Its been a little while since I’ve ranted about structured product but for the second straight year a set of structured producted produced by JB Global have created some annoyance in me. I don’t know much about JB Global other than, they’re not too global, and they release a lot of structured products because, as far as I can tell, they are an easy sell to the gullible.
Now, these products do sound quite appealing. The latest set includes returns that are linked to the performance of Berkshire Hathaway (Warren Buffet’s company); China and India; US Real Estate (that appears quite cheap compared to Australian property…unfortunately for the US there is still a massive over-supply); our favourite sharemarket, ASX200. They’re capital protected and you can borrow up to 100% of the investment! There are numerous other components to the product but there is one aspect to the product that stopped me looking any further into it…the incorrect definition of how the issuer calculates stock market volatility.
Now, this perhaps doesn’t sound much on the surface, but the products final payout is dependent on the level of calculated volatility of the underlying assets (the higher the vol the lower the payout) so the fact they use the wrong formula destroys my interest and I cannot have any faith in it. For those who are interested in this error, when calculating annualised sharemarket volatility based on daily prices you calculate the annualised figure by multiplying the daily volatility by the square root of 252 (which is the approximate number of trading days in a calendar year)…this product multiplies the daily volatility by the square root of 365 (obviously the number of days in the year) which results in an artificially inflated figure that is not at all a reflection of annual volatility…hence the marketing materials and anything else to do with this product is quite meaningless to me and should be to anyone else looking at this product. And don’t forget, the higher the vol the lower the payout and the vol is calculated incorrectly too high!
I found the following excerpt on Greg Mankiw’s blog (http://gregmankiw.blogspot.com/) and as he suggests I’m sure it “might help explain some of California’s fiscal problems”. As a colleague said to me this afternoon, “I don’t even think the Bondi lifesavers get paid anywhere near this; even with their TV show!”…
According to a [Newport Beach] city report on lifeguard pay for the calendar year 2010, of the 14 full-time lifeguards, 13 collected more than $120,000 in total compensation; one lifeguard collected $98,160.65. More than half the lifeguards collected more than $150,000 for 2010 with the two highest-paid collecting $211,451 and $203,481 in total compensation respectively….Lifeguards are able to retire with 90 percent of their salary, after only 30 years of work at as early as the age of 50.
Believe it or not it comes from Lifetime Annuities…the obvious catch is that you need to survive beyond your life expectancy. In Australia, this product type has been totally out of favour since the government reduced social security benefits associated with them a few years back but perhaps this is an overreaction and their true value has been forgotten.
I’ll quote an extreme example from the Canadian academic, Moshe Milevsky.
Lets suppose five 95 year olds place $100 each into a term deposit, paying 6%, and after 1 year the $530 ($500 + 6% interest) is split between the survivors. Now apparently the probability of a 95 year old surviving one year is 80% which means we expect there to be four survivors splitting $530 between them or $132.50 each. That is a return of 32.5% comprising of 6% interest plus 26.5% in mortality credits.
Now a lifetime annuity does not actually allow you to cash out at the end of 1 year or any term for that matter. But, the above example still shows you how a return can be enhanced by a long life thanks to others invested int he product dying earlier. For those who live a long long time it is highly unlikely the returns on any sharemarket portfolio will outperform the lifetime annuity. So, for the retired with excellent health and a family history of long life, perhaps the lifetime annuity should be a serious consideration for part of the retirement investment portfolio.
Please note…my remuneration has absolutely no connection with the sale of lifetime annuities. In fact my employer would probably hate this article!!!
I just had a meeting with Charlie Lanchester, who manages half of Perpetual’s massive Industrial Share Fund, and his views on the Australian economy were far more dire than many commentators are saying. Like many, he believes that commodity prices are very high and showing signs of faultering (doesn’t mean they going to crash just beware) and also like many, the Australian residential housing prices are in some trouble (once again not that they’ll crash but that there’s cause for concern). Now whilst, many commentators (including me) agree with these views, Charlie (like me) is of the belief that the Reserve bank is not likely to (or should not) increase interest rates in the short term and that there is a reasonable probability that interest rates could be lower in 12 months time, such is the weakness in the underlying Australian economy. If the Reserve Bank increases rates Charlie believes this could be potentially disastrous for the Australian housing market and we can all extrapolate on the potential effects of that.
It is amazing that economists of the bigger banks are suggesting rate hikes, particularly given they are more likely to suffer the consequences of a housing market decline. Either way, Charlie believes that the real sufferers of a housing market decline are likely to be companies in the consumer discretionary sector and as we’ve seen in recent days, some of the bigger players in property securities, like Westfield, Mirvac and Co.
As mentioned in earlier posts, Australian investors are facing some big risks…
- very very high commodity prices (for when they crash they really crash)
- record high residential property prices (that have effectively propped up this ecoomy through the GFC)
- China needing to slow and contain inflation
- a Euro Sovereign crisis that could always overflow into global financial markets
- record high AUD that is contributing to our two speed economy and preventing foreign investment
Our markets are mostly financial services and commodities (plus a fair share of property) so when investing ensure these risks are considered in full.
Contrary to suggestions in my last post, yields across the yield curve have moved a bit today…as the above chart shows the curve is up between 5bp and 9bps. This is a result of the Reserve Bank increasing its inflation outlook over the next 2 years. The Reserve Bank believes inflation will be above its target range due to increases in the costs of fruit and vegetables thanks to the Queensland floods as well as wage inflation caused from the mining sector. It also expects unemploymet to fall to 4.25%.
Attended a Researcher’s conference yesterday which had an interesting line-up of speakers that covered China, the global economy, Small cap stocks, and . The first guy was very impressive, an investment Strategist, he did a “Me-style” global economic presentation (perhaps that’s why I liked him) where the key points were…
- Commodity Prices in a bubble
- Australian house prices in a bubble
- China must/will slow, given inflationary pressures, and internal asset bubbles
- Australian dollar at irrationally high levels
- Euro Sovereign crisis must result in defaults for Greece, Portugal, Ireland,
- US economy is stuffed and recovery will be slow for many years
Whilst these are extreme views its not difficult to make a case for any of them. His markets forecast was that he was forecasting global shares to outperform Australian shares…fine. BUT, he then articulated that he was still quite confident in the Australian economy, Australian sharemarket and that our interest rates will rise (which is clearly a consensus view).
My comments…how on earth can anyone (and many do) agree on points 1,2,3, and 5 and not think our economy (and sharemarket) is facing a potential perfect storm (I actually put this question in these words to him)? To me unfortunately his conflict of interest, as a fundie, got in the way of his answer. Either way, I’m also a little concerned about points 1 through to 3 (or even 5 given our reliance on the global banking system…point 6 is a factored in and its likely impact other than to keep the US dollar weak) and the downside risks to our economy and markets. If interest rates do go up, then that could be the catalyst to set off point 2 which could flow into the financial system and the rest of the Aussie economy and therefore sharemarkets. If China slows, as Nouriel Roubini is forecasting along with many others, then the biggest impact on our market will be the impact on point 1 (although aided by a cushioning effect from point 4 also dropping) which could be quite shocking (~35% of our market is Resource based).
I’ll end by quoting Jeremy Grantham from his latest newsletter, “beware the sell-side strategist offering arguments as to why overpriced markets are actually cheap”…whilst the analyst wasn’t necessarily saying assets were cheap he was denying the potential impact of these expensive markets on our own therefore suggesting our market is fairly priced…unfortunately given the downside risk I’m not so sure.
Plenty of food for thought.
With last week’s high CPI figures coming out there has been increased talk about the Reserve Bank increasing interest rates. The above yield curve chart shows that since 12 April, the yields on government bonds have actually decreased across the board by around 20bps suggesting less long term confidence in our economy than two weeks ago. As has been commented on, the CPI figures were high largely (not totally) because of the high Food and Energy prices…keep in mind the Reserve Bank’s actions will have virtually zero impact on Food and Energy prices as they are high because of a combination of natural disasters, middle east conflict, and a bit of proprietary trading by those nasty US investment banks.
With home prices starting to fall (I did say that residential property would peak when my partner and I purchased a property back in February), the Australian dollar killing our tourism and foreign investment, and underlying inflation (excluding volatile items) actually near 10year lows, whilst our economy is still looking well, as the yield curve movement suggests our economy is not as rosy as the papers and fund managers make us believe and controllable inflation is under control.
Hopefully no interest rate rise today!
