The see-saw equity market has been making things difficult for fund managers over the past 6 months - they found the last quarter of 2018 tough enough as the market tanked under the pressure of US investors' reaction to 10-year bond rates at 3.25%, and locally the side effects Hayne Royal Commission. Subsequently the ASX rebounded 6% in February as 10-year US bond returns retreated to yield 2.75%, just as many fund managers reset their portfolios to be more defensive and risk averse.

Of course not helping markets are the multiple geopolitical and associated economic issues they're facing: Brexit is getting closer and closer to the wire without a solution; Europe's economy is slowing partly as a result of Brexit, and partly due to China's slowdown; Trump's mega arm wrestle with Xi isn't going as well as he'd like to tweet, with evidence that it is hurting the US economy as well and possibly as much as China's; and finally the Donald might be realising that negotiating with Korea is not as easy as simply comparing and bragging about the size of his button.

While on the subject of China, an article today on Bloomberg's "Five Things To Start Your Day" (well recommended if you don't already receive it) citing the exodus of Chinese property buyers as the main cause of the property downturn in Australia (having bid it up in the first place), and elsewhere around the globe. Whilst that may be a major reason, so is the banks' tightening of loan eligibility (or possibly just applying what was there in the first place) along with the impending end of 5-year fixed-term interest-only mortgages being switched to principal and interest loans; low wages growth, in turn leading to poor retail sales figures as consumers' confidence is eroded and they pull their collective heads in.

For the property market it is somewhat of a perfect storm, and coming at the end of an extended period of double digit annual growth, bound to fall further. Whilst not property experts, Hedge Clippings would suggest the worst for the property market is not over yet, particularly with the imminent potential of a change in government, and with it the introduction of restrictive negative gearing rules amongst other goodies.

It's been a mixed week of general news, with the Australian equity market recovering some of last year's late sell off by rising over 5% in February, courtesy in particular of the banking sector which rallied (in relief?) over 8%. It's worth remembering, however, that CBA for instance is still a long way from regaining sight of $100.

The Trump/Kim show is set for round 3 at least, but it was never going to be a straightforward negotiation. Kim's not easy, and Trump's well… Trump. Maybe he wanted to get back to Washington as quickly as possible to speak to his ex-solicitor, Steve Cohen. Markets will stay nervous, but understanding that a war starting in 1949 and which has yet to have a truce signed is not going to be fixed by a couple of high profile summit meetings. There'll be a resolution…. in due course.

Unlike Brexit, which is heading for goodness knows what? A hard exit? Disaster, although some look forward to it. A negotiated exit? Looking increasingly unlikely as the EU has the whip hand, or acceptable to many in Westminster or the UK at large. A second referendum? The first was an error of judgement, the second if held would probably result in a reversal, and a lot of unhappy Brexiteers.

In China, factory output hit a three-year low dipping below the all-important 50 level. That's a problem for Australian companies dependent on China, and not only in the resources sector such as BHP and RIO. Think Blackmores, who didn't see China's buyers coming and, by their own admission, didn't see them going either. Irrespective of the ongoing trade talks, factory output is down because consumer spending is down or slowing, particularly at the luxury or discretionary level.

And finally, on to funds management and financial services: We read with interest that Advisor Ratings are to publish Financial "Advisor" rankings. Great idea, but it will be difficult to accurately focus on their quality of advice, rather than only providing an orange or red flag for those surveyed (assuming they take part) who fall short. However, it will hopefully weed out some who shouldn't be in the industry. Along with the HRC's call for all advisors to have to declare their affiliations with, or ownership by, a financial institution or product issuer, this will at least provide consumers with some warning.

The dictionary lists synonyms for "advisor" as "counsellor, mentor, guide, consultant, confident, guide, aide, helper" etc. The bottom line is that an "advisor" must be able to declare they're independent, or not be permitted to use the term. If not, they risk being classified as being in product distribution, business development or sales. Such advisors should also be required to declare which products they have affiliations with and justify each product's inclusion on any recommendation or recommended product list.

This week Hedge Clippings attended the 500+ advisor/fund manager annual info-fest run by Graham Rich's Portfolio Construction Forum (PCF). Run is probably an understatement, as is managed - the event is a superb example of organisational efficiency, or should we say control. 

PCF is a longstanding annual event and thus has the benefit of years of experience, some serious theatrics, audio volumes to rival a Bruce Springsteen concert and, led by Rich himself, with an excellent line up of speakers, plus the obligatory "pay to perform" fund managers. In case you're wondering, this is not a paid endorsement or return favour for a freebie or contra ticket - Hedge Clippings coughed up the $795 entrance fee and will happily do so again next time around.

Why? Simply the professionalism of the production and the quality of the speakers - in spite of the geographically impossible location in deepest Redfern, which it seems, as we wandered hopelessly lost* (as Google Maps doesn't call it Redfern do they, probably preferring the more fashionable Eveleigh) around the streets. It seems Redfern has been transformed from "no go" to "inner city chic" in the blink of Sydney's property boom.

But we digress - back to the speakers, the main morning attraction being a global economic review from the likes of Jonathan Pain who is seriously bearish on property. Another, Longview Economics' Chris Watling from London, who held an equally bearish view based on his concern over the expansion of global debt at record low rates (in some cases, zero) which now exceeds GFC levels.

Watling's theme was that "bubbles always burst", having always started with cheap money, and always ending when it gets more expensive. He particularly singled out BBB corporate bonds issued by companies he described as "Zombies" who, after paying their bond holders, had nothing left to invest in R&D or production, and who in a normal interest rate environment would not be able to survive. He was equally critical of valuations, citing We Work currently priced at 20 times revenue!

Watling was unable to predict the timing of the bubble's burst, but one got the impression that, even though he might have been singing from the same song sheet for a while, time was running out.

Watling was followed by Ron Temple from Lazard Asset Management who was more sanguine, but cautioned that global growth was slowing, was surprised by the Fed's recent "pivot" but believed Euro growth will rebound.

Forecasters are notoriously good at predicting the future, but equally bad at calling the timing. We're reminded of the old adage that "the right trade, but with the wrong timing frequently results in a bad outcome."
  
*OK, our fault. A little prior preparation the day before would have averted the long walk, but at least Redfern was a pleasant revelation, and who would have thought we'd say that twenty, or even ten years ago.

As we progressed through 2018 we became used to - fixated almost - the HRC on the evening news, and front pages of the press the following day. Shock and awe (Orr) at the misdeeds and doings at the big end of town, and great fodder for program producers and print sub-editors.

Less than a month after the release of the final report and for many it's a case of moving onto the next big story - maybe that's just the news cycle of the modern age. However, the ripples - or should we say the tsunami - from the HRC continue to impact the financial services sector even as some are questioning if in the long term the real lessons have been learned.

The Commission had a number of immediate effects, particularly on the reputations, and in several cases the careers, of executives, directors and, in the case of AMP and NAB, the Chair of previously impeccable institutions. Shareholder value was equally shredded, although unlike the careers and reputations, it will no doubt recover over time - with the possible exception of AMP where we don't believe any amount of optimism is justified. If the writing was not already on AMP's wall, yesterday's results would appear to confirm it.

Laws may be tightened, ASIC and APRA's teeth sharpened, but how does one really change culture?

In the case of NAB, Hedge Clippings believes the reason the board was so out of touch with its own business was that they rarely actually experienced it at the coal-face. I am well reminded of, whilst working (thankfully briefly) for NAB's newly acquired broking arm A.C Goode in the late 80's, asking my then NAB director to address a team of remaining client advisors with a few words of encouragement post some necessary thinning of their ranks in the aftermath of the '87 crash:

"I'm afraid I can't do that", he replied. "Why not?", I queried. "Generals can't get down in the trenches." was the response. Of course not - they might get shot! The lesson is that while banking products and markets may change, culture is entrenched.

Whether the Hayne Royal Commission will be sufficient to change culture in the long term remains to be seen. We have after all seen previous enquiries (albeit not Royal Commissions) come to nought or very little. Think the Henry Tax Review - which sadly he'll be less well remembered for than his short time in the sights of Commissioner Hayne and counsel assisting, Rowena Orr.

For some of the best in depth coverage of the HRC and its recommendations (as opposed to or apart from Hedge Clippings' brief weekly rants) you should read 'Cuffelinks' and the excellent opinion of editor Graham Hand. For instance, this piece on the Hayne vs. Henry exchange entitled "Ken forgot it was Kenneth's stage", or this on "8 things the Royal Commission missed".  

And on a lighter note, or as we used to call it - "And now for something completely different",we found this clip of Trump's visit to Europe. Particularly relevant as it looks as if a US State of Emergency is looking more likely to be declared.

There was a varied response to Royal Commissioner Hayne's final report and recommendations - some saying it didn't go far enough by not banning vertical integration between wealth management and advice space, as well as not naming those it had referred for prosecution, while others, and in particular mortgage brokers, said it went too far.

We'd have to say Mr Hayne came down particularly harshly on mortgage brokers, who have become an entrenched part of the housing finance system over the past 20 years, particularly since Aussie Home Loans switched from claiming "We'll save ya" as a low cost mortgage originator to becoming a broker owned by the CBA. Yet he didn't recommend a ban on Vertical Integration to limit financial advisors who in reality are a sales and distribution channel of the finance and insurance product issuers such as AMP.

Overall, while looking at vertical integration, the HRC didn't really touch on many of the conflicts and circular requirements within the distribution and research processes operating in the managed fund sector. Having said that, the disclosure and transparency requirements on actual dealer group ownership he has proposed are overdue and welcome.

Overall the market told the real story as it invariably does, with the banks and AMP enjoying a significant rally, and mortgage brokers falling off a cliff.

Maybe there were greater expectations after the public shellacking the industry and specific individuals received during the public hearings. Maybe what everyone wanted was a public lynching, with crowds around the guillotine, but in reality they got that - Directors, CEOs and Chairmen, with tarnished reputations, out the door. We will wait to see the outcome of the twenty-something recommendations for prosecution of criminal conduct, but it is likely to keep the lawyers happy.

However, now politicians will have their say, and with only 10 sitting days prior to the budget, anything can happen. The government is hoping it can adhere to the motto "Festina Lente" (which as I'm sure you would know translated means "Hasten Slowly"), while the opposition can't wait for election time (Festina, Festina, Festina!).

Before we leave the Hayne Royal Commission, one of its side effects has been to slow housing credit, and with it property prices, such that the NAB's Consumer Anxiety Index is at a three year high (probably a notch or two lower than NAB's boardroom anxiety). Consumer confidence is fickle and slows consumer spending, such that the RBA's cautionary comments have lead to a revision of the future of rate rises. While there may be some borrowers hoping for a rate cut, it doesn't signify a great economic outlook.

Casting a view globally there are multiple clocks ticking away as countdowns take place. A countdown to the next stage of US govt shutdown, a countdown to US/China tariffs, a countdown to Brexit and, just so we're not left out, a countdown to the Federal election.

No wonder the Consumer Anxiety Index is high. At least NAB got that right!

A couple of things on Hedge Clippings' radar today… including the Hayne Royal Commission's report delivered to the Government today prior to being made public next week (assuming some politician doesn't leak it earlier, but they wouldn't do that would they?), an article published in today's Australian showing the number of inactive accounts in the superannuation system as exposed by the Productivity Commission, and the US 10 year bond rate which influenced the US Fed's Policy change.

Let's start with ghost accounts and the revenue they make for superannuation funds at their members' expense. With 25 million super accounts in the system, and 7.8 million of them being inactive or duplications, the funds are ripping a staggering $2.6 billion a year out of their members' combined balances. Surely there's a simple way to prevent this - namely requiring each person's Tax File Number to be used as the core and common identifier on every super account.

When first coming into the work force every employee has to apply for a TFN, and has to choose a super fund. When changing employer, and/or opening a new super account, this would, or could, throw up an immediate flag with the option to switch, close or combine accounts.

Of course, using the TFN would alarm the alarmists, who would claim it was a stealthy way to introduce a common identifier - a.k.a. the Australia Card - even though it already exists. However, the $2.6 billion a year in fee savings could more than pay for its introduction! While it may sound simple to Hedge Clippings, don't expect the superannuation industry to support the idea and wave goodbye to all those fees for no reason.

As far as the Commissioner Hayne's final report is concerned there's no doubt he'll be forthright. Having already given us a taste in his courtroom, and the interim report, the final version is unlikely to have any major revelations but will undoubtably have some firm recommendations. We hope these don't only focus or result in more legislation and red tape; rather enforcement of the existing requirements in the Corporations Act to operate fairly, efficiently and honestly, and a lengthy zebra suntan for those deliberately and consistently found to have not been doing so.

Both the HRC and the PC's findings and recommendations are going to be negatively affected by the upcoming election and whichever party and their respective vested self interest groups is in power after election night. This will be disappointing, as there's a risk that both the HRC and PC's findings run risk of going the same way as Ken Henry's review of the taxation system.

For those who can't recall the Henry Review, a.k.a. Australia's Future Tax System Review, it was commissioned back in 2008 under Kevin Rudd's 2020 summit (help! we're nearly there), and released in 2010. Unfortunately, superannuation was excluded from the review (how bright was that?) but there were still 139 recommendations, of which over 100 ended up in Canberra's waste paper basket. One of the one's that did make it into law was the Mineral Resource Rent Tax, which in 2014 eventually went the way of the dodo under Tony Abbott.

Elsewhere on this week's radar: Mid last year there were expectations of a continued Fed tightening, and concerns about the US 10 year bond rate rising above 3%, which subsequently came to pass, spiking to 3.24% in November. As a result, this helped to spoil the equity bull market which had been built in part on the prolonged era of QE, low rates and easy money, with the US market taking a tumble in the 4^th quarter, aided of course by Trump's arm wrestle with China's President (for life) Xi.

Fast forward and new Fed chair Jerome Powell reversed tightening expectations overnight, and with the US 10 year bond rate having fallen to 2.7%, once again making equities attractive on a relative yield and risk basis - as a comparison the dividend yield on the S&P500 last year was less than 2%, although the risk remains.

Hedge Clippings believes that while performance is always important, awareness of and avoidance of risk can be essential, particularly if it result in significant or permanent loss of capital. With that in mind, this week we turned our minds to two current risk thematics.

Manager and Market Risk

Obviously 2018 was a difficult year for equity markets, with a positive start before tripping and falling badly in the final quarter. In spite of that, just under 30% of funds who have reported their December results to date returned positive performance for 2018, and just under 50% outperformed the ASX200 Accumulation Index (which fell -2.84%) which www.fundmonitors.com use as a standard comparison.

There has been plenty written in the press about how actively managed funds have disappointed investors in 2018, and in many cases that's true. So how does the average investor make the choice?

As every offer document will be at pains to point out (and as required by ASIC) past performance is no guarantee of future performance. However, the difficulty is that if you can't use past performance as a guide, what do you use? Although we don't recommend the punting analogy, there is a good reason that the form guide to the races is published!

What the form guide will not highlight, and careful analysis of a fund's past performance will, is that risk and downside past performance is just as important as positive returns, if not more so. Certainly, both should be looked at in combination along with each investor's risk tolerance and return objectives.

However, the figures above are a stark reminder that in addition to manager selection based on reliable research, holding a diversified portfolio of funds is an equally important component when investing in actively managed funds. In many ways this is no different to successfully investing in listed equities directly, which requires thorough research and a diversified portfolio. One of the often unrealised benefits of holding a number of managed funds is that they in turn can provide far greater diversification than can comfortably be managed by most individual investors.

As we frequently point out one of the best ways of reducing risk, whether it be when investing directly in individual equities, or managed funds, is to diversify your investments. It is true that in some cases this can dampen your returns, but more importantly, provided funds are carefully selected to have a low correlation to each other, investing in say 5, 10 or more managed funds, and thus potentially between 200 to 1,000 individual companies, will provide a significantly lower volatility and risk of capital loss.

This approach also provides the opportunity for diversification across asset classes such as equities, fixed income or property, in addition to geographic diversification if required. Within equities it also provides the opportunity to choose or avoid market sectors, such as large caps, small caps, or resources.

Selecting a fund manager purely based on their returns without having at least one eye, or possibly both, on their risk profile, and therefore the potential for loss of capital, is risky indeed.

Market & Geo-political Risk

While overall looking at markets there still seems to be significant risk, this is compounded by an ongoing and heightened political risk. The US shutdown continues as Trump plays chicken with the Democrat-controlled lower house. The longer this goes on the more entrenched the opinion of each, along with the reputational loss of not winning the argument, and the loss of voter trust along with it.

Of course, with the shutdown also comes a significant loss of consumer sentiment, and with limited government information being released it is difficult to tell to what extent it is impacting the US economy. Needless to say, it is likely to be significant.

Crossing back to China, an admission (at last) that the "longer for stronger" argument would come to an end sooner or later. Whether that is being caused by Trumps trade policies, concerns over industrial espionage or just the inevitable can be debated. Probably a combination of all three.

Meanwhile in Europe, Brexit is continuing to wreak havoc not only in the UK, but also on the mainland with figures overnight confirming the deteriorating outlook in both Germany and France. As far as Brexit is concerned even the experts have given up making predictions on the outcomes, leaving it to the bookies to figure the odds for each outcome. Most Brits we talk to seems to be reverting to the WW2 slogan of "Keep Calm and Carry On" but that may be wearing a little thin.

In Australia the risk also remains political with an upcoming election where elements of the Liberal party are doing their damnedest to lose.

And on that happy and somewhat uncertain note, we wish all readers a Happy Australia Day tomorrow, whenever you think it should be celebrated, or even if you think it shouldn't!

Happy New Year 2019, and welcome back from Hedge Clippings after a most welcome, albeit weight gaining, three week break.

Maybe it's advancing years, maybe the combined effects of the festive season (or a combination of the two), or possibly the avalanche of information which builds up while one's away, but it was difficult to know quite where to start for the first edition of Hedge Clippings of the year. Certainly, there are a larger than usual number of fund performance updates to follow these comments, so a brief word on performance for 2018.

It will go down as a year of two parts - the first three quarters, most of which were positive, followed by a horror final quarter as a combination of factors finally cracked the advance of the bull market which commenced post GFC in 2009. The decline in the property market was inevitable but cemented by the revelations and implications of the Hayne Royal Commission.  

In spite of reports in the media from some quarters, as far as fund performances are concerned there were some outstanding results given the backdrop of equity markets, both locally and overseas. At this stage it is too early to accurately define year-end results as only 35% of funds' December returns are in. However, based on what we know to date 30% of December results were positive, with around 40% of funds providing a positive result for the year, and 67% outperforming the ASX200 Accumulation Index.

Experience tells me that these numbers might slip somewhat once all 430 funds now in the www.fundmonitors.com database have lodged returns, but those figures are far from the wipe out headlines in sections of the media.

Elsewhere much of the information avalanche (maybe some we will claim the term "infolanche" if it hasn't been taken elsewhere) concerned more of the same, consisting of mainly negative news of geo-political issues which seem to be dominating print and screen.  Without dissecting each at this time of the week, let's just list the major ones which will make markets - and managing money - difficult over the next 12 months (at least!):
 

1. Brexit's causing uncertainty. What a shambles, impacting not only on the UK but also the EU economy. Whatever the outcome a large proportion of the population will be deeply divided and dissatisfied.  In fact, it is quite possible that the final outcome will please no-one.
2. US Government shutdown uncertainty (short term), and depending on how long it drags on the more serious it becomes and, we suspect, the more entrenched the opposing sides will become.
3. US/China trade negotiation uncertainty, although more likely than not to be resolved eventually, hopefully sooner than later. However, there's a strong risk that additional damage is being done to an already wavering growth rate in China.
4. Australian Election outcome, which seems pretty certain, and not a positive from an investment perspective - franking credits, negative gearing, Bill Shorten's class warfare rhetoric etc.
5. Australian property: Continuing negativity thanks to economic and electoral uncertainty, plus one of the highest levels of household debt/property price ratios in the developed world.
6. The Hayne Royal Commission findings due on February 1 are unlikely to help consumer and investor sentiment, increase focus on the financial sector and therefore further potential damage to property, or management's bonuses!
7. Consumer confidence (or lack thereof) based on all of the above, but in particular items 4, 5 & 6.

Finally, and there's certainly insufficient time or space to do it justice here, the Productivity Commission's report into at least parts of the Superannuation system. We welcome the report's focus on increased transparency and on investors' and workers' retirement outcomes being paramount, but there's a need for a total review of super, including its complexity and the confusion that results, much of which we believe is responsible for the lack of engagement by the average worker. 

There's a long way to go before this debate is over, but the squealing from various vested interests, both industry, for profit and political, leads one to think the Productivity Commission is on the right track!

This is our last "Hedge Clippings" for the year.  Thank you for your support and feedback over 2018, we hope our various Friday afternoon musings have been to your liking - or at least if not, of interest.  We'll be back after the break, but in the meantime would like to take this opportunity of wishing you and your families a Happy Christmas and a Healthy and Prosperous New Year.

Looking back it was a year when the music stopped on a number of fronts - although it had been becoming pretty discordant for some time. It's been a year when geopolitics has been the dominant theme - or themes, with markets and economists trying to work out what's next, and getting the wobbles in the process:

Brexit - David Cameron will be remembered for making an offer he didn't need to, and giving 36% of the UK electorate control over an outcome he didn't want. It was always going to be ugly, but it has turned out to be a disaster where no one is likely to be happy with whatever the eventual outcome holds. What on earth was he thinking?  The truth is he probably wasn't, so he neatly sidestepped his responsibility, leaving it to his stoic but hapless successor to sort out the mess he created.

Trump - Where do you start?  The Donald seems immune to any kind of advice or what one might call statesmanlike behaviour. He thrives on confrontation and apportioning blame and responsibility for his mistakes to others - aides, Chiefs of Staff, Lawyers - and even the Federal Reserve.  He has certainly achieved certain gaols - to what extent they'll be of the own goal variety (or maybe that should be in goal?) remain to be seen.

China - The music hasn't stopped but it is getting louder! The Chinese Communist Party finally seems to be being held to account for wanting to dominate the world's economy, and is not liking the pushback it is receiving from the incumbents.

Australia - A combination of the Hayne Royal Commission, and the revolving door at the Lodge are threatening what's been a record economic run. The HRC has helped to put the skids under an overly heated residential property market - something the Reserve Bank had been trying to do more subtlety for a while. Either way the above combinations - along with the strong chance of a change of government next year - are likely to see consumer confidence erode further, with the risk that the economic record comes to an end.

The music may not have stopped, but the tune will have changed significantly.

There's not much good news around to welcome Santa!

Nearly every economist got this week's GDP figures for the September quarter wrong (+0.3% and 2.8% YoY). Now there's speculation that the R word will be back on the agenda. And if not a Recession, then possibly a slowdown, and rate cuts down the track from the RBA if the December quarter figures are equally disappointing. That's a big turnaround in expectations, even if most experts weren't expecting an upward movement in rates any time soon.

Anecdotally, based on going to a department store earlier this week, and worse still, a shopping mall, (which Hedge Clippings generally tries to avoid like the plague unless absolutely necessary) there doesn't seem to be much Christmas cheer running through retailers' cash registers. Maybe consumers are all shopping online, maybe they're waiting until the last moment (like yours truly), but quite possibly they're just pulling their heads in.

Why?  Because as noted above, there's not much good news around unless you're an extreme, and possibly unrealistic optimist!

• As recently as May this year one of the (so called) expert real estate commentators downgraded their 2018 housing price forecast on a weighted capital city basis to between -2% to +2%. Fast forward just 6 months and with the property market down 10% they're realising a further 10% fall is not out of the question as banks pull their heads (sorry, lending criteria) in and faith in the financial markets has been tested by the exposure of the Hayne Royal Commission on the front pages and TV nightly news.

• Irrespective of one's political preferences there's a general lack of confidence in our glorious pollies, and an election, and a change in government is just around the corner.

• Globally the Trump / China spat is far from resolved, creating uncertainty in US markets. Brexit is uncertainty personified, and even the German economy - not long ago the envy of the world - is suffering.

• In the US, 10 year bond yields, having recently threatened to rise above 3.5% and spoil the equity market's party, are now threatening to fall below 3% based on concerns about a US slowdown in 2019.  The yield curve is close to inverting as 10 and 2 year bond rates are dangerously close to each other.

• Every US recession for more than half a century has been preceded by an inversion of the curve, although to be accurate not every inversion has been succeeded by a recession.

Could the unthinkable - an end to Australia's record growth run - happen? Hopefully not, but there are enough signs, and opinions pointing in that direction, that it would be unwise to rule it out completely.