Thursday, November 5, 2009

How To Buy Shares In Australia

My sister asked me a good question the other day. She asked "How do I buy shares?"

Of course I launched into a long and detailed explanation involving dividend yields, return on equity and interest coverage ratios, at which point she interrupted and told me she just wanted to know how buying shares works - how you physically purchase them.

Buying stocks for the first time can be a daunting experience. There is a lot of new terminology which seems especially designed to confuse new investors. So this article is aimed and beginners who what to learn how to buy shares.

Why Do You Want To Buy Shares?

First a quick recap. Before taking the plunge it's worth thinking a little about your reasons for investing. While stock market investments have performed well over the longer term they can be a little volatile over the short term. You only need to look back at the behaviour of world equity markets in late 2008 and early 2009 to see evidence of this.

For this reason, most people consider shares to be a medium to long term investment (sure, there are stock traders who only hold positions for days or even hours before selling but that's another story). Three to five years or longer is typically quoted as a reasonable holding period. So if you're looking for somewhere to stash the money you're saving toward that holiday, the stock market is probably not the place.

What Do You Get When You Buy Shares?

It's important to understand that when you invest in equities, it's more than just a ticker symbol you see quoted in the financial newspapers or on the news at night. You're buying a part ownership in a company - a real business. I think that's a critical point to remember. It's not like money in the bank or a term deposit - you own a small part of a business.

As such you're hoping that the business will grow and that your stake in the business will grow along with it so that you will one day sell your stake for more than you paid for it. You would probably also expect some income in the form of dividends along the way.

So, How Do You Buy Shares?

In practical terms, there are really two ways to invest in shares. You can buy them when a company floats on the Australian Stock Exchange or you can purchase stock in a publicly listed company 'on market'. (There are actually special circumstances where you can purchase shares off-market but these scenarios are beyond the scope of this article.)

Buying Shares In A Float.

When a company lists on the Australian Stock exchange it's called a float. What typically happens is that shares in the company are offered to the public in what's called an Initial Public Offering or IPO.

The company must produce a document called a prospectus which contains information about the history and nature of the business, financial results, any risks inherent in the business and what the future plans for the company are (including what they plan to do with the money raised by the offer). It's a very important document and should be read very carefully by any prospective investor.

It's worth noting that Telstra and Commonwealth Bank shares are the exception when it comes to stock market floats. Typically new companies listing on the ASX are much smaller with shorter operating histories than these two blue chip behemoths. And a fair proportion are outright speculative punts - junior oil and minerals explorers looking for a big resource discovery.

However, if you know what you're looking for, you can occasionally find solid businesses with a good record of profitability listing at reasonable valuations. It can be a good opportunity to get in early on a fast growing company. CSL and Cochlear are two companies which come to mind. Investors in the original float of either of these companies would be sitting on very tidy profits right now.

Although it probably shouldn't be a big consideration, you should also know that there is no brokerage payable when you invest through an IPO.

Buying Shares Through A Stockbroker

Types Of Broker

Full service brokers provide advice to their clients. They will provide recommendations on how to invest your money including what specific stocks to buy and sell. You will normally pay more for this level of service.

Discount brokers will allow you to buy and sell stocks but don't provide personal investment advice. They sometimes offer research information which is general in nature. Their brokerage fees are generally lower.

And speaking brokerage, that takes us nicely into the other main way of buying shares - on the sharemarket through a stock broker. When you buy shares in publicly listed companies through the stock exchange you're buying from another party. You're not buying from the stockbroking firm or from the company itself. There needs to be someone selling in order to buy. The seller may be a private investor like you or they may be an institution like a fund manager. The thing to remember is that you're buying a piece of a business from another party.

Shares listed on the Australian Stock Exchange need to be bought through a stockbroking firm. The stockbroker is responsible for executing purchase and sale transactions on you behalf. For this service they charge a fee called brokerage.

In order to operate as a share broker in Australia, you must be licensed by ASIC (the Australian Securities and Investments Commission). To be safe you should check that your broker is licensed by ASIC.

Before a stockbroker will accept your order, you'll normally have to set up a trading account with them. This is usually a fairly straight forward affair and shouldn't take more than a few days to to complete the process.

Most brokers will also need your bank account details. This is so that funds can be transfered to and from your account to pay for any purchases or receive the proceeds from any sales.

Order Types - 'At Market' and 'At Limit'

When it comes time to make your purchase, there are 2 types of order you can place - 'at market' and 'at limit' orders.

At market orders mean that you are seeking to purchase a set number of shares in a company at whatever the prevailing market price is at that time. So in effect, you will be accepting the offer of a seller who is selling at the lowest price.

At limit orders differ in that instead of just buying at the prevailing market price, you set the price at which you're willing to buy (or sell). This may be above or below the current market price. If you place an at limit order below the current market price, you will need to wait until the share price drops to that level before your order is executed. If the price doesn't get that low then your order wont be executed. I think under ordinary circumstances your order will be valid for 30 days before being purged from the Australian Stock Exchange system. There are a number of exceptions to this rule - I think one of them is when a stock goes ex-dividend.

Most brokers allow you to place orders to buy shares online or over the phone (check out the brokerage fees as they sometimes differ depending on the method you use to place your order). Whichever method you choose, make sure you check, then double check the details of your proposed transaction (make sure you don't have too many zeros), as once the trade takes place you are committed.

Settlement

Once your trade is executed, there is what's called a settlement period of 3 (business) days. After 3 days the broker 'settles' the trade - they will take the funds from your bank account to pay for the transaction and you will then be the legal owner of those shares.

Unlike in the old days, you wont actually receive a paper share certificate. What you will receive is a CHESS Holding Statement. This statement lists your current shareholding along with any recent transactions. The CHESS system is responsible for handling the settlement of stock market transactions and for maintaining who is the registered owner of each parcel of shares.

There are 2 options for managing your shareholdings. You can choose to be Broker Sponsored or Issuer Sponsored. If you're Broker Sponsored it means that your stockbroker is able to manage your holdings on your behalf. With Issuer Sponsored, the company you hold shares in will manage the holding. Visit the ASX website to find out more about the differences.

I find being broker sponsor to be more convenient as all of my holdings are grouped together and if I ever need to change any details (like my address) it all gets done in one go.

What's Next?

You've probably noted a glaring omission from the article - choosing the best shares to buy. Well that topic is a whole series of articles in itself. I have offered some of my thoughts on this topic in the past and I'll share some more in an upcoming post.


Thursday, October 22, 2009

Kathmandu IPO - Kathmandu Shares Set To Float

Hot on the heels of the initial public offering of Myer shares comes the Kathmandu float. It seems that the present owners of the outdoor goods and clothing retailer have judged that now might be a good time to sell down their stake given the recent strength in Australian shares and the high levels of demand being reported for Myer shares.

The Kathmandu prospectus is available from the kathmanduholdings.com website. The retail offer is set to open next Tuesday and close at COB on 6 November. The share offer is expected to raise between $278M and $375M through the sale of between 167 and 197 million shares at a price of $1.65 to $1.90. The proceeds of the offer will be used to pay down debt, fund the cost of the offer with the balance going to the present owners of the company.

Kathmandu was bought from founder Jan Cameron by Goldman Sachs JBWere and Quadrant Private Equity in 2006 and they are now looking at taking some money off the table. It has been reported that they may retain a stake of up to 15% in the listed entity but I suspect that will depend upon demand.

In order to buy shares in the offer you need to purchase through a broker who has received an allocation. There is some stock available to employees with the rest being sold in an institutional offer.

Kathmandu shares will be listed on both the Australian and New Zealand stock exchanges. The retailer operates 84 stores in Australia, New Zealand and the UK and is looking to open another 18 stores.

Monday, September 28, 2009

Myer Prospectus Released

Here is the latest update on the initial public offering of Myer shares.

Today the prospectus was made available for download on the Myer website. I have downloaded it and had a quick scan through.

One thing that struck me is that there is no application form. As far as I can tell, retail investors have 3 options to invest in the float:
  • as a staff member of Myer;
  • as a member of the loyalty card program; or
  • through an allocation from a stock broker.
If you don't fall into one of these categories, the prospectus says that you will be eligible if you're a member of Myer One loyalty card program on 23 October 2009. I guess that means you still have time to become a member.

The offer will be priced between $3.90 and $4.90 per share with the final price to be set upon completion of the institutional offer.

It seems that demand will probably be strong as I read in The Age today that 140,000 investors have pre-registered their interest in the share offer.

Wednesday, September 23, 2009

Myer Float - How To Buy Shares In The Myer IPO

Since my post yesterday on the IPO of Myer shares, I've had a couple of questions about how investors can get access to the float. As I mentioned yesterday, the strong brand name will probably attract lots of retail investors to the float and I guess people are worried about missing out.

According to the offer website, as long as you become a Myer One member by 5:00 pm on Friday 25 September, you will be eligible to preregister and have your prospectus mailed to you along with a personalized application form.

But I also read in the FAQ that you will not receive any priority by preregistering.

"If you apply for shares under the Myer Share Offer, you will be treated the same whether or not you have pre-registered."
So there appears to be no reason to panic just yet. Although there has been speculation that preferential treatment would be given to loyalty card holders, the information in the FAQ does seem to contradict this.

If you're worried about missing out, maybe the safest bet is to join up to the loyalty card program before Friday. That way you'll be covered if investors who preregister their interest in the IPO do receive preferential treatment in the Myer float.

Tuesday, September 22, 2009

Myer Shares Set To Float

It looks like Myer shares will once again be available on the Australian stock market. The Myer IPO (Initial Public Offering) could well be wrapped up by the end of the year.

According to the www.mypieceofmyer.com.au website, the group "currently intends to lodge a prospectus with the Australian Securities and Investments Commission for the offering of shares in Myer Holdings Limited on or about 28 September 2009".

With the ASX indices racing ahead over the past few months, it may well be an opportune time for the float, providing the Aussie sharemarket doesn't fall over in the next month or two. We've managed to get through the 1st anniversary of the GFC, but October has been a diabolical month for investors in years gone by - although not so much in recent years.

Pre-registration for the Myer float is only available to the company's staff and for Myer One loyalty card members.

The TPG (Texas Pacific Group) led private equity consortium took the iconic retailer private just over 3 years ago. Since then they have managed to increase profits and (not surprisingly) management say that recent trading has been strong.

The interesting thing for me will be the structure of the new listed entity's balance sheet - or more specifically, how much debt it carries. The modus operandi in most private equity deals is the use a lot of leverage (debt) in the buyout. Sometimes when the shares are floated they still carry a significant level of debt. Repco is one of those situations which comes to mind. The cyclic nature of retailing along with excessive debt can be a risky combination.

I suspect that the issue will still be popular though. It is a well known brand which along with some heavy marketing aimed at retail investors should ensure the Myer share float is successful.

Monday, September 21, 2009

Exchange Traded Funds - ETF Investing In Australia

My interest in Exchange Traded Funds has grown since I first wrote about asset allocation a few months ago. As you may recall from that post, I like the strategy as a way of diversifying away from Australian shares and as a way of making the investment process more objective and systematic. Anyway, this line of reasoning caused me to search for a cost effective and relatively simple way of implementing a fairly basic asset allocation - and the humble ETF fits the bill.

What Are Exchange Traded Funds?

An ETF is an open ended fund which trades on the stock exchange (open-ended means that the fund can issue or redeem shares at any time). Most of the ETFs I've looked at are designed to track the price of a particular index. They are similar to shares in that you can buy and sell them through your normal stock broker. The only cost you need to pay is brokerage. Another way in which they are like shares is that they pay distributions in a similar way to which shares pay dividends.

The funds' underlying investment is in the shares that make up a particular index. So an ETF designed to track the performance of the ASX 50 will aim to hold each of the components of the ASX 50. This is why the price of an ETF will track the price of the index. There are some mechanisms in place to ensure this is the case and that the share price does not vary too much from the underlying index. Basically there are market makers (also known as authorized participants) who buy or sell depending on demand in order to ensure an orderly market.

Why Use An ETF?

If you're looking for a way to gain exposure to shares in a particular region or market segment but don't want to have worry about choosing shares to buy yourself, then I think Exchange Traded Funds have a number of benefits.

As I mentioned earlier, you can buy or sell shares in an ETF on the Australian Stock Exchange just like you would any other shares. This makes them quite a convenient investment vehicle. For the cost of brokerage, you can buy a stake in the S&P 500 (one of the popular US large cap stock indexes) or maybe the S&P Europe 350 (an index comprised of 350 European stocks).

As well as being cheap to buy compared to managed funds or buying international shares directly, they also have low management fees compared to managed funds. This is because they take a passive approach to their investments by just buying the index resulting in lower transaction costs and there is no need to employ highly paid active investment managers.

Exchange Traded Funds may also offer some tax advantages over more actively managed funds. Because they mostly buy and hold (except for portfolio re-balancing) there is less capital gains tax payable because the underlying share are not frequently bought and sold.

Where I find ETFs to be most useful is in gaining exposure to international shares. I manage my own portfolio of Australian shares but I don't have the time or the expertise to invest internationally. ETFs give me that diversification at a low cost and with the convenience of being able to buy and sell directly on the Australian Stock Exchange.

ETF Providers

Most of the international exchange traded funds which are listed on the ASX are issued by Barclays Global Investors, although they trade and are marketed under the name iShares. There are also a couple of Vanguard funds. Vanguard have built quite a reputation as an index fund manager. They also offer some unlisted funds, although I believe the management costs are higher.

The Australian ETFs are issued by State Street Global Advisers and Vanguard. The State Street products trade under the name Streettracks.

Exchange Traded Fund List

There are many to choose from. Here is a list of some of them.

Australia:

- SPDR S&P/ASX 50 Fund (ASX:SFY) - tracks the performance of Australia's largest 50 companies.
- SPDR S&P/ASX 200 Fund (ASX:STW) - tracks the performance of Australia's largest 200 companies.
- Vanguard Australian Shares Index - tracks the performance of Australia's largest 300 companies.
- SPDR S&P/ASX 200 Listed Property Fund - tracks the performance of the S&P/ASX 200 A-REIT Index

International ETFs:

There are many products available to give investors access to a broad range of international shares. As you would expect, American shares are well represented. iShares offer US Large-Cap, Mid-Cap and Small-Cap products tracking various S&P indices and the Russell 2000 index as well. Vanguard also offer a fund which tracks the overall performance of the US market.

In Asia, iShares offers products tracking the MSCI index for Hong Kong, Singapore, Taiwan, Japan, or South Korea or the FTSE/Xinhua 25 index in China.

There is a iShares product for Europe which tracks the S&P Europe 350.

Then there's a number of products with broader scope. There's an iShares Emerging Markets Exchange Traded Fund which I guess you could say is more theme-based, rather than region based. Or the BRIC index (representing Brazil, Russia, India and China) is available as well if you're a believer in the economic growth story of these parts of the world.

Or you can zoom out even further and invest in the S&P Global 100 index, made up of 100 large-cap companies from around the world.

Exchange Traded Commodities

For investors who want to invest in commodities, ETCs (Exchange Traded Commodities) could be an option. These products are similar to ETF's except instead of buying shares, I believe the funds actually buy and hold the actual commodity. As I wrote about in my post about investing in gold, there is a gold ETC available. Or you can choose from platinum, silver and palladium. I need to research these a little better. Once I do, I'll write more about them.

Currency Risk

Just to wrap things up, I should point out that to the best of my knowledge, none of the International ETF's employ any sort of currency hedging strategy. This means that for the duration of your investment in the fund, you are exposed to currency fluctuations of the Australian dollar against other currencies.

So for example, if you bought into one of the US funds, and the $A increased in value against the $US, then the value of your investment in Australian dollar terms will have fallen even before taking into account the performance of the underlying investment.

This is not the end of the world. But it is something to be aware of when buying international Exchange Traded Funds.

Wednesday, August 26, 2009

Best Shares To Buy Now For The Long Term

Many investors will be feeling bruised and battered after a year or two of punishing stock market conditions. Even those who don't purchase shares directly will be feeling the pain. Superannuation returns have plummeted and most managed funds have gone backwards as well. So how do we as investors go about finding the best shares to buy now that stock prices seem to have stabilized?

In this post I'd like to describe some of the criteria I look at when investing. With share prices cheaper than they've been in years (although not as cheap as they were in March) I think now is a good time to buy shares provided they are as a long term investment in a quality business.

Perhaps at this point I should provide a caveat. I think there is a good chance that the Australian stock market will fall again in the short term. It has probably risen too far, too fast and any unexpected nasty surprises could trigger a sell-off. Or it might just be a round of profit taking as traders seek to lock in their short term gains. But if you're buying with a 5 year plus time-frame in mind, then short term setbacks shouldn't be too much of a concern and today's share prices will look good value.

Finding Good Shares To Buy Is About Reducing Risk

If events over the past 18 months have taught us anything about investing, it is that we need to understand the risk we take when we invest. Not just when buying stocks. It applies equally to other financial products as well. If you look back over the past year or two, you'll notice the financial landscape is littered with collapsed investment schemes. Opes Prime and Storm Financial are two high profile Australian examples but there are plenty more.

Permanent loss of capital is something which I believe should be avoided at all costs. Consider a portfolio of 10 stocks, each with with equal weighting. If you were to sustain a 100% (permanent) loss in one of those holdings (think of ABC Learning or Babcock & Brown) then you would need to generate a return of over 11% on the rest of the portfolio just to break even! Avoiding such disasters puts you ahead of thousands of other investors already (even some of the professionals).

For this reason, debt is one of the most important things for me to look at. I'm interested in the debt to equity ratio, the interest coverage and any debt that falls due in the short term.

Debt to equity is the amount of debt a business takes on when compared to the shareholders' equity. It's difficult to prescribe an exact ratio to look for as companies in different industries can sustain different levels. Cyclical industries like retailing have cash flows which can vary greatly through the economic cycle so high levels of debt are a problem during a downturn. Conversely, utilities with relatively stable cash flow through the economic cycle can probably sustain higher levels of borrowing. But in general, lower is better. Less than 1 is good and less than 0.5 is better.

Interest coverage is another thing to check. A company's ability to service it's debt is critical. The interest coverage ratio is the number of times the interest bill is covered by EBIT (Earnings Before Interest and Tax). I like 3 times as a rule of thumb but obviously more is better. Also, I like to go back over the past 5 to 10 years and pick what looks like the lowest EBIT figure over that period and use that in my calculation. That way I know that there's adequate coverage even at the bottom of the economic cycle.

What Are The Best Performing Shares?

Making sure that a company will still exist in 10 years time is one thing, but I also want to know that I will earn a decent return on my hard-earned cash over that tome. For that reason, I want to know that a company is going to take my investment and do something with it.

There are a couple of measures I look at to find out. Return on equity is one. It provides a measure of the rate of return the company is able to generate on its shareholders' funds. So a company which can generate a return of 15% on equity over an extended period of time is a pretty good investment. If this return is maintained as the equity levels grow (ie. the company is reinvesting profits into the business and continuing to generate good return on this additional investment). For companies with high levels of debt, the return on equity figure can be inflated by the level of leverage used. However, as I've already noted, I'm trying to avoid those companies with significant levels of debt.

Alternatively, we could use return on invested capital as our performance measure. Some argue that it gives a more realistic measure of financial performance as it takes into account all of the funds employed in generating profits, not just those contributed by investors. After all, a company which only takes 100 million dollars to return a profit of 20 million dollars probably has a better business than one which has to invest 200 million dollars to earn that same 20 million dollars even if in each case shareholders have only contributed 100 million dollars (the additional $100 million for the second company was funded by debt).

Value is important as well. Low debt and a high return on invested capital don't justify an excessive share price. I want to invest in a high quality company but if I pay too much then the return I can expect on my investment over the long term will be correspondingly lower.

What I like to do is build up a list of stocks which meet these strict quality criteria, then rank the list according to their relative value, from cheapest at the top to most expensive at the bottom. I can then apply some more subjective criteria to a handful of the stocks at the top of the list. Online brokers like ComSec have all of the data I need to compile my list. If your online broker doesn't have the information, you could use NineMSN or even the Australian Financial Review website (but I think you have to be a subscriber).

What I mean by subjective is to look at some of the factors which can't be boiled down into simple ratios and percentages. I need to use my judgment as to the future of the industry in which the business operates. I need to make an assessment of the quality of the management running that business. After this process, one or two companies will stand out and these are typically the ones where my money gets invested.

By following the above process, I hope to find not only the best shares to buy now, but also those that are worth holding in my portfolio for the long term.

Wednesday, August 12, 2009

Value Investing Podcast - The Value Guys

Who said value investing has to be boring?

If you're a stock market investor with a bias towards buying value, then The Value Guys podcast might be right up your alley. Although it's a sometimes light-hearted discussion of stock investments, the principles these guys apply when analyzing a potential investment are well worth listening to.

The two protagonists on this weekly podcast go by the names of Val Hughes and Vern Value (they're at pains to point out that thee names are not real). In each episode Vern and Val pick 3 stocks each which they think may be undervalued and put forward their arguments as to why this might be the case.

Although The Value Guys mainly discuss American stocks, those of us investing in the Australian stock market will still get something out of it. As I mentioned earlier, I find it interesting to listen to the way they approach valuing these companies. And they're entertaining as well.

You might also be interested on the Australian Stock Exchange podcasts and the Gannon On Investing podcasts.

Thursday, April 30, 2009

Buying International Shares

Should Australian's buy overseas shares as part of a balanced investment portfolio?

The Australian stock market is a very small portion of the overall investment universe - less than two percent, depending upon who you listen to. So today I'm going to explore why you might like to consider investing in international shares as well as a discussing some of the options.

The reason I started thinking about this was that I was recently reading about an investment concept known as asset allocation. The idea behind asset allocation is that you spread your investments across different assets classes with different risk profiles and for which returns are not always correlated. One of the asset classes suggested by many financial planners and other investment professionals is international shares.

By buying shares in overseas companies you can gain access to some the largest companies in the world. These businesses are truly global in their operations and many produce products consumed by us all the time. These are companies like ExxonMobil, General Electric, BP, Royal Dutch Shell Group, HSBC Group, Toyota Motor and GlaxoSmithKline, just to name a handful.

But just to temper your enthusiasm for these global giants for a moment, just remember that the normal rules of stock market investing apply to these companies as well. Do your homework. While larger companies are often seen as more secure investments because of the scale of their operations, financial strength and their ability to attract the most skilled managers, it still pays to remember some of the high profile casualties of the global financial crisis. I would avoid any of the stocks with large debt burdens or a patchy history of profitability.

Another good reason to buy international shares is for exposure to some of the faster growing or emerging economies. While the risks in these areas are significantly higher, the rewards can be substantial.

How To Buy Overseas Share Investments

The most common way of gaining international investment exposure is via a managed fund of some description. Here the choices are many and varied.

You can choose a fund which concentrates on a particular region. For example, the Platinum Asia Fund invests in companies which operate in the Asian region. And BT Funds Management offer a European fund. (These are not recommendations, but rather just a couple of concreate examples.)

Another way in which the investments are divided is by industry or investment 'theme'. Examples of these might be Healthcare or Technology. These funds would buy shares in companies which operate within a particular sector of the economy.

Or if you have a relatively small amount of money to invest, or you don't feel strongly about any of the regions or themes on offer, you may want to look at a broadly diversified international managed fund which buys shares in companies all over the world. The better managed funds in this category will give you exposure to businesses in many industries across all regions of the world.

There are also a number of listed investment companies and exchange traded funds which hold internalional shares and you can buy and sell these on the Australian Stock Exchange. There are many options available here so this is probably a topic for another day. If you have any interest in pursuing this angle, have a look on the ASX website at the iShares product and also their section on Listed Investment Companies.

The last option you may consider is to buy shares in international companies directly. Many stock brokers offer international trading as part of their service. Costs are normally higher than you would pay for buying and selling Australian shares both in terms of brokerage and also their fees. However, this option is probably more suited to more experienced investors.

As I mentioned in my post on buying American shares, another factor to consider is currency risk. This is the risk that the value of the Australian dollar will change when compared to the local currency of the country in which you invested during the interval between when you bought and sold.

If the value of the Australian dollar goes up, you will receive less when you sell than you would have if the exchange rate had stayed the same or dropped. Of course the opposite is true as well. If the Aussie dollar drops, you will make more money.

Many managed funds offer a product which is hedged. This means that they will try to take currency fluctuations out of the picture (through the currency futures markets) so that any returns will be in constant dollar terms.

Last (but unfortunately not least) you will need to consider tax implications. Any dividends paid will be subject to tax under each foreign country's tax laws. Rates will vary depending on the country in question. Then the dividends would also be subject to tax in Australia. Depending on the country of origin of the income, you may be entitled to some tax relief whereby you may only be taxed on the difference between the foreign rate and the Australian rate.

Also, the franking credits available under Australia's dividend imputation system don't apply to foreign dividends. Tax on foreign earnings is a complex area and you should seek professional advice before buying international shares.

Thursday, April 2, 2009

Asset Allocation - Investing By The Numbers

What is asset allocation and how can it make you a better investor?

I've been reading a lot about asset allocation lately. I don't recall what prompted this sudden interest. Perhaps it's a factor of age. My investment strategy has always been heavily skewed towards Australian shares, for a number of reasons, but mainly because shares traditionally have a good return when compared to other asset classes and although they are more volatile, since retirement is still a fair way off, I was happy to accept the volatility in exchange for higher returns. However, while retirement is still a fair way off, it's still something which I need to take seriously as the recent fall in world stock markets would have been disastrous if I was about to retire.

The idea behind asset allocation is that you spread your investments across different asset classes where the risk profiles are different and the returns aren't perfectly correlated. In this way, you're taking advantage of diversification to spread your risk while at the same time you're smoothing out your returns as your investments in different asset classes grow (or sometimes decline) at varying rates at different times (to each other).

What all of this means is that (hopefully) not all of your investments will perform poorly at the same time.

What asset classes can you choose to invest in? Well this depends on how exotic you want to get. Normally, you would be choosing from equities (shares), real estate, fixed interest (bonds) and cash. However, you may break shares up according to size (ie. small cap and large cap) or by region (Australian, American, European, Asian, etc). Real estate may be broken down into residential and commercial or industrial.

Strategic Asset Allocation

Strategic asset allocation involves setting fixed percentages of your investment portfolio to be invested in each asset class. For example, a more aggressive investor might choose something like the following:

40% Shares
30% Real Estate
20% Fixed Interest
10% Cash


The above is just an example. To work out your own asset allocation, you need to consider a number of factors like your tolerance for risk, the term of your investment (are you saving for retirement or a deposit for a house?) and your stage in life (the older you get, the harder it is to recover from capital losses).

Over time, your actual portfolio will tend to move away from its original allocation. Investments will grow at different rates causing them to make up a larger or smaller percentage of your portfolio than was originally intended.

This is where portfolio re-balancing comes in. The idea is that as the value of each of your investment becomes skewed from the original allocation, you buy or sell in order to maintain the correct weighting. I like this idea as it means that you're selling down something which has outperformed and buying into something which is theoretically cheap. It also makes the decision to buy or sell more objective.

Tactical Asset Allocation

If you're not a buy and hold kind of person, then a tactical asset allocation model may hold more appeal. You still have your ideal or planned weightings for each asset class but under this model you may choose to move away from these targets for short periods of time to exploit pricing or other factors which lead you to believe that a particular asset class will outperform.

While I've read that any out-performance is purely theoretical in nature and difficult to achieve in practice, what I like about asset allocation as a methodology is that it provides a framework for investors. If properly adhered to, I think it can take some of the emotion out of investing.

Sunday, March 22, 2009

Value Investing - Buying Shares For The Long Term

Investors buy shares in Australian companies for many reasons. Some buy stock in a company simply because they think the share price will go up, some may purchase based on the advice of their stock broker and some may even take the plunge based on a tip they received down at the pub on the weekend. However, today I'd like to discuss an alternative approach to the Australian stock market called value investing.

Value investing is an investment strategy or paradigm based on the teachings of Benjamin Graham and David Dodd going right back to the major sharemarket crash and subsequent great depression in 1929. In a nutshell, it involves buying shares at prices which are a significant discount to their intrinsic or underlying value based on fundamental analysis.

For those that are serious about buying shares and who have not heard of Benjamin Graham, I suggest you take the time to find out about the man. Security Analysis, originally published in 1934, became the foundation upon which an entire profession was built. While Security Analysis is worth reading, another of Graham's books titled The Intelligent Investor is much more accessible and I would say compulsory reading.

Perhaps the most famous of Graham's students is Warren Buffett - a renowned value investor and one who has consistently outperformed the S&P 500 index throughout his career. Other perhaps lesser known students, although each successful in their own right, include Irving Kahn, Bill Ruane and Charles Brandes. To find out more about the success of his students, read Buffett's article - The Superinvestors of Graham-and-Doddsville.

One of the most important concepts to come out of Benjamin Graham's writings is the margin of safety concept. The idea is that you're buying at a discount to intrinsic value, thereby giving yourself a buffer or margin of safety in case anything goes wrong.

One of Graham's classic methods of valuation was to use net current asset value. This approach calculated the value as being the company's current assets (I think from memory it may even have even been just cash and cash equivalents) less all liabilities. If you could buy shares in a company at less than two thirds of its net current asset value, Graham believed you had a low risk situation with significant upside potential.

So how do we apply these teachings? We need to understand the distinction between price and value. Price is what people are willing to pay for any given share while value is what it's actually worth. Trading and technical analysis involve looking at price and volume indicators, but does that really tell us what the company is worth and whether the current price over or under-values the company? Using fundamental analysis, we delve into the financial statements of the business to find out what it's really worth - it's value. I found a really good discussion of this topic in this article - Do prices Really Matter?.

Buying shares in the current market conditions requires patience and discretion. I suspect the days of making money by just taking advantage of the rising Australian sharemarket may be over for a while. I think the principles taught by value investing will provide you with useful tools during this period.

Thursday, March 19, 2009

Buying American Shares

Why should you consider buying US shares and how do you go about making your purchase?

The Australian stock market makes up only a couple of percent of world equity markets by market capitalization while the US stock market is a whopping 30% (based on some figures I found relating to values back in early 2007). This is a marked contrast and may give you an insight into why you might consider buying American shares.

Apart from being a much larger stock market by market capitalization and having an economy many times larger than Australia's, there are many more companies listed on US stock exchanges including some of the largest in the world.

Consider global companies with household brand names like Coca Cola, Johnson & Johnson, Kraft Foods, McDonalds and Microsoft among others. These are huge, truly international companies which dominate their industry the world over. It's hard to think of any Australian stocks which have the global reach and market dominance of these American giants.

So how do you go about buying US stocks? Broadly speaking, there are 2 main ways to go about it. You can either buy directly or you can invest in a managed fund which has at least some exposure to the sector.

A number of Australian stock brokers allow you to buy American shares. I'll let you do your own investigation as to the services offered fees (brokerage, etc) charged. I know that Commonwealth Securities charges $65 per trade. Remember that you'll need to do your own research into which stocks to buy. Also tracking your investment becomes even more important because you're less likely to hear about these companies through the Australian news media.

The other option is to invest via a managed fund. In this way, you don't need to worry about researching specific stocks. The fund manager does the leg work for you. Of course you should still put in the effort to choose one or more fund mangers to whom you happy to entrust your hard earned cash. Almost all international managed funds will have exposure to US shares but some fund managers offer products which target North America specifically. Of course, you will pay for the expertise of the fund manager through the ongoing management fees which are charged on your investment.

One of the risks inherent in being an Australian buying American shares (or buying international shares in general) is currency risk. Currency risk is the chance that the exchange rates chance between when you buy and when you sell. If the Australian dollar strengthens against the US dollar, you will lose money. This is because each US dollar you get for selling your American shares will no longer buy as many Australian dollars.

Of course this cuts both ways. If the Australian dollar drops in value against the US dollar (as it has done recently) you will end up with a greater profit. However, the important thing to remember is that it's notoriously difficult to forecast foreign currency movements. Therefore you need to be aware of this extra risk in on top of the general market and stock specific risks.

If you decide to go with a managed fund, you have the option of choosing a hedged or unhedged fund. Hedging means the manager will use currency derivatives to eliminate the currency risk. An unhedged fund will give you full exposure to currency movements - both up and down.

I'll leave you with one final thought. If you have your retirement savings invested in an Australian superannuation fund, there is a good chance the fund manager has been buying American shares on your behalf.

Saturday, January 31, 2009

Are Directors Buying Shares In Their Own Companies?

Before deciding whether to buy shares in any given company, there are a number of things I look at. One of things I check out is what the insiders are doing. By this I mean looking at whether the directors of the company I'm interested in have been buying shares recently (or maybe selling shares instead). Since I invest on the Australian stock market, I'm able to find this information fairly easily as companies listed on the Australian Stock Exchange (ASX) are required to report directors transactions to the market.

So why should I care whether the directors are buying or selling shares? Well, the directors of any listed company have (or maybe I should say "should have") a pretty good idea of the prospects of their business. If they're buying shares then it's probably a sign that they are comfortable with the future of the company and see value in its stock at the prevailing market prices. Similarly, if you notice that a director is selling shares in their own company, it could be a sign of trouble to come - maybe they consider the stock to be over valued or they could be anticipating weakness in the business in the future. However, this is by no means foolproof. It's entirely possible that the director is selling just because they need to money for something else.

One of the more interesting Change of Director`s Interest Notice's issued last week was for Harold Mitchell who bought 295 thousand shares in Mitchell Communication Group Limited (ASX Code MCU). Mr Mitchell now holds in excess of 83 million shares in the company. The purchase price was around 45 cents per share and compares to a current price of 33 cents. MCU has traded as high as 99 cents in the last year after peaking at over $1.40 in 2007.

Mitchell Communication Group is a diversified media group and from what I understand, Harold Mitchell is known as a mover and shaker in the media buying industry within Australia. The most recent purchase is one of a number of recent acquisitions of MCU shares by Mr Mitchell.

Sunday, January 25, 2009

Ethical Managed Funds

What is ethical investing and why should you choose an ethical fund manager?

Ethical or socially responsible investing is not an easy term to define. I always considered it to mean not buying shares in companies which operate in sectors such as gambling, tobacco, alcohol and mining of minerals such as uranium which might be considered damaging to society or the environment. So I always figured that an ethical managed fund would be one which holds investments outside of these sectors.

Having done a done a little research on this topic, it seems that this area is more complex than I first thought. According to the Responsible Investment Association of Australasia, there are a number of methods which fund managers (or investors generally I guess) can adopt in their approach to ethical investments.

Broadly speaking, there are 4 different methods. These are Negative Screening, Positive Screening, Best Of Sector and Sustainability Analysis.

Negative screening is essentially what I've already described. The fund manager will simply avoid investing in certain sectors of the stock market like those I mentioned above, but beyond that, they can buy shares in whatever companies they like provided they don't operate in those industries.

Positive screening on the other hand aims to identify specific companies whose operations are likely to have a positive impact on society and the environment. I guess you could consider this a more active approach.

The best of sector approach does not discriminate between industries but rather will seek out investments, within each sector, in a company which is seen to be the most 'ethical' in that sector. So the fund manager may invest in a company within the gambling industry but they would choose the company which could be considered a leader when it comes to sustainability.

Finally, sustainability analysis involves analysis of the entire stock market using information from a broad range of sources then ranking companies based on a set of standard criteria.
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Within Australia, the main players in this space seem to be Hunter Hall and Australian Ethical Investment.

Hunter Hall run a number of funds and seem to have a bias towards value investing. According to their website, Hunter Hall employ a negative screen which "restricts investment in companies that derive revenues associated with the sale of armaments or tobacco, gambling, cruelty to animals, destruction of the environment and uranium mining". You can choose from both listed and unlisted funds.

Australian Ethical Investment offer 5 different retail funds and a superannuation fund. As far as I can tell they seem to use the positive screen approach to their investing. And I'm sure I read that both Hunter Hall and Australian Ethical Investment donate a set percentage of profits to charity each year.

An interesting piece of information I picked up during my research is that the name of the Marketing Manager of Australian Ethical Investment is Roger Green. Does anyone else find that amusing?

One thing I kept reading was that ethical managed funds are more likely to underperform the market because they are restricted in what they can invest in. Given the recent resources boom on the Australian stock market, I'd be curious to know how these funds have fared over the past few years when compared to their 'less ethical' peers.

But even if there was evidence of underperformance, I suspect that if, as an investor, you feel strongly enough about social issues or about the environment to choose an ethical managed fund, then wearing a potential performance hit for your beliefs probably wont bother you too much.

Monday, January 5, 2009

Australian Stock Market Floats For 2008

New company floats on the Australian Stock Exchange copped an absolute pasting during 2008. I can't be any more plain than that. Very few companies whose shares listed on the ASX during 2008 ended up which a share price exceeding the issue price.

Float activity was down on previous years as well, as measured by either the number of new issues or by the aggregate amount of capital raised. But this was to be expected. With the All Ordinaries down 43% for the year and panic stricken investors heading for the exits at the first sign of trouble only the very brave or very needy chanced their arm with an IPO. I suspect most executives who had intentions to float in 2008 would have delayed their plans until a calmer mood prevailed over world stock markets.

Measured by the number of new company floats, 2008 was a poor year, with only 72 new listings. This is the lowest since 2002 and is a far cry from the peak in 2007 of 242 new company floats. Also, only 2 billion dollars was raised last year - once again well behind the 9.7 billion dollar figure for 2007.

Of the 72 floats, only 2 finished with their heads above water.
  • Phosphate Australia (ASX:POZ) finished the year at 44 cents after listing in July at an issue price of 20 cents - an impressive 120% gain.
  • Heartware (ASX:HIN) finished up 20% at 60 cents after an Initial Public Offering at 50 cents in November.

An honorable mention should go to Tiaro Coal who have managed to break even by finishing the year at 20 cents - the same as the issue price back in March when the Australian Stock Exchange was first graced with it's presence.

After that it gets ugly. More than two thirds of new listings finished the year at less than 40% of their original issue price. The companies floated were mostly small with lots of mining and exploration plays amongst them. But there is one exception...

BrisConnections floated at the end of July at an issue price of $1.00. Since then it has plummeted like a stone to 0.1 cents - not $0.10, but $0.001 or a tenth of a cent. The company plans to construct a toll road in Brisbane connecting the Airport to some other stuff (I don't know the geography of Brisbane very well). I believe there are lots of tunnels involved.

BrisConnections has so far raised $400M out of its total $1.2B - and this is where it gets interesting. You see the shares (stapled securities to be more accurate) were issued on a partly paid basis with 2 further installments due (each of $1.00) over the next couple of years. This means the the purchase of each one of these securities at the knock down, bargain basement price of $0.001 buys you the obligation to stump up another $2.00 down the track.

I can almost hear your brain ticking over as you ponder that one. Let's say you have a lazy $500 to 'invest'. At the going rate of a tenth of one cent per security, your 500 dollars (plus brokerage of course) will buy you 500,000 of these little beauties. "Not bad!", you say. Then you do the maths and work out that over the next 2 years you'll need to fork out an additional 1 million dollars - that's $1,000,000 - to make the installment payments.

And just to make sure you are in no doubt as to your legal requirement in this matter, the kind folks at BrisConnections sent out a letter to shareholders early last month reminding shareholders of their obligation to make the installment payments. In the letter, they stated that "BrisConnections will take a vigorous approach to collecting any such outstanding payments."

Finally, I should point out that, despite the tone of this article, I don't mean to imply that all of the floats to hit the Australian stock market in 2008 were of poor quality, although I suspect some of them may well have been. Value investors would know that a fall in price does not necessarily mean the company is no good. On the contrary, value investors may well want to pick through the carnage of last year's IPOs to see if there are any hidden gems which may be worthly of closer inspection.

Saturday, January 3, 2009

Australian Stock Market Worst Annual Return Ever?

The Australian stock market gave investors a wild ride during 2008. It was not a year for the fainthearted. An investment in Australian shares as measured by the All Ordinaries index is down by almost 43% - that really hurts!

Graph of Australian shares for 2008Australian Stock Market Chart - 2008


The All Ords started out the year at 6,462.8 and finished at 3,659.3. Along the way it touched a high of 6,462.8 on the first trading day of the year before plunging to a low of 3,201.5 on 21 November. As far as I can tell, this is the worst performance recorded since 1900.

Australian Shares Not All Bad News...

Unless you've had to sell shares, the good news is that this is only a paper loss. Granted, it might be some time before the sharemarket regains the levels it was at in 2007, but if you have a long term view and focus on the fundamentals of the businesses you're invested in, there should be light at the end of the tunnel.

Even better, if you have cash available, there are some screaming bargains on offer at the moment. I think that prudent and discerning investors will do very well in Australian shares over the medium term. But I suspect there could be more volatility on the way.

The All Ordinaries has recovered slightly from it's low point in November but as we've seen in recent months fear and panic can wipe out any tentative gains in the blink of an eye. Baring any more catastrophes (by that I mean large corporate collapses or bailouts) the next interesting time will be when listed companies start reporting their financial results to the ASX in a month or two.

Until now, the market has been anticipating the impact of the global slowdown in economic activity. Once we start seeing some actual financial results, we'll have a much better idea of how the various sectors, and the individual companies within those sectors are faring.