Is your super fund using performance-enhancing drugs?

These days whenever I watch sport, I can’t help wondering whether the competitors that win are using performance-enhancing drugs. I think ever since the Lance Armstrong saga a number of years ago, many people are now sceptical of sport, particularly when there are large amounts of money on the table.

My suspicions were again aroused recently when I read an article in The Wall Street Journal. The journalists reported that Nike may have been directly involved in performance-enhancing programs or doping of their track and field athletes (see article).

There’s no doubt that drugs in sport gives players an unfair advantage over their competition. It’s certainly not a level playing field when the majority are not taking drugs and then somebody comes along and cleans up the trophies and the money because of artificial enhancement of their performance.

The problem can then progress over time to a situation where such a large proportion of the field is taking performance-enhancing drugs, anybody who is clean does not stand a chance of getting on the podium. The Lance Armstrong scenario is a case in point.

But what does all this have to do with superannuation? Well, recently APRA finally commenced its enquiry into the classification of superannuation investment options, such as which assets should be classified as defensive and which should be classified as growth.

So why is this such an issue?

Well, think of it like the performance-enhancing drug situation. You have a group of competitors (super fund asset managers) that are all abiding by the rules with 50% growth-based exposure and 50% defensive-based exposure portfolios. They all refer to them as ‘balanced’ and are competing on equal terms.

Whichever fund ‘wins’ the title of top-earning super fund receives the fame, the glory, and more importantly the cash influx of new investors joining the fund.

Then a new super fund asset manager comes on the scene that might say something like this: ‘Definition of growth exposure and defensive exposure is nonsense …” As a result, this fund manager believes it can break the rules and use what I will term ‘performance enhancing stimulants’ to boost its fund’s returns.

So while on the surface the fund manager might be calling the fund ‘balanced’, in reality, it puts very little exposure into defensive assets; in fact it reduces it down to, say, 10 or even 0%.

As you can imagine, the returns are higher, the fame and glory follows, and around $2 billion or so of new investor money rolls in the door. All these new investors think this is great; they are in a balanced fund and look how great the returns are. Yet these investors are unaware of what the fund might be doing with their lifetime savings and all the extra risk that comes with this investment option.

Now other fund managers might think this is unfair, and with the stakes so high, they also look to inject performance-enhancing stimulants into their portfolios too. Before long, we have moved onto phase two as I outlined above in the example of Lance Armstrong: whereas before just one fund tried it; it becomes prevalent to the detriment of investors.

In fact, this issue is happening right now, with a large number of industry superannuation funds having exposure to growth-based assets.

Will this end in tears? When it comes to investing, if it sounds too good to be true, then usually it is – but only time will tell.

I believe when a person chooses an investment option, it should be reflective of what they are expecting and should also be protected by regulator guidelines around what mix of assets can provide long-term conservative, balanced growth.

Unfortunately, it might be some time before this becomes a reality, so until then we are left to navigate this maze of performance-enhanced fund managers, and try to figure out which investment to choose that best matches your goals.

If you are trying to decide what investment options you need for your superannuation, I recommend you seek professional guidance from a suitably qualified and practising financial planner and of course, I recommend AJ Financial Planning.

Will QE tear apart Australian society?

These days formulating monetary policy, which is set by the Reserve Bank of Australia (RBA) and other central reserve banks such as the US Federal Reserve, may give the impression that it is a sophisticated process and an exact science. It’s reasonable to think that these micro-adjustments of interest rates are to ensure that our economy will stay healthy and that the changes are set to perfection.

If we were to put together a list of criteria that we thought could be the objectives of the RBA and other similar operations around the world, it would be fair to consider the following four factors to be important to decision makers:

  1. A stable and positive economic environment.
  2. A stable and positive employment and wage situation.
  3. A stable and fair cost of capital, for borrowers not paying too much, and investors or lenders being fairly rewarded for the risks they take on.
  4. A stable housing market where ownership is available to the average Australian in key capital cities.

If we take a scientific approach to this broad range of criteria over the past 100 years, the question arises as to whether they are being met over the long term. Or are we just see-sawing through the boom–bust–recovery–repeat cycle?

It is fairly early days, but questions are starting to be asked about monetary policy:

  1. Are the interest rate changes by the RBA (and others) a blunt instrument or a precision tool?
  2. Does the changing of interest rates discriminate between segments of the population?
  3. Are there more effective methods to regulate the economic health of our nation that should be applied first?

Let’s take a simple and recent example. Typically, when a housing market or economy got too heated, in the past the RBA would step in and gradually increase the cost of capital on borrowers by raising interest rates.

Now, the trade-off with this is that households are affected – and some might say hurt – financially. People on very tight budgets find they struggle to make ends meet, whereas people on high incomes who have surplus income are possibly less affected. The flip side of this is that lenders and investors make an instant higher rate of return on capital, either through loans, a term deposit or other fixed-interest investment.

The question is, has monetary policy targeted or discriminated against a specific group of the population, or was the pain felt equally across society for the greater good?

In more recent times we saw a change of approach, which I am not sure was deliberate but it highlights why I believe we should be thinking about this problem a different way.

Recently we saw APRA step in and raise the service rates that banks apply to evaluate a loan. The interest rates for existing borrowers did not change, yet any new borrowers, who were likely to be buyers of property, are now subject to a tougher lending regime. These new borrowers do not pay a higher interest rate, but are subjected to much tougher lending criteria.

This subtle change might have been one of the key reasons for the cooling and then stabilising of the housing market, which had started to overheat. If borrowers collectively can’t pay more for property, then prices will naturally adjust to meet this new status quo.

So was this approach more equitable for the citizens of Australia than the change in interest rates as in the earlier example?

At the time of writing this article, the market is forecasting further interest rates cut by the RBA, which will drop rates to ultra-low levels.

If this strategy plays out, it will likely favour anybody who has a home loan, but disadvantage anybody who wants to get a return on their retirement funds. It will certainly place tremendous pressure on retirees who invest capital into the markets to obtain a reasonable rate of return on the fixed-interest part of their portfolio.

My issue with this kind of monetary policy is that it directly and unfairly targets segments of the population.

The reality with monetary policy is that in most cases it is not black and white. Each change has a widespread knock-on effect on the economy and on citizens. Not enough work has been done in this area to properly consider these effects and ensure a socially equitable outcome.

Today the RBA cash rate sits at 1%. If the status quo of the boom–bust–recover–repeat cycle continues, we have historically used around 3% in cuts to interest rates when a meltdown occurs. So we don’t have much to play with, as a 3% cut would take our RBA cash rate into negative. You only have to look at Germany and Switzerland to see the reality of negative interest rates – so it’s not as crazy as it sounds.

Right now, Australian and New Zealand are apparently considering the option of using Quantitative Easing – otherwise known as QE – as another tool.

In our view this would be the equivalent of a nuclear bomb monetarily and societally. The main reason I say this is that it is effectively ‘printing money’. The ‘treatment’ is to try to stimulate the economy by injecting massive amounts of liquidity into the financial system: rather like gulping down a Red Bull.

Like any ‘quick-fix’ medicine, there are always side-effects. With QE, one side-effect is that it can inflate asset prices both of property and shares.

In my view this is troubling as it can widen the wealth gap. People who have assets can benefit significantly, whereas people who have little find attaining assets becomes further from their reach.

Populations that have very wide gaps in social structure often results in unstable political environments and general societal unrest. One might refer to this as the ‘populism cycle’. Social unrest has a history of reoccurrence. We have already seen the effects of this around the world, where housing becomes unaffordable and making ends meets becomes an insurmountable challenge.

Hopefully, before the RBA pushes the red button, there will be some widespread, open and frank discussion with decision makers and the Australian people about QE.

I would be bold enough to say, in fact, that a referendum on QE should be held, so that society is informed before this tool of mass destruction is unleashed.

Getting a return on fixed interest these days is fairly challenging for the average investor. If you are worried about where to get a decent fixed-interest return and what options might be available, I recommend you speak to a suitably qualified, practising financial planner and of course I recommend you contact AJ Financial Planning.

Australian Super’s Elephant Gun Problem

Back in 1987, Warren Buffet made the following statement in a letter to Berkshire Hathaway shareholders: ‘Our basic principle is that if you want to shoot rare, fast-moving elephants, you should always carry a loaded gun …’

Before you gasp in horror, the elephant he was referring to was a metaphor for the purchase of a large business, and the gun meant having the available cash to transact quickly when others cannot, or if there are concerns about the future due to economic uncertainty (such as a share market crash). Historically, Warren has been able to secure such purchases on very favourable terms and a large number of them have proven to be very profitable.

In his letter he went onto say: “If we find the right sort of business elephant within the next five years or so, the wait will have been worthwhile.”

More recently Warren has routinely explained to shareholders at Berkshire Hathaway’s annual general meetings and at media interviews that as a company gets larger, it becomes harder to outperform the market. The company’s 2018 annual report valued its portfolio at around US$172 billion. Yet one only has to look at Berkshire Hathaway’s share price to see it has underperformed on the S&P index by around 15.28% over the past five years. So it would be fair to wonder whether the company is starting to come under some pressure for its performance. It is unclear if this is a long-term trend, or simply that the market has not had a crash for a long time, to allow Warren to deploy his elephant gun.

In portfolio theory we talk about the law of large numbers, and the main reason fund managers that are providing “active management” understand their limitations with the size of assets they actively manage. In a lot of cases, the good ones simply close the fund to new investors at some point as the fund cannot handle unlimited amounts of capital.

There are a few reasons why this law persists in our industry. The first has to do with position size. Let’s take a portfolio worth around $1 million. If you purchase an investment option worth around $10,000 and it goes up by 30%, you might say ‘Hey, what a great return!’ Well, not really. You just gave yourself an administrative stomach-ache. The return, although good, only moved up the value of your fund by 0.3%. As the size of the portfolio gets larger – say $150 billion plus – your ability to buy a large enough stake to make a worthwhile return gets harder and harder.

Another aspect of this law has to do with being able to move capital around in the portfolio. With such massive position sizes it can sometimes take six to twelve months just to sell out, which creates some questions about being nimble in a quickly changing market.

The third reason has to do with inflows. Each year a huge amount flows into Berkshire Hathaway from dividends of listed companies that Berkshire Hathaway owns and all the profits from the private companies they own too. Warren’s company needs to allocate this into existing or new investment options. This growing cash pile can make the situation worse: when there is too much cash not being deployed effectively we call this ‘cash drag’ because it can create a drag on performance returns.

So, what does all this have to do with Australian Super? Well, as at 30 June 2018 this super fund provider reported that they had about A$140 billion or so in funds, which they manage on behalf of members. They also have a huge amount in super contributions coming in, which they need to allocate each year to investment options.

The larger the super funds become should mean some increase in economics with hopefully cheaper fees in the long term based on economics of scale. This would normally be one of the selling points of increasing its size. However, it appears Australia Super did not get this memo, as they had close to doubled their administration fees by 30 June 2019.

The reality is that as these super funds get larger, they start to push the limits of what they can do as an outperformance fund and may simply just track or underperform the respective indexes. It will be just a case of time to see if this plays out.

As you can see, if your money is being lumped into a large pool and yet you are looking for an active management approach, you start to see a clash with these two strategies in the longer term.

So the next time you are thinking about selecting your investment options or a superannuation fund, it is important that you seek quality advice from a practising financial planner and of course, I recommend AJ Financial Planning.

When does a brand lose authenticity?

For some time I have been thinking about the following equation and asking myself, does it hold true?

increase business size = lost authenticity

Recently Suzy attended the VidCon industry event, which is held in LA each year. Around 30,000 people attend and this is pretty much the largest industry YouTube event in the world. As a point of interest, YouTube is owned by Google, and the reasons Suzy was there on AJ Financial Planning’s behalf was to get some insights on the latest trends in media and marketing, market insights, and new investment ideas in areas of growth.

With YouTube attracting around two billion views per day, there are a lot of eyeballs interested in this streaming platform.

Whenever we get boots on the ground to track down new ideas and insights from time to time, I particularly like to look at side issues or missions that relate more to business, and where things are at and where they are headed in specific areas. In the past we haven’t reported on the information gathered, but this time I want to share some of the interesting aspects of our findings as something a little bit different from our normal market and finance information.

I told Suzy that my particular interest was in a business located in sunny LA in the coastal town of Costa Mesa, which is close to Huntington Beach. It’s a small jiujitsu academy called Art of Jui jitsu (AOJ). You might ask what does jiujitsu have to do with financial planning and taking care of my investments? Fair question. Well, for me it was more how AOJ is being run. The building where it’s located is classic 1950s architecture, which I have a soft spot for, and a unique selection for a business premises. The business’s branding is refreshing and clean, the studio fitout unique and simple, with wellselected artwork. In reality, this was no ordinary dojo. We were interested to see if these themes could be extended to other businesses, and how the elements had come together.

Now Suzy just made a simple call to the AOJ operation and indicated that she wanted to drop by just to see the place from an architectural and design perspective. She mentioned that she had come all the way from Australia and the person she spoke to sounded happy and surprised. They were also very welcoming. I refer to this as a test of the Aloha spirit of a business, a term from Hawaiian culture.

Upon Suzy’s arrival there was a small team of staff who warmly greeted her. Suzy noticed that the design of the dojo is influenced by feminine energy, with a white design that is unusual in what is generally a masculine environment. It was welcoming and had a unique twist, blending both feminine and masculine energy within the environment.

Now, a normal, oldschool type of entrepreneur would try to franchise this idea, or scale it up around the US and the rest of the world to make millions!

Thus comes the question: by doing so, would you lose the magic of this experience and would the authenticity be diluted with scale? Would this business’s Aloha spirit be lost each time it was duplicated?

We know that a copy of a copy is never as good as the original. If you have thousands of people running these facsimile businesses but with different agendas, at what point does it get too difficult to get everybody on the same page? After all, a great concept can only take you so far.

More importantly, though, is it okay for this business to just be as it is and not become a massive empire?

The authenticity of a company transcends not just the fluffy stuff people see in the media; it is the fabric of the company and at some point, I wonder if growth will cause cracks in its structure?

So for any budding entrepreneurs thinking about growing their business exponentially, I wonder at what point does the successful formula start to break down or does it ever break down?

As for Suzy and her experiences at VidCon, stay tuned! We will have more on her insights on this and possible investment opportunities too!