Hedge Clippings | 11 August 2023

CBA's results shows what's happening in the 'burbs.

Hedge Clippings wouldn't dream of suggesting we have any credentials as a bank analyst, but over the years (too many to count!) we have been a bank "watcher" or observer. As such, we retain a healthy dose of cynicism for the messages the various banks' boards and spin doctors churn out whilst trying to convince customers and the general population that they're there to help, and are thoroughly easy to get on with. At the same time, we do recognise that between them, banks have their fingers on the pulse of the economy given the data they have access to, even though they may have those same fingers in our pockets!

Things have improved over the years, but as we've also always noted, the only thing worse than a highly profitable bank is one that's losing money. We can still recall Westpac back in 1992, when it lost $2 billion, resulting in Kerry Packer coming to the "rescue" as he and Al "Chainsaw" Dunlap briefly joined the board. Or more recently during the GFC, when the entire banking system was under pressure, resulting in, among other things, then PM Kevin "07" Rudd establishing bank guarantees for depositors to prevent a wide scale run on the banking system. We suspect Ken Henry, who served as Treasury Secretary from 2001 to 2011, was the brains behind that, but full credit to Kevin for implementing it.

Of course, when it comes to self-serving spin, Kevin was an expert, as shown in this self congratulatory piece in the AFR he penned ten years after the event in 2018, carefully glossing over some of the less successful aspects of his term(s) as PM. To be fair, although not entirely as a result of Rudd's doing, Australia did dodge a GFC led recession, a feat no other developed economy managed.

We digress. Back to the CBA's result, and specifically the spending patterns of their customers, and any implications that can be found relating to a recession - or lack thereof - in the current environment. Page 11 of CBA's investor presentation indicates a sound lending picture supported by the strong labour market: Troublesome & Impaired Assets are up slightly YoY, but lower than they were in FY 2019. Home loan arrears are marginally down YoY, (0.47% vs 0.49%) but well down on 2019 (0.68%).

The CBA presentation confirmed what most anecdotal evidence has been indicating - there's a two speed economy running, or at least two different economies based on age demographics. The younger the customer, and therefore presumably those with lower savings, the tougher it is, so they're reining in spending, even compared to 3 months ago. Meanwhile, those over 35, and particularly those over 65, have increased savings YoY, and those over 55 and 65 have increased their card spending YoY (who uses cash anymore?) with the latter 2 groups spending more now than even 3 months ago.

Not everything in the garden is rosy however, with one third of rate increases still to be felt. Even so, 90+ day mortgage arrears are below June '20, '21, and '22, as are 30+ day arrears, albeit the latter has kicked up slightly (0.92% vs 0.82%) as one would expect over the past 12 months. Overall, the number of cases of hardship across all personal credit has dropped by 27% since the pre-COVID average.

On balance, given the RBA seems to have called a halt to further rate rises as inflation's taken a turn for the better, and employment remains strong, the outlook for the economy, while muted, is positive. The 2/3rds of home owners without a mortgage are happily spending, and don't seem overly stressed by inflation around the 5% mark, possibly remembering what real inflation was in the last century.

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The Australian Green Bond Program, with Ardea

Fidante Partners

July 2023

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Are You a Trader, an Investor, or a Hybrid of Both?

Marcus Today

July 2023

Ask the average investor how they invest and you will get one of two answers. 'Fundamental Analysis' or 'Technical Analysis', and never the two shall meet. It all goes back to Benjamin Graham, who wrote 'The Intelligent Investor' in 1949, the Bible of Fundamental Analysis. In there was the line: "We do not hesitate to declare that (Technical Analysis) is as fallacious as it is popular". In that one sentence he erected a wall between Fundamental and Technical Analysis, or to put it another way, between investors and traders, and it has stood for 62 years, with the proponents of both seemingly hell bent on putting each other down, and they both have their points.

The Bad Bits

• Are embarrassingly useless at 'timing the market'. They declare that it can't be done. How ridiculous. They are going to wear the next GFC right on the nose.
• Can't sell. They don't. They don't know how.
• Aren't disciplined. They don't have any discipline. They'll watch stocks get destroyed without doing anything about it, and the bigger the loss, the more likely they are to persist with it.
• Aren't vigilant. They 'set and forget'. Forget! About their money! What planet are they on?
• Don't have a Trading Plan. They don't have one. Incredible. Net result, they let their losses run and cut their profits. The complete opposite of what they should be doing.
• Are emotional. They believe the things that make them feel good, and disregard the things that make them feel bad. They listen to stock tips. They invest on the thinnest of evidence. It's not rational.
• Are 'lemmings'. They get in when it's obvious, and get out when it's obvious. Put another way, they buy at the top and sell at the bottom.
• Are often wrong. Do you know how many flawed assumptions go into Fundamental Analysis, into those highbrow calculations of intrinsic value? Rubbish in, rubbish out, no matter how smart the calculation.

• Rely on past prices as a predictor of future prices, which is ridiculous.
• Know nothing about a company. They might as well trade cabbages.
• Are short-term, which means they'll never see the magic of compounding returns.
• Don't care about dividends and miss out on franking.
• Will never get hold of a great stock and keep it forever because they fidget.
• Can't actually time the market anyway, despite professing to do so.
• Are 'lemmings'. They just look at what everyone else is doing and follows them.
• Have to spend all day doing it, so don't have a life.
• Are out of touch. Many technical devotees use their reliance on charts as an excuse to never read or watch stock announcements, the news, politics.
• "Have you ever met a rich technical analyst?"

But the truth is that they both have a lot to learn from each other, and if we look at the positives instead of the negatives, you'll see why.

The Good Bits

• Are not just technical analysts, they are traders(there's a difference), which means they have trading skills. These skills are universal, and are as useful for investors as they are for traders.
• Are not short-term. Trading techniques can be applied over any time frame. Apply them over minutes and hours, and yes, it is gambling. Apply them over days, and it is trading. Apply them over weeks and months, and it is investing. You can easily adapt trading skills to any investor.
• Have exactly the same ambition as a long-term investor, as Warren Buffett even, the ambition to buy a stock that goes up forever. They are doing exactly the same thing.
• Have a Trading Plan, and because of that, they never miss a night's sleep.
• Are unemotional. They know what they are going to do at all times, because from the moment they buy a stock, they have a system.
• Are decisive. Traders never prevaricate, they never agonise, they know what to do, they decided way before the trade was even opened.
• They are honest. They know that making money in the stock market is about buying stocks with a high probability of going up. It's not about predicting the future. No-one can do that.
• Are not proud. They know that things will change, that they will get themselves into a pickle. The difference is that when they do they act, they don't stand by some grand but flawed declaration about the future through thick and thin.
• Are not 'lemmings'. On the contrary, they see the market as a battlefield, as combat, one on one. They know they are in a war with the herd, and because of that, they retain an independence of mind and action.
• See trading as a business, and they analyse their success and failure like a business. They constantly adapt, educate, and improve.

• Are good at identifying companies that make money, and that's the root of it all in the long-term.
• Are good at identifying rubbish companies.
• Can identify good management.
• Can identify sector trends.
• Are well read.

The Bottom Line

As any experienced trader will tell you, there is no Holy Grail for success, no one approach that works. Amidst so much grey and so little black and white, the game is simply about trying to get an edge on random outcomes and to do that you would be a fool not to use every tool in the shed, and that's the point, every tool. Not one or the other, but every. You dismiss nothing and learn everything, and this is where so many people go wrong. They decide they are in one camp or the other when it would be far more effective to be in both. The bottom line is that you make a big mistake writing off traders as an investor, or investors as a trader. They both have some good bits and some great bits. You would do well to explore both.

Author: Marcus Padley, Founder of Marcus Today

Funds operated by this manager:

Marcus Today Equity Income SMA, Marcus Today Growth SMA

Political lobbying risks in the US

4D Infrastructure

July 2023

In recent years, political controversies involving US utility companies have caused significant concern for investors.

There have been instances where lobbying activities have contravened the law and resulted in companies and individuals being criminally investigated and punished. Other instances, though not necessarily criminal, have also resulted in negative market reactions. In both scenarios, political lobbying controversies have been difficult for investors to foresee and, therefore, difficult to avoid.

Utilities' role in US politics

Utilities are responsible for the delivery of power and gas from source to end-customers, and are considered key players in the energy supply chain. As a result of the importance of both energy prices and reliability to businesses and consumers alike, utilities are central to economic growth, efficiency and quality of life in their operating jurisdictions.

For these reasons, utility operators believe their corporate responsibility dictates that they should have a voice in the development of energy legislation. With energy legislation and regulation established at both federal and state levels in the US, lobbying is considered important in ensuring that legislation is in the best interest of all stakeholders, including shareholders.

Risk to investors of inappropriate lobbying

Lobbying undertaken by utilities in an open and ethical manner supports a more thorough understanding of energy markets for legislators and a better outcome for both customers and shareholders. The obvious concern is that utilities and/or management teams lobby for their own self-interest or solely that of their shareholders, with little consideration to other stakeholders such as customers. Problems eventuate when lobbying contravenes the law and/or ethical expectations.

Companies should have ethical charters outlining the values that guide how they operate, including how they interact in the political sphere. The old saying, "would you feel comfortable with your behaviour being published on the front page of the newspaper" is also a good guide for what constitutes ethical political lobbying.

Potential violations of the law are often difficult to identify until it's too late and enforcement agencies are involved. Regardless of guilt, once a review is underway, the utility in question will feel pressure as the process evolves. This potentially includes:

1. a lengthy process in which share prices remain deflated;
2.  significant financial penalties if found liable;
3. management disruption as changes are made and teams focus on remedial actions;
4. disruption to regulatory/legislative relationships held by the company; and/or
5. reputational harm which is difficult to quantify and doesn't go away for an extended period of time.

Utilities across the world are bound by a social license to operate. Regardless of strict legality, that social license may be tarnished based on the public's perception that the company has received special treatment from legislators/regulators based on aggressive/unethical lobbying activities. This scenario could result in public backlash, and regulators/legislators taking detrimental action against the utility to reinforce their independence. This can take the form of fines, difficult regulatory decisions, out-of-cycle regulatory reviews and irrational oversight. Negative financial ramifications and poor market sentiment are the result, and re-establishing customer faith in regulators and utilities takes a long time.

4D's approach to political lobbying risk

Due to the high legal, financial and reputational risk associated with lobbying activities, 4D undertakes significant due diligence to identify utilities that are at higher risk and steps being taken to mitigate this risk.

Internal controls

Political lobbying should be guided by a political engagement policy or a similar document recognised by the company board. It should be easily publicly available and outline a set of criteria guiding lobbying efforts and political contributions, and provide authority for contributions and oversight.

Best practice for authority of contributions is for the annual political contributions budget to be developed by the corporate affairs team (or equivalent). The individual contributions should be reviewed by a legal professional and signed off by the most senior executive in the team. It's often a good idea to include an executive or leadership committee review it to ensure widespread knowledge and acceptance of contributions. In our view, large contributions should be reviewed and signed off by the CEO (~>$1 million).

The board audit subcommittee should also review contributions on behalf of the board. A recommendation should then be provided to the board as part of that oversight. Any newly planned contributions should also be reviewed by an audit committee.

This ensures that senior leadership approve all contributions, approvals involve multiple parties, and the board has ultimate oversight.

Transparency

Ensure public transparency of all contributions to individual political figures and parties, political action committees (PAC), other tax-exempt structures (such as 501(c)4 structures), trade associations and political consultancy/advisory groups.

Stakeholders should have access to all internal control and governance documents relating to political engagement.

Appropriate size of contributions

The size of political contributions should be moderated so that they don't give the impression that a political favour is expected in exchange for the contribution. Many utilities have outlined that any individual contribution over $1 million requires CEO sign-off, suggesting that this size of contribution is rare.

Overall contributions need to be moderated as no financial return should be expected on these funds - it should be perceived more as a cost, rather than an investment with the expectation of receiving something in return.

Focus on the utilisation of structures for contributions

Some tax-exempt structures provide anonymity to contributors. Companies should seriously question why they need/prefer anonymity when making a contribution. Generally speaking, such structures have attracted scepticism from the media and stakeholders, and should be avoided unless there is a specific reason for their use.

Some utilities in the past have engaged political consultancy groups. These groups have historically provided anonymity in political lobbying. Interactions with these groups should be transparent internally and externally, including taking meeting minutes for all interactions. Companies should be very clear on their motivations for engaging such groups, and they shouldn't be considered as vehicles to undertake clandestine political manoeuvres.

US federal election laws prohibit corporations and labour unions from making political contributions to federal candidates and national political parties. As a result, companies often use their own, or third party, PACs to make contributions to individuals and parties.

'Pay for play' legislation

Some utility management teams suggest that when a company makes significant contributions to support or oppose a particular ballot measure, it can be interpreted as a 'pay for play' situation. Rightfully or wrongfully, this could be perceived as bribery or a quid-pro-quo arrangement. Best practice would be to lobby through trade associations or PACs with correct governance practices in place to avoid any direct link between the company and an individual ballot measure or proposal.

Third party verification of lobbying controls and practices

Third party verification of companies' political disclosures and practices can support investors' due diligence efforts. One of the more well-known verification groups is the Center for Political Accountability (CPA), which releases the CPA-Zicklin Index annually. Using 24 metrics, or "indicators", the CPA-Zicklin Index assesses companies' disclosure practices, spending and accountability policies for utilisation of corporate funds to influence elections. It does not address company spending on lobbying or PACs.

4D's actions post lobbying controversies

Recent lobbying controversies have influenced our decision to divest companies from our funds. We have exited positions based on the likelihood that a controversy violated the law, disrupted relationships with regulators and stakeholders, and/or there was a lack of definitive action from boards in identifying and rectifying flaws in lobbying controls, processes and disclosures. By contrast, we have also retained positions where our due diligence suggested the above negative thresholds were not violated. Every situation is considered on a case-by-case basis involving internal due diligence as well as engagement with the company in question.

As part of our research into political lobbying best practice, we reached out to companies who rate highly on the CPA-Zicklin Index for comment on this paper and their approach to lobbying. Two such companies in Southern Company and CMS Energy provided their feedback below.

"CMS Energy is ranked First Tier in the CPA-Zicklin Index. We are engaged in the political process, supporting pragmatic policies that are focused on safe, reliable, and affordable energy for Michigan. Our code of conduct and other policies strictly prohibit impermissible political activity, and we have strong controls and oversight established to ensure ethical compliance with all relevant laws. We include more information regarding our political engagement on our website." - CMS Energy.

"This paper highlights the tangible benefits of a clear and comprehensive approach to political disclosure and accountability. Southern Company takes pride in our status as a Trendsetter in the CPA-Zicklin Index of Corporate Political Disclosure and Accountability as we seek to achieve optimal outcomes for our customers." - Southern Company.

Funds operated by this manager:

4D Global Infrastructure Fund (Unhedged), 4D Global Infrastructure Fund (AUD Hedged), 4D Emerging Markets Infrastructure Fund

For more information about 4D Infrastructure, visit https://www.4dinfra.com/

^{The content contained in this article represents the opinions of the authors. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the authors to express their personal views on investing and for the entertainment of the reader.}