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Getting interesting times into perspective

By Tony Negline.

This article may be out of date.

15th October 2008

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"May you live in interesting times," is said to be the first of three Chinese curses of increasing severity, which according to the online encyclopedia Wikipedia has slipped into popular usage.

Some investors will believe that this curse has been visited on us as we pass through these strange and forbidding financial markets.  No doubt a goodly portion of these have fled to what they see as safer ground.

One lady familiar with my line of work said to me last week, "I'm too nervous to open the recent letter from my super fund showing my account balance."

A few years ago Paul Johnson said that committed married couples going through a rough patch patiently wait for better days.  Based on recent research of small super fund trustees it would appear that they too are displaying a similar level of stoicism.  They're taking their losses on the chin and are waiting for the markets to turnaround and, more importantly, they are not panicking.

It is always dangerous to talk about past investment performances as if they were sure to be repeated.  Nevertheless it sometimes helps in putting some of the recent market volatility into perspective.

For example, $100,000 invested in the All Ordinaries ASX 200 in March 1982 would have been worth over $1.46 million at the end of October 2007.  By the end of September 2008 it had fallen to $1 million.  The value of these investments is now equivalent to that last seen in late 2005.

At the time of writing our investment had fallen to $933,000 or values last seen in mid-2005.  An additional fall of 10% would see prices below late 2004 prices and the value of our investment would be about $800,000.

Since March '82 total dividend payments from these share investments would have been over $580,000 before any tax issues such as franking credits are taken into account.  The average income return has been about 4% (before franking) per annum.

Our 26 and a half year investment period covers sharemarket booms (1987, 1995 – 2000, 2003 – 2007), busts (1987, 1994, 2001/02 and 2007/08) and periods of sideways movements.

It's always good to compare these investments on a level playing field using consumer inflation figures.  The $100,000 invested in March '82 would now have purchasing power of about $300,000.

The sharemarket would have to fall to values last seen in 1992 for our investment to be worth only $300,000.

Whilst these numbers might give some proof that 'time in the market' is a sounder strategy than 'timing the market' it doesn't take into account some of the other important factors that small super fund trustees have to think about when framing an investment strategy.

Roger Lowenstein wrote in his forward to Edwin Lefèvre's book "Reminiscences of a Stock Operator" that "speculators buy the trend; investors are in for the long haul … one reason people lose money today is that they have lost sight of this distinction; they profess to have the long-term in mind and yet cannot resist following where the hot money has led".

Some super funds – especially those paying pensions – will need to carefully balance their income paying investments and their capital growth investments because better income returns tend to mean lower capital returns.

Trustees also have to consider the risk of each investment type?  The 30% drop in the Australian sharemarket since November 2007 has brought into clear focus that super fund trustees can loose their beneficiaries quite a lot of money especially if those assets have to be liquidated at a market low-point to pay a benefit.

For example suppose our investment above was all being used to pay a pension for someone aged at least 65 but under 75.  In June '07 the account balance would have been $1.35m and pension payments would have to be at least $67,500.

Because of franking credits the level of income into the fund would probably have been roughly this number.

By June 2008 the account balance would have been $1.12m meaning income payments must be at least $56,000.  Is the fund member ready to accept a drop of at least thirty percent of their pension income payments?

If not then the super fund trustee will have to make a decision about which assets should be sold to make some of the pension payments.  Not a particularly palatable situation in the current market.

Some super fund trustees are using the recent market turmoil to sell assets and buy back into those same assets at a better price.  For example suppose a fund bought BHP shares a few years ago at $20.  The super fund trustees like BHP and intend to be long-term holders of the stock.  The trustee might decide to sell their shares at the current market price (let's say $30 per share) and book a taxable profit of about $6 per share.  With the net proceeds they buy back into BHP at $30 per share.  This now gives them a higher acquisition price when they come to finally sell the shares.

This was a popular and useful strategy but because of information released by the tax office about "wash sales" in March is not allowed.  In any event because capital gains for assets purchased after September 1999 is worked out using the "two-thirds reduction" methodology no longer has the same benefit in many cases.

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