Long Table – LON (ASX)

We’ve all tucked into an expensive, yet incredibly delicious Maggie Beer ice cream before, and there is no doubt we have all had our share of smashed avocado with a flat white in one  of Melbourne and Sydney’s many respected cafes. Well, an investment in Long Table may offer a chance to profit from these trends.

Long Table has been around for some time, but is only just coming into its own as a ‘House of Brands’. The company is well known for being the 48% owners of the Maggie Beer brand, and recently agreed to purchase the remaining 52% for just $10m as it seeks to ramp up its sales growth. Long Table also owns a number of little- known, but growing brands including Saint David Dairy, which is a micro-dairy based in Fitzroy, Melbourne, and Paris Creek Farms, a bio-dynamic, organic dairy in South Australia. Through these acquisitions and business lines the company has delivered a near fully vertically integrated business model.

Leading the charge is  Laura  McBain, who left her lucrative position as CEO of Bellamy’s Australia, the infant formula producer, to run this fledgling company. Laura is well connected to the Tasmanian agricultural scene and the fact that someone of her experience and stature, not to mention the pay cut, would join a small company like Long Table, bodes well for the future.

As with Webster’s, the company is coming to the end of a period of transition after it appears too little attention was placed on the efficient operation and distribution of the Maggie Beer brand. Maggie Beer’s long-established career offers Long Table the ability to leverage off the respect she has in the public and industry, and the high quality synonymous with her name. The Maggie Beer brand spans various products, focused around home entertainment, including pate’s, pastes, jams, ice cream, and more recently cheese. Interestingly, Maggie’s recent book, a ‘Recipe for Life’, offers recipes that can help reduce the risk of dementia, and are likely to form part of an eat-at-home line to be offered by Long Table in the future.

Alongside Maggie Beer, is Saint David Dairy, located on St David Street in Fitzroy, Melbourne. The area is the heart of hipsters and the branding could not be more authentic. There is a proven trend that hipsters are willing to pay more for authentic products, and the business has been focused on supplying award winner butters, milks and yoghurts to Australian restaurants and independents for some time. Whilst only a small part of the business, the sector and revenue is growing (up 31% in the first half to $3.6m) via the corporate support of the Long Table Group. The gross margin is also strong at 61%. The final business is Paris Creek Farms, located in Meadows and producing a series of milk, yoghurt and cheese for the domestic market. As with  Saint  David,  the  brand is authentic, local and organic, branded ‘food for purists’, as management seek to capitalise on restaurants need to identify the source of their products and consumers wish to support smaller businesses. The company saw revenue fall 6% in the first half, delivered a gross margin of 42% and a loss of $1.8m as they reset their pricing across Australia.

The first half of the 2019 financial year has been a difficult one, involving a great deal of consolidation and corporate activity. Saint David was acquired during this period, Paris Creek was re-branded, and the Maggie Beer purchase was finalised. The highlights came from Paris Creek, which now supplies over 500 stores and has began a rollout with Metcash, whilst Maggie Beer sales are expected to deliver earnings of at least $1.7 to $1.9m. The company announced a $13m capital raise to fund the Maggie Beer acquisition, with only $4.0m being raised placing pressure on the business in the short-term. For the first half Group Revenue was $23.1m, with $11.5m coming from Maggie Beer and $8.0m from Paris Creek. The former produced a profit of $1.482m, the latter a loss of $1.802m and St David $692k.

Whilst the results were not particularly great given the period of transition, the opportunities are substantial  with  a  lot of low hanging fruit available to an astute management team. With 100% of Maggie Beer now owned, management  have  been able to create efficiencies by having these products produced by Paris Farms, reducing input and staff costs substantially. They have also integrated the Maggie Beer sales team into the business who will now expand their product line to include both the other key brands. The Paris Creek brand struggled somewhat due to an ill- fated decision to offer non-standard milk and yoghurt lines, which added cost to production and confused consumers; this has since been rectified. St David, which remains possibly, is also entering a ramp up phase,  with   management   looking   at expansion opportunities in Sydney and expanding their reach of independent stores and cafes and introducing a number of non-milk-based products, like almond and soy, which are part of an incredibly fast growing market.

Overall view

At a market cap of just $35m, an investment in Long Table isn’t for everyone, however, it may offer great returns for those willing to be patient. The company is well capitalised with trade payables of just $4.4m, however Good Will from the purchase of Maggie Beer represents one of the largest assets   at $41m. An investment in Long Table at this point is a bet that the company can ramp up both sales and margins on under  a more professional and experienced management team; with the odds likely in your favour. Given the size of the company, we would expect further capital raisings to be announced as further acquisitions are identified, with a improved cost control likely to see the losses turn into gains sooner rather than later.

The company’s high-quality products, which claim to be Barista approved, are positioned to give the discerning Millennial consumer with the warm feeling that they know the cows producing their milk are happy, or which farms they are supporting. An expansion into non-dairy products, like almond and soy milk, exposes the company to a fast-growing sector that should add to returns. Whilst it may be a while down the road before the company rewards shareholders, it’s a very interesting speculative opportunity  in  the  midst  of  a turnaround.

Webster’s Ltd – WBA (ASX)

With Australia’s water markets a common thread throughout this issue, we would be remiss not to provide an update and our view on one of Australia’s largest water right owners, Webster’s Ltd (WBA). WBA is the combined Tandou entity, chaired by one of Australia’s most experienced business people, in Chris Corrigan, who stepped down from the booming Qube Holdings group to focus on this sector.

At last report, WBA holds just over 150k mega litres of water rights across the eastern Seaboard, but primarily in the Murray Darling Basin; noted by James Dunn as Australia’s largest water region. The group has operations across the east of Australia, including Tasmania, with around 20,000 irrigable hectares of property at any one time under management or ownership. The groups biggest crops are in cotton, walnuts and almonds, with livestock including lambs a growing share of their business. The company has the ability to produce as much as 180,000 bales of cotton each year and currently delivers 90% of Australia’s annual walnut crop (that’s some sort of monopoly). Yet by far the company’s largest asset is it’s substantial water rights holdings which are carried at a book value of $162m on their balance sheet but which many experts believe are worth in excess of $350m at the present time. Given WBA’s market capitalisation is just $545m, the horticultural and agricultural assets nearly come for free to shareholders.

WBA was caught up in a 4 Corners report in 2017 which made allegations regarding the company’s water use, ownership and intentions following the purchase of the Tandou cotton farming properties in NSW and the associated water rights. Such was the coverage of the report that management saw fit to put out a press release, highlighting in their words ‘fabrications’ and lack of research undertaken in this ‘hack job’ by the ABC. Effectively, the reporters and several land owners were suggesting that Webster’s had breached various obligations regarding its use, storage and ownership of water. The company stands by its stated goal, which is to ‘own a wide range of water entitlements…… and convert these entitlements into more valuable horticultural and agricultural products’.

WBA is coming to the close of a period of transition, which began when the company decommissioned the cotton farm operations at Tandou, due to concerns about the availability of water from the Menindee system, and converted the property to livestock farming of lambs. The group also sold another cotton farming property, Bengerang, for $132m in 2018, to a series of private investors and pension funds. This and more recent decisions to purchase further almond and walnut orchards  in  the Riverina district in NSW has seen the company sharpen it’s focus on the region where they have the greatest competitive advantage. For the 12 months ending 30 September 2018, the company remains reliant on the Agricultural division, which included cotton, wheat and livestock, for $153m in revenue and $43m in  profit, and  the  Horticultural  division  delivering $53m and $10m in profit respectively. Unfortunately, comparisons to previous years offer little value to the substantial land sales and change of strategic direction that have occurred.

Whilst some may question the best use of limited water in Australia, there is no doubt that cotton, almonds and walnuts offer some of the great return on  investment for farmers particularly in export markets. The walnut orchards alone deliver  a  profit margin of around 20%, with WBA delivering the second highest yields on record in 2018 and selling prices increasing 17% globally. As with all agricultural businesses, there was some weakness in the 2018 crop due to non-pollination events, however, management’s recent decision to divest a number of non-core properties has allowed them to continue to invest in further plantings, as well as purchase additional and surrounding properties. The company’s walnut operations, which are vertically integrated, are one of the few Australian monopolies still available to investors to take part in.

Where many agricultural investors go wrong, is in over-leveraging their business and not maintaining sufficient diversification of their income. WBA is well placed on both areas, first, their gearing ration is just 28.5% after using the sale proceeds to reduce debt, and secondly, their income is spread across annual crops, like cotton, and perennial crops like walnuts and almonds, which once producing provide a consistent income. This has more recently been complemented by a move to increased livestock capabilities following the purchase of 50,000 hectare property for lambs at Backpaddle. Following the recent transactions, PSP Investments, a global pension fund, own some 19% of the property, and Chris Corrigan himself 13%; this provides important support for further capital raisings and asset purchases.

Overall view

In our view, the change in direction of WBA comes at an opportune time and offers an excellent entry point for investors. The company trades expensively on a Price- Earnings ratio of 30x, however, this is muddied by the combination of a transition year for the companies finances and the fact that some 60% of the companies shares are owned by insiders. Continued improvement in 2018-19 operations, which have been highlighted by management should see earnings grow strongly in the years to come. We believe some level of valuation premium is reasonable given the monopoly position in walnuts and the large water, relatively high security, water entitlements. Outside of BlueSky’s Water Fund, which trades at NTA but offers limited liquidity, WBA is one of the few true water investments left in Australia. We believe the company will continue on its expansion into perennial crops where is has a competitive advantage and is likely to do through further capital raisings. The strategy being undertaken is not unlike that of Harvard Endowment, which has spent many years buying up pristine Napa  Valley  property  in  order  to take ownership of the water located underneath. For this reason, we would not be surprised to see further pension fund interest in the company’s assets. Given Qube Holdings strong turnaround, would not expect someone like Chris Corrigan to walk away to waste time in WBA unless he sees real opportunity in the sector.

It’s a buy for us.

 

Market Update

“A pessimist sees the difficulty in every opportunity, an optimist sees the opportunity in every difficulty.”

Winston Churchill

We thought this quote was appropriate  given  the   position of both geopolitics and globalasset markets, but also when applied to the proposed changes to Australia’s taxation system. There is well-founded concern about the implications of the proposed removal  of franking credit refunds, yet rather than dwelling on the problem, we have been and continue to pursue opportunities both in Australia and around the world. This quote also delves into the heart of our investment approach, in that with volatility comes opportunity, but generally most  people  are too pessimistic or uncomfortable to make what will become the most profitable investment decisions. There is every reason to believe that an inevitable crash will occur at some time in the future, yet this pessimistic view results in inaction or a poorly constructed investment strategy.We thought this quote was appropriate  given  the   position of both geopolitics and global

Franking Credits & Investing for Income

As you would expect, many of our discussions with clients have been focused on concerns surrounding the proposed Labor Party policy to cut the refund of franking credits, which will apply to anyone not receiving an Age Pension. As a first step, it’s important to stress that there is a low probability that markets or individual shares will fall substantially following a Labor party victory. This is due to a number of reasons including:

  • The substantial portion of major Australian shares owned by foreign institutions that already have no use for franking credits;
  • The majority of Australia’s largest investors, particularly institutions and pension funds will still receive the full benefit of the franking credits as a deduction against their income tax, meaning it is unlikely their portfolios will change;
  • The increased involvement of pension funds in what has been the DIY investor dominated preference share sector, with Uni Super’s $200m bid for the latest NAB preference share a perfect example;
  • It is likely to be the major listed investment companies (LICs), which pay investors consistent fully franked dividends by virtue of paying tax at the company rate that feel the brunt of any volatility as opposed to managed funds, which are structured as unit trusts and simply pass the associated income onto the
  • The fact that the Labor Party first must win the Federal Election with a sufficient majority and secondly, require the support of the Senate to pass the proposed legislation.

There is no doubt the implications for those receiving franking credit refunds will be substantial, yet we believe the legislation is unlikely to be approved in its current form with a cap on refunds the more likely result.

The proposed change and concern around income levels has lead us to important discussions around the income needs of investors and the ability to produce the required income in an ultra-low interest rate environment.

Whilst the proposed change will have a substantial impact for some, there is no simple solution to replacing this lost income should the legislation pass. For instance, consider the dividend currently offered from Westpac Banking Corporation shares (WBC), which is around 7.2% before franking credits are applied and 10.3% after. There are very few assets around the world that offer yields of 7.2%, let alone 10.3% without requiring the investor to take on a substantial amount of risk. Potential examples include mezzanine construction debt, unsecured personal loans, highly leveraged property or even Turkish (14%) and Russian (8%) Government bonds. Investments of this risk level are simply not suited those in or saving for their retirement in most cases.

So with an increasing income required to be drawn from superannuation, but lower interest rates, less franking credits and slower economic growth, the question of sustainability has come to a head. Investors can simply not expect to achieve an income of 6, 7 or 9% without either taking an extreme level of risk or giving up either the potential for capital growth, or capital in its own right.

We have always believed that the more appropriate strategy in this environment is for investors to seek total returns, from both growth and income, rather than focusing solely on income. The Australian market will eventually mirror the US, where more businesses reinvest their profits, or undertake share buybacks, and dividend pay-out ratios are closer to 30-40% rather than the 70- 80% they are today. We have already seen the implications of companies paying out the majority of their profits in dividends, becoming akin to a bond or term deposit, whereby their share prices simply stagnate.

At this point it is important for those investing through superannuation to keep in mind that the entire system was set up to ensure that your superannuation balance is withdrawn overtime so that it eventually becomes taxable. It was not intended as an estate planning tool, hence why the minimum pension payments increase regularly as you age from 4% to 5% at 65 and reaching a maximum of 14% in your 90’s. That does mean you should not seek to maximise your balance through sound investing and strategic advice.

Investment Committee Minutes

The Australian reporting season was quite poor, with increasing input and compliance costs crimping profit growth which fell 5.5% for the 136 companies that reported. Yet even as the Australian economy continued to weaken, with GDP growth of just 0.2% and retail sales of just 0.1%, the ASX staged a remarkable recovery, finishing up 10.89% for the quarter. This suggests that investors are willing to pay more for less earnings than were available before reporting season. Every sector in the ASX 200 delivered a positive return with Consumer Staples (5.15%) and Healthcare (6.28%) the weakest. The theme of the season was the increase in ‘capital management’ by boards who announced a substantial amount of special dividends, off-market buy backs and returns of capital to investors. This was particularly so in the mining sector, who after investing at poorly at the top of the market have elected to return capital rather than reinvest in their businesses.

The rally was  spurred  on  by  a  rebound in global risk taking as the US Federal Reserve indicated  it  was  putting   rates on hold, the  Bank  of  Japan  continued its market intervention, the European Central Bank re-commenced its lending program and economists began to predict rate cuts in Australia. The best performing market around the world was the Shanghai Composite (20.09%) after being sold off heavily in the December quarter. Around the world markets are being driven primarily by monetary and fiscal policy decisions, with the latter becoming increasingly important amid a slowdown in global trade. Both the US and China have announced or passed substantial tax reform packages, with various members of the EU and even Australia to follow. The Australian economy remains as reliant as ever on the Chinese to take our exports, with the current 34% under threat following recent bans on coal imports at a number of Chinese ports. It was the Chinese who helped our economy survive the Global Financial Crisis, by spurring the mining boom, they then assisted in the transition to our residential construction boom, but are there any booms left for Australia? The latest GDP figures suggest the growth sector of the economy in 2019 and looking forward will be Government spending, as fiscal policy comes to the fore at a time when the RBA is too worried about stoking house price growth through an interest rate cut.

Looking forward, forecasts for global growth continue to be cut as an overleveraged developed work copes with the threat of an overleveraged or less tan confident consumer and an ageing population. The emerging economies continue to support global trade figures, particularly India and China, but will this be enough? We don’t subscribe to the ‘late cycle’ theory nor the importance of a ‘per capita recession’ in Australia as these are simply economic terms based on backward looking information. At this point, we expect the global economy to keep tracking along at slower than historic levels, but with a great deal of transition and volatility. This was exhibited during reporting season where some 40 companies saw their share price move in excess of 10% when they reported and at least 10 moving by more than 20%. Companies are continuing to adjust to this outlook, with a combination of historically low interest rates, weak productivity gains, ageing demographic and slower economic growth contributing to weak income growth across the world.

We continue to stress the benefit that you have as a self-directed investor, being the ability to control the investment of your capital. You do not need to rush into making decisions, nor do you need to be fully exposed to sharemarkets at all times or forced to invest new contributions into expensive assets as soon as they are received (as is the case with many popular industry funds). You can own any asset you like or hold cash and wait for markets to fall before deploying it

After the worst quarter for markets in close to decade, almost every major  market  recovered strongly in the first quarter of 2019; in fact the S&P 500 posted its strongest quarter since 2009. The ASX 200 rallied 10.9%, supported by the mining (17.8%), technology (20.7%) and communications (16.9%), all of which had fallen heavily in the previous quarter. We also saw a rally in bond proxies including utilities (11.6%), property (14.7%) and industrials (11.7%). Following the trade truce in February, the Shanghai Composite (20.1%), S&P 500 (13.6%), Nasdaq (16.5%) Nikkei (5.9%) and European CAC 40  (13.1%) all delivered similarly solid returns. The performance was supported  by  an about face in central  bank  policy  around  the world, however, the threat of slower growth saw some weakness in  the  final  week of March. The Model Portfolio had delivered an extremely strong quarter, with just three investments delivering a negative return, that being AMP Ltd (-12.03%), Orora Ltd (-2.61%) and the Winton Global Alpha Fund (0.03%). Looking more closely, the Value Bucket (+7.62%) was the standout with its combination of resources, including Santos Ltd (26.90%) and smaller companies, Pengana Emerging Companies Fund (10.08%), benefitting most from the return of the risk on trade around the world. The contrarian Orbis Fund (+7.43%), which seeks highly undervalued companies around the world benefitted from well-timed investments in beaten down sectors, including Facebook and healthcare companies.

The Thematic Bucket  also  performed  well   (+6.22%), with all investments delivering a positive return, but driven by the Asian consumer focused  Platinum  International  Brands Fund (15.14%) as the Chinese Government announced sweeping fiscal and monetary policy. Ramsay Healthcare  (12.96%) reported more strongly than expected, confirming our view that recent weakness was cyclical not structural, whilst the theme focused Munro Fund (6.46%) saw its newest holding, Worldpay, receive a substantial takeover offer. The Income Bucket (+7.11%) benefitted  from  the   perceived   weakness of the Royal  Commission’s  final  report, with investors flocking to the major banks following the removal of uncertainty, ANZ (6.42%) and NAB (4.99%) were the major beneficiaries. Telstra (20.52%) rallied after TPG’s announcement that it would be cancelling the rollout of its  5G  network.  The standout, however, was the franking credit focused Plato Fund (16.27%), which benefitted from record levels of  ordinary  and special dividends announced during reporting season. As expected, the Targeted Return Bucket (2.22%) delivered a positive return, but below that of the higher volatility Buckets, with growth-focused Pinebridge (6.98%) the strongest, supported by an improving Invesco Global Targeted Returns Fund (2.87%). Overall, the Model Portfolio benefitted from the Investment Committee’s preference to invest into what many experts believe to be boring, old fashioned businesses, but which we view as being profitable and exposed to the right sectors of the economy to generate returns in what appear to  be more difficult conditions ahead.

Recession is Coming

“Winter is coming,” says Game of Thrones.

“Recession is coming,” says the US yield curve.

The only difference is that winter – the real-world winter, that is – always comes, at the same time.

Recession, its economic equivalent, is less predictable.

On the most widely-used definition – two consecutive quarters of shrinkage in gross domestic product (GDP), the value of all goods and services produced in the economy – the United States has not experienced recession since the period between the fourth quarter of 2007  and  the  second  quarter of 2009, during which the US economy contracted by 4%.

Australia, famously, has not seen a recession since 1991: of the developed nations, only the Netherlands has avoided recession for longer than Australia.

Recessions represent the trough of the economic cycle, and as such, they usually cause a slump in the stock market – as can be seen in the accompanying chart, which shows the recession and stock market (S&P 500 index) slumps in the US since World War II.

The point is that recessions and stock market corrections (defined as a fall of 10% or more: a correction becomes a “bear market” when the fall exceeds 10%) are common occurrences, but not predictable. They both represent a “known known” in investment, meaning that investors must factor the prospects of each into their investment strategy, and monitor whether they are becoming more likely or less likely.

The chart tells us that since World War II, the average recession strips 1.9% from US GDP; and the average stock market sell-off takes 30% off the value of the stock market.

One of the most widely accepted warning signs is flashing red at the moment: the inversion of the US yield  curve.  When  the interest rate on longer-term bonds actually falls below that of the shorter-term securities, it is seen by many observers as harbinger of an economic slump.

Last week – for the second time this year – the yield on 10-year US Treasury notes fell below the 3-month Treasury bill yield. It had done so in March, too, but only stayed there for a matter of days before the premium for longer-dated debt (the natural state) was restored.

What worried investors at the time was the March inversion was the first such event since 2007 – and we all know now what was coming down the track in 2007.

The US economy is actually showing signs of health at present: economic growth for the first quarter of 2019 was stronger than expected, at an annualised rate of 3.2%. That was  considered  a  surprise  given the headwinds the US  economy  faced: the ongoing  trade  tensions  with  China,  a prolonged government shutdown, and global economic uncertainty.

The strength in US economic numbers continues to surprise. Consumer confidence rebounded quickly once the shutdown ended, and retail sales were robust in March: in fact, retail sales grew in March by 1.6%, their fastest growth rate since September 2017. For the year to March, US retail sales rose by 3.6%.

The jobs market is also posting strong numbers. After lagging expectations in February – when just 20,000 new jobs were initially reported – the US added 196,000 new jobs in March, while the number of Americans filing applications for unemployment benefits dropped in April to the lowest level in almost 50 years.

Those are not recessionary numbers, but investors have to ask themselves, what is the bond market worried about, given the two yield-curve inversions this year?

The US stock market appears blithely unconcerned, with all three major indices (Dow Jones Industrial Average, S&P 500 and Nasdaq Composite Index) either  at, or close to, record highs, as many US companies have reported stronger-than- expected profits for the first (March) quarter.

Of course, investors should not take the insouciant current push to  record  highs  as gospel: this mood comes less than six months after markets panicked in December, rattled by slowing global growth, continuing trade frictions between the US and China, perceptions that the US Federal Reserve was  raising  interest  rates  too  quickly,  US third-quarter economic growth being revised downward, and the unwelcome prospect of a US government shutdown. The 9% plunge in the S&P 500 in December (accompanied by an 8.6% drop in the Dow Jones and a 9.4% fall in the Nasdaq Composite) was almost the worst since the Great Depression of 1931.

The mood quickly turned around, as the Fed reversed course on rate rises and the prospects for agreement in the US-China trade talks improved, but that is the essential point – sentiment can change very quickly in the markets.

Which brings us back to – what is the bond market worried about?

It is worried about high debt levels (government and corporate), and the elevated default risk in the event of any economic slowdown. It is worried about the chances of a full-blown trade war between the US and China – just last week, the US upped the ante, lifting tariffs on about US$200 billion ($286 billion) in Chinese goods to 25%. It is worried about geopolitical tensions, and excessive share valuations in a late-cycle economy.

Should investors be worried? Well, they certainly should be armed with the knowledge that recessions and market slumps happen.

In a long-term investment holding period, an investor will likely experience multiple recessions and market contractions. But these periods pass.

Your investment strategy should always allow for what you do know about how economies and markets behave: there is no excuse, given recent history, for being blind- sided by a recession or a market slump. If you have a strategic asset allocation that progressively moves, through  the  cycle,  to overweight cash and fixed income, and underweight market-linked assets – such that you can be confident that you ride out a market downturn, without drawing-down on assets – you can also be in a position to put money back into the market, somewhere near the bottom.

Amid the gloom of 2007–2009, that opportunity – clear only in hindsight – came about for many investors. We could be close to another such opportunity.

 

 

Interesting Charts

An increasingly common question we receive as financial advisers relates to the valuation of portfolios and how long they are likely to last. As the majority of the people we work with invest through superannuation, due to its tax effectiveness, it’s important to understand the underlying purpose of this investment vehicle.

Superannuation was originally created as a means to fund one’s own retirement, rather than an entity structure through which capital could be passed through various generations. The result of this purpose was the imposition of minimum pension payments that must be made in order to retain the tax exempt status of your super fund. These minimum pension payments increase aggressively as you age, with the intention of ensuring all of your retirement capital is paid out of the tax effective environment and either consumed, or invested in your own name at which point it becomes taxable.

The first chart shows the minimum pension drawdowns applied by the Australian Government, and as you can see, from as young as 80 at least 7% of your fund must be paid out each year as a pension. This naturally has the result of forcing the balance of superannuation accounts to fall each year as funds are withdrawn.

The upcoming election and in particular the proposed banning of franking credit refunds offers a strategic opportunity for investors with pension balances exceeding $1.6m; particularly those who do not require the increasing income that must be drawn from their super fund.

If the Labor Party is successful in passing this proposal, there will be little benefit in retaining funds within the pension phase if these payments are not being spent. In many cases, you may actually be better off reducing your pension balance below the $1.6m cap and thereby reducing the amount of capital that must be withdrawn from the fund each year. This will have limited tax impact, if any, as the franking credits being received are likely to be sufficient to offset any tax bill that may be payable.

Given the early nature of this proposal, we do not recommend any action be taken, but for clients of Wattle Partners, we will be in contact with tailored advice during May

Looking globally…………….

In an example of why we continue to seek more investment opportunities offshore, Avengers: Endgame was released last week and fast became the biggest worldwide movie opening in history, bringing in USD$1.223bn in its first week. The Avenger’s franchise, owned by Marvel (who now sponsor the AFL’s home ground in the Docklands) which has spanned some 21 movies, is owned by Walt Disney Corporation. This is the same Walt Disney that also owns the rights to the Star Wars franchise and recently purchased Rupert Murdoch’s 21st Century Fox businesses. The chart below shows the movement in Disney’s share price in recent months courtesy of Bloomberg:

The Wattle Watch

In any given month, Wattle Partners meets with many different professionals offering a new investment product, idea or scheme. Most are a pass from us, but now and again some pique our interest.  

This month we met with met with Barwon Investment partners about their Healthcare Property Fund but were surprised to learn about their Listed Private Equity capabilities.

With estimates of some $1.2tn in capital committed to private equity funds around the world, there is some concern the market is becoming flooded. In just the last few months a number of Australian equity managers, including Pengana, have launched listed private equity funds that invest into illiquid, unlisted companies. As part of our meeting with Barwon regarding their Healthcare Property Fund, we were surprised to hear about their innovative solution to benefitting from the private equity boom.

What is the fund?

To put it simply, the Barwon Listed Private Equity Fund seeks to invest in listed companies involved in the Private Equity sector. This includes buyout firms, who acquire and then sell companies, private debt providers, who lend to these companies and sometimes take ownership stakes, alternative asset managers, who manage the underlying funds and derive performance fees and finally, private equity backed listed companies. The opportunity set around the world is much larger than we expected, at 950 companies and over $1.7tn in market capitalisation combined across the likes of TPG, KKR, Oaktree, Blackstone and Berkshire.

Barwon have been running this strategy for over 11 years and have accumulated $350m from sophisticated investors and family offices. The fund has delivered a return of 19.8% per annum over the last 10 years and 14.4% per annum over the last three.

Whilst it can be difficult to understand why an Australian fund manager has a competitive advantage in this sector, it seems they are one of very few around the world who have chosen to focus on this area of the market. The fund will invest into just 20 individual companies, based on bottom up stock selection, will not use leverage and offers daily liquidity. They seek to generate a return of 3% over the public markets return and provide full transparency into the underlying portfolio.

The fund is highly diversified, with the largest allocation (36%) to buy out firms or those offering growth capital like 3i Group and Onex. This is followed by private debt provides (20%) like Oaktree capital and Blackrock’s specialist lending company. Next is alternative asset managers (27%) including Blackstone and KKR, providing exposure to the many funds raised and managed by these companies in the last decade. 16% of the fund is then allocated to companies currently backed by PE firms, including Australia’s Cardno and Gentrack Group.

In an environment that is becoming more difficult to generate positive returns every day, we continue to seek out opportunities and specialists who can add value in their areas of interest. It is these groups and people who have built a competitive advantage that are best placed to deliver better than average returns at substantially less risk than listed markets and which warrant further consideration.

5 tasks as 30 June approaches

In the coming months we will be providing detailed recommendations for end of financial year superannuation and tax planning strategies. As expected, the tax reform proposed by a potential Labor Government is creating a great deal of uncertainty, however, our advice remains that investors should not make any major changes based on these proposed changes. This is for several reasons, firstly, the Federal Election is now looking closer than many expected and secondly, the independent parties who will form the Senate have generally been at odds with the franking credit and negative gearing proposals.

There are also concerns regarding the introduction of a flat tax rate of 30% for income generated by a family trust, reducing the ability to distribute income between family members. Again, action should only be taken if this legislation is passed, rather than proactively given the likely capital gains or other tax implications of doing so. Family trusts will remain the second most tax effective entity behind superannuation, particularly following the introduction of the $1.6m superannuation cap, and more so for those earning over $90,000 where the marginal tax rate hits 37%.

As the 30th of June approaches, we suggest all SMSF trustees and superannuants take a closer look at the following:

  1. Contributions

The contribution limits remain the same as 2018, with every Australian able to make just $25,000 in concessional or pre-tax contributions (including salary sacrifice, Super Guarantee and self-made contributions). For anyone earnings in excess of $18,200 (the tax-free threshold) concessional contributions, taxed at 15% within your super fund, represents a great tax saving opportunity.

Australian’s are also eligible to contribute up to $100,000 in non-concessional of after-tax contributions that are not taxed upon entry to your

super fund. For those nearing 65 years of age, the bring-forward rule, allowing you to contribute $300,000 in a single year, may be worth considering. However, given the Coalition proposals to increase the age at which the work test must be met to 66 and 67 in future years, it may be best holding off on utilising the bring-forward rule until after the election, particularly if you are currently 64.

   2.Pension Payments

In return for the tax exemption provided on both the income and capitals of investments held in the pension phase of superannuation (now capped at $1.6m) you are required to draw a minimum amount of your balance each year. The minimum annual drawdown runs across the financial year and is applied to the value of your pension balance on 30 June 2018 for the current financial year as shown in the table below. It is imperative that the minimum is drawn, otherwise your fund may be deemed to be in accumulation phase and taxed applied at the normal rate of 15%.

It’s important to note for those with balances over $1.6m, that the minimum drawdowns will be lower following the introduction of this cap, and also that your balanced can and will likely exceed $1.6m due to the application of earnings, meaning the minimum pension may be higher than the previous year.

Age %
Under 65 4%
65 – 74 5%
75 – 79 6%
80 – 84 7%
85 – 89 9%
90 – 94 11%
95+ 14%

     3.Binding Nominations

With most SMSF tax returns now completed and lodged, it’s an opportunity to make sure you have your estate planning strategy in place and to confirm that any binding nominations, which direct your superannuation benefits to your beneficiaries are up to date and valid. Superannuation remains a non-estate asset, as a result, its payment is controlled by the trustees of the super fund, with a binding death nomination the simplest way to have certainty that it will either be paid directly to your beneficiaries or to your estate. It’s important to ensure any nomination is witnessed by independent people.

    4.Accounting Fees

As with the binding nomination and estate planning review, it’s also an opportune time to take stock of the fees you are paying for the completion of your tax return. Technology has greatly improved particularly in the SMSF sector, which the most anyone should be paying for a SMSF tax return being $2,000 to $2,500 per year. If you are paying more than this, it’s worth discussing with your accountant to work out if there is any way this service can be simplified and achieved at a lower cost.

    5.Portfolio Adjustments

As a non-strategic opportunity, we suggest investors look across their portfolios at this time of year and considering whether they should be making adjustments to their current portfolios. Our approach is the reverse of many, in that we generally recommend cutting back and taking profits on winners, and increasing the losers, where they offer substantial value.