Chris Lee & Partners Ltd

Taking Stock 28 March 2024

DESPITE the memories of the 2007-08 collapse of contributory mortgage funds and finance companies, there are still some 200,000 (estimated) retail investors who accept the retail offers in these sectors.

Several building societies, mortgage funds and a few finance companies continue to attract retail funds, even though similar returns are available from more risk-averse sectors.

Perhaps the building societies could argue that having a local branch and providing a service based on people might be the key point of difference.  Perhaps parochialism is strong in places like Nelson and the Wairarapa.

I cannot fathom what the benefit might be for a contributory mortgage fund (CMF).  These funds have no capital and have no access to the data that the trading banks use when banks choose to not lend. By definition they are lenders to those unable to attract bank loans. Yet the mortgage funds offer little or no rate advantage over bank deposit rates.

Perhaps the users have some sort of resistance to banks.

Use of finance companies is even more mysterious. Very few finance companies offer retail debentures and those that do offer rates less than are achievable from the subordinated issues of the trading banks. For example, ANZ recently issued a security paying 7.6% and likely to be repaid in six years.

Yet the likes of the tiny General Finance, a second-tier lender, is paying around 7.0% for five years.  Figure that out!

General Finance, privately-owned with token capital, is hardly a comparably low risk to an AA-rated bank, even when the bank is offering a subordinated security.

All of this anomalous investor behaviour must have been in the thoughts of the International Monetary Fund when it recommended that the NZ taxpayer should offer guarantees to deposit-taking institutions.

To be clear, there will be no guarantee for CMFs. The lack of guarantee will presumably cause the CMFs to offer high nett rates (lower fees/costs) or to lose any competitive advantage and lose support.

But there is a likelihood, though not a certainty, that small, privately-owned finance companies with the new guarantee will become “as safe as a bank”. There is no certainty, as the guarantee must be subject to an application to the Reserve Bank, which will administer the scheme.

Surely the Reserve Bank will have tough entry conditions.  One such condition must be a credible credit rating from an acceptable credit rating agency. That alone ought to set the tone, yet many will recall how Hanover Finance was rated BB plus, just one notch below investment grade, by Fitch in April 2008, just three months before Hanover’s nett assets were visibly minus $300m, less than 10 cents in the dollar of its published balance sheet valuation.

Credit rating agencies are hardly biblical, in their knowledge.

Today, General Finance has a rating of BB but could be eligible for the taxpayer guarantee if the Reserve Bank accepts any application supported by any level of credit rating.

Remarkably, the current Reserve Bank proposal is to charge the likes of General Finance just 20 basis points on its deposits in return for the Crown guarantee.

I strongly disagree with this pricing. It may yet be lifted. NO private insurer would guarantee a BB finance company’s depositors for 0.2%, or even 2.0%.

To offset the risk of guaranteeing an inherently vulnerable sector the Reserve Bank could impose strict covenants on each finance company applicant, effectively acting as the overseer of management decisions.

My recommendation is that the Reserve Bank should approve such matters as executive salaries, bonuses, and proposed dividends before allowing any of these to be paid. This power would protect investors from the sort of raids that occurred in Hanover, whose chairman was paid just under a million a year, rather more than the chair of any of the banks at that time, and whose shareholders stripped out a $90 million dividend before the company failed.

Equally, Bridgecorp’s Rodney Petricevic paid himself more than bank CEOs. He paid himself A$2m a year to oversee his rotten company, 20 years ago!

I expect the Reserve Bank will approve the covenants pledged by finance companies, will micro-manage the lending of finance companies and will be heavy-handed about all forms of risk-taking, including any mis-matches on the cashflow planning.

In these ways, it may deter finance companies from applying for the guarantee.

There will, of course, be those that do not apply.

Any prospectus or offer from the non-guaranteed should loudly acknowledge that the investor is taking the whole of the risk, rather like the “smoking kills” warning on cigarette packets.

Those that want to chase a living by lending money, but do not want to be micro-managed by the Reserve Bank, might want to consider a model used at wholesale levels, with success.

Such ambitious people could set up a managed lending fund with no capital and pass the whole of the return to the investor, minus a credible management fee (say,1%).  The investor would then receive a credible return for the full risk.

If, for example, the fund specialised in bridging finance, a fair return would be between 11% and 20%, depending on the lending criteria.

The Reserve Bank would not be monitoring such managed funds.  The FMA would regulate such a fund.

What is clear to me is that a finance company with little capital (say, 12.5% of assets), little access to more capital, run by people with imperfect investment histories, should not be guaranteed at any price.

My opinion will not prevail.

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THE Ashburton spud king, Allan Pye, who died last week, displayed the type of NZ business success that is rarely seen outside the rural sector.

Pye, who left school at 14, was a risk-taker, a big user of debt, practical, completely uninterested in overt consumption – and a man who built for himself and his family extreme wealth.

He was a truly productive New Zealander, much more interested in exploiting the mix of soil, rain, labour, and machinery than he was in bragging about flash boats or cars.  A flash tractor was his pinnacle!

He had his first help from the late Allan Hubbard, after Pye had signed up to buy adjoining land but neglected to demand an irrevocable commitment from his bank. When the bank reneged, Pye turned to Hubbard, beginning a multi-decade relationship which made both of the men hundreds of millions, including money made in Tasmania.

It was in Tasmania that Pye displayed his high levels of flexible thinking. He bought dairy land without sufficient due diligence, paid too much, and looked as though he would come a cropper. But he persuaded telephone and power companies to rent a little land to install their towers, generating sufficient surpluses to offset the lower dairy returns he was experiencing because of poor rainfall.

I spent some hours with Allan Pye when I was researching the book I wrote on Hubbard, The Billion Dollar Bonfire.

The two were mates. Pye enjoyed his dealings with Hubbard but with humour noted that it was never a true partnership.

“There was always a little extra for Hubbard,” Pye said, because he who has the cheque book “makes the rules”.

Pye was a quintessential rural New Zealander, a breed of person that most in the South Island would relate to, better than they could ever relate to “the suits of Queen Street”.

Allan Pye was 83 when he died, a true example of a self-made man who achieved his wealth by doing things his way.

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THE astonishing rise in the trading price of bitcoin – a roughly 500% increase in less than two years – has largely been attributed to US financial market regulators.

This year, they authorised the creation of Exchanged Traded Funds which simply buy, sell and hold bitcoin, legitimising bitcoin as an alternative asset suitable for those we might describe as consenting adults.

It is hard to describe bitcoin as a genuine currency but if one just views it as a collectible – no different from, say, Non-Fungible Tokens – then it is reasonable to allow an ETF to specialise in it.

ETFs can buy artwork, rare metals, and old music. Why should they be barred from buying bitcoin?  If consenting adults are allowed to engage in cage fighting, why should they not buy Non-Fungible Tokens?

Those who are committed to the view that bitcoin has a future as a currency will quote its limited supply (21m coins) as an attraction not shared by the US dollar, for example. The US dollar has an infinite supply source, printed in trillions whenever those in authority choose to push the print button. No one should be surprised that major holders of US dollars are looking for currency constraints that do not devalue existing supplies.

I expect those who traditionally have hoarded fiat currencies might welcome an alternative currency. For many years, Russia, China and India have discussed an alternative currency based on a basket of real commodities like oil or gold.

The bitcoin ETF, which has attracted US$10 billion of investor money in just seven weeks, is clearly an alternative asset class for believers.

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WAIKATO’S premier horse stud, founded by Patrick Hogan and based on the amazing sire Sir Tristram, was bought some years ago by the amiable Brendan Lindsay.

Brendan’s history is astonishing.

A Kapiti Coast lad, whose attendance at school was at best random, he was the son of the late Arnold Lindsay, an old-timer who loved his golf, tennis, punts on mining stocks and who himself was more streetwise than academic. He was a golfing partner of mine many years ago.

Brendan’s life changed when he conjured up a coat hanger that varied in colour, each colour representing a different size. From his garage, he produced enough to convince the retail trade, first in NZ, then globally, and by the time he had reached middle age he had sold his company to Americans for a rather stunning $600m.

The purchase of a horse stud seemed logical for the amiable punter. 

Now he is allegedly committing a sizeable sum to a new private equity lending fund which will aim to take lending market share from the banks. 

Many years ago, Taking Stock discussed the global trend of private equity moving away from equity punting and into money lending. It has taken a while for this trend to be noticed in NZ. Private equity lending is subject to much less scrutiny than bank lending.

Lindsay’s investment comes at a time when the banks are again positioning to fend off those who want to disrupt bank intermediation costs.

In NZ for some years our smarter financial market organisations have been offering such lending products to wealthy individuals, touting highly-documented loans at high prices.  Pearlfisher Capital, for example, has returned 15% plus returns, helped in its marketing and governance by Jarden, which zealously guarded its own reputation with investors.

Lindsay is to invest in a fund that hopes to raise tens of millions and intends to lend to NZ businesses which cannot access bank funding. My deference to the banks is explained by the undeniable advantage banks have to relevant data.

A non-bank can ask about a client’s history and can crosscheck with the non-bank’s network.

But a bank knows. It does not have to ask. It knows exactly the behaviour of its clients, their reliability, their income, their spending habits, their weaknesses and, especially, the response to previous setbacks.

The banks’ databases are unrivalled and hard to game.

Private equity lenders often sell themselves as “bank trained”, just as various market commentators seek to establish credibility by referring to themselves as former senior bankers, even if their experience was unimpressively narrow and not highly valued by their bank employers.

I can think of quite a few “ex-bankers” who either have, or should have, spent some time in jail but still sell themselves as “bankers”.

Private equity lending funds will need to perform brilliantly to offset their absence of capital and their lack of data on their clients’ files.

Lindsay, if he remains streetwise, will be getting very specific help in overseeing the loans his money might fund.

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Travel Dates

Our advisors will be in the following locations on the dates below:

8 April – Wellington – Edward Lee

10 April – Auckland (Ellerslie) – Edward Lee

11 April – Auckland (Albany) – Edward Lee

12 April – Auckland (CBD) – Edward Lee

12 April – Lower Hutt – Fraser Hunter

18 April – Tauranga – Johnny Lee

19 April – Hamilton – Johnny Lee

19 April – Christchurch – Edward Lee

Chris Lee

Chris Lee & Partners

Taking Stock 21 March 2024

ABSURD performance fees, hidden charges, monumental executive bonuses, and pursuit of social ideologies are all behaviours that retail investors loathe.

But their level of distrust soars higher when they discover that some people are trading shares in listed companies after receiving company information that others do not have.

You might call this insider trading, or asymmetry of information.

This sort of behaviour dominated the “wild west” era of the 1980s when some of our biggest companies allowed their directors to instruct their superannuation provider to buy shares in companies that the big company was about to take over.

This was not a rare event. There were many listed companies allowing information to be exploited, or misleading the market with cynically ambiguous information for personal advantage. Worse, some such cheats were knighted, feted for their behaviour.

Asymmetry of information was a huge factor in the eventual destruction of public trust. It remains a threat that justifies vigilance.

The laws today offer genuine sanctions, but the subject of ensuring the markets are not disadvantaged continues to be a problem.

The recent provision to the ASX, and the subsequent withdrawal, of key information on Santana Minerals’ gold project at Bendigo, Central Otago, highlights the potential problem.

In this case the drama relates to the ASX’s commendably prescriptive rules about what mining companies may release to the market, to ensure the market is not duped by the self-interested.

The ASX does not want spruikers to feed to the market false signals that might lead to unwarranted ramping of a share price, a common curse in Asia, Canada and even Australia and New Zealand.

The ASX rules on what you may say, and the qualifications and status of who can authenticate company releases, are commendably rigid. They are essentially good rules.

A miner must not release projections of future profitability based on uncertainties, such as the future conversion of “inferred” gold into “indicated” gold.

Directors who lie or cheat go to jail.

That protection is important for all investors.

However, directors can also face the judges if they retain information about the company that should be shared symmetrically with the market but might be known to only a small number of people.

Earlier this year from Santana’s modest prefab field office in Bendigo, Central Otago, came the announcement that Santana was undergoing pre-feasibility studies, using internal and probably external experts to calculate the likely economics of mining its discovered gold at Bendigo, most of which is “indicated” rather than ”inferred”.

To be precise, it had had independent calculations confirm 1.3m of “indicated” gold in just one of its explored areas, and a further 0.9m of “inferred” gold, awaiting more intensive drilling to prove whether its status can be lifted to “indicated”.

In today’s world one would not proceed with a major rock mining project if one had no certainty of the resource being at least one million ounces. The capital costs are extreme. In a high-grade area, the capital costs must be written off over many years from mining margins.

A mine with a million ounces might extract 100,000 ounces a year at profitable margins, providing the grade of the gold was at least a gram a tonne of rock. Santana’s unusually high grade exceeds two grams a tonne so a million-ounce resource makes an attractive mining proposition. By comparison, nearby Macraes mine extracts 0.9 grams per tonne, and is nicely profitable.

Santana therefore embarked on a pre-feasibility study, calculating the costs involved in digging up the rock, processing it, recovering gold, protecting the environment, paying royalties and taxes, and then assessing the likely value of the project for its shareholders.

Fairly obviously, the outcome of the study would be of crucial interest to existing and potential investors in Santana.  If some new investors heard of the outcome of the study and others did not, the asymmetry of information would be highly unfair.

While Santana was doing this work, so were others.

Australian brokers employ analysts who publish their workings. Those reports on Bendigo were published. Their forecasts were bullish, to say the least.

Within Santana’s shareholders are long-term gold investors, retired executives of other gold mining companies, and others with expertise in understanding all the technical data Santana has provided. They, too, have recorded their projections and often share them, for example through social media.

But Santana’s own forecasts are by a distance the most relevant, as there is real accountability for their thoroughness of the work.

Santana’s view on the costs of extracting the gold follows the calculating of mining costs, capital costs and head office costs.  Mining costs involve labour, energy, fuel, transport, and processing. Admin costs might be described as Head Office costs.

Capital costs include the building of the open pit, road building, depreciation on plant and equipment, cost of borrowing, the writing off of exploration costs, and the structures built to preserve the purity of waterways.

I am not sure whether the cost of royalties sits in mining or capital costs but royalties are a real cost, in Santana’s case perhaps reaching 5% of gross production.

Santana’s pre-feasibility study made these calculations and produced an outcome valuing the project at more than $2 billion nett, assuming no further gold-bearing ore would be discovered. Given the licence comprises 270sq kilometres and the proposed mine covers around two square kilometres, the odds of there being no further discovery would be extreme.

So Santana, in my view responsibly, published as soon as it could its findings, ensuring there was symmetry of information in the market.

But the ASX reacted by demanding SMI withdraw its announcement, believing the information might be misleading and would contravene provisions of the ASX rules.

Santana obeyed. It withdrew. It did not agree with the ASX.  It felt it had adopted conservative assumptions – I would say highly conservative assumptions – to ensure its pre-feasibility study was robust. It wanted the market to be fully informed.

Clearly Santana believed it was not spruiking the market and that it was prepared to be accountable for its findings.

As an example of its conservatism, it assumed it might mine only 100,000 ounces a year, while others believe it might extract more than 200,000 ounces.  It used a sale price of around $NZ2800 an ounce when the current gold price is around NZ$3500, 25% higher.

Yet Santana had no option but to withdraw its published study, so it released instead an investor presentation, as it is permitted to do, restating the potential of the project, referring back to the technical data from which investors can draw their own conclusions if they can interpret the data.

Its directors could not afford to be in breach of rules that may be enforced with large penalties, with the ultimate sanction of a criminal charge or even jail sentences.

The tension between anti-spruiking rules and a fully-informed market remains a reality.

What matters most?

Is it more important to have a uniformly-informed market or to apply unthinkingly anti-spruiker rules?

In my opinion, the ASX should have access to a skilled person who could validate Santana’s pre-feasibility study and then, if validated, authorise its publication.

To pretend that the Santana calculations were unworthy and/or improper was balderdash.

Anti-spruiking rules are essential. So is symmetry of information. There ought to be some sort of validation process that identifies spruiking but differentiates those who have zero reason to spruik and are quite prepared to be accountable for their professionalism.

Jail is a fairly strong disincentive. The reputable directors and executives of Santana’s promising project would hardly risk incarceration for fabricating figures.

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AS I discovered recently from a five-day visit to Melbourne for a special family occasion, Australia has some attractive aspects – and some others that are ugly.

As well, it has some rotten soul who transferred his or her lurgy to me.

The ledger I so envy includes a comparatively excellent newspaper, The Australian.  Its penetrating, well-written business coverage comes from people who seem to understand business, discussing the real issues of strategy, comparative advantage, sustainability, innovation, value-add, productivity and risk/return.  There seems to be no pandering to the lowest common denominator. There seems to be no gushy stuff, no gotcha mentality, no attention to those who will never be included in the conversations of decision-makers.

There were no business page articles about making marmalade, home budgeting, shopping around for cheap petrol, nor was there the envy rubbish about other people’s wealth.

Australia and New Zealand business leaders actually read The Australian. The newspaper deserves an hour or so of concentrated reading and helps the debates that investors need to follow.

The good ledger I noted included Melbourne’s motorways.  Pay the toll and you pass over a giant city, mostly non-stop at 80-100kph. What joy.

Its best suburbs glisten.  Sorrento, beside the sea to the east, has a main street of nicely-painted shops, clean footpaths, wide car parks and tidy homes, its council setting high standards. In NZ, perhaps Wanaka is our equivalent, in terms of the tidiness of its town centre.

But there is another ledger which seems likely to divide Australians in the near future.

Its new Federal Climate Change Minister, somewhat of a novice, allegedly has been overheard talking of an imminent plan, as yet unpublished, to ban production of petrol/diesel farm vehicles, like utes.  Clearly he has not been discreet if the wants this plan to be completed behind closed doors.

The biggest participants in its automotive sector say that Ford and Toyota would react by closing their considerable manufacturing plants.

There is no immediate off-setting plan to switch electricity generation from coal or to build the extensive recharging network before the ban begins, allegedly next year.

I expect the protests will include blocking those magnificent motorways.

Anyone believing that Australia is winning its fight to staff its health sector should read this.

The Australian health sector says it has lost 75,000 nurses since Covid, surveys of those nurses describing burnout and patient foul behaviour, such as spitting, punching and abusing.

The average nursing salary of A$83,722 is less than the average salary of librarians, warehouse managers and experienced retail works.  The figures quoted by Talent.com for various categories of wages are (in Australian dollars):-

Nursing – $78,404-109,506

Retail workers - $54,095 - $144,250

Warehouse managers - $60,000 - $120,000

Plumbers - $67,534 - $107,428

Rubbish collectors - $67,755 - $125,000

Librarians - $77,809 - $102,353

Teachers – 85,000 - $145,965

Traffic control - $77,674 - $95,130

Carpenters - $66,567 - $96,600

The Nurses’ Association is calling for an immediate 35% wage rise and wants nurses to receive training so they can perform more of the doctors’ elementary tasks.

Victoria has a land tax, calculated on any land worth more than $50,000 (a boat shed block?), and an Empty Dwelling Tax on any bach or dwelling not demonstrably used for at least 30 days a year.  Of course Australia also has a capital gains tax on virtually all assets.

All of this reveals why comparisons between Australia and New Zealand salaries are nearly always futile.

Investors over-allocating to Australian investments will have to hope that the iron ore price stays high.  Its economy relies on mineral extraction and on consumer spending. There are many obvious signals that stress is rising on households.

New Zealand investors need to be selective when switching to Australian funds.

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THE Oyster property management group is suspending investor withdrawals, selling properties it manages into a stressed market, and producing utterly inadequate cash returns.

Few will be surprised.

Over-leveraged property funds, created to generate management fees during the bullish segment of the property cycle, were doomed to poor performance during the less bullish times that follow increases in debt servicing.

Oyster, like most syndicators, sold a sizzle that had to fizzle out.

Du Val, Williams, Provincia, Augusta and Oyster are all examples of organisations that needed a roaring tail wind to feed their fund managers first and their investor with the leftovers.

Contributory mortgage funds ought to be adjusting, accepting that the 4% to 6% returns they offer are not a fair return for risk.

Contributory mortgage funds have no capital.  They describe as “capital” the difference between the value of their security (a property) and the amount lent.  That margin is similar to what banks retain.  Banks have tens of billions of capital to subsidise any future problems.

I guess the good news to which we should look forward is that growing stress will lead to forced sales and therefore bargain prices, exploited by people with the credibility to borrow to buy.

My expectation is that these new credible buyers will need to share much more of the return, and operate much more leanly, if they are to attract investment money from the public.

Something, surely, has to improve the structure so that these cyclical disasters are less painful.

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Travel Dates

Our advisors will be in the following locations on the dates below:

22 March – Napier – Edward Lee (full)

25 March – Palmerston North – David Colman

8 April – Wellington – Edward Lee

10 April – Auckland (Ellerslie) – Edward Lee

11 April – Auckland (Albany) – Edward Lee

12 April – Auckland (CBD) – Edward Lee

18 April – Tauranga – Johnny Lee

19 April – Hamilton – Johnny Lee

Chris Lee

Chris Lee & Partners

Taking Stock 14 March 2024

Fraser Hunter writes:

LISTED Investment Companies (LICs) have been a key tool in New Zealand share portfolios for decades. The premise was attractive: rather than owning a share in a single company, by using an LIC an investor could access a diversified portfolio of assets across a market or strategy, managed by a team of professional fund managers. 

The concept was even more attractive for fund managers, who raised capital via an initial public offering and were able to invest and grow these funds for the long term without the worry of client withdrawals.  Investors would instead trade amongst each other on the market rather than redeem assets within the fund.

Like a lot of industries, the investment landscape has evolved speedily, with technology, changing preferences and regulation resulting in a new wave of investment options and legacy products and regulators struggling to keep up.

The exponential growth of Exchange Traded Funds (ETFs) has disrupted the traditional fund management industry. One significant trend is the increasing popularity of ETFs, which are known for their low costs and passive investment strategy. This trend has created challenges for LICs, resulting in heightened competition and the need to adjust to evolving market dynamics.

As investor preferences shift towards lower-cost, more transparent investment options, LICs have come under increasing scrutiny and pressure, with many investors perceiving LICs as an outdated, expensive option. This perception has been fuelled by persistent discounts to underlying asset values at which many LICs trade, eating into investor returns.

Offshore, shareholder activism has become more prevalent, with investors voting to shut down funds where they believe discounts may not be recovered, forcing managers to justify their value proposition in a highly competitive market. 

Despite these challenges, LICs continue to hold appeal for certain investor segments, particularly those seeking active management and potential alpha (benchmark outperformance) generation. However, to remain relevant, LICs must adapt to the changing investment landscape, embracing greater transparency, cost-efficiency, and responsiveness to shareholder demands.

LISTED Investment Companies have a rich history in New Zealand and Australia, as well as the UK. In Australia, LICs such as AFI date back to the 1920s and have been listed on the ASX since the 1970s. 

The number of LICs has grown rapidly over the past decade, from 40 to 100 by 2021, driven by investor demand for listed investment vehicles, the popularity of Self-Managed Superannuation Funds (SMSFs), and the desire for predictable tax-efficient income. 

In New Zealand, the Listed Investment Company options are scarce, with the main options being the Fisher Funds products, Kingfish, Barramundi and Marlin, offering managed exposure to NZ Shares, Australian Shares and International Shares. 

Outside of the Fishers products, the remaining NZX listed LICs are predominantly UK investment trusts, City of London, Templeton Emerging Markets, Henderson Far East, F&C Investment Trust, The Bankers Investment Trust, along with Australia’s AFI. 

While the NZX has often expressed a desire to attract LICs to the local market, this has never really taken off. Part of this could be due to relatively high regulatory and listing requirements for our market and not enough demand to attract large fund managers. Local investors already have the option of investing in LICs via the ASX or via investment platforms, as well as alternatives such as ETFs and unlisted managed funds.

Smartshares ETFs have been the NZX’s primary driver of listed fund growth in recent years. Initially, I believed that the Quay Street Funds, acquired from Craigs Investment Partners, might eventually be listed on the Exchange. However, there has been no indication of this happening. 

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INVESTORS entering the market have no shortage of options, the key ones being concentrated or diversified, direct or indirect, active vs passive.

Inexperienced or more modest portfolio holders have been encouraged to grow investments under a fund structure, benefiting from collective size to get access to scale, expertise or market access that may otherwise be too hard or expensive for them to get individually.

Low-cost direct share platforms offer access to global shares, though this doesn’t always result in great outcomes for retail investors. Sharesies’ Kiwisaver product for example, has guardrails to essentially protect investors from themselves, capping individual positions at 5% and requiring at least half the funds to be invested with an approved base fund. 

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LISTED Investment Companies and Exchange-Traded Funds cater to diverse investor needs, with LICs offering active management and potential tax advantages, while ETFs provide diversification and lower fees.

Despite the rising popularity of ETFs, LICs remain relevant for investors seeking experienced management and regular dividends. The unique characteristics of LICs, such as their active management approach and potential tax benefits like imputation credits, attract investors looking for opportunities beyond passive index tracking offered by ETFs. Additionally, LICs often provide access to skilled fund managers who aim to outperform benchmarks, appealing to investors seeking higher returns through active investment strategies.

Investing in LICs can present opportunities as well as challenges, particularly concerning discounts to Net Tangible Assets (NTA). Discounts occur when an LIC's market price falls below the value of its underlying assets, reflecting concerns about the manager's performance or portfolio quality.

Understanding these discounts is crucial for investors aiming to capitalise on undervalued LICs. Factors like management quality, investment prospects, and the discount/premium to NTA play a significant role in evaluating LIC investment opportunities.

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ACROSS the LIC sector, different types of LICs may be impacted by the discount to NAV (Net Asset Value) issue to varying degrees. For instance, as we’ve seen recently, funds holding illiquid assets such as property and private equity can trade at big discounts to (potentially stale) valuations. Funds such as the Fisher Funds typically trade at a discount of up to -6%, at which point the fund begins repurchasing its shares. 

High-quality funds like AFI, the ASX's largest, have historically traded at a premium to NTA (Net Tangible Assets), suggesting investor confidence in the manager's long-term performance and ability to navigate market volatility.

Since Covid, the level of discounts across LICs has widened, with some of Australia's largest LICs trading at discounts close to -25% as of 31 January. The small-cap funds have fared worse, seeing discounts as high as -34%. On average, the LIC market is trading at a discount of -9.3%.

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HISTORICALLY, purchasing quality LICs at a discount has been a favoured strategy among shrewd investors seeking value opportunities. Discounts can enhance yields for income-focused investors and offer opportunities for supercharged returns should the discount be narrowed over time.

However, investors should exercise caution as discounts on LICs may indicate underlying issues, such as poor management performance, portfolio quality concerns, or low liquidity in investments. It is not as simple as seeking out the biggest discount, as there are often valid reasons behind an LIC's discount, from which they may never recover.

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FACED with a discount, investment managers can employ various strategies to close the gap driven by poor performance, market concerns, liquidity constraints, and changes to dividend policies. These discounts can hinder the growth of LICs, prompting managers to implement tools to bridge the gap and improve the health of their business.

One strategy is share buybacks, where LICs repurchase their shares from the market to reduce the number of shares outstanding, thereby increasing the share price relative to NTA.

Another strategy is to provide consistent and growing dividend payments. LICs with stable and growing dividends signal strength in the manager's ability to sustain these payments over the long term and are compelling to income-seeking investors.

Increasingly, managers are considering converting LICs to unlisted and open-ended funds. This structural change can help delist the LIC and convert it into a fund that is not traded on the stock exchange, potentially addressing the discount issue.

The closure of funds within LICs can reflect poorly on the manager, increasingly prompting a role of activism among investors. As shareholders become more assertive in their demands for transparency and performance, the closure of funds signifies a lack of alignment with investor interests and the failure to deliver as promised. This trend highlights a growing emphasis on accountability and the need for LIC managers to demonstrate value and performance that aligns with investor expectations.

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ONE other notable development post-Covid is the removal of adviser incentives, particularly in recommending LICs. This move aims to eliminate commission-based compensation structures which had historically been a key part of marketing LICs.

For LICs, the ‘new’ challenge is to maintain their appeal to investors and advisers without the leverage of sales commissions. Some have the ability to demonstrate the value of their offerings, such as their investment strategy, performance track record, and the quality of their management teams. Others don’t have such advantages to fall back on.

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LOOKING ahead, LICs face significant challenges in the investment landscape, partly due to the emergence of alternatives better suited to modern investor needs and partly due to an overabundance of fund openings leading to industry consolidation.

Poorly governed strategies that fail to serve investor interests or deliver as promised are being scrutinised, leading to discounts, closures, and restructuring. However, there remains a place for active funds that are well-managed and aligned with investor interests, provided they can fulfil their promise of easy access and solid returns.

The shift in Australia towards greater accountability and efficiency is a positive development, underscoring the evolving nature of the investment industry and the importance of meeting investor expectations in a competitive market. It is hoped that similar improvements will be seen in New Zealand's local options.

Investors interested in adding Listed Investment Company exposure to their portfolio, or reviewing existing holdings, are encouraged to chat with one of our advisers.

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Travel Dates

Our advisors will be in the following locations on the dates below:

20 March – Christchurch – Johnny Lee (FULL)

21 March – Napier – Edward Lee

22 March – Napier – Edward Lee

25 March – Palmerston North – David Colman

10 April – Auckland (Ellerslie) – Edward Lee

11 April – Auckland (Albany) – Edward Lee

12 April – Auckland (CBD) – Edward Lee

18 April – Tauranga – Johnny Lee

19 April – Hamilton – Johnny Lee

Fraser Hunter

Chris Lee & Partners Ltd

Taking Stock 7 March 2024 

MORE than a decade after the New Zealand taxpayer watched its Prime Minister Key allow the bonfire of billions, we seem to be determined to do it again.

Any capital market veteran will recall in detail how Key inherited a poorly-designed Crown guarantee system, drawn up almost overnight with no reference to those in the private sector who saw its flaws. The scheme covered privately-owned finance companies, many of which were governed and managed dishonestly.

It was Clark’s government that had approved the design, but it was Key’s government tasked with implementing it.

Arrogance and ignorance characterised the political oversight of the scheme. Frankly, that oversight was of kindergarten standards.

In effect the NZ taxpayers enabled some fairly greedy, self-focused people to transfer wealth from taxpayers to a few score of venal backstreet entrepreneurs.

A Crown guarantee of anything, let alone backstreet finance companies, is a hugely hazardous concept. The risks for guaranteeing highly-regulated banks is very low. The risk of guaranteeing second-tier lenders is extreme.

We tried it in 2008. Bleakly administered by Treasury, and arrogantly overseen, the concept was ruthlessly exploited.

Surely, we would never repeat the mistake.

Well, any day soon, responding to IMF suggestions that we need solutions to combat potential moneylending stress, the NZ Government will introduce a guarantee for all banks, credit unions, building societies, and finance companies that the Reserve Bank monitors and admits into the scheme.

To be clear, if a deposit taker is not monitored and supervised by the Reserve Bank, its deposits will NOT be guaranteed. If we are to have such a wide guarantee the Reserve Bank is our best hope of making a dumb idea work. In effect it will do what historically was done so badly by trust companies.

To qualify for Reserve Bank supervision, deposit takers will have to meet various criteria, though one of the most important - passing a fit and proper person test – has been enforced historically so feebly that those who were identified as “rascals” were barely challenged.

One explanation for the weak fit and proper enforcement is the fear that courts would set a “woke” false standard of who qualifies as fit and proper. Courts favour a second chance option for offenders. Reserve Bank decisions can be appealed. Globally, regulators are wary of courts.

So here we go again.

The rules are being drafted after thorough period of consultation with interested parties. Good minds in the Reserve bank will prepare rules and seek to make a bad idea work.

Readers can imagine who were the most strident in their submissions.

Without doubt the loudest voices were those who would benefit from this guarantee and who would want the guarantee for next to no cost.

At a recent NZ Shareholders Association meeting the owner of one small finance company implored the Reserve Bank to price the guarantee “fairly”, his definition clearly meaning that the price would not reflect risk. His voice should be heard - and ignored.

To impartial market observers the only possible means of pricing a guarantee would be on the basis of risk - higher costs for higher risks.

A finance company, governed and managed by mediocre people, not supported by a strong credit rating, should be paying a high cost for the guarantee, if there is to be a guarantee. I believe there should be no guarantee.

A strongly capitalised bank would clearly pay very little.

In the original 2008 Crown Deposit Guarantee Scheme the banks paid several hundred million for a guarantee that cost the Crown nothing.

In contrast, the non-bank deposit takers paid next to nothing yet cost the Crown billions, though in fairness at least a billion of that cost was sanctioned by goofy politicians more interested in appearances than in detail, Key prominent in the failed oversight.

Why are we now introducing a new deposit guarantee when we all know of the moral hazard of guaranteeing that use of other people's money? Did the IMF insist we had such a tool to avoid market dysfunction?

What was wrong with the Open Bank Resolution which recognised the need for a stable permanent banking sector?

Why would a government, with next-to-no experience or insight into the risks of second tier lending, want to provide a guarantee that no private sector insurer would ever offer?

Think back to 2007 and the private sector insurers.

We had then many ratbag finance companies of which three, Bridgecorp, Capital and Merchant Finance (CMF), and MFS Pacific, enticed the public to invest in their debenture offers by claiming the loans were guaranteed – “no risk”.

Bridgecorp and CMF alleged all their loans were insured by the likes of Lloyds of London, effectively implying no depositor could ever lose. Bridgecorp was allowed by the poorly-led Securities Commission to advertise that Lloyds, with its AAA credit rating, was Bridgecorp’s guarantor.

No sane capital market participant believed such lies.

They knew no insurer, for a fee of one or two percent, or ten percent for that matter, would underwrite second and third mortgages approved by greedy money-lending clowns, chasing higher returns, to fuel paper profits, in turn leading to rapid wealth for those in charge.

What a private insurer might do is to guarantee a rock-solid loan, where the security far exceeded the amount of the loan. Such loans did not exist in third-tier lending houses.

So what happened next was inevitable.

Stupid loans failed. None met the requirements of any provider of a guarantee.

Bridgecorp and CMF Investors lost heavily. They had been duped. The guarantee never existed as advertised.

Clowns went to jail. But compensation for their fraud was minimal.

Investors lost hundreds of millions just to those three “insured” companies.

No sane organisation guarantees high-risk loans.

In effect, the new Crown deposit guarantee will take the risk of underwriting the loan portfolio of money lenders.

Once offered, the guarantee stands, unable to be withdrawn for depositors who were promised a Crown payout.

The Reserve Bank is now going to be asked to guarantee depositors, effectively paying the cost of bad lending by money lenders who will range from skilled and well overseen (most bankers) to wealth-chasing people of variable skills (many finance companies).

Those who want to invest in the lower-tier lending companies would therefore get a return sponsored by the Crown, providing the finance company has been accepted by the Reserve Bank, after meeting what I hope will be stringent criteria.

How absurd!

To minimise the inevitable cost, I have submitted the following: -

1) The cost of the guarantee needs to reflect risk. Second tier lenders with little access to capital represent high risk. Privately-owned finance companies, especially those involved with property lending, should be excluded.

2) The supervisors must have the skills and networks to penetrate the misleading information provided by lenders. (More of this to follow).

3) The enforcement/punishment for cheating must be supported by new laws that strip the wealth and freedom of those who cheat, and those who are negligent or incompetent in overseeing any misinformation, such as directors and auditors. New law must make all the people liable to lose their personal assets including those assets they have redirected to other structures like trusts. The new law fully enforced, simply must disincentivise any owner, director, or company executive who contemplates cheating.

Only with those sanctions, used brutally, would the taxpayer avoid being gamed.

There will always be ambiguity in the information provided but some knowledge of backstreet lenders might mitigate the risks.

A non-bank deposit taker survives only if it has real capital, access to more capital, conservatively managed cash flows, a standby facility from a reputable organisation, a loan book secured by properly valued assets, and a loan book whose duration is matched by the repayment schedules of the deposits that fund it.

The loan book and spread of those lent money is as important as the spread of people who provide the deposits.

SVB, a US bank, went broke last year, to the extreme cost of others, because its deposit comprised a small number of huge depositors (deposits in the billions), all repayable within very short terms or at call. When the rumours began that money was recalled. Insolvency resulted. No bank can survive a day when half of its deposits are withdrawn, as happened at SVB.

A bank has a stable deposit book when it has a wide range of depositors whose savings and deposits are withdrawn predictably.

A bank has a stable loan book if it has a wide range of loans across a carefully chosen range of business sectors, with easily enforced, regular repayment schedules.

A finance company performing bridging finance or property development lending needs a very large capital base, it needs a standby facility to offset delays in repayment, and it needs to generate long dated deposits to cope with repayment delays. Ten-year deposits are hard to entice.

The Reserve Bank will need strict rules about loan rollovers, strict rules that relate to property development loans and bridging finance, and strict rules about matching deposits with loan duration.

Perhaps the Reserve Bank itself should be the supplier of the standby facility that covers up liquidity problems.

If trading banks provide standby facilities to finance companies, the banks would naturally have the right to cancel such a facility when troubles were detected. Accordingly standby facilities can be misleading, even meaningless, as was the case with South Canterbury Finance.

The guarantee system, skilfully administered, would need a large team of specialists in the Reserve Bank, working closely with market veterans to sniff out bad market practices.

Such a Reserve Bank team would be expensive.

The cost should be built into very high guarantee fees for those organisations which present the greatest risk. 

And the fit and proper person qualification must act with zero tolerance of those who have failed before, leaving the public money in their wake.

Is all of this worth the effort? Why guarantee any finance company?

The 2008 disasters showed us that rats get through the tiniest of cracks.

Liars proved to be commonplace, when companies are facing survival.

The controllers - market regulators (the Securities Commission), directors, trustees, auditors, and executives proved to be wholly unable or unwilling to maintain any sort of standards in the years leading up to the 2008 disaster. They escaped accountability.

The investing public were fleeced. The taxpayers were in turn stripped of billions because of the Crown guarantee.

Why are we doing this again?

Guaranteeing a risk with other people's money is a hazard we do not need.

Bring in rules that have unpalatable consequences for those who cheat or are stupid. Let the public choose to price the risk they are prepared to take. Let there be no guarantor, I contend.

Privately-owned second-tier lenders would need to pay high double-digit interest rates in most cases, to match the risks they pose, if the past is any sort of guideline. For the guarantee to be self-funded the guarantee fee might be five per cent or more.  What is the point of this?

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The ANZ Bank’s appointment of the former Jarden CEO Scott St John as its new chairman is a logical and appropriate decision.

St John has had similar roles in organisations like Fisher and Paykel Healthcare and Auckland University.

He is well connected in Auckland, comfortable but not gushy in social circles, carefully wary of media misrepresentation, and oversaw the final part of an era when Jarden moved well clear of others in the capital markets. He had been CEO of Jarden for more than a decade, building a most impressive network.

He replaces the ultimate crowd-pleasing politician John Key, whose unctuous political skills were well developed, and whose corporate media skills were right up there with Labour's Robertson.

St John will bring structure and formality to the role and is unlikely to expose the bank or his opinion to New Zealand’s formal or social media. I expect his engagement with the media to be formal and infrequent.

He is an old school type who prefers to leave idle chatter to others.

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THE Crown’s decision to fast track the approval process for what might be high-value projects has given hope to the likes of the seabed mining proposals offshore of Taranaki and the Chatham Islands.

It might also expedite the consenting of the proposed gold mine at Bendigo, Santana Minerals.

Together these projects promise high levels of revenue for the Crown, and including Bendigo’s royalties & PAYE taxes, could exceed a billion dollars over the first 10 years of its mine.

It seems highly unlikely that any of these projects would be allowed to behave with environmental recklessness.

Providing good standards are policed, these projects have the potential to contribute towards the shortfall in our infrastructural budgets.

Heaven knows we need a very large contribution!

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Investment Opportunities

ANZ Bank New Zealand Preference Shares

ANZ has announced a new issue of Perpetual Preference Share (PPS), redeemable after 6 years (2030), with an anticipated rate to be set above 7.50% per annum (paid quarterly).

Holders of the ANBHA, ANBHB or ANBHC instruments will be familiar with this structure. The ANZ retains the right (but not the obligation) to repay the principal amount on redemption date.

ANBHA and ANBHB have both already repaid, with ANBHC able to be redeemed in 2028.

This new investment will be listed on the NZDX providing investors liquidity on the secondary market, so investors do not have to wait until 2030 if they wished to sell beforehand. Our expectations, based on previous trading trends for bank perpetual preference shares, is that it will likely trade around par value, subject to market conditions at the time.

A presentation and investment document can be found on our website (under current investments).

The ANZ Bank has also confirmed that it will pay the transaction costs for this offer, accordingly, no brokerage will be charged.

The offer closes at 10am tomorrow, Friday 8 March, with payment due no later than 15 March.

Investors interested in an allocation of this new offer should contact us urgently as we are expecting heavy demand for this investment.

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Travel Dates

Our advisors will be in the following locations on the dates below:

20 March – Christchurch – Johnny Lee (FULL)

21 March – Napier – Edward Lee

22 March – Napier – Edward Lee

25 March – Palmerston North – David Colman

10 April – Auckland (Ellerslie) – Edward Lee

11 April – Auckland (Albany) – Edward Lee

12 April – Auckland (CBD) – Edward Lee

18 April – Tauranga – Johnny Lee

19 April – Hamilton – Johnny Lee

Chris Lee

Chris Lee & Partners Ltd