Investments to meet different needs
Strategic has access to and uses a wide range of investment vehicles when building your portfolio. Each investment has its own strengths and weaknesses. Strategic takes into account these factors when building a portfolio.
Strategic’s independent operation means that a very wide range of options are available for portfolio construction and asset allocation in line with your profile.
Your exposure to investments will be determined by the investment quantum, goals and objectives and investor profile. At each Portfolio Review you have an opportunity to confirm that you are comfortable with the types of investments that make up your portfolio. As always, our objective is to minimise risk and maximise returns. This is both an art and a science!
Listed Fixed Interest Securities (Bank Bonds & Corporate Bonds)
Fixed interest securities are initially offered to the public through a broker and then traded on the secondary market. They can be bought and sold in the same way as a share. Their price will depend on the prevailing interest rate. They are also known as Tradable Bonds.
There are Bank Bonds and Corporate Bonds and their underlying security will be aligned with the issuer (the Bank or the Corporation). Bank Bonds could be described as wholesale term deposits. The advantage of Tradable Bonds is that they provide a wider range of options compared with Term Deposits. Often the yield will be higher and if funds are required before the maturity date they can be sold providing a high level of liquidity/flexibility. On the opposite side of the equation it is important to note that if interest rates increase an existing Bond will decrease in value. Strategic buys Bonds for clients on the assumption that they will be held to maturity but has the option to sell them if the market conditions are right. Clients need to be prepared to forgo liquidity to secure capital value if the market moves against them. In larger portfolios a range of bonds can be held with a range of maturity dates which assists with liquidity needs. Bank Bonds usually provide the best return for the level of security. Government Bonds are also available on the same basis but with a lower yield. Strategic will take a view on the trend in interest rates to optimise returns for clients. Bonds are subject to withholding tax at the investor’s tax rate.
Through its two brokers Strategic has access to global stock /share markets. A share in a specific trading company has the potential of obtaining a return directly from the increase of the share price and any dividends paid from the success of the company. The share will be exposed to the fortunes of the market sector in which the company operates in. e.g. tourism is impacted by currency, pandemics, economic confidence etc. In addition the performance of the shares will be significantly influenced by the quality of the management team.
Investing in a direct share brings with it specific risk, in other words, you are relying on one company in its field of operations to do well. The risk is not diversified. To diversify risk a number of shares would need to he held which were purchased on a range of different assumptions or markets. This would still leave you with “market risk”. If the share market falls because of a loss of confidence in the economic climate either locally or globally your holdings’ share prices may fall just because of the negative sentiment in the “market place”. This can often create a good buying opportunity! If a wide selection of shares is held this also brings with it a fairly high level of administration and taxation reporting requirement. Some direct shares will fall within the Foreign Investment Funds regime. Whilst there are no external management costs there is brokerage to be paid for purchasing and selling the shares. Strategic selects a small number of company shares with a compelling story like Ryman Healthcare.
This class of investment seeks to use a manager who will apply analytical skills to select and manage investments which, at very least, will provide diversification and, at best, enhance returns. There are a variety of structures for “grouping” investments. All reduce the administration that would be incurred in holding the underlying assets directly in addition to the fund selection. It is important to understand the differing features of each of the types.
Unit Trusts are also know as Mutual Funds. Investments in these should be held for at least 1o years. to optmise returns. They will often cover a particular sector of the investment markets e.g. International Shares and each manager will have their own mandate (based on the Trust Deed) on what criteria will be used to select the underlying investments. They provide an excellent way of diversifying away specific risk but they will still be subject to market risk. Units within the fund are held by the Trustee or Responsible Entity on behalf of the investor. A fund manager could go bankrupt and the assets would remain intact. Investors must apply for units using an Investment Statement and can request a Prospectus.
It is the task of the Trustee to make sure that the criteria for managing the funds is fulfilled by the manager. The manager deducts expenses and a management fee from the funds as detailed in the Investment Statement. Unit Trusts are “open ended” which means they are open for new funds to be added or taken out. Not all fund managers are created equal and not all will add sufficient value to justify their fees. Most will have an entry fee, generally to cover sellers commission. It is Strategic’s practice to rebate the any entry fee that we receive and apply a flat placement fee which enables a “hire and fire” strategy if the funds do not perform. Strategic’s clients switching from one Unit Trust to another, under the Portfolio Management Contract, there is no fee.
If there is a run on the fund the manager has to sell assets to meet redemptions. In difficult market conditions this could be a “fire sale”. To avoid this these popular funds have to retain a degree of cash to cover normal redemption requests so the entire fund is not invested in the main asset class.
Mutual Funds can either be taxed as a company at 33% or more commonly as Portfolio Investment Entities (PIE’s) which reflect the investor’s personal tax rate up to a maximum of 30%.
An Exchange-Traded Fund (ETF)
This type of Fund is relatively new to the New Zealand investor but is likely to grow in acceptance. Strategic currently uses the Gold Fund in this sector. Again it is essential to have a 10 year time frame.
An exchange-traded fund is an investment entity that tracks an index, a basket of assets, or commodities. Since it is traded like shares, its price changes throughout the day. Its net asset value is not calculated daily but price tends to be close to its underlying assets. If ETF prices deviate from the underlying net asset value then arbitrage is possible. These are an attractive investment because ETF expense ratios are lower than most unit trusts (mutual funds), tax efficient, and great way to diversify like Unit Trusts.
Unlike a Unit Trust an ETF can be bought or sold throughout each trading day.
Unlike unit trusts, the fund does not sell or redeem their individual shares at net asset value. Instead, financial institutions purchase and redeem these shares from the ETF in large blocks, called creation units. The purchase and redemption of these creation units are with the institutions contributing or receiving a basket of securities in the proportion held by the ETF.
An ETF fund is an efficient way to diversify into the stock market, having similar features to shares. The ETF shares can be kept for the long-term or actively traded, with the following advantages:
Lower costs than other investment products because most are not actively managed and are insulated from buying and selling shares to accommodate purchases and redemptions. They also have lower marketing, distribution and accounting expenses. Buying and selling flexibility at market prices can be done at any time, unlike mutual funds that can only be traded at the end of the day. They can be bought on margin, shorted, hedged, and stop and limit orders placed. Tax efficient because securities need not be sold to meet redemptions with relatively low turnover and capital gains.
Market exposure and diversification provide an economical way to rebalance portfolio allocations, especially an index ETF that has exposure to a diverse variety of markets that includes international, country, industry, bond, and commodities indices. Transparency, as portfolios are priced frequently throughout the day.
Investment Trusts are companies that invest in the shares of other companies. They are a popular way of investing for income, growth or both. Again it is essential to have a 10 year time frame. Investment Trusts mainly feature on the London Stock Exchange. Although several are listed on the NZX, liquidity can be an issue with these less traded trusts.
The money you invest is pooled with that of other investors and a professional fund manager then buys shares in a wider range of companies than most individual shareholders would have access to. By pooling money and investing this way even people with small amounts of money can gain exposure to a diverse and professionally run portfolio of shares, spreading the risk of stock market investment.
Trusts often specialise in particular sectors and types of company such as communications or alternative energy producers. Others specialise in companies from different parts of the world. There are over 300 investment trusts responsible for the management of billions of pounds worth of assets on behalf of investors. Your money is pooled with other investor’s money, reducing costs and increasing investment opportunities.
The risk is spread because you are investing in a wide range of shares. Manager’s expertise means your money is invested effectively. The charges are low compared with Unit Trusts so more of your money starts working from the moment you invest.
Investment Trusts are different from other forms of collective investment as they have Independent boards of directors whose duty it is to look after your interests as a shareholder.
Shares in an investment trust are issued only once, when the Trust is created. This makes Investment Trusts closed-ended: the number of shares the trust issues, and therefore the amount of money it raises to invest, is fixed at the start. This enables fund managers to plan ahead. Unit trusts, on the other hand, are open-ended. They expand and contract all the time as people invest in or leave the fund.
As companies, investment trusts can borrow to purchase additional investments. Not all do so. This is called ‘financial gearing’ and allows investment trusts to take advantage of a favourable situation or a particularly attractive stock without having to sell existing investments. The idea is to make enough of a return on the investment to be able to repay the loan and make a profit. Obviously, the more a trust borrows, the higher risk it’s taking but the greater the potential returns if markets rise. If the market drops then the investor must bear the losses in addition to the cost of the initial loan. Not all investment trusts use financial gearing and many of those that do, use it to very modest levels. Whether or not to use gearing is a decision taken by the fund manager and the board of directors. Other investment vehicles are unable to borrow to the same extent or as cheaply as investment trusts. Strategic keeps track of this as part of managing your portfolio.
Buying at a discount
If demand for a trust’s shares is low, the price can fall. When the price of the shares falls below its net asset value (NAV) this is called ‘trading at a discount’. This may represent a good buying opportunity. If the discount narrows, there is the potential for enhanced returns. The prices of unit trusts are calculated depending on the value of their assets, so you can never buy them at a discount. If the share price rises above the NAV, the investment trust is trading at a ‘premium’. This is rare but occurs where there is particularly high demand for an investment trust. The discount/premium is just one factor amongst many and should never be the sole reason for a purchase or sale but Strategic haves used this to enhance returns.
The majority of Investment Trusts used in Strategic’s Portfolios are listed on either the NZX (trading volume can be thin and liquidity sometimes difficult but have less brokerage / stamp duty than in UK) or on the LSE (London Stock Exchange). For liquidity reasons Strategic mostly uses the LSE. They are mostly managed from a UK Pound perspective so changes in the value of the NZ$ and the UK Pound will impact. Most Investment Trusts will come under the FIF Tax regime.
Grouped Investments but not Investment Trusts
There are a range of investments which are similar to Investments Trusts but are not regulated as such. They are traded as shares and in other respects are similar to Investment Trusts. 10 Year time frames are essential and risk are similar.
Non Listed Closed end Funds
Funds are raised and then invested in the mandate of the fund. Often the Fund manager will provide a liquidity option by buying back units from the client. This often has terms attached. The Man OM-IP Series is this type of Fund. The Capital Guarantee that the Fund manager arranges depends on the funds being committed for a set period of time 6-10 years. Access to funds in this example are available after two years but the capital guarantee only applies if funds are held to maturity. This type of structure is also used with non liquid assets which are directly held like Property e.g.Multiplex Property Fund.
Strategic will mix and match the investments to reflect your needs. Each of the Five Asset Allocation Sectors will be populated with investments and, where possible, exposure to any one investment will be limited to 10% of your portfolio. This “lifeboat approach” has served our clients well during challenging times. It is the impact of the overall mix of investments that is ultimately important.
Not all clients will have every type of investment.