of buy it.”

Sauter again, on the mentality of

investors who ‘sell low’.

“Within Labor Party politics …

if you want loyalty, get a dog.”

Liberal’s MP Bruce Billson on Tim

Mathieson’s gift to Julia Gillard on her

50th birthday.

Out ofcontext

It’s a dog’s life

Monkey Management

Comb-over King rules

AND sticking with the animal theme forthis week (no that wasn’t aimed at you, MrBouris), Outsider was more than a littleamused to hear that the Wikipedia page ofthe Assistant Treasurer and Minister forFinancial Services and Superannuation,Bill Shorten, was recently, well, ‘modified’shall we say, such that the image wasreplaced with that of a Jack Russell terrier.

No doubt, this is a reference to therecently concluded ABC comedy At HomeWith Julia, where Prime Minister Gillard’scharacter has a pet Jack Russell she hasnamed Bill Shorten.

Admittedly, Outsider didn’t manage to

catch the show – its 9:30pm timeslot was alittle late for a chap who is usually all tuck-ered out after the 7.30 Report – but he didappreciate the irony behind Gillard’s char-acter relegating the notoriously ambitiousShorten to the role of household pet.Outsider assumes the selection of the JackRussell breed (which has the reputation ofbeing a notorious leg-humper) is a purecoincidence in this case.

Outsider was also impressed to hear thatin real life the Jack Russell from the showgets about by the rather exotic moniker ofWildenfox Pavarotti, and even has his ownIMDb page.

At time of writing, Outsider is pleasedto report Shorten’s page now features amore recognisable likeness of theHonourable Member for Maribyrnong,which appears to have been taken at alocal watering hole (judging from thenumber of liquor bottles and liquorlicensing posters in the background) –although, Outsider did notice the “source”location of the photo is listed as comingfrom an Irish dog enthusiast website, withthe link then taking the reader to anotherimage of a Jack Russell. Outsider feels yetanother one of those bouts of Schaden-freude coming on…

A L I G H T - H E A R T E D L O O K A T T H E O T H E R S I D E O F M A K I N G M O N E Y

IT is now roughly one year and onefortnight since ING Direct causeda minor stir by dumping lovableScottish rogue Billy Connolly fromtheir marketing campaigns and

replacing him with a naked,orange, slightly disconcert-ing-looking, strangely English-sounding Orangutan named

Charles.Outsider can only presume

there has been some kind ofmarket research done thatfound a good fit betweenfinancial services and large

primates, because it wasrecently brought to Outsider’sattention that the official

spokesperson of the US-basedAXA Equitable Life Insurance Com-pany is an 800 pound gorilla.Except rather than having a posh-sounding name like Charles, it issimply called the 800 pound gorilla.

What’s more, the Gen-Y typesaround the Money Managementoffices have pointed out to Out-sider that said Gorilla has its (his?)own Twitter account.

Outsider himself isn’t on theTwitter – while he takes pride inattempting to keep up with mosttechnological advances, thelatest social media revolutionmay prove a bridge to far. But hehas had a quick glance at the

Twitter page of the rather intimi-dating primate, and wasimpressed to see it had morethan 2000 followers and hadsent more than 2000 “tweets”.

And Outsider was even moreimpressed that the websiteattached to the Gorilla’s accountactually takes you to AXA Equi-table’s social media page, whichadvises clients: “please do notpost, ‘tweet’ or direct-messageyour account/policy number, tele-phone number, or any othersecure or personal information” –which is probably the most soundadvice Outsider has ever heardfrom an 800 pound Gorilla.

money management (october 13, 2011)

Documents

stephen prendeville

steadyfor practices

fos ombudsman

financialplanning businesses

fofa cutoff

demandfor businesses

unprecedented activity

aspect of fofa dealtwith