Written By Jim Parker for “Outside the Flags”.

When you haven’t got much capital of your own, the road to financial security can seem long, hard and complex. But the truth is that wealth building is relatively simple. All it takes is time and the price of a cup of coffee.

A son of a friend just graduated from university. Still in his early 20s and with student loans to pay off, Josh has hardly any savings or capacity to save much at all. So Josh and I met for coffee and a chat. He had acquired a taste for espresso while studying and working at night waiting tables. (The coffee kept him awake).

“How much do you spend on espresso each week?” I asked him. After thinking for a moment, he replied that he averaged about two cups a day, each costing $3. That equated to about $40 a week or $160 a month. “Well, what if you sacrificed the coffee and put the cash into a savings scheme instead?” I suggested.

Josh looked doubtful. Kicking caffeine wouldn’t be easy. Besides, he couldn’t imagine that loose change spent on coffee would make much difference to his long-term financial position. I dealt with the first problem by suggesting he make instant coffee at home and bring it into work each day in a flask. The second problem – that it wouldn’t be effective – I dealt with by telling him about the miracle of compounding.

With initial balance of $100, a monthly contribution of $160 and a yield of 5%, his coffee money would gradually accumulate to a pool of a quarter of a million dollars by the time of his retirement. And this was without saving another cent.
Assuming Josh’s salary was to rise on his graduation, he might bump up that monthly contribution to $500.

In this case, his savings pool would grow to three quarters of a million by his retirement. And this was a conservative estimate.

This sounds too easy, he said. That’s because it is easy, I replied. The interest he earned on his saving was paid into his account and included in the next calculation. So he was earning interest on interest. The key was that firstly he was starting early. Secondly, he was saving a small amount consistently month after month. Thirdly, he was exercising patience. The rest of it was just the effect of time and compounding. (Obviously, this young man’s earnings will be subject to tax. But the purpose of this exercise was to show him that a small sacrifice, made regularly, would yield significant results over time.)

Josh now refers to his savings plan as his ‘espresso portfolio’. The initial pain of kicking his expensive caffeine habit was made up for by the slow roast of a savings scheme that promised him a comfortable retirement.

Even for those of us much older than Josh, there are lessons here. We tend to underestimate the effect of gradual saving and patience in building wealth, just as we tend to over-rate gimmicks promoted in the media. We can’t control the ups and downs of markets or the daily noise of the media. We can control our own behaviour.

Now enough of this talk about money. How about a coffee? It’s on me.

See the link to the guide below;

DES-15 Things to Do-30s-Guide

Housing affordability continues to sit atop the list of hard-to-solve political issues in Australia. In late October, the government gave the first insight into the mechanics of the First Home Loan Deposit Scheme (FHLDS), its latest attempt to ease the struggle many young Australians face when looking to buy their first home.

Last month, Treasury released an exposure draft of the investment mandate that would govern the FHLDS. This draft mandate was finalised on November 11, 2019 without significant amendment. With this in mind, we will first look at the nuts and bolts of the FHLDS in November’s Technical Journal. In this month’s Industry Insights we focus on the historical context of the FHLDS, as well as some of the potential issues with, and opportunities presented by, the scheme.

So, let’s start with how the scheme will work.

The scheme in a nutshell

Under the scheme, the National Housing Finance and Investment Corporation (NHFIC) will provide a guarantee to help eligible first home buyers increase their security amount on the purchase of their first home to 20 per cent. First home buyers need to meet an income test, the purchased home needs to be valued below set thresholds and the first home buyer(s) need to have at least 5 per cent of the home’s value as a deposit.

The scheme will commence on January 1, 2020 and a limit of 10,000 guarantees per financial year applies. Guarantees would be applied on a first-come, first-served basis.

In practice

The NHFIC provides a guarantee that increases the borrower’s security to 20 per cent of the value of the property at purchase. So, if the borrower has a 5 per cent deposit, the guarantee is for a further 15 per cent. If the borrower has 10 per cent, the guarantee is for 10 per cent and so on. By lifting the borrower’s security amount to 20%, the lender should no longer require the borrower to take out mortgage protection insurance. The cost of such insurance can vary from hundreds to thousands of dollars a year, depending on the age of the life insured, the size of the loan and associated repayments, and the events covered.

For a loan to be eligible for the scheme, it needs to meet the following criteria:

1. It is provided by an eligible lender,
2. There are no more than two borrowers,
3. If there are two borrowers, they are spouses or de facto partners,
4. Each owner is a first home buyer and will occupy the home,
5. The loan is to purchase residential property which does not exceed the price cap,
6. Loan repayments are on a principal and interest basis and the term does not exceed 30 years (although an interest-only period is permissible where the loan relates to the building of a new residence),
7. If the loan is to buy land it must also be to build a home on the land,
8. The loan to value ratio is between 80 and 95 per cent.

In practice

For an FHLDS guarantee to apply to a loan issued to the maximum of two borrowers, the borrowers must be in a spousal, or de facto, relationship. This is in contrast to the conditions of the First Home Super Saver scheme, where more than 2 joint purchasers can pool their funds and no specific relationship between the purchasers is required.

Eligible Loans

If a loan is already approved for the scheme, it can be refinanced, and the scheme will continue to apply to it.

There are limits on how many FHLDS guarantees can be applied to loans issued by the big four banks (Westpac, NAB, ANZ and Commonwealth Bank). Only two of these banks may have any FHLDS guarantees applied to their loans in a given financial year, and a maximum 5,000 guarantees may be applied to loans from those two banks.

First home buyer

In order to qualify for the scheme, each owner of the home purchased with the loan must:

• Have never held a freehold interest, long-term lease (as described in section 104-115 of the Income Tax Assessment Act 1997)  or company title over a property in Australia,
• Be at least 18 years of age and an Australian citizen, and
• Meet the income test.

The income test

The income test is applied to the financial year preceding the year the loan agreement is entered into and assesses taxable income. To qualify for the scheme, such income cannot exceed:

• $200,000 combined for couples, or
• $125,000 for singles.

Price cap

FHLDS guarantees can only be applied to loans on properties that do not exceed the price cap for that region.

The price cap for the calendar year is determined by the NHFIC each January 1. The investment mandate applies the price cap at commencement as:

• ACT – $500,000
• Sydney, Illawarra, Newcastle and Lake Macquarie – $700,000
• Other NSW – $450,000
• Melbourne and Geelong – $600,000
• Other Vic – $375,000
• Brisbane, Sunshine Coast and Gold Coast – $475,000
• Other Qld – $400,000
• NT – $375,000
• Adelaide – $400,000
• Other SA – $250,000
• Perth – $400,000
• Other WA – $300,000
• Hobart – $400,000
• Other Tas – $300,000
• Jervis Bay and Norfolk Island – $450,000
• Christmas Island and Cocos (Keeling) Islands – $300,000

The definition of cities and regional centres listed is taken from the Australian Statistical Geography Standard. Regional centres are defined as those in Statistical Area Level 4. An interactive map provided by the ABS is available here.

Value

The value of a property is taken at the time the loan contract is entered into, and is the value of the property assessed by the lender. This may be different to the market value at which the property was purchased.

Guarantee limit

The NHFIC’s guarantee under the scheme is limited to 20 per cent of the value of the property, less the deposit paid by the purchaser(s). The guarantee ceases when the outstanding loan amount is less than 80 per cent of the value of the property as assessed by the lender at the time of purchase.

The scheme will not be a financial product

Along with the draft mandate, draft regulations were consulted upon by Treasury that would exempt the scheme from being considered a financial product. As such, the recommendation that a client apply for a FHLDS guarantee will be free from the compliance requirements attached to advice on a financial product.

Under the National Consumer Credit Protection Act 2009, the FHLDS does not seem to represent credit either. As the borrower has no obligation to repay the government for their guarantee, no debt  to the government is incurred or deferred. That said, the loan to which the FHLDS guarantee is applied is most certainly credit, and for an adviser to provide any specific guidance on the loan to a client, they will need to operate under an Australian Credit Licence.

Change is inevitable

The investment mandate may well be subject to change before the FHLDS is launched. That said, the current rules do provide a good insight into the broader shape of the scheme and how it will apply to clients. Keep an eye out for this month’s Industry Insights where will discuss some of the deeper issues arising from the FHLDS.

To celebrate this wonderful milestone for Loan, we have included some pictures from her wedding in August 2019;

 

 

As you will know Australian Private Capital has provided a scholarship at La Trobe University for a number of years.  In order to be considered, the recipient needs to live outside of Melbourne and be intending to study in a finance related field. 

The reason why APC provides this financial support is we recognise that relocating to Melbourne to study is a difficult endeavour for many.  Being away from family and friends is not easy and the financial burden can place a strain undermining the student’s focus on their studies.

This year, our scholarship is being awarded to Luh Emi Purnama Madrini.  Luh became interested in business and finance when he completed VCE studies in Business and Accounting which lead him to enrol in La Trobe’s VCE Plus program.

Luh commenced a Bachelor of Commerce at La Trobe and has since transferred to a double Commerce / Law degree.  Luh’s decision to study at La Trobe has a historical family link as his father studied at La Trobe.  Growing up as a farmer in an extremely disadvantaged village in Indonesia, Luh’s father himself received scholarships to study at La Trobe and provided him the means and opportunity to break the cycle of poverty.

The impact of these scholarships has had enormous benefits for Luh’s father and his family, allowing other family members to come to Australia and study.

This experience illustrates the power of education and business opportunity to break the cycle of poverty.  This notion of ‘Business being a force for immense good in the world’ has motivated APC over many years in our supportive endeavours at both Melbourne Business School and La Trobe University and is something we are very proud to continue to do.

I have been working in and around investment markets for 35 years now. A lot has happened over that time. The 1987 crash, the recession Australia had to have, the Asian crisis, the tech boom/tech wreck, the mining boom, the Global Financial Crisis, the Eurozone crisis. Financial deregulation, financial reregulation. The end of the cold war, US domination, the rise of Asia and then China. And so on. But as someone once observed the more things change the more they stay the same. And this is particularly true in relation to investing. So, what I have done here is put some thought into the nine most important things I have learned over the past 35 years.

# 1 There is always a cycle

Droll as it sounds, the one big thing I have seen over and over in the past 35 years is that investment markets constantly go through cyclical phases of good times and bad. Some are short term, such as those that relate to the 3 to 5 year business cycle. Some are longer, such as the secular swings seen over 10 to 20 year periods in shares. Some get stuck in certain phases for long periods. Debate is endless about what drives cycles, but they continue. But all eventually contain the seeds of their own reversal. Ultimately there is no such thing as new eras, new paradigms and new normal as all things must pass. What’s more share markets often lead economic cycles, so economic data is often of no use in timing turning points in shares.

# 2 The crowd gets it wrong at extremes

What’s more is that these cycles in markets get magnified by bouts of investor irrationality that take them well away from fundamentally justified levels. This is rooted in investor psychology and flows from a range of behavioural biases investors suffer from. These include the tendency to project the current state of the world into the future, the tendency to look for evidence that confirms your views, overconfidence and a lower tolerance for losses than gains. So, while fundamentals may be at the core of cyclical swings in markets, they are often magnified by investor psychology if enough people suffer from the same irrational biases at the same time. From this it follows that what the investor crowd is doing is often not good for you to do too. We often feel safest when investing in an asset when neighbours and friends are doing the same and media commentary is reinforcing the message that it’s the right thing to do. This “safety in numbers” approach is often doomed to failure. Whether its investors piling into Japanese shares at the end of the 1980s, Asian shares into the mid 1990s, IT stocks in the late 1990s, US housing and dodgy credit in the mid 2000s or Bitcoin in 2017. The problem is that when everyone is bullish and has bought into an asset in euphoria there is no one left to buy but lots of people who can sell on bad news. So, the point of maximum opportunity is when the crowd is pessimistic, and the point of maximum risk is when the crowd is euphoric.

# 3 What you pay for an investment matters a lot

The cheaper you buy an asset the higher its prospective return. Guides to this are price to earnings ratios for share markets (the lower the better – see the next chart) and yields, ie the ratio of dividends, rents or interest payments to the value of the asset (the higher the better). Flowing from this it follows that yesterdays winners are often tomorrows losers – because they became overvalued and over loved and vice versa. But while this seems obvious, the reality is that many find it easier to buy after shares have had a strong run because confidence is high and sell when they have had a big fall because confidence is low. But the key point is that the more you pay for an asset the lower its potential return and vice versa.

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: Global Financial Data, AMP Capital

# 4 Getting markets right is not as easy as you think

In hindsight it all looks easy. Looking back, it always looks obvious that a particular boom would go bust when it did. But that’s just Harry hindsight talking! Looking forward no-one has a perfect crystal ball. As JK Galbraith observed “there are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” Usually the grander the forecast – calls for “great booms” or “great crashes ahead” – the greater the need for scepticism as such calls invariably get the timing wrong (in which case you lose before it comes right) or are dead wrong. Market prognosticators suffer from the same psychological biases as everyone else. If getting markets right were easy, then the prognosticators would be mega rich and would have stopped doing it long ago. Related to this many get it wrong by letting blind faith – “there is too much debt”, “house prices are too high and are guaranteed to crash”, “the Eurozone will break up” – get in the way of good investment decisions. They may be right one day, but an investor can lose a lot of money in the interim. The problem for ordinary investors is that it’s not getting easier as the world is getting noisier as the flow of information and opinion has turned from a trickle to a flood and the prognosticators have had to get shriller to get heard.

# 5 Investment markets don’t learn

A key lesson from the history of investment markets is that they don’t seem to learn. The same mistakes are repeated over and over as markets lurch from one extreme to another. This is even though after each bust many say it will never happen again and the regulators move in to try and make sure it doesn’t. But it does! Often just somewhere else. Sure, the details change but the pattern doesn’t. As Mark Twain is said to have said: “history doesn’t repeat, but it rhymes.” Sure, individuals learn and the bigger the blow up the longer the learning lasts. But there’s always a fresh stream of newcomers to markets and in time collective memory dims.

# 6 Compound interest is like magic

This one goes way back to my good friend Dr Don Stammer. One dollar invested in Australian cash in 1900 would today be worth $240 and if it had been invested in bonds it would be worth $950, but if it was allocated to Australian shares it would be worth $593,169. Although the average annual return on Australian shares (11.8% pa) is just double that on Australian bonds (5.9% pa) over the last 119 years, the magic of compounding higher returns leads to a substantially higher balance over long periods. Yes, there were lots of rough periods along the way for shares as highlighted by arrows on the chart, but the impact of compounding at a higher long-term return is huge over long periods of time. The same applies to other growth-related assets such as property.

 

 

 

 

 

 

 

 

 

 

 

 

 

Source: Global Financial Data, AMP Capital

# 7 It pays to be optimistic

The well-known advocate of value investing Benjamin Graham observed that “To be an investor you must be a believer in a better tomorrow.” If you don’t believe the bank will look after your deposits, that most borrowers will pay their debts, that most companies will grow their profits, that properties will earn rents, etc then you should not invest. Since 1900 the Australian share market has had a positive return in roughly eight years out of ten and for the US share market it’s roughly seven years out of 10. So getting too hung up worrying about the next two or three years in 10 that the market will fall risks missing out on the seven or eight years out of 10 when it rises.

# 8 Keep it simple stupid

Investing should be simple, but we have a knack for overcomplicating it. And it’s getting worse with more options, more information, more apps and platforms, more opportunities for gearing and more rules & regulations around investing. But when we overcomplicate investments we can’t see the wood for the trees. You spend too much time on second order issues like this share versus that share or this fund manager versus that fund manager, so you end up ignoring the key driver of your portfolio’s performance – which is its high-level asset allocation across shares, bonds, property, etc. Or you have investments you don’t understand or get too highly geared. So, it’s best to keep it simple, don’t fret the small stuff, keep the gearing manageable and don’t invest in products you don’t understand.

# 9 You need to know yourself to succeed at investing 

We all suffer from the psychological weaknesses referred to earlier. But smart investors are aware of them and seek to manage them. One way to do this is to take a long-term approach to investing. But this is also about knowing what you want to do. If you want to take a day to day role in managing your investments then regular trading and/or a self managed super fund (SMSF) may work, but you need to recognise that will require a lot of effort to get right and will need a rigorous process. If you don’t have the time and would rather do other things like sailing, working at your day job, or having fun with the kids then it may be best to use managed funds. It’s also about knowing how you would react if your investment suddenly dropped 20% in value. If your reaction were to be to want to get out then you will either have to find a way to avoid that as you would just be selling low and locking in a loss or if you can’t then you may have to consider an investment strategy offering greater stability over time (which would probably mean accepting lower returns).

So what does all this mean for investors?

All of this underpins what I call the Nine Keys to Successful Investing which are:

1. Make the most of the power of compound interest. This is one of the best ways to build wealth and this means making sure you have the right asset mix. 
2. Don’t get thrown off by the cycle. The trouble is that cycles can throw investors out of a well thought out investment strategy. But they also create opportunities. 
3. Invest for the long term. Given the difficulty in getting market and stock moves right in the short-term, for most it’s best to get a long-term plan that suits your level of wealth, age, tolerance of volatility, etc, and stick to it. 
4. Diversify. Don’t put all your eggs in one basket. But also, don’t over diversify as this will just complicate for no benefit.
5. Turn down the noise. After having worked out a strategy thats right for you, it’s important to turn down the noise on the information flow and prognosticating babble now surrounding investment markets and stay focussed. In the digital world we now live in this is getting harder.
6. Buy low, sell high. The cheaper you buy an asset, the higher its prospective return will likely be and vice versa. 
7. Beware the crowd at extremes.Don’t get sucked into the euphoria or doom and gloom around an asset.
8. Focus on investments that you understand and that offer sustainable cash flow. If it looks dodgy, hard to understand or has to be based on odd valuation measures or lots of debt to stack up then it’s best to stay away. 

Seek advice. Given the psychological traps we are all susceptible too and the fact that investing is not easy, a good approach is to seek advice

Written by Shane Oliver of AMP Capital

What is it?

The Protecting Your Super Package which passed in February 2019 has seen a range of measures recently introduced which affect the way that small and inactive superannuation accounts are handled.  In the main, these measures are a positive.  The key objective of the legislation is to limit the erosion of low balance super accounts by fees and unwanted insurance premiums.

For most of you, APC will have worked together with you to ensure your superannuation accounts are consolidated or in good working order.  But for various reasons, individuals might have a number of superannuation accounts at any given point in time – so sometimes it can be hard for you to keep track.   Given the pace of implementation of some of these changes, we have provided an overview of the key measures below – and always, APC is here to help.

Insurance Opt-In

The first stage of these measures has begun to take place. Certain people will have been asked to ‘opt-in’ for their insurance before 1 July 2019 – that is, an election made to keep your insurance despite having an inactive account.  Opting-in notifies your super fund that you are aware of the insurance and that you do want to continue paying the premium.  If you have done this, you won’t need to do it again.  It only becomes a question once an account becomes inactive and this generally means 16 months without activity, like any contributions received.

Inactive Low Balance Accounts

Super funds will be required to transfer ‘inactive low balance’ accounts to the Australian Tax Office if certain criteria is met, commencing in the coming months and then ongoing.  Low balance means less than $6,000.  The account must also be deemed inactive for the preceding 16 months.  If you have insurance that you ‘opted-in’ for attached to the account, you won’t be affected.

Once transferred, the ATO will aim to locate your ‘active’ account, ultimately consolidating your superannuation monies there.

What should you do?

Consolidation of your inactive accounts is likely to be a good thing for most, particularly if you might have accounts from previous employment that you have had trouble keeping track of.

If you think an unwanted change has been made to your accounts, please feel free to contact us or raise it at your next planning meeting.  This includes any cancellation of insurance cover that might have formed part of your wealth protection strategy.

Using MyGov to keep Track

A great place to start will be through your myGov account.  Specifically, ‘linking’ the ATO will allow you to see the information they have about your superannuation balances and accounts.

In fact, APC might ask you for information from time to time which can be found here and that will allow us to better advise you when it comes to your superannuation strategies.  This will be an important tool and ‘source of truth’ for most going forward.

As always, if you have any questions please don’t hesitate to ask.

Investing in Australian residential property is an aspiration for many.  APC recognises the diversification benefit of owning an investment property in your financial asset portfolio. As it is unlisted, this asset class behaves differently to listed assets such as shares.  This is what is called ‘correlation benefit’ meaning that as assets move in value (up or down) they do so at different times resulting in a smoother rate of return over time.

However it is our experience that investors do not always take into account the risks associated with owning residential investment property.  Some of these include;

• Illiquidity risk
• Single asset risk
• High transaction costs to both purchase and sell
• High carrying costs

Over many years of assessing the rate of return of investment property, it is our experience that the actual return on investment (ROI) is often far lower than many owners actually believe it to be.

This article deals with understanding what the actual expenses are in owning an investment property so that you can accurately assess (hopefully before purchasing an investment property) what the likely ROI – return on investment – will be.  By doing so, you can compare that ROI with other potential investment assets to ultimately determine the best investment decisions for you.

Quoted Income ROI Figures – Gross or Net?
Generally speaking, an investor in Australian residential property has – or should have – a long term investment time horizon.   

We often see rental income ROI figures quoted by agents that on the face of it look quite attractive. However when you scratch beneath the surface all is not as it seems.  The following example illustrates some of the costs you should be well aware of;

Melbourne apartment – $600,000 with an income yield of 3.75%

 

 

However, the quoted purchase price does not include costs associated with the purchase itself such as stamp duty, agent and conveyancing costs.

 

 

 

So the actual purchase price is $634,070 and therefore the rental yield is 3.55%.

 

 

However, this also is not the full story as to produce the ongoing rental income, there are likely other expenses that are incurred.  These include agency fees, rates, body corporate fees, insurance and a provision for maintenance or a sinking fund.  The sinking fund is to cover the costs of ‘plant & equipment’ that over time will fail and need to be replaced.  This does not include the sinking fund for ‘Capital Works’ that a body corporate may also have if the investment property is an apartment.

 

 

 

 

 

 

 

 

So, what started as an income ROI of 3.75% has now become 1.53%!

For some investors, another cost which is not included in this example is land tax. In Victoria, land tax is payable on taxable land you own over the value of $250,000. The rate of tax increases as the value of taxable land you own increases. Your home is not included as a taxable land value.

If you owe land tax then this cost also should be included in the ongoing costs of owning a residential investment property.

Depreciation
An important tax deduction available for residential property investors is depreciation.  This deduction improves the after tax return of a property asset. From July 1^st, 2017 there were important changes to what depreciation on ‘plant & equipment’ such as dishwashers, carpets, hot water systems etc can be claimed. 

Essentially, if you purchased an investment property after May 20^th, 2017 and the ‘plant & equipment’ in that property had already been ‘used’ at that date, you cannot claim any depreciation deduction on that asset. If however you then purchase a new asset (say a dishwasher) then a depreciation expense can be claimed.

So, if you are considering purchasing a residential investment property only ‘new’ plant & equipment may be depreciated and that value used as a tax deduction.

Travel Expenses
Also May 20^th, 2017, you cannot claim any travel expenses related to that residential investment property.

Conclusion
Ultimately, the ‘after tax’ income ROI on an investment property will include other factors such as;

• The owner’s marginal rate of income tax
• The amount borrowed to purchase the asset
• The interest rate on the loan
• The legitimate depreciation claimed
• Prevailing rate of inflation over the measure time period

Just ensure that you are incorporating all the associated costs of the property to ensure that you understand what the accurate income ROI actually is. Once you know this you can then more easily understand what the ‘break even’ rate of capital return needs to be.

With these two important pieces of analysis you are in a position to know if you should (a) hold an existing property asset or (b) purchase one.

As always, if you wish discuss this article with APC please contact any member of our advice team.

In reviewing the performance figures for the APC Classic Portfolios (click here) you will notice that for the first time in quite some time, some portfolios have underperformed their benchmark over the 1 Year time frame though they all outperform over longer timeframes.

One year returns can vary significantly due to short term factors, so this timeframe is really just ‘noise’ when it comes to understanding an investment portfolio’s long term capacity.  However it is important to understand why this has occurred. We explore this below and the reasons behind the variance from the ‘benchmark’.

A Quick Review: ‘Our Investment Philosophy’
As you may recall, Australian Private Capital (APC) has an Investment Philosophy that is evidenced based on many years of academic research with the following as keystone principles, when it comes to the equity component:

• Risk and Return are related – the greater the Risk, the greater the expected Return
• Small Cap stocks have a greater expected Return than Large Cap stocks given they have inherently greater associated Risk – (Size Premium)
• Value (or cheap) stocks have a greater expected Return than Growth stocks- (Value Premium)

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The ‘Size Premium’ is reasonably easy to understand.  All large companies were once small companies.  As an investor, if you buy a stock in a small company and due to it’s success it becomes a large company, you will do very well.  The risk of course is that not all small companies become large and some will fail.  This is the associated risk of investing in small cap stocks.  APC diversifies this risk by buying many ‘small cap’ stocks in our portfolios.   

The ‘Value Premium’ is also reasonably easy to understand.  An accountant values a company which is known as the ‘Book Value’.  The sharemarket will value the same company (it’s share price) and by multiplying the number of shares on issue by the share price this generates a ‘Market Value’.  Those companies that have a ‘Market Value’ less than the ‘Book Value’ are considered undervalued or ‘cheap’ and this is known as the ‘Value Premium’.  The reasons for this undervaluation can be varied however over time many of these of companies generate a greater return for investors given the greater associated risk of investing in ‘under-valued’ companies.  APC diversifies this risk by buying many ‘value’ stocks in our portfolios.

What is the Evidence?
As APC’s Investment Principles are based on a ‘rules based’ approach, it is possible to track how often the ‘Size Premium’ and the ‘Value Premium’ are evident over various time periods historically:

 

 

 

Based on this research APC’s portfolio ‘tilts’ towards ‘Small Cap’ stocks and ‘Value’ stocks will likely generate a greater Return than the broader market for the majority of the time, which historically has been the case.

So What Happened During the Last 12 Months?
However sometimes this is not the case and over the past 12 months both ‘Small Cap’ stocks and ‘Value’ stocks have underperformed ‘Large Cap’ and ‘Growth’ stocks both here in Australia and  overseas:

 

 

 

As illustrated above, both of the ‘tilts’ that APC adopt in the Australian and international shares sectors underperformed the broader market over the past year leading to the growth oriented APC Classic Portfolios underperforming their benchmarks for the first time in many years.

In Summary
Whilst these specific ‘tilts’ in APC’s Investment Philosophy are likely to generate greater portfolio returns over medium to longer timeframes, it is not always the case over shorter timeframes and in the 12 months to June this year we have experienced an absence of both the premiums we expect to observe. 

We understand this happens from time to time and have observed it before.

Past investment behaviour informs us that ‘Small cap’ and ‘Value’ stocks will likely return to generating an investment return premium but we just don’t know when. However when they do history illustrates their outperformance is likely to be significant and reward the patient investor.

As always, if you would like to discuss your portfolio with APC we would encourage you to contact any member of the advice team who will be happy to assist.