Tuesday 28th October 2008
The Financial Fortnight That Was
In This Issue
Quote for Consideration
Financial Topic Demystified - Exchange rates and how they impact on investments
Fascinating Financial Fact - The Trade Weighted Index
Market News
Is a Self Managed Super Fund For You?
Eureka Report Articles
Other Websites of Interest
ABC Radio Segments
Dimensional Fund Performance Graphs
Quick Links
 
How can we improve our emails?
We value your input.
 
Click on the following link to be taken to be taken to our feedback forum. 
 
Provide a suggestion or cast your vote towards suggestions made by other subscribers.
 
Financial Fortnight emails feedback forum
 

Forward this issue to a Friend

Greetings! 
 

Welcome to the latest edition of The Financial Fortnight That Was.

We have a bumper issue for you today.  In this edition we take a look at the Australian dollar exchange rate and its impact on investments, we take a look at the Trade Weighted Index, provide a summary of the movements in markets over the past fortnight and provide some points to consider if you are considering implementing a self managed super fund.

 

We also highly recommend the two links to videos contained in our other websites of interest section.

 

We hope that you find the material informative and relevant!

A Quote for Consideration 

"I can't predict the short-term movements of the stock market. I haven't the faintest idea as to whether stocks will be higher or lower a month - or a year - from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over"


Warren Buffett - October 16, 2008
 

Financial Topic Demystified 
Exchange rates and how they impact on investments
 

It was interesting to look back at the corresponding edition last year - 30th October 2007.  In that edition we were looking at exchange rate movements with some talk in the press about the Australian dollar reaching parity with the US dollar.  Well we now know that it nearly got there reaching a peak of 98 cents in July.  How the mighty Aussie dollar has fallen now lingering around the low 60s and that high only thanks to some intervention on the part of the RBA.

 

In this edition we revisit the relationship between the Australian dollar and other currencies and how movement in the Australian dollar impacts on investments.

 

The recent movements in the Australian dollar compared to other currencies has seen a significant depreciation in value across the board.  Since the beginning of 2008 until Monday 27th October we have seen it decrease:

  • 29.7% against the US Dollar (36.7% from its peak in July)
  • 10.8% against the UK pound sterling(19.8% from its peak in July)
  • 17.7% against the Euro(23.7% from its peak in July)
  • 41.2% against the Japanese Yen(46.0% from its peak in July)
  • 25.3% against the Trade Weighted Index#(30.8% from its peak in July)

There can be many reasons for movements in the value of a currency but the basic story is about supply and demand.  Since December 1983 Australia has used a floating exchange system.  Under this system changes in demand and supply of a currency affect its value.  Demand for the Aussie dollar is affected by

  • financial flows into Australia from overseas investors which in turn is affected by the level of interest rates and level of confidence in the economy,
  • expectations of a future appreciation in the $A will increase demand by speculators,
  • demand for Australian exports

Supply on the other hand is represented by:

  • financial flows out of Australia
  • speculators expecting the $A to go down
  • demand for imports

Given the recent depreciation of the $A there appears to be greater pressures on the supply side of the currency which has forced the exchange rate downwards.  A couple of key theories that are being suggested as a cause:

i)                    the Aussie dollar is seen as a commodity currency as the Australian economy is heavily reliant on the sale of commodities.  As the prices for these commodities fall so to does the exchange rate.

ii)                   Our currency and financial markets are seen as a riskier and money at present is flowing to historically safer places particularly the US dollar and the Japanese Yen.

 

These are reasonably simplistic economic theories but seem to make sense given the current markets.

 

What Does This All Mean for Investors?

Mainstream media tend to latch on to the stories where the fall in currency is not so well received - for those people going on overseas holidays or buying imported goods. 

 

However for mainstream investors (who are not trading currencies) the major implication of changes in exchange rates for investors is that it changes the value of international investment in terms of Australian dollars.  If you bought investments in the US at the beginning of the year one $A would have bought you 88.16 US cents of investments.  If you wanted to convert those 88.16 cents back into $A on the 27th of October you would have been able to buy 142.33 Australian cents (at the exchange rate of 61.94).  Without taking into account investment returns and transaction costs you would have made 42.33 cents on the original dollar.

 

If the dollar was rising in value the opposite would be true leading to a loss.

 

So over the past few months while share markets around the world have been knocked around, unhedged international share investments have faired relatively better compared to Australian share investments.  Still well and truly negative but at least more palatable.

 

Our Approach to Exchange Rates

At 'A Clear Direction' we believe that exchange rate movements pose a couple of questions.

  • Do we steer clear from international investments because of the risk of exchange rate movements?
  • Do we 'hedge' our clients away from exchange rate risks by using global investments that have in built currency hedges against rate changes? or
  • Do we try to capture this type of diversification in our portfolios by exposing some of the portfolio to exchange rate movements?

In line with our overall philosophy towards investment markets, we do not believe you can time when exchange rates will rise or fall.  Therefore, our philosophy is to incorporate hedged investments in our high yield investments - international fixed interest and listed property.  This protects these more regular and higher income sources from exchange rate movements.  However we also look to expose investment portfolios to some exchange rate risk and diversification through using un-hedged international share funds.  This has worked well over recent months but of course does not work well when the Aussie dollar is rising in value.

 

Fascinating Financial Fact

The Trade Weighted Index
 

The most commonly referred to exchange rate comparison for the Australian dollar is in terms of the US dollar.  However, the USA is not our major trading partner with a lot more business being done with other parts of the world, particularly Asia.  To try to reflect the value of the Australian dollar in a more universal manner the Reserve Bank of Australia publish details of the value of the $A against a basket of overseas currencies called the Trade Weighted Index (TWI).  As the name suggests it values the Australian dollar according to the currencies of our major trading partners and gives each currency a weighting depending on the strength of trade between a particularly country.  The greater the level of trade with a country the greater the weighting of that country's currency within the TWI.

 

On the 3oth September the RBA announced the new composition of the TWI.  This provides a very interesting summary of our major trading partners.  The really interesting point is that China's Renminbi has jumped into first position pushing the Japanese Yen out of first place for the first time since 1983/84.

 

The full composition listing of the underlying 22 nations and currencies follow.  These currencies account for 93.2% of Australia's two-way merchandise trade:


Weights in the Trade-Weighted Index

(per cent)

 

 

 

2008/09

2007/08

Chinese renminbi

16.3672

15.4486

Japanese yen

15.4040

15.4860

European euro

11.6517

12.1703

United States dollar

9.8797

10.7432

South Korean won

5.7786

5.9057

Singapore dollar

5.2102

4.5637

United Kingdom pound sterling

4.7535

4.1943

New Zealand dollar

4.6565

4.6553

Thai baht

3.8019

3.5465

Malaysian ringgit

3.2705

2.9989

Indian rupee

3.0844

3.5320

New Taiwan dollar

2.9903

3.2771

Indonesian rupiah

2.4053

2.7489

Vietnamese dong

1.9640

1.9032

United Arab Emirates dirham

1.5930

1.2801

Papua New Guinea kina

1.2341

1.1564

Hong Kong dollar

1.1934

1.3785

South African rand

1.1040

1.1496

Canadian dollar

1.0786

1.1892

Saudi Arabian riyal

0.8916

0.9166

Swiss franc

0.8685

0.9401

Swedish krona

0.8190

0.8158


One point to take away is that this is another signal of the growing importance of China for Australia's continued economic strength.

 

For more complex information on how the TWI is calculated take a look at the following website -

 

 

http://www.rba.gov.au/MediaReleases/2008/mr_08_19.html

 
Market News
 

ASX P/E Ratio and Dividend Yields

 

The P/E ratio is a common broad indicator of the price of shares.  It is a calculation of the price of shares compared to expected earnings.   A higher ratio indicates that share prices are more expensive.  The historical P/E ratio for the ASX has been between 14 & 15.  The dividend yield is the calculation of dividend payments divided by the market capitalisation of the company or index.  The historical average in Australia is around 4%.

 

As of October 21st the P/E ratio for the S&P/ASX 200 was 9.51.  The dividend yield was 5.79%.

 

Market Indices

 

Since our previous edition, all growth asset markets have fallen in value.  The S&P ASX200 Index has fallen by 2.30% from 10th to the 24th of October.  It is now down 41.68% from the same time last year and down 38.97% for the calendar year so far. 

 

The MSCI World Index - ex Australia, a measure of the global market, has fallen 2.83% over the same period.  The index is down 44.04% from the same time last year and down 42.50% for the calendar year so far.

 

Emerging markets have also experienced negative movement with the MSCI Emerging Markets Index falling a further 16.34% since the 10th of October.  This index is down 55.10% from the same time last year and down 54.38% for the calendar year so far.

 

Listed property has seen the strongest falls over the past fortnight.  Australian listed property trusts have fallen 14.00%.  The index is down 60.38% from the same time last year and also down 53.74% for the calendar year so far.

 

The S&P/Citigroup Global REIT - Ex Australia Index has fallen over the fortnight by 16.21%.  This measure is down 25.11% from the same time last year and down 19.74% for the calendar year so far.

 

Exchange Rates

As of 4pm the 24th of October, the value of the Australian dollar is down 0.56% against the US Dollar at .6514.  It is now down

 
 

27.41% from the same time last year and down 26.11% for the calendar year so far.  Since October 10th the Aussie has actually risen 0.94% against the Trade Weighted Index, with the index now at 53.7.  This puts it down by 24.15% since the same time last year and down 21.83% for the calendar year so far.  (The Trade Weighted Index measures The Australian dollar against a basket of foreign currencies.)

 

General News

 

The Australian Bureau of Statistic has released the latest consumer price index data to the end of September 2008.  The CPI has increased 1.25 over the September quarter leaving inflation at 5% through the year.

 

The Westpac-Melbourne Institute leading index which indicates the likely speed of economic activity three to nine months into the future, slowed to an annualised pace in 2.5 per cent in August, its weakest level in six years.

 
Is a Self Managed Super Fund For You?
Scott's Financial Happenings Blog - Posted Thursday 23 October
 

There is an understandable lure towards implementing a Self Managed Super Fund through which you can invest and control your superannuation assets rather than leaving it up to someone else.  An article I read today suggested that there were over 372,000 SMSFs in Australia as of early 2008 with 47,500 new funds registered in 2007.

 

So is it worth getting on the band wagon?

 

My response to that question revolves around three key determinants:

  • Costs,
  • Benefits, &
  • Responsibility

Cost

A key element in the decision making around any investment alternative is the cost of implementing and maintaining the strategy.  The article I was reading outlined the Australian Tax Office's annual return data for Self Managed Super Funds.  It suggested that the ratio of operating expenses to total assets for SMSFs were:

 

  • 10.51% for funds with assets of up to $50,000
  • between 2.63% & 3.55% for funds with balances between $50,000 & $200,000
  • 2.26% for funds with assets between $200,000 & $500,000

The 2008 Rainmaker Fee Review provides some perspective for these fees.  This review suggested that workplace super funds now average 1.41%.

 

What are the fees for a superannuation portfolio we would recommend?

 

Based on a 40/60 portfolio - 40% invested in defensive assets such as cash and fixed interest investments and 60% invested in growth assets such as Australian shares, international shares and property our fees come in at:

 

  • $50,000 portfolio - 1.66%
  • $200,000 portfolio - 1.34%
  • $500,000 portfolio - 1.18%

We feel that our fees are very competitive both against workplace averages but especially when considered against the SMSF averages mentioned above.

 

Benefits

Fees are important but not the only criteria to consider.  Benefits from using a self managed super fund can range from the control it allows you to take of your own investments to what investments you can actually include within the fund.  For instance, under certain conditions you can include art work and even business property with the superannuation fund.  There are some clear rules about these more unusual asset classes including the sole purpose and arm's length test but a self managed super fund definitely provides other asset class opportunities.

 

If you are not interested, or do not see the value of holding these assets within your superannuation fund then this benefit disappears.

 

In terms of the control benefit there are other ways of having more control of your super without going down the SMSF path.

 

We employ an administration service for the majority of our superannuation and pension clients.  Using this service, clients through their financial advisor, are able to purchase a large range of assets within their fund including shares listed on the ASX.  They therefore take significant control of their portfolio.  No art work or business real property but not everyone has that compulsion.

 

We are open in saying that we would love the costs of using such services to be cheaper but with the rebate we receive from the provider we use which we pass on in full to our clients, we can keep overall costs below average SMSF and the workplace averages.

 

Responsibility

Unfortunately, with more freedom and control comes greater responsibility.  A lot more scrutiny is being placed on self managed super funds.  Anyone who is contemplating going down this path must be prepared to take on the trustee responsibilities that come with this.

 

Our preference is to use an administration service which will take on the trustee responsibilities for you including completion of tax and auditing requirements.  As long as the cost of this service is kept to a minimum we believe the benefits and peace of mind it provides clients is well worth it.

 

Self Managed Super Funds definitely have their place providing benefits to users and if well managed can even be quite cost effective. 

 

Our preference though, is to not recommend the use of SMSFs as an administration service can provide just us much control at lower costs without the trustee responsibilities.

 

If you wanted to discuss this issue in more detail please get in contact for a free no obligation meeting / discussion.

 
Regards,
Scott Keefer

Other blogs over the past fortnight have included:
 
Eureka Report Articles
 
Since our last edition Scott Francis has contributed another three articles to Alan Kohler's Eureka Report.  Click on the link below to be taken to this item:
 
Click here to be forwarded to all of Scott's Eureka Report Articles
 
Other Websites of Interest
 

A site we have alerted readers to before was the Index Funds Advisors site from the US.

 

Over the past few weeks they have uploaded onto their site two really useful video pieces:

 

Should you be worried about your investments - presented by Mark Hebner.  It will take up about 35Mb of download but well worth a listen.  The text is also provided on the website if you would prefer to read his comments.

 

Is it different this time? - presented by Weston Wellington - Vice President of Dimensional Fund Advisors in the USA. Weston provides a 15 minute summary including power point slides providing a really useful historical perspective.  The size of the download is 29 Mb but well worth viewing.

 

Recent Updates to the Website
ABC Radio Segments
 
We have updated the site to include two of Scott's most recent segments on Weekends with Warren:
 
4th October - Personal Finance Strategies in the Context of the Credit Crisis

25th October - Mortgage funds / what is happening in investment markets / the NAB & ANZ results

Updated Dimensional Fund Performance Graphs
 

Since our last edition we have updated the Dimensional Fund Performance Graphs page on our website.  The graphs show the performance of the Dimensional funds that we use to build investment portfolios for our clients.  They have been updated to contain data up until the end of September 2008.

 

Commentary:

Unsurprisingly, the graphs show negative monthly returns over September for all sections of Australian and international markets. In particular, the Australian Small Company, Australian ASX200 index and the global Emerging Markets trusts have seen the strongest falls.  It should be noted that the performance of the other international investments, Small Company, Value and MSCI World Index have had moderated falls due to the fall of the Australian dollar - down 7.4% against the US dollar, 5.0% against the EURO, 11.4% against the Japanese Yen and 6.4% against the Trade Weighted Index over September.  The fall in the Aussie dollar exchange rate over August and September has been 15.2% against the US dollar, 8.0% against the EURO, 18.1% against the Japanese Yen and 12.1% against the Trade Weighted Index.

 

Over the long run, the graphs continue to clearly show the existence of the risk premiums (small, value and emerging markets) that the research tells us should exist:

 

Australian Share Trusts - 7 Year returns

 

7 Yr Return

to Sept 2008

Premium over ASX 200

Accumulation Index

ASX 200 Accumulation Index

12.41%

-

Dimensional Australian Value Trust

16.25%

3.84%

Dimensional Australian Small Company Trust

17.27%

4.86%

 

International Share Trusts - 8 Year returns

 

8 Yr Return

to Sept 2008

Premium over MSCI World (ex Australia) Index

MSCI World (ex Australia) Index

-2.67%

-

Dimensional Global Value Trust

3.12%

5.79%

Dimensional Global Small Company Trust

3.36%

6.03%

Dimensional Emerging Markets Trust

9.09%

11.76%

NB - These premiums are higher than what we would expect going forward.

 

Please click on the following link to be taken to the graphs - Dimensional Fund Performance Graphs.

 

For anyone new to our website, it is important to point out that we build investment portfolios for clients based on the best available academic research.  Take a look at our Building Portfolios and Our Research Based Approach pages for more details.  In our view, this research compels us to use the three factor model developed by Fama and French.  In Australia, the most effective method of investing using this model is through trusts implemented by Dimensional Fund Advisors (www.dimensional.com.au).  We do not receive any form of commission or payment from Dimensional for using their trusts.  We use them because they provide the returns clients are entitled to from share markets.

 

However, academic theory is nothing if it can not be implemented and provide the returns that are promised by the research.  Therefore, we like to provide the historical returns of the funds that we use to build investment portfolios.


Please let us know if you have any feedback regarding these graphs by using the Request for More Information form to the right or via our User Voice feedback forum.


 
Requesting feedback 
   

We encourage subscribers to ask questions or make comments either directly by sending an email to our email address: [email protected] or by engaging with our feedback site:

 

Financial Fortnight Feedback Forum

 

After clicking on the link you will be taken to our Financial Fortnight User Voice page.  On that page you will be able to provide suggestions or vote on suggestions that have been made by other subscribers.  By submitting an idea, you enable other users to view your idea and add their vote if they think it is worthwhile.  By casting your vote you are telling us whether you think the ideas are worthy and which ideas should be implemented first.

 
We welcome your feedback. 

 

We hope you have enjoyed reading the latest edition.  If you have any comments or suggestions for future topics please do not hesitate to get in contact.
 
Have a great fortnight!
 
Cheers,
The Two Scotts
 

The Financial Fortnight is a publication of A Clear Direction Financial Planning.  It contains general financial advice.  Readers should check this advice with a professional financial adviser before acting on any of the material contained in this email.

Scott Francis & Scott Keefer
1 Park Road - PO Box 1688
Milton QLD 4064
(07) 3876 6223

A Clear Direction Financial Planning is an Authorised Representative (No. 283723)

of FYG Planners Pty Ltd ABN 55 094 972 540

Australian Financial Services Licensee (No. 224543)

Registered Office: Level 1, 10 Wilson Street Burnie Tas 7320