What do Napoleon, strip clubs and the sharemarket have in common? Over promising and under delivering / by Adam Howard

Last week I took a pot shot at Australian investors.  Now, I have to be clear here; I am also taking a shot at myself here, as I am an Australian, and an investor.  A really bad investor, but an investor nonetheless.

I am no different.  The equities I have owned are almost exclusively financials or resources.  I’ll provide two examples, but will not name names.

Example 1

Financial services (insurance) company.  Large cap at market value of approximately $16 Billion as at 15/2/15.  I bought it as a growth share so this would place it as a large cap growth share on the attached table.  But, in revealing the depths of my ignorance, it was really a yield share.

Medium risk/return mix.

Purchased on the basis the stock appeared undervalued.  I have no idea what I based that opinion on.  Sold the shares for roughly what I paid about 6 months later.

I declare this a win as, given my ignorance loss appeared as almost a given.  Despite this, no money was lost.

Example 2

Oil and Gas Explorer.  Small/mid cap with market value of about $100m at time of purchase, but that size hid very speculative nature of stock.  Company had recently announced good results of drilling program and I bought at the top of the curve.

Oil fields were subsea in Southeast Asia.  This purchase sat at the absolute top end of the curve, just before PE and VC.

High risk/high potential return.

Bought at 17c and still hold my shares which are now at 0.5c a share.

I declare this a loss, but not an altogether unpredictable one.

The issue with the share market is that its tempting…so tempting.  It could be the path to wealth, or it could lead to ruin.

It’s like a strip club to a drunk bloke…

Or Moscow to Napoleon.

The world of yesterday

The world of yesterday

So, the real return shown above is the point at which the value of your money or whatever you hold doesn’t lose or gain any value.

There is another point on the curve which is called the risk free rate of return, and it’s the point on the curve named “Short Term Treasuries”, or in our case Australian Government Bonds (AGBs), and the term in “short term” is 90 days.

This return is regarded as, as close to risk free as you can get due to the very low likelihood of default.  But the fact they pay interest at all means there is some risk.  I mean, why else would you get paid interest?

Australia doesn’t really have a “short term treasury” so I am using the 10 year Australian Government Bond yield.

I thought what might be interesting is provide a table of rates of return for investments that fall in or around these categories.    Then it might be clearer why lower interest rates are leading to people investing, and also the massive increase in potential return as things get riskier.

Obviously these rates of return will change depending on the state of a nation’s economy and what has been happening recently.  Remember, the cash rate is currently 2.25%, GDP Growth is 3.2% and CPI growth or inflation is 2.1%.

The reason for including the small cap fund managers’ result (as indicated in the S&P ASX SPIVA Australia scorecard) was to show the potential returns, because the Small Ords Index results are bad for 12 months, 3 years, 5 years and 10 years.

It’s actually quite strange, that according to industry data, fund managers regularly failed to beat the ASX 200 and All Ords indices, which included the larger listed companies.

But small cap fund managers almost always beat the ASX Small Cap Index, as shown by the above results.

Curious….

Anyway, a good way of looking at the risk associated with equity (shares) is to see the range of performances in that market in Australia over the 12 months to Feb 2015.

I could be wrong, but that seems to be a big variance, in both markets.

Based on the above two tables you can see the risk/return curve is by no means definitive.  Residential property in Perth yielded a worse result than corporate bonds, while the large cap market had greater extremes than the small cap sector.

I guess I would treat the curve as indicative only….

On the topic of Australian investors I was given some other interesting data by another friend we will call The Brother.  The Brother is a large man, in most departments.  Large head, large snout, large appetite and large intellect.

The Brother has been working in the shadowy world of hedge funds in the UK for over a decade and has done quite nicely, thank you very much…and he felt gracious enough to provide me with some information about that rare bird…the Australian investor.

Who are they?  Who makes the decisions to buy and sell? 

Well:

  • 38% of Australians own shares (shareholders);
  • 96% of shareholders only own shares, and no other investment instruments; and
  • share ownership is more common amongst those with higher household incomes, higher levels of education and older Australians.

The peaks are:

  • 58% of households with income over $200k pa own share;
  • 51% of those with post graduate qualifications own shares;
  • 49% of 65 – 74 year olds own shares; and
  • superannuation funds own about 30% of all Australian equities.

I have attached a link to the source data for some of these points below.  The rest are courtesy of The Brother.

Australian Share Ownership Study

The cool part of the report is where shareholders are divided into four different groups, with some interesting names;

  1. Unsure Delegators – 31% of all shareholders who regard the share market as a frightening place and need assistance.
  2. Confident Traders – 25% of all shareholders who find trading fun and exciting and have a relatively good knowledge of the share market.
  3. Self-Reliant Dabblers – 22% of all shareholders who have some knowledge and manage their own investments, but still regard the share market as a dangerous place.
  4. Informed Diligents – 22% of all shareholders who do their own research and ensure they are aware of the mechanisms of the market.

So, a third of all shareholders have little or no knowledge of how the market works; find it frightening and delegate the task of managing their money to others.  That seems risky, considering the variance shown above.

And here are some other little titbits about investment funds:

  • Australia’s Investment Funds Asset pool holds $1.7 Trillion AUD, or more than 100% of Aussie GDP;
  • our Superannuation Investment Funds total $1.8 Trillion AUD, larger again;
  • we are incredibly inward looking as only 17% of all investment funds are invested in international stocks; and
  • to give you an idea of the opportunity investors are missing, the market capitalisation of the four biggest companies in the world, Apple, Exxon Mobil, Microsoft and Google at November 2014 was $1.56 trillion USD, or about $2.08 trillion AUD.

I guess the summary of last week’s Update, and this week's, is that as investors Australians seem to only be at the start of the journey.  Our market needs to mature and become more balanced, as does our economy.  Sometimes our hubris at being a small country asked to play with the big dogs gets the better of us.

Our investors need to work harder at being informed and find experts they trust who have a track record of success.

And we need to get better at identifying that success.

Last week I mentioned HLB Mann Judd, which might be a good place to start.

The Brother is returning to our sunny shores and is a wealth of knowledge.

Better get looking.

Food for thought….