FS Private Wealth Volume 09 Issue 01

The Journal of Family Office Investment

Volume 09 Issue 01

BRINGING IT HOME

Kumar Palghat

Unlisted infrastructure IPIF

Liquidity events Koda Capital

Published by

Real estate Philanthropy Cognitive biases

Get the Advantage.

Partner with CMC Markets.

Easily switch between our two platforms, standard and Pro, offering an extensive range of products available to trade under one login.

Take your client management to the next level with essential adviser tools, analyse your clients’ portfolios with ease using external data feeds and an excel add-in for our Pro platform.

Our comprehensive trading solution means there’s no better choice for client management. Find out more at www.cmcmarkets.com/en-au/partners.

Advantage platform

International Shares

Online Options

Adviser tools

Seek independent advice and consider the relevant Terms and Conditions at cmcmarkets.com.au when deciding whether to invest in CMC Markets products. CMC Markets Stockbroking Limited (ABN 69 081 002 851 AFSL No. 246381).

Contents

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

1

COVER STORY

BRINGING

IT HOME Kumar Palghat, KP4

16 VANTAGE

POINT

26

The drought and bushfires have already raised the likelihood of a negative first quarter 2020 for the Australian GDP and COVID-19 guarantees a second negative quarter, putting the economy in a technical recession. Benjamin Ong writes.

HIGHLIGHTS Featurette Buying a boat

13 IN THIS ISSUE A NEW RECORD LOW FOR AUSTRALIAN RATES

27

All eyes are on the Reserve Bank of Australia, as it pushes the official cash rate to 25 basis points and sets about quantitative easing for the first time in its history.

CHINESE ECONOMIC ACTIVITY SLUMPS

22

27

The China Manufacturing Purchasing Managers Index (PMI) slipped to 35.7 in February in a new record low and significantly lower than market expectations.

BANK OF MUM AND DAD

Featured fund manager Flexstone Partners

27

The fifth largest home lender in Australia, is surprisingly not a small regional bank or a credit union

Whitepaper Wealth after liquidity events

30

but Aussie parents, who put an average of $73,522 towards their children’s home purchases.

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

2

Contents

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

05

A NEW FAMILY OFFICE ON THE BLOCK Christopher Page, managing director, Financial Standard Last year, Kumar Palghat tendered his retirement at Sydney fixed income boutique Kapstream Capital after 30 odd years in investing. He has since turned his attention to his family office and we’ve got the details.

Published by a Rainmaker Information company.

A: Level 7, 55 Clarence Street, Sydney, NSW, 2000, Australia T: +61 2 8234 7500 F: +61 2 8234 7599 W: www.financialstandard.com.au Associate Editor

06

Samantha Sherry samantha.sherry@financialstandard.com.au Graphic Designer

07

Jessica Beaver jessica.beaver@financialstandard.com.au Technical Services Roger Marshman roger.marshman@rainmaker.com.au Advertising Stephanie Antonis stephanie.antonis@financialstandard.com.au Director of Media and Publishing Michelle Baltazar michelle.baltazar@financialstandard.com.au

News

CRESTONE CELEBRATES $100M WITH HIRES PENDAL FAMILY OFFICE LEAD MOVES HARPER BERNAYS HIRES PM

Kanika Sood kanika.sood@financialstandard.com.au Production Manager

Welcome note

News

IMF ASKS GOVERNMENTS TO STEP UP INVESTING GIANTS EXPECT CRISIS SYDNEY MORE EXPENSIVE THAN DUBAI

10

12

News

SOPHISTICATED INVESTOR DEFINITION EVOLVES NETWEALTH DRESSES UP FOR HNWS News

AUSSIE MINI-NASDAQ IS HERE ADVISERS KEEN FOR THE NEW INDEX

Managing Director Christopher Page christopher.page@financialstandard.com.au

FS Private Wealth

The Journal of Family Office Investment ISSN 2200-4971

16

All editorial is copyright and may not be reproduced without consent. Opinions expressed in FS Private Wealth are not necessarily those of Financial Standard or Rainmaker Information. Financial Standard is a Rainmaker Information company.

Cover story

BRINGING IT HOME Kumar Palghat, KP4 Palghat shares how he is taking his picks, as turns his energies to managing his family’s money after a long career in fixed income investing.

ABN 57 604 552 874

Subscriptions hotline:

1300 884 434 Ask about our PLUS DEALS

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

For more news and updates, visit www.fsprivatewealth.com.au

FS Private Wealth

CURRENTLY DISTRIBUTING *RETURNS MAY VARY

Our difference. > A strong track record in commercial property.

Diversify with a specialist.

With our strong track record and our

> Commercial business precincts are what we specialise in. > A quality approach that’s focused on delivering long-term, sustainable income for our investors. > A brilliant combination of responsive management and flexible leasing.

team’s experience in this niche market over the last 35 years we created this open-ended Fund, specifically to extend our specialised investment offering to a broader range of investors

> We don’t just manage the Fund. We’re also invested in it.

in a way that is more flexible and more sustainable into the future.

To learn more about this unique investment opportunity and what sets Stronghold apart contact us today.

Visit sppfinvest.com.au Call 1300 148 971

*OPEN TO WHOLESALE INVESTORS ONLY. This summary is intended to provide general information only and has been prepared by Foundation Funds Management Limited ACN 623 977 122, AFSL 508424* (“we”), without taking into account any particular person’s objectives, financial situation or needs. Investors should, before acting on this information, consider the appropriateness of this information having regard to their personal circumstances. We recommend investors obtain financial advice specific to their situation before making any financial investment decision.

4

Contents

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

WHITE PAPERS

30

Taxation and Estate Planning

WEALTH MANAGEMENT AFTER LIQUIDITY EVENTS

By Sean Abbott, Koda Capital This whitepaper breaks down wealth management and estate planning considerations for Australians who have just sold a business.

38

Ethics and Governance

COGNITIVE BIASES IN ETHICAL DECISION-MAKING

By Paul Sills, barrister and mediator If you never got around to reading Daniel Kahneman’s classic Thinking Fast and Slow, this author explains succinctly how to rid your decision-making of cognitive biases.

44

Investment

IMPACTS OF CORONAVIRUS

By Chris Kushlis, T. Rowe Price This paper takes a preliminary look at the near-term impact of the coronavirus on various asset classes, and assesses the likelihood of a post-economic rebound compared to the 2003’s SARS outbreak.

47

Investment

UNLISTED INFRASTRUCTURE ALLOCATIONS

By Nicole Connolly, Infrastructure Partners Investment Fund How does unlisted infrastructure stack up against other asset classes? This whitepaper compares the risk-return profile and examines the structure, performance and asset valuation criteria for infrastructure funds.

51

By Caitriona Fay, Perpetual Fay draws upon her network of philanthropy leaders to make the case that funders should cede the role of ‘expert’ to the organisations they fund.

66

WHY SUSTAINABILITY MATTERS IN REAL ESTATE

By Chris Nunn, AMP Capital ESG has come a long way in Australian buildings. This whitepaper explains the real estate sub-sector’s journey and the road ahead.

Philanthropy

BEST PRACTICE PRINCIPLES IN PHILANTHROPY

Investment

57

Investment

THE RUPEE AS A DIVERSIFIER

By Mugunthan Siva, India Avenue Investment Management Many Australian investors only have exposure to AUD and USD. But the Indian Rupee can provide low correlation to AUD, and a hedge against falling commodity prices.

62

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

Investment

CRM SYSTEMS AND FINANCIAL ADVICE

By Dylan Navra, Praemium Asia Advisers must look beyond the traditional back-office systems that only store contact information, create a single view of client holdings and monitor remuneration.

FS Private Wealth

Welcome note

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

5

Christopher Page managing director Financial Standard

A new family office on the block no secret that Australia’s rich don’t like to disIt’scuss publically how they save or splurge.

But every once in a while, Financial Standard comes across someone willing to share their hits and misses when it comes to investing their family money.

We got a taste of this last year, when David Orford showed us, down to individual funds and service providers, how he invested his $73 million payout from selling Financial Synergy to IRESS. In this edition, we are back with another such story from Kumar Palghat.

Palghat is well recognised in Sydney’s funds management circles, first as the PIMCO portfolio manager who set up the global giant’s Australia Pacific operations, and then as a co-founder of Kapstream Capital, from which he announced his retirement last year.

But perhaps not many outside his immediate coterie are aware that he turned his focus to family office investing last year.

Palghat speaks candidly about how he is taking his investment picks, where Vanguard ETFs have stolen the cake from active equities managers.

He also touches on succession planning for his family office, caveats of being a dual citizen – and some simpler joys that come with looking after your own money, like watching Netflix in workhours and installing a ping pong table in the office.

“There’s no shortage of people selling ideas or

wanting to manage my money. I can have a coffee four times a day because everyone’s got something to sell,” Palghat says, referring to fund managers and private banks.

If you, like Palghat, plan to sell your business eventually, our whitepaper section includes insights from Koda Capital on how to manage liquidity events after a sale.

This edition would be incomplete without acknowledging the human impact of two catastrophes in the recent months: the bushfires in Victoria and New South Wales, and the threat of coronavirus across the world.

While most economists pegged only a small dip in our GDP to the bushfires, the coronavirus (or COVID-19, per its official name) is already making its economic impact felt at the time of writing.

The Reserve Bank of Australia and other central banks have cut rates and are rolling out quantitative easing programs while governments announce fiscal stimulus. Institutional investors and their advisors are predicting a recession with discernibly more conviction than in the recent years.

And so, we have included a whitepaper on the topic, with global investing giant T. Rowe Price sharing its outlook for equities, fixed income, and currencies.

Happy reading, stay safe, and see you in the next issue. fs

While most economists pegged only a small dip in our GDP to the bushfires, the coronavirus is already making its economic impact felt.

Christopher Page managing director, Financial Standard

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

6

News

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Crestone bolsters team Elizabeth McArthur

C New role for boutique manager A Sydney firm that manages money for family offices and highnet-worths has hired a portfolio manager from Discovery Asset Management which shut shop last year.

Peter Moller joined Harper Bernays, which describes itself as one of Australia’s “oldest and most discreet” investment management firms.

Moller was most recently a director at Discovery Asset Management for five years, where he covered industrials, consumer discretionary stocks, healthcare and materials.

Prior to this, he was a senior analyst/portfolio manager for QIC’s Australian small companies fund for six years.

Discovery Asset Management shut down around June 2019 as its co-founder Stuart Jordan decided to retire and a superannuation fund yanked back a mandate, the AFR reported.

Discovery was not the only boutique manager to shut shop last year.

At least eight boutiques indicated intention to close in 2019, including Denning Pryce, Sigma Funds Management and Mhor Asset Management while Melbourne long/short manager ARCO wound up its funds after being abandoned by its family office backer. fs

The numbers

80

Size of Crestone’s team, as at January 14.

restone Wealth Management started the year with eight new appointments, bringing its team to 80 in mid-January.

The firm said the hires reaffirm its commitment to high-quality professional advice in the high net worth and ultra-high net worth client segments.

Paul Shalhoub, Duane O’Donnell, John Taylor and Elliott Greenberg were appointed as investment advisers in Crestone’s Sydney offices.

Shalhoub joined Crestone from Commonwealth Bank of Australia, where he was an executive manager in the private banking business. Prior to that, he spent eight years as a director at UBS. O’Donnell, Taylor and Greenberg were previously relationship managers at Credit Suisse Private Banking.

Later in 2019, Rachel Etherington joined from a Sydney-based family office as a sustainable investment adviser. She is also a non-executive director of Future Super.

Jaime Sanqui also joined Crestone’s Melbourne office from a previous role as investment adviser with CBA Private Office.

Finally in December, Greg Tripis joined as investment adviser from a senior investment adviser position at CBA, along with Nick Mandie who was a private client adviser at Ord Minnett.

Mandie is also the founder of Koala Kids Foundation, a charity that supports children with cancer and their families.

Crestone head of advisory Michael Tritton said: “Delivering the best investment-led offering for clients was instrumental; a focus on client outcomes, an owner-operated partnership, a well-resourced CIO team, some of the best strategic relationships, alongside truly global investment opportunities and a strong governance pedigree really made Crestone an exciting choice for these advisers.”

Crestone head of advisory for Victoria Adam Ginnivan said: “It is a testament to our business model that Crestone can attract advisers of this calibre.”

“Each was looking for specific qualities in their next business opportunity.

Crestone was able to clearly demonstrate these attributes, making the decision to join us an easy one.” fs

Pendal family office head moves to boutique Kanika Sood

Pendal’s head of family offices moved to Phil King’s alternatives house Regal Funds Management as the latter restructures its distribution team.

Rob Saunders has taken on the role of Regal’s head of wholesale and family office, including the private banks, starting on December 2.

The move comes as Regal restructures its distribution efforts to a channel or segment focus.

As a part of this its distribution head Aidan Kelleher left the company.

Saunders was at Pendal for seven months as the head of private bank, broker and family office distribution. Prior to this, he was equities boutique Ophir Asset Management’s head of sales for about three years.

He is not the only one to leave Pendal for Regal in recent months.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

In October, Rebecca Fesq left as Pendal’s head of client experience and direct after five years in the role to join Regal as its global head of distribution and marketing.

Regal is best known as a long/short equities manager and is one of the few that can take short positions in small caps.

It has been expanding its remit to add other alternative investments, such as its recent venture with Gresham Partners to launch a resources royalties fund.

The Gresham Resources Royalties Fund (GRRF) has a capacity of over $150 million.

It is managed by Gresham Royalties Management Pty Limited, of which Regal, Gresham and the two principles own a third each. The principles are James Morrison and Simon Klimt, formerly of Barclays. fs

FS Private Wealth

News

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Sydney more expensive than Dubai

IMF says virus fallout worse than GFC

Sydney is more expensive than Dubai and has the world’s priciest business-class flights but bestvalue luxury shopping, says a new report.

Sydney came in as the 15th most expensive city in the world, ahead of Dubai at 17 in Julius Baer’s Global Wealth and Lifestyle Report 2020.

It is the world’s most expensive city to fly out of business class and to get laser eye surgery in.

A large number of items hover around the global average.

But its rich enjoy the best deals on luxury watches, jewellery and hotel suites at home. These can be a fifth of the price of the most expensive city on the list, Hong Kong.

When it comes to property, Sydneysiders pay just over the international average.

“Tight lending conditions had taken the heat out of the market but more accommodative policy could see an uptick in 2020,” the report said.

Sydney, alongside Vancouver and Frankfurt, were the three cities with the best value on eight luxury items: watches, women’s handbags and shoes, jewelery, men’s suits, fine wine and beauty services.

Sydney’s luxury goods market is growing at about 3% a year and amounts to about US $5 billion a year, according to Satista Consumer Market Outlook cited in the report.

The report ranked 28 cities based on how expensive they were. Overall, Hong Kong, Shanghai and Tokyo took the first three spots. Sydney was near the middle.

Julius Baer is a Swiss wealth manager, with a presence across the world. fs

T

FS Private Wealth

Eliza Bavin

The quote

The economic impact is already visible in the countries most affected by the outbreak.

he International Monetary Fund has called on every government around the world to introduce substantial targeted policies to support the economy through the coronavirus epidemic.

In a blog post, Gita Gopinath, economic counsellor and director of the research department at the IMF, warned that the coronavirus outbreak is different from past issues.

“This health crisis will have a significant economic fallout, reflecting shocks to supply and demand different from past crises,” Gopinath said.

“The goal is to prevent a temporary crisis from permanently harming people and firms through job losses and bankruptcies.”

Countries’ measures like travel restrictions and quarantines to deal with the virus when there is no vaccine, have bought valuable time to avoid overwhelming the health system but have damaged the global economy, she said.

“The economic impact is already visible in the countries most affected by the outbreak. For example, in China, manufacturing and service sector activity declined dramatically in February,” Gopinath said.

7

“While the drop in manufacturing is comparable to the start of the global financial crisis, the decline in services appears larger this time – reflecting the large impact of social distancing.”

She also pointed to the devastating effects on the global supply and demand for dry bulk shipping stocks, like building materials and commodities.

Gopinath said the effects are similar to during the most acute phase of the global financial crisis, reflecting curtailed economic activity associated with the unprecedented containment effort.

“This drop was not seen in recent epidemics or after the 9/11 attacks,” she said.

“Since the start of the recent US equity market selloff on February 20, 2020, airline stock prices have been hit disproportionately, in line with the post-9/11 terrorist attacks but lower than after the global financial crisis.”

In response, the IMF said central banks must be prepared to provide “ample liquidity” and banks and nonbank finance companies.

The fund also called on governments to offer temporary and targeted credit guarantees for the near term liquidity needs of financial institutions. fs

World’s largest investors expect crisis Kanika Sood

More than half of the world’s biggest money managers think another GFC will strike soon yet they don’t plan to fiddle much with their asset allocations in 2020, according to a new survey of 500 institutional investors.

Natixis Investment Managers surveyed 500 institutional investors globally and found that the highest proportion of them (58%) are expecting another global financial crisis in the next one to three years. A further 20% think the financial crisis could arrive in four to five years.

About 5% think next year will be the year the markets melt. Only 6% each think we have still got 10 years or no chance of a GFC.

Despite the bearish outlook, instos plan to leave their asset allocations on hold.

Why the mismatch?

Natixis said it could be simply because stocks are expensive and bond yields are low – leaving them no alternative places to invest.

“The most likely rationale for staying put is simply the direct conflict presented by an aging bull market for equities and an extended low yield environment for fixed income,” Natixis said in the report.

Natixis said the allocation to fixed income will fall slightly over the next year (39.1% to 38.7%). So will equities (36.5% to 35.8%), while alternatives will pick up slightly (from 17.5% to 18.7%). fs

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

8

News

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

The mandate playbook There’s a new trick in institutional investors’ playbooks, which high-net-worth investors could borrow to keep their fund managers in line.

The instos are now very willing to spark unplanned reviews of their external fundies if there is a data breach or cyber security threat at the latter’s systems, says CoreData after surveying 117 institutional investors around the globe.

Such an event had a 57% chance of the institutional investor putting a fund manager mandate on the red list.

This was the same likelihood as an increase in fees (57%) and was deemed more important than a change in fund manager (54%).

“Cyber-security and data protection is gaining importance among institutional investors. They are classing cyber security or data breach to be as significant as an increase in fees and a greater cause of alarm than a fund manager change, when considering whether to review a mandate,” CoreData said.

Other factors that were likely to trigger a manager review were style drift (50%) and a substantial swelling or drying of the assets in the strategy (42%).

Surprisingly, institutional investors were not spookedout by bad press stories on their mandated managers.

Unflattering press coverage only had a 37% likelihood of landing a manager in an external review.

They are also willing to put up relative underperformance, with a 32% chance of a review after three quarters of consecutive underperformance.

So when is the last time you grilled your fundie about their cybersecurity? fs

Mining billionaires sell Coolabah stake Kanika Sood

M The numbers

$116m Estimated valuation of Coolabah.

ining billionaires, the Bennett family, have offloaded their 25% stake in Christopher Joye’s credit boutique Coolabah to ASX-listed Pinnacle Investment Management.

Pinnacle is paying $29.1 million for the interest, which values the boutique at north of $116 million.

An extra $5 million is subject to Coolabah hitting certain milestones over the next 18 months to four and a half years.

The interest is changing hands from the Bennet family’s private investment business AMB Capital Partners to Pinnacle.

Following the completion, Coolabah will be owned 75% by its investment team and 25% by Pinnacle.

Pinnacle will be one of the distributors for the boutique.

Coolabah Capital Investments manages about $3.3 billion. Roughly 20% of this is on behalf of industry funds, while the remaining is for retail (in-

cluding its Smarter Money Investments brand) and smaller institutions.

“Partnering with CCI is totally consistent with Pinnacle’s strategy. We regard Chris and his team as highest quality in their field who have delivered consistently outstanding results for their clients by generating alpha from liquid, high-grade credit,” Pinnacle said in a statement.

“Furthermore, more than 90% of the FUM is subject to performance fees providing strong alignment with clients,” Pinnacle said.

In July, Coolabah took full ownership of Smarter Money Investments (which had $1 billion in funds under management) as it bought back Yellow Brick Road’s 50% stake in the business.

Pinnacle is funding the purchase via a facility from CBA. Berkshire Global Advisers acted as the adviser to Pinnacle.

Pinnacle has since added a new Asia macro boutique, from a former Morgan Stanley investor. fs

How Magellan got to $100 billion Here’s a fun fact as Magellan asset management crosses $100 billion. The Aussie powerhouse is raising a growing slice of its money overseas.

Magellan reported its total funds under management as $104 billion at the end of January.

Just one year ago, this number was about $73 billion.

“We are not believers in chest beating. The markets can be humbling...next month we could be under that if they don’t go well,” Magellan general manager of distribution Frank Casarotti told Financial Standard.

“No one here is doing high fives or [popping] champagne corks. To put it bluntly, we are just getting on with it.”

Analysis of Magellan’s FUM from Rainmaker shows that it is increasingly raising its money from overseas investors.

Casarotti confirmed this, adding that most of its institutional investors are from overseas.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

It’s a shift that started in late 2011, when Magellan picked up UK wealth manager St James Place as a client. It’s still a client and in fact, Magellan’s biggest insto one, Casarotti says.

Performance has helped: Magellan remains the top performing global equities manager in Australia on 10-year returns even though smaller shops such as Hyperion and Aoris have excelled in shorter-term performance.

The swelling funds under management and robust returns have come with a good bottom line. Last year’s, MFG reported NPAT of $377 million, up from $212 million last year.

And Magellan has had a few firsts on the way: it worked out how to list an active ETF without giving away its stockholdings for free, it front-ran Treasury’s current scrutiny into adviser/broker commissions on LITs and LICs last year and has been working on a retirement product. fs

FS Private Wealth

News

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

9

Rich lister backs new boutique

Geared super funds hit jackpot

Glen Holding’s Channel Capital has signed on a new boutique that is backed by former Swisse Vitamins boss Radek Sali.

The Impact Fund has three former Goldman Sachs investors at the helm and will invest in infrastructure and real estate opportunities that are focused on making a positive impact.

The fund is targeting 7% to 11% per annum in returns, with a distribution yield of 6%. Channel did not disclose the fees.

Current investments include aged care, affordable housing, behind-the-metre solar and a social impact bond.

It opens to wholesale and institutional investors in 2020 and had raised about $40 million at December last year in a friends and family raise.

The boutique has backing of Light Warrior, an investment firm set up by Radek Sali after Swisse Vitamins was sold to a Chinese firm about three years ago. Sali, in November, made an appearance at the Financial Planning Association’s annual Congress in Melbourne.

Crossing over from Light Warrior is former Goldman Sachs investor Matthew Tominc, as the new boutique’s investment chief.

He is joined by Alex Debney, formerly of Maquarie’s real assets and infrastructure business and Goldman Sachs.

The investment committee is chaired by Adam Gregory, also formerly of Goldman Sachs, with new appointments to follow in the New Year. Channel’s Andrew King will take on the distribution of the new boutique. King said it will start by pitching to wholesale and institutional market, with plans of eventually getting it on platforms and to advisers. fs

F

FS Private Wealth

Harrison Worley

The numbers

68.6%

One-year return of a geared superannuation fund from CFS.

ancy nearly 70% returns from your retirement savings in a year?

That’s what some geared superannuation funds delivered in 2019 for investors adventurous enough to dial up the risk.

According to new Rainmaker research, the top 10 geared retirement and superannuation funds achieved returns in excess of 50% in the 12 months to November 2019, as a bull run in financial markets and fortunate timing propelled funds with additional financial exposure to the top of the performance tables.

Colonial First State options took out the first eight positions in the top 10, with the wealth manager’s FirstChoice Wholesale Pension Geared Share option achieving a 68.6% net return for the 12 months to November.

On a three-year basis, the fund returned 29.7%.

According to Colonial First State’s website, the fund achieved a 61.75% return for the 12 months to 31 December 2019. Additionally, CFS’s data also shows its Colonial First State Wholesale Geared Global Property Securi-

ties option registered a 69.55% return over the same period.

The first non-CFS option to feature in the top 10 was Suncorp’s Brighter Super Pension Perpetual Wholesale Geared Australian Share option, which returned 52.1% and 20% across the one and three year timeframes.

Rainmaker head of superannuation research Jason Ross described the results as “fairly spectacular”.

“Geared funds provide a far higher risk for investors. During bull runs these returns are exponential, essentially resulting in a compounding effect,” Ross told Financial Standard.

However, Ross warned against getting too excited by the results, noting that during corrections or bear markets geared funds experience extremely low returns, with their negative returns also compounded.

“These performance figures are for a particular point in time corresponding with a correction in financial markets that occurred in the fourth quarter of 2018 following trade tensions between the US and China, and the fourth quarter of last year, which saw a bull run in financial markets,” Ross added. fs

Bob Sahota’s boutique launches second fund Kanika Sood

Bob Sahota’s private debt boutique has raised $100 million for its second fund with a Sydney superannuation fund onboard again as an investor.

The Revolution Private Debt Fund II follows the boutique’s inaugural fund which raised $200 million and had Australian Catholic Superannuation and Retirement Fund and Catholic Super as investors.

ACSRF is back again with an investment in the new fund. Other investors are understood to be private banks, not-for-profits and HNWs. Fund II will have the same strategy and return profile as the original one.

But this time, the boutique and its distribution partner Channel Capital have opted for an openended vehicle and will remain open to quarterly applications for new investors.

It is offering the fund in two versions, one for institutional investors with a one-year lock in period (Fund I had a three-year lock in) and six-month redemption windows, and for wholesale investors who will have quarterly redemption windows.

The original fund is now fully invested with investments in Australia and New Zealand leveraged buyout debt, private and some public asset-backed securities and commercial real estate debt.

Channel Capital started raising for the second fund late last year and hit $100 millon at December 31.

Revolution Asset Management was launched in late 2017-early 2018 by Bob Sahota, Simon Petris and David Saija.

Sahota was previously the head of fixed income at Challenger, managing $9.3 billion for Challenger Life Company and Australian superannuation funds. fs

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

10

News

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Netwealth taps HNWs

Money doesn’t make you sophisticated

Harrison Worley

Netwealth is looking to take advantage of growing demand among high net-worth and private wealth investors for sophisticated platform offerings, with plans afoot for the launch of a premium product in the coming months.

The $28 billion platform is set to launch a new “Premium” offering within its flagship accelerator range for high-net worth, private wealth and sophisticated investors, as it continues its shift towards a user-pays model.

Speaking to Financial Standard, Netwealth managing director Matt Heine said the platform was focused on ensuring it had a range of user-pays options available on the platform, from those suited for “low sophistication” investors to more intricate offerings for the likes of high-net worth clients.

“With all the change going on in the industry at the moment and a real focus on best interest, we’ve been very focused on moving towards more of a user-pays model when it comes to building the platform and the different product options available,” Heine told Financial Standard.

Heine said a big part of that is ensuring a solution exists for clients with simple needs looking for a lower cost product.

“And at the other end of the extreme where we’re working increasingly with high net worth and private wealth groups, we’re able to offer a range of services that aren’t generally available in the industry, such as bonds, international trading with multi-currency trading, and IM funds,” he added.

Heine said it was important for Netwealth to be able to offer a specific product for wholesale investors who need global access and more sophisticated portfolio construction. fs

Elizabeth McArthur

U The quote

Even with someone with $60 million in investable assets, we are generally preparing statements of advice.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

nder the FASEA Code of Ethics the amount of money an individual has to invest can no longer be relied upon to determine whether they are a sophisticated investor or not.

Sophisticated investors are defined

by ASIC’s Money Smart as investors with a gross annual income of $250,000 or more in each of the previous two years and net assets of at least $2.5 million.

That’s the same definition prescribed

by Corporations Regulations 2001.

However, in FASEA’s guidance accompanying its Code of Ethics, accounting certificates declaring a person to be a wholesale investor because of assets alone were brought into question.

FASEA chief executive Stephen Glenfield told Financial Standard: “This relates to Standard One – complying with the intent of the law. In the guidance to the Code we give an example of an adviser relying on accounting certificates that declare the person to be a wholesale investor because of assets (most likely the family home), yet it is clear in dealing with the person they are not a sophisticated investor and have little understanding of finance.”

The example in question details a couple with a family home in Bondi worth $3.4 million whose stockbroker and financial adviser declare them wholesale clients.

When the wife in this imaginary scenario comes into a $20,000 inheritance, she tells the adviser that she has no clue about money matters and asks for a recommendation.

The stock the adviser recommends crashes by 25% and, as the client is a wholesale investor, there is no Statement of Advice.

“The code, which governs ethical behaviour and values, would suggest that ethically you should treat this person in a manner consistent with their level of financial understanding,” Glenfield said.

However, he reiterated that the code does not apply to genuine wholesale advice.

David Lane, director, senior adviser and representative at Pitcher Partners Brisbane, said: “By the law the simple answer is a sophisticated investor is someone with at least $2.5 million in investable assets and $250,000 in annual income. That’s what qualifies them for the accountant’s certificate.”

However, he said to meet best interests duty most good financial advisers would not look at clients in such simple terms.

Lane said his team usually excludes the home from the assets in question in this matter, which would avoid the situation in FASEA’s example.

“We adopt the philosophy that advice should be tailored to the individual and that we should be educating them and explaining everything along the way,” Lane said.

“So even with our high net worth clients, even with someone with $60 million in investable assets, we are generally preparing statements of advice.”

Lane said where it might be pertinent to use the sophisticated investor definition is in accessing investment options that are not available to retail clients.

He said: “FASEA’s code solidifies the fact that you can’t just go off assets to categorise someone but it’s always been the case that you should be tailoring advice to the individual.”

Last year, Standard Six created confusion, stating that advisers must consider clients’ potential broader, long-term interests. Glenfield had to clarify this did not mean advisers had to ask their clients about ESG or ethical investments.

“Rather, where a client indicates they only wish to invest in ethical or green investments, Standard Six requires the adviser to consider whether this is in the client’s best interest,” he said at the time. fs

FS Private Wealth

News

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

11

Pzena adds local fund

Top managers awarded

Harrison Worley

T

Spurred by the local success of its emerging markets value fund, Pzena Investment Management has introduced its second Australian pooled vehicle.

The classic value equities manager has launched the Pzena Global Focused Value fund to Australian and New Zealand high net-worth and institutional investors in an effort to capitalise on the shrinking availability of deep value managers as passive equity investing continues to dominate popularity.

The fund will be managed according to the firm’s “classic value” philosophy, which sees it hold between 40 and 60 stocks which sell at “substantial discounts” to their normal earnings potential, and held until they reach the middle of the firm’s universe valuation.

“In launching the fund at this time, Pzena recognises the very wide valuation dispersion between the cheapest and most expensive stocks in global stock markets today,” managing principal and co-chief investment officer Richard Pzena said.

“The extreme level of undervaluation of value stocks provides a rich environment to invest in a portfolio of outstanding companies trading at depressed valuations.”

Speaking to Financial Standard, Pzena managing principal and president Bill Lipsey said that despite the very competitive nature of the investment management industry, the number of deep value managers is shrinking, which presents Pzena with an opportunity to grow.

“I think it is part of what explains why we’ve been growing for the last five years in a world where high active share investing has been unpopular,” he said. fs

FS Private Wealth

Jamie Williamson

The quote

[These] awards reward investment managers that see their job as more than achieving headline returns.

he third annual Financial Standard Investment Leadership Awards were held in Sydney on February 18, celebrating excellence in Australia’s investment management industry.

Macquarie Investment Management took out the title of Investment Manager of the Year for the second year in a row at the 2020 Financial Standard Investment Leadership Awards.

It was one of two awards presented to Macquarie, with the manager also taking home the prize for Multi-Asset Balanced Product of the Year for the Macquarie Balanced Growth Fund.

Macquarie was also a finalist for four other awards on the night.

The wins are based on Rainmaker analysis of more than seven factors, including performance across multiple time periods, volatility, downside risk, and multiple performance ratios such as Sharpe and Sortino.

That same analytical process was applied to 20 other categories across six major asset class sectors.

“The Investment Leadership Awards reward investment managers that see their job as more than achieving headline returns.

They see their job as managing client assets for the long term in a way that

achieves investment objectives without taking undue risk,” Rainmaker head of investment research John Dyall said.

“To assess this, Rainmaker’s primary goal was to construct an awards system from the perspective of the investors.”

In total, a further four managers took home more than one award: Australian Ethical, BlackRock, Magellan and Pendal.

Australian Ethical’s Australian Shares Fund was named top High Performance fund and top ESG Australian Equity product.

Pendal Group also had a good night, with its Pendal Global Emerging Markets Opportunities Fund named best International Equities - Emerging Markets product and the Pendal MicroCap Opportunities Fund named best Australian Equities - Small Cap. BlackRock was recognised for the top International Equities - Index/Enhanced product in the BlackRock Fission Indexed International Equity Fund.

Later, the BlackRock Scientific Diversified Stable Fund was named the top Multi-Asset - Capital Stable product.

Magellan took home the award for best International Equities - High Performance and the Property - Infrastructure. fs

Fund managers driven to alternatives: Report Eliza Bavin

Fund managers are being pushed into allocating more of their portfolios towards alternatives, as traditional investments continue to provide low returns, according to a new Morningstar report.

The Multi Sector Wrap report examines 78 multisector funds, and found that industry funds are “far more aggressive” with their allocations to nontraditional assets.

“AustralianSuper, Cbus, and Sunsuper are all permitted to have the majority of their portfolios invested in alternatives,” the report said.

“According to our latest surveyed data, Cbus and Sunsuper have roughly 30% allocations, while AustralianSuper has roughly half as much.”

The report said that the push into more non-

traditional investments by industry funds is not surprising as thy have a “stickier” client base and long-term investment horizon.

The report also noted that the allowable allocations for non-traditional investments have a broad scope between different multisector managers.

“What is notable is the magnitude of the allowable ranges and the portion of the budget currently being used,” the report said.

“Pendal introduced an alternative allocation into its strategic asset allocation in 2012 and is now allocating 15% of the portfolio, the highest among the non-industry funds in our rated universe!” It said managers like CFS, Pendal and MLC most often opt for alternative investments in listed assets, while industry funds focus on the unlisted options. fs

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

12

News

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

The new All Tech ETF

ASX kicks off new technology index

Kanika Sood

Investors looking to ride the freshly-minted S&P/ASX All Tech Index were slated to have access to a new ETF from BetaShares, but its fees are not cheap.

The BetaShares S&P/ASX Australian Technology ETF (ATEC) will charge about 48bps per year.

This makes it more expensive than other passive ASX sector exposures, where resources ETFs charge 35 to 40bps while financials charge 39 to 40bps.

BetaShares chief executive Alex Vynokur said ATEC’s pricing is competitive.

“The index has done 17.4% [annualised] over the last year compared to the broader ASX 200’s 9%. The fees are a very small part of the returns and I would say the pricing is very competitive,” Vynokur said.

He also says for most users, technology is a small part of their portfolios unlike a core exposure such as the ASX200, where BetaShares’s A200 is the cheapest broad-based Aussie equities product.

“As the ETF continues expanding and builds scale, there will always been an opportunity to look at the overall cost,” Vynokur said.

BetaShares has ETFs tracking the NASDAQ, Asian tech stocks, and now, the ASX All Tech Index.

For ATEC, it sees potential demand from overseas investors looking to access Australian tech stocks.

“It’s very early days yet but we have seen inflows from big global investors [pension funds and wealth groups]. Stocks like Afterpay and Xero are phenomenal success stories but there are also smaller tech companies in Australia [and the] ETF will be attractive to investors looking for diversified exposure,” he said. fs

Ally Selby

A The quote

The tech space plays really well into that ESG space.

fter several years in the making, the ASX has launched a new technology index, set to boost the profiles of Australia’s tech darlings and provide new opportunities to investors.

The S&P/ASX All Tech Index, which has been christened as Australian NASDAQ in the news, will allow Australian and global investors alike to track the performance of our nation’s expanding technology industry, identify new opportunities and facilitate the development of index-based strategies.

ASX chief executive and managing director Dominic Stevens said the launch comes on the back of a period of stellar growth for the Australian tech sector.

“Over the last three years, the annualised total return from the S&P/ ASX 200 has been around 10%, while the return from the new All Tech Index over the same period – if it had existed – would have been over 20%,” Stevens said.

At launch, the index featured 46 Australian technology companies

across information technology (80% of the index), communication services (14.6%), consumer discretionary (3.1%) and healthcare (2.3%).

It had a market capitalisation of over $100 billion at the time of listing.

The 10 biggest constituents were Zero, Computershare, AfterPay, REA Group, Altium, Carsales.com, Wisetech Global, Link Administration Holdings, NextDC and Appen.

The index does not have a set number of constituents, and can be changed at each quarterly rebalance.

The companies featured in the index need to have a minimum float adjusted market cap of $120 million, a daily traded value of $120,000 and a minimum of a 30% relative liquidity ratio.

S&P Dow Jones Indices senior director of global equity indices Michael Orzano said he was excited by the new partnership.

“Australian and global investors will now have a way of tracking these technology companies, further contributing to the growth and liquidity of the sector.” fs

Advisers keen for local tech stocks Michelle Baltazar

The S&P/ASX All Tech Index’s launch in February has advisers excited but also curious about how the index will work.

Sydney-based financial adviser Glen Hare from Fox & Hare Financial Advice said the development aligns with the investment needs of their millennial clients.

“Given the demographic of our clients, they’ve seen the tech giants grow so they’re really conscious of opportunities in the tech space,” Hare said.

Hare said a lot of the firm’s clients already look to invest ethically.

Investing in mining companies and investing in banks that then lend on to mining companies, which dominate the ASX, doesn’t sit well with them. And so Fox & Hare proactively put together alternative strategies that invest in healthcare, sustainable energy and in tech.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

“The tech space plays really well into that ESG space because they’re newer companies and don’t have the [legacy issues] of banking and mining businesses,” he said.

Josh Dalton, director at Dalton Financial Partners, agrees the new index will help his clients with a strong stance on climate change but limitations of the mining and banking heavy ASX. That said, Dalton will be waiting for some clarification on what counts as a tech company within the index.

“Will it also include finance companies or will it be a pure software and app play for my clients?”

Following the launch of the index, the industry will soon see a raft of exchange traded funds (ETFs) built around it.

“From an investing perspective, low-cost products such as ETFs are products we often use as part of our client strategy so that would be something we would look at.” fs

FS Private Wealth

Featurette

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

13

A boat of one’s own A luxurious yacht or a little tinny – boats are fun but largely a bad investment, Kanika Sood writes.

W

ith close to 60,000 kilometres of coastline and spots such as the Whitsundays and Hamilton Island, it’s hard to fault an Aussie who has made some money and now wants to buy a boat.

Over two million Australians hold a boating licence. Each year brings 14,500 new boat registrations, according to July 2018 data compiled by the Boating Industry Association.

“Usually we see people who have been financially successful or when they have just sold a business, decide to buy a boat to achieve another life goal,” says Roger Perrett, an executive adviser at Viridian Advisory and former competitive sailor.

“They want to have an on-water experience for a period of time or even for the rest of their life.”

His clients’ purchases can range from small sailboats, to powerboats which don’t have sails but an engine, to yachts to go racing. The prices for such boats can be anywhere from $15,000 to $5 million.

Boats are fun but they are depreciating assets. And they can rack up significant maintenance costs each year. Therefore, buying one is not a decision that should be taken lightly.

“What I generally think of, as a rule of thumb, is that you should not spend over 10% of your overall net worth on [it],” says Perrett.

However, this 10% is a very general rule, he warns.

“If someone really wants to create wealth and not have that lossmaking experience, they wouldn’t go anywhere near that 10% range,” he says.

“On the other hand, there are people who go above that. For example, they might say, ‘I’ve just had someone in my family die and I don’t know how much longer I have, I want to enjoy life and my money’.”

Boat ownership There are many ways to own a boat: you can buy outright, join others in buying shares in a boat, buy a charter for a longer period of time like a year, or just the usual hourly charter.

Getting into a shared arrangement brings down the cost and takes off some burden of the maintenance, Perrett says. However,

FS Private Wealth

it’s limited in that you have to go through a booking arrangement, and you may not be able to take it outside a certain area or personalise the decor.

“Some people might think if I am going to spend that much on a boat, I want to be able to take it out to Hamilton Island or the Barrier Reef and the other owners may not want that,” he says.

He adds that usually at the end of such an arrangement (which can be with friends or a random group) people go their own ways, the boat gets sold, and they get some money back.

More to some people’s taste might be a rental with a boating company, where they can hop on and off for an agreed period of time through the year.

“Usually they have a lot of boats and you might be able to say I want to take out a 40 footer this weekend but next month I have a special occasion like a birthday so I’ll take the 60 footer,” he says.

Maintenance costs Congratulations, you’ve bought a boat. The real expense starts now.

“This is often the case with lifestyle assets. They buy an expensive asset, and it looks like it’s cheap, much cheaper than they expected,” says Ian Gillies, who is a partner and adviser at Melbourne-based high-net-worth advice firm Hamilton Wealth.

“But often the actual annual cost of ownership, which can be significant particularly if it’s not a new boat, is [overlooked].”

Boating is a booming business in Australia. The industry reported an annual turnover of $8.47 billion in the 2018 financial year, according to data from AMIAG State of the Industry Survey.

It has grown steadily over the past three years – recovering from a slump in 2015 – and 70% of the industry’s participants expected it to continue over the 12 months to June 2019.

There are more than 2250 businesses in the marine industry, including new and used boat sales, boat builders, charter operators, marinas, engine sales, and other professionals.

And you will need their services once you own a boat.

Gillies, who has worked as a sailing instructor and coach, has an exhaustive list of the actual purchase cost and the subsequent ongoing expenses of owning a boat.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

14

Featurette

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

It starts with a survey to determine the state of the general boat (about $30 per foot) and engine inspections (up to $180 an hour).

There’s an initial boat registration fee, which is usually calculated by the length of the boat. In New South Wales, for example, this is capped at $676.

Then you will have to buy berth lines, ropes to tie the boat to a wharf or a mooring. And a tender, a smaller inflatable boat to put on the side.

There is currently no stamp duty on boat sales, unlike cars. In last year’s state elections, NSW Labor proposed to extend stamp duty starting at $7600 to all boat sales valued at $200,000 or more with the view of raising $96 million over four years. However, it did not win the election.

Then there are the ongoing annual costs. This includes things like annual registration renewals that don’t cost much and biggerticket spends like insurance, berthing fees, yacht club membership and labour for maintenance.

“Insurance can be a bit pricey, depending on where you store the boat. Usually about 1-2% of the purchase price is the ballpark to start,” Gillies says.

Maintenance costs include pulling the boat out of water at least once a year, scrubbing the areas in contact with the water and servicing the engine. And the ongoing fuel costs for motorboats.

There’s costs for the covers, sails, carpet, freshwater pumps, sanitation system, propellers, refrigeration systems and batteries that may need replacing in part or full every couple of years.

Gillies says all of this may add up to a package of $16,000 to $25,000 for just a small tinny.

Fortunately most of his clients don’t want to buy big boats, they are happy with something they can entertain their family and friends on.

Still, as a rule, Gillies doesn’t make recommendations around how much a client should spend.

“It’s very much a discretionary purchase, not one I would suggest to people as it’s very rarely that they would realise their purchase price on upon resale,” he says.

“You’ve got to think, where am I going to berth it, how much do I have to spend on it, who am I going to use the boat with, do I know how to operate the boat and who’s going to maintain it.”

And for those who can’t be bothered with the research, Gillies has a tale narrated to him by an accountant a few years ago.

The accountant had a tradie client who had done exceptionally well in business. And he turned up on his quarterly uptake of his business and said, “I’ve just bought a [second-hand] helicopter!”

The accountant said, “Oh, I didn’t know you could fly.”

He said, “I can’t. I am going to get lessons.”

When the tradie met with the accountant nine months later, the accountant asked him how he was going with the lessons.

He said, “Oh no, I didn’t take the lessons. I sold the helicopter.

I found that you had to maintain the engine on an hourly basis.”

When he bought it, he didn’t think to check the maintenance program or when next services on various components were scheduled.

And with only 15 hours to go on the engine before a major overhaul, he realised the continued cost of ownership was way higher than the purchase price.

You would not expect to buy a boat and make a profit.

First-time boat owner’s guide

By Ian Gillies

1. D on’t buy a boat without a survey. Take special note if buying privately, directly from a friend or family and without a broker.

2. D on’t underestimate the maintenance costs. They can run into thousands each year.

3. I f you plan on chartering your boat purchase to cover costs, check the charter company’s requirements before buying the boat.

4. There are no clear-cut tax benefits or negative gearing like an investment property without an acceptable business plan.

5. Most importantly, don’t expect to make money. Boats don’t go up in value like collectable cars.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

Generating a return

If the ongoing costs of keeping your boat are too much, you can charter it out in through a company when you are not using it, much like an Airbnb.

Such companies have their own requirements about the kind of boats they are willing to take.

“If you are thinking about putting your boat into charter, it makes sense to talk to them first about what types of boats they are looking for and whether they are actually looking for anything,” Gillies says.

The first option is to operate it as a small business model, as laid out in ATO taxation ruling 2003/4 on income tax and boat hire arrangements.

“It basically means if you meet a certain criteria in operating your charter boat, you may be able to make tax deductions,” Gillies says.

“The boat owner has to have a commercial plan for the rental, which sets out the expectation of profits over the life of the agreement or the life of the boat. They have to demonstrate that they are involved in the actual running of the business.

“You can’t just say I am renting it out and do nothing.”

If these conditions are met, the boat owner may be able eligible for a GST rebate if it’s a new boat, and claim depreciation or losses.

“They can use the boat privately, provided they make the appropriate adjustments on the tax returns – much like a holiday house,” Gillies says.

The other option is the passive business model.

Like the name implies, the boat owner just puts their boat into charter and doesn’t establish business plan to make a profit or take direct involvement in the rental’s operation, Gillies explains.

The boat owner can get the lifestyle benefits, and they might cover some of the holding costs from the income stream.

But the ATO quarantines the benefits – because they don’t see it as a business – and any tax deductions can only be used to offset against charter boat income.

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Featurette

15

“It’s not like negative gearing while buying a property; you can’t take against other income. It can only be against income from the charter,” Gillies says.

The Sydney Hobart Yacht Race If you want to go a step further and have a stab at the Sydney Hobart Yacht Race, here’s how much it will cost.

Michael Coxon is the managing director of North Sails Australia Proprietary Ltd which sells almost half the world’s total sails.

The boats that race in the Sydney Hobart race can range from 30 footers that cost $100,000 to 100 footers, a newly built one of which could set you back $30 million, he says.

“I would say a small boat probably would invest around about $50,000 in doing the race. And then I could imagine a bigger boat could spend in excess of $500,000 because they usually fly in professional crew together with running costs to maintain performance and saftey,” Coxon says.

The smaller boats may only have three people on them while the bigger ones have up to 25 in crew.

This ranges from Corinthian or amateur (who don’t charge the boat owner money and do it for the love of sport), to professionals (who charge anywhere between $300 to $2000 a day depending on their experience and position on the boat) to a combination of the above.

The average boat in the race has about 15 sails in its inventory, each designed for a certain wind angle and strength, he says. A sail for a small boat costs about $10,000 to about $160,000 for the 100-foot yacht.

“The Wild Oats, Black Jacks and Comanches are the high profile [yachts] attracting much of the media interest for line honors, however its the smaller yachts that tend to fight it out for the Tattersall Cup, the holy grail of the Hobart Race.”

Racing boats tend to not have split ownership and they are more expensive to maintain because they need to perform, Coxon says.

“Most fleet sailing has an interesting twist as it is not driven by prize money, unlike a horse racing. You are just doing it for the love of the sport,” he says.

Are racing yachts better at holding their value than cruising boats?

“The honest answer is no. You would not expect to buy a boat and make a profit,” he says.

So there you have it, boats – either for a weekend party or for competitive racing – are usually a depreciating asset with big ongoing expenses.

Financial advisers are generally not too enthusiastic about clients digging deep into their pockets to buy one.

However, boats are great fun and top of most Aussies’ wish lists for lifestyle assets.

If you are tempted to buy one, remember the tradie, who splashed on a helicopter only to find the engine was too expensive to run, and do your due diligence. fs

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

16

Cover story

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Cover story

17

BRINGING IT HOME

Kumar Palghat made his millions as a star fund manager, first at PIMCO and then at his Sydney boutique Kapstream Capital. Nearly a year after announcing his retirement, he’s turning his investment prowess towards managing his family’s money. Kanika Sood writes.

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

18

Cover story

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

The quote

There’s no shortage of people selling ideas or wanting to manage my money.

I can have a coffee four times a day because everyone’s got something to sell.

W

hen Kumar Palghat meets for an interview at his new office in Sydney’s Circular Quay, he has spent the morning troubleshooting his trading accounts with the banks.

“It’s crazy,” he says. “I tried to set them up and there are all these issues, like you fill the form wrong or whatever.” In his past life, the task would have been delegated to a low-level back office employee.

It would not have been a job for the man who was a top fund manager at PIMCO, or oversaw US $80 billion worth of investments at Janus Henderson, or built and sold the now $17 billion fixed income boutique Kapstream Capital.

But the times have changed and Palghat hung up his boots last year. The official retirement was not until this March though he went on gardening leave last year.

“The last six months, all I’ve done is enjoy myself, go for drinks, travel and not worry about anything,” he says.

He’s back in Sydney, at a new address and with a company company focused on managing his family’s money.

“I’ve been working for 30 years. And for the first time, in 30 years, I feel like now I could take some time off.

Think about what I want to do,” he says.

He registered KP4 Pty Ltd in 2006, around the time Kapstream was set up. The company’s name takes after the four K’s in the family: wife Kathy and their two daughters.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

Palghat’s life story reads like a fairy tale.

He was born in southern India, to a middle-class family, and lost his father when he was 13. He moved to the United States by himself as a 19-year-old commerce graduate to study an MBA at Marymount University.

His arrival in finance was accidental. His first job was as a humble teller for mortgages at the credit union that served the World Bank and the International Monetary Fund.

He ended up working at the World Bank, first as a settlements officer and then as a repo trader. An investment officer’s sickie one day opened the door to investing.

The next three decades of his life are an almost even split between World Bank, where he rose to being an investment officer; PIMCO, where he became one of the fixed income giant’s first global portfolio managers in California and later lead portfolio management as it set shop in Australia Pacific; and Kapstream which he co-founded and built to a well-respected fixed income house, favored by many superannuation funds.

In between, he did a stint at Janus Henderson, heading its US $80 billion invested in fixed income portfolios, including the fund managed by legendary but temperamental bond investor Bill Gross.

The boutique was founded in 2006 by Palghat and Nick Maroutsos. In its early days, Challenger’s multiboutique business Fidante Partners had a 25% stake in Kapstream, which it later sold for $45 million. Janus Capital (and later, Janus Henderson Group) eventu-

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

ally came to own all of Kapstream. When Palghat announced his retirement last year, the boutique had promoted two managers, Raymond Lee and Daniel Siluk, to its leadership team while Steve Goldman had been leading the flagship absolute return strategy for about four years.

Kapstream has grown to about $17 billion in total assets, as at February end and since Palghat’s unofficial departure, has launched an exchange-traded fund in partnership with Challenger, which still remains its distribution partner despite having sold its equity stake.

On the way, he met his wife, Kathy Palghat and started a family. The couple met while both worked at the World Bank credit union in Washington DC in the 1980s. Kathy Palghat went on to work as an economist for the US Treasury, specialising in Africa.

She eventually raised the couple’s two daughters, who are now in their 20s.

Palghat had a 55% stake in Kapstream and the last of the payments from the sale to Janus Henderson have just come through. This stake alone could have been worth $176 million, according to a 2014 AFR story written by fund manager and columnist Christopher Joye, who cited unnamed analysts.

In our conversation, he declines to comment on his net worth.

“You know, it’s hard. It’s hard to answer because you don’t want to disclose what your net worth is roughly for the public to know…It’s more than what I had,” he says.

Top of his mind, as he focuses on his family’s wealth, are four things: investments, succession, philanthropy, and tax and legal.

The family currently invests in equities, bonds, property. And Palghat is tinkering with new ideas.

“It’s pretty standard asset allocation. Nothing rocket science,” he says.

The couple owns three residential properties. Their main residence is in Sydney’s Double Bay. They also own a weekender in Sydney’s Palm Beach, which they use from Thursdays to Sundays.

KP4’s offices are the family’s first commercial property purchase.

The mezzanine-level office space has floor-to-ceiling windows that look out on Circular Quay’s strip of restaurants on one side.

The other side is a few minutes’ walk from the Sydney Opera House.

The previous owner, another financial services company called RPG Group, is still next door.

And it has left behind chairs and workstations of its fund managers, which Palghat plans to rip out to install a ping pong table.

It’s a sweet spot and it’s convenient. Palghat’s Double Bay house is a ferry ride away.

The purchase also gives the family exposure to a commercial real estate asset.

“It’s hard to find 100 square meters in the city. As soon as we found it, we were like we should own it,” he says.

“I don’t have enough commercial, but I’m too small to buy a big building.”

When it comes to bonds and equities, Palghat doesn’t come into his new offices every morning raring to put in trades. He also doesn’t spend his days researching securities for his family’s money, choosing to watch a lot of YouTube and Netflix instead.

His fixed income allocations are, understandably, with Kapstream.

And he invests directly in some direct bonds and term deposits.

FS Private Wealth

Cover story

19

For a man who’s spent his life in active management, he is surprisingly gun shy of handing his money to fundies for his equities allocations.

No equities fund manager’s business development manager has been able to squeeze out a mandate from KP4 so far – but Palghat is a fan of Vanguard’s ETFs. “I am [an active manager] but I just don’t think anybody has successfully outperformed the ASX. The index is so biased. It’s all big four banks, two mining companies, one telco and one airline,” he says, adding that KP4 is underweight equities.

“Yeah, if you add value buying small caps or something…but the fees they charge are high compared to Vanguard funds at 20 basis points.

“And no one calls me, bugs me if I change tomorrow.”

He’s underweight equities and property (especially commercial).

“So I’m really a little bit more cash but I never got around to buying that much equities and I am afraid to buy it now,” he says.

“I will increase it slowly, so dollar cost averaging.

“But once I set my asset allocation for my own money I’m not going to worry. I’m a long term investor, I don’t look at the markets every day, I’m just going to buy and hold it. And it does what it does.”

Palghat isn’t interested in “alternatives” that are so often pitched to HNW investors as a source of uncorrelated returns. He’s not keen on syndicated loans or unlisted infrastructure. But he has had a look at private debt funds which can offer as much as 8% in annual returns.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

20

Cover story

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

“It sounded interesting but the devil is in the details…a question I think of is why are people borrowing money at 8% when cash rate is at 75 basis points [since down to 25bps]? Are the banks really not funding it?”

He thinks they are a good option for investors willing to give up the liquidity and transparency of publicly-traded fixed income instruments, but so far has shied from making an allocation himself.

“But weighted average returns of my Vanguard funds were 22% last year,” he says.

He’s quite happy thinking about his next project. It could be something like venture capital or private equity.

“I am not trying to make more from what I have, [it is] more than enough,” he says.

“But maybe one day I’ll get involved in private equity or venture capital. But then once you get involved, you’re almost working full time again. You give seed money to a startup and 99% of the times they will need more money, and they will come to you for more because you are already invested.

“At some point, you’re going to get involved because your care, you’ve already invested money. So you’re going to start working for the company or doing whatever is necessary and hopefully it succeeds.”

He’s interested in investing directly in something like medical equipment companies, instead of going through responsible investment fund managers.

The recent bushfires are also on his mind. Water rights will become more valuable than oil, he thinks, but there’s an ethical dilemma in being the one able to profit.

“The riparian rights are already sold to governments and people that already own it, right. So you [have] got to buy land with water tables underneath them,” he says.

“The question is how do you find it? How do you own it? But then there’s a moral issue because people are going to need water.

“When there’s a drought, am I going to be the guy that is controlling water when people need it? I wouldn’t do it.

“So yes, it’s a good idea. Yes, we need to figure out how to do it.

But I don’t want to be the guy that owns it,” he says.

After all the hard work on the investing front, Palghat and his wife face a question that is all too common for modern families: who takes over the family office after them?

He says over the next 12 months he wants to talk to his daughters, wife and the extended family about it.

“With the girls, it’s going to them and saying, ‘what is this KP4 going to do?’ Does either one of them or my son in laws want to take over or not? The answer probably is not,” he says.

The older of the couple’s daughter is a post doctorate researcher in cognitive science at Monash University. Her husband is studying for a Phd in mathematics. The younger daughter coordinates online sales for a men’s clothing brand.

“Okay, if you are not interested, we’ve got to figure out what you have – some income to support yourself. So maybe, they are interested in the outsourced investments,” he says.

Palghat is open to the possibility that his daughters will instead be interested in something completely different from KP4.

“Let’s say they don’t want to work for dad’s company, they might want to do their own thing. Then they need to get some advice, investment advice from somebody,” he says.

The family is citizens of Australia as well as the US. This brings into the equation, tax and legal needs that are more complicated than usual.

For example, as US citizens, they can’t own more than 50% of an Aussie company or be the majority shareholder.

“Then you have these issues such as inheritance tax in the US. Today you pay income tax [that is] the higher of the two countries.

You need tax advice,” he says.

Palghat says he hasn’t found many professionals who can help with such issues.

“There’s no shortage of people selling ideas or wanting to manage my money. I can have a coffee four times a day because everyone’s got something to sell,” he says, referring to fund managers and private banks.

“But I’ve not found anybody who understands how the tax laws work. “My tax guy does my US and Aussie taxes and he’s good at taxes but not sure about structures,” he says.

The family doesn’t have a philanthropic structure yet – setting that up is on the todo list for the year ahead.

Palghat is also still shackled by a noncompete from Janus Henderson until next year. He is hunting for his next project but isn’t sure what it will be.

“I think I’m young enough, but there’s something else left. I don’t know what it is.

I haven’t figured out what it is.” he says.

“Maybe there’s nothing else.”

Meanwhile, he sometimes goes to Kapstream’s investment meetings just to get a feel of the markets.

He’s also writing a book about his life and the markets, and is 40 pages in. “I’ve had an incredible run for a kid that just came from India with nothing. So if I can do it others can too,” he says, of the inspiration to write the book.

But he’s quick to rule out taking a directorship or co-mingling money with other family offices.

“If I lose money now, my wife’s going to yell at me. And that’s about it. When you commingle it, you’re fine when you are making money. But when you lose it, you lose all your friendships with it.

One of Palghat’s favourite books is Malcolm Gladwell’s Outliers, which argues that successful figures like Bill Gates and The Beatles, were intelligent, hit their 10,000 hours of practice early in life, but also had many chance factors going for them. In other words, their timing was right.

Palghat believes this applies to him. He is smart and he worked hard, but he was also a fixed income investor at a time when central bank rates were high, superannuation funds mostly outsourced their investments and humans had an edge over machines in investing.

And so he rules out coming back with a new fixed income house, like the ones where he made his fortune.

“It has had its run and if someone wants to set it up, good luck to them,” he says.

“I wouldn’t do it.” fs

I’ve had an incredible run for a kid that just came from India with

nothing.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

– SPONSORED CONTENT –

22

Featured fund manager

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2019

FS Private Wealth

– SPONSORED CONTENT –

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2019

Featured fund manager

23

STRENGTH IN RELATIONSHIPS Amid fierce competition in the private equity industry, forging solid relationships is pivotal in order to stay, according to Flexstone Partners managing partner David Arcauz.

O

ver the last 20 years, the popularity of coinvestments in the private equity sector has intensified.

What was once considered a minor strategy has become a significant feature in the world of direct investing, thanks to its competitive fees, higher-return potential and

outperformance.

According to McKinsey & Company’s latest report on private markets, co-investment activity shows no signs of slowing down.

The demand “vastly outstrips” opportunities, leading to an imbalance that not only frustrates limited partners but prevents portfolios gaining the diversification necessary to optimise the risk-return balance of these instruments, McKinsey wrote.

Flexstone Partners managing partner David Arcauz attests to the insatiable demand for co-investing.

“It is very competitive and family offices and pension plans want to be part of these deals,” he says.

Since 2008, global co-investments have been a key strategy for the European firm, helping boost assets under management to US$7.3 billion ($11.3 billion).

About US$700 million ($1.1 billion) has been deployed across 90 co-investments split between three US and two European funds.

In a bid to continue the success of its track record and make this strategy accessible to Australian investors, Flexstone has introduced the Series IV Co-investment Fund (Fund IV) to new wholesale clients.

“We select the right deals and wrap them up in Fund IV, which has an attractive pricing with reduced fees and carried interest. From a total expense ratio standpoint, this vehicle is competitive and a good alternative to a fund-of-fund or a normal fund,” Geneva-based Arcauz says.

FS Private Wealth

With an expected first close scheduled this June, the fund offers exposure to 40 to 50 co-investments that invest directly into small and mid-market private companies (enterprise value between €50 million and €500 million) across the US, Europe (40-45% respectively) and the rest in Asia.

Property-engrossed investors have enjoyed favourable conditions of record-low interest rates with no end in sight. But many are broadening their options.

Private equity provides a great diversifier and delivers higher returns, says Louise Watson, Natixis Investment Managers managing director and head of distribution for Australia and New Zealand, highlighting a new level of sophistication among family offices and institutional investors.

“They are becoming more comfortable with risk and allowing capital to be locked up a little longer in strategies like private equity co-investments. That’s where Flexstone is uniquely placed; it offers diversified returns that aren’t available in portfolios already,” Watson says.

An affiliate of Natixis, Flexstone was established in 2018 when Natixis brought together three of its private investment affiliates: Caspian Private Equity, Euro Private Equity and Eagle Asia Partners.

Targeting €750 million ($1.3 billion) in size, Watson says Fund IV is available to institutions, family offices and high-networth investors that want exposure to global private equity investments, especially at the lower end of the market, which is more difficult to access.

Robust relationships The last two decades saw the value of global private equity assets grow twice as fast as listed equities.

In 2019, Preqin reported private equity assets hit a record high of US$4.1 trillion ($6.2 trillion) as a result of the influx in in-

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

– SPONSORED CONTENT –

24

Featured fund manager

vestable capital and increased competition driving up asset prices.

For the majority of investors (87%), the asset class has either met or exceeded their return expectations.

“There is a high demand for co-investing, so we need to be quick, reliable and transparent with the managers,” Arcauz says.

At the heart of it is selecting the right fund managers and leveraging these relationships. Flexstone draws from up to 40 active longterm relationships with managers in the US and Europe respectively.

“What derives from these relationships are co-investment opportunities. We assess roughly 150 co-investment opportunities every year,” he says.

When a deal is presented, he and his team want to be able to say yes or no fairly quickly. As much as 85% or more of the deals are discarded, at times for strategic and/or geographic reasons.

With the remaining 10-15%, extensive due diligence into the company and its management is undertaken, ultimately leading to a disciplined selection of the best 7% of the deals.

“While we do have portfolio construction guidelines, we are not restricted by sector, we try to be opportunistic in order to build a diversified portfolio,” he says.

While it only takes about four weeks to complete a transaction, Arcauz says it’s a complex process that involves conducting extensive legal and governance discussions.

Arcauz’s career at Flexstone began nearly four years ago when he was hired to help run the investment practice in Europe and cover institutional clients. One thing he’s learned over the course of his 20 years in private equity is that it’s a relationship business, especially in small and mid-market segment.

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

“[Relationships and network] help me get our clients in great funds and source co-investment opportunities – being among the first investors a manager calls for a deal is important.”

Thinking ahead Aligning Flexstone’s interests with the fund managers is critical in Arcauz’s view. He describes the early phases of entering deals as exciting, but warns the unexpected could eventuate.

“A wedding analogy is one way of looking at it,” he says.

“After getting married there is the honeymoon period, but couples might want to keep in mind what could happen down the road.

In terms of co-investment two things could potentially happen: the fund manager for whatever reason will want to get out of the deal, but the co-investor might not be ready to exit and will want more time for the business to grow.”

Deals were rejected in the past because the manager wanted to stay for a shorter period (less than three years) and was targeting a lower return (less than the IRR of 20%+).

The second is the effects of a potential downturn whereby many businesses will be tested and subsequently need more funding. Coinvestors therefore must critically decide whether or not to invest more money.

Execution risk must also be at the forefront of co-investors’ minds.

Arcauz notes investing in companies globally comes with different jurisdictions, tax and legal systems. “[Given] our strong track record, it will be interesting to see how we stack up against our competitors [in Australia]. I am looking forward to the challenge.” fs

NATIXIS INVESTMENT MANAGERS Natixis Investment Managers ($1,004.5 billion AUM1) is a multi-affiliate organisation that offers a single point of access to more than 20 specialised investment firms in the Americas, Europe and Asia. The firm ranks among the world’s largest asset managers. Through its Durable Portfolio Construction® philosophy, the company is dedicated to providing innovative ideas on asset allocation and risk management that can help institutions, advisors and individuals address a range of modern market challenges.

1 Net asset value as of September 30, 2019. Assets under management (“AUM”), as reported, may include notional assets, assets serviced, gross assets, assets of minority-owned affiliated entities and other types of non-regulatory AUM managed or serviced by firms affiliated with Natixis Investment Managers.

2 Cerulli Quantitative Update: Global Markets 2019 ranked Natixis Investment Managers as the 17th largest asset

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

manager in the world based on assets under management as of December 31, 2018.

Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results. Use of overlay management and tax management strategies does not guarantee a profit or protect against a loss in an investor’s portfolio.

This presentation is intended for educational purposes, is general in nature and does not take into account any particular person’s objectives, financial situation or needs. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser or tax or legal professional.

Natixis Investment Managers Australia Pty Limited is part of the Natixis Investment Managers distribution network in Australia as defined by the Corporations Act 2001.

FS Private Wealth

A C T I V E LY C O N N E C T I N G I N V E S T O R S T O A LT E R N AT I V E O P P O RT U N I T I E S Diversification l Risk Management l Outcomes Our range of alternative investments may help investors better diversify their portfolios--no matter what the markets are doing.

Learn more at im.natixis.com/au

Provided by Natixis Investment Managers Australia Pty Limited (ABN 60088 786 299) (AFSL No. 246830) and is intended for the general information of financial advisers and wholesale clients only. This document may contain references to copyrights, indexes and trademarks that may not be registered in all jurisdictions. Third party registrations are the property of their respective owners and are not affiliated with Natixis Investment Managers or any of its related or affiliated companies (collectively “Natixis”). Such third party owners do not sponsor, endorse or participate in the provision of any Natixis services, funds or other financial products.• ADINT167-0220

26

Vantage point

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Benjamin Ong director of economics and investments Financial Standard

Sector review Australian recession here we come “If you don’t have anything nice to say, don’t say anything at all.” his quote, attributed to Alice Roosevelt LongT worth - daughter of former US President Teddy Roosevelt - had me struggling on whether or not

The Good Economics Guide Making sense of key economic data

Your definitive handbook to understanding the Australian economy

Edition

01

The guide Ben Ong is the author of the Financial Standard Good Economics Guide: Making sense of key economic data, a handy reference tool for investors, analysts, strategists and finance commentators, available in newsagents.

to submit this column.

Here’s to hoping I’m 200% way off my rockers, but as one country after another self-isolates itself to contain the still-growing coronavirus pandemic, the likelihood that Australia’s 28-year run of growth sans recession will come to an end has increased.

Just have a look at the sharp dive the latest Markit Economics JP Morgan Global PMI has taken in February.

But according to JP Morgan, the index dropped form 52.2 in January to 46.1 in February, which is its lowest level since May 2009.

“The more than six-point drop in the headline index was the second sharpest in the survey history, the current record being set in October 2001 (the month directly following the 9/11 attacks).”

And that’s just February, before many other countries locked down their borders and implemented social isolation.

In the past, I have always found solace in the Australian dollar’s depreciation in times of trouble.

On March 19, the Australian dollar fell to 55 cents, its lowest level in 18 years, after previously slipping below US60c for the first time since 2003.

But this time is different.

The equilibrium-setting mechanism offered by a free-floating currency is worth zilch when trading partners even ban handshakes. Australia couldn’t

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

even give its products for free. Free education, free tours, free whatever are good enough enticements ... but not when citizens of the earth are banned from leaving or entering national domiciles.

Economics 101 dictates that the A$’s depreciation would make imports more expensive, boosting domestic earnings (substitution effect) and improve company earnings via its translation effects.

But with world economic activity frozen, international earnings are down. With Australia nearing complete lockdown, there’ll be no domestic earnings to hope for.

Lockdowns and bans from social gatherings would negate the cash splurge from monetary and fiscal authorities. Citizens will have more money that they couldn’t spend and if they could, there’s nothing to buy because of disruptions to the supply chain.

The drought and bushfires already raised the likelihood of a negative first quarter 2020 for Australian GDP, the coronavirus guarantees a second quarter - putting the economy in a technical recession.

Having said this, reports that China is starting to re-open for business offer a silver lining, the same way that China’s strong growth in 2008-2009 prevented the Australian economy from falling into a recession when many others sank.

While it’s almost certain that Australian GDP growth will contract in the first quarter, the succeeding three months to June remains uncertain, depending on the progression of the coronavirus.

Australia and the world could turn in a sharp V-shaped recovery if the virus is licked before then. fs

FS Private Wealth

Vantage point

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

27

News bites

Australia wages and unemployment Coronavirus succeeded in prompting an RBA rate cut where earlier reports of continued lacklustre growth in wages and a pick-up in the unemployment rate failed. Annual growth in total wages remained unchanged at 2.2% in the December quarter from the previous quarter.

This would impair households’ ability to pay down debt and/or increase spending, more so, given the latest update on the Australian labour market. The unemployment rate increased to 5.3% in January from 5.1% in December. The underemployment rate increased to 8.6% from 8.1% in December, suggesting that the flat wages growth seen in the December 2019 quarter would remain flat going forward, at best.

Property

RBA cuts rates, starts QE The Reserve Bank of Australia cut the cash rate to 25 basis points in an emergency meeting on March 19, taking it to a new record low. It also said it would undertake quantitative easing for the first time in history. The central bank promised at least $90 billion over next three years to lending institutions willing to extend loans to small and mid-sized businesses.

Earlier in March, Prime Minister Scott Morison announced a $17.6 billion stimulus package, as COVID-19 hinders growth. If you have lost track of the rate cuts, we have had five of them since January last year when the cash rate was 1.50% and had been untouched for nearly two and a half years.

China PMI The first read on the coronavirus’ impact on China is out, and it’s worrisome. The official NBS Manufacturing PMI dropped to a reading of 35.7 in February from 50 in the previous month. This is the lowest level on record and is below market expectations for a decline to 46. Lockdowns, quarantines, disruptions to supply chains and travel restrictions also took the services sector down with the official NBS Non-Manufacturing PMI in China plunging to a record low reading of 29.6 in February 2020 from 54.1 in the previous month.

The corresponding readings from Caixin were not as severe – manufacturing down to 40.3 from 51.1 in January; services down to 51.8 from 52.5 – but the message is the same, activity is slowing. fs

Bank of Mum and Dad Jamie Williamson

Prepared by: Rainmaker Information Source: Mozo

atest Mozo insights show the Bank of L Mum and Dad is the fifth biggest home lender in Australia, lending an average of $73,522 to their children, and it’s got one in four parents at risk of financial hardship.

On a national scale, it’s equated to $92 billion over the last two years. This places it ahead of ING and Suncorp.

Commonwealth Bank sits firmly in the top spot at $442 billion.

“The property market in Australia is incredibly challenging for younger generations to break into with property prices surging by 395% in the last twenty five years. For this reason the Bank of Mum and Dad has become an

FS Private Wealth

essential player in our nation’s housing market,” Mozo director Kirsty Lamont said.

Overall, 64% of parents are sharing their savings with their children for this purpose, with 34% cutting back on expenses to make it happen.

About 16% are using the equity in their own homes and 13% are delaying retirement.

Sadly, 4% are resorting to selling assets.

“Many parents are feeling the pressure to help their children purchase their first property and for some, this is causing a real strain, especially when they find themselves working for far longer than they’d envisioned or repayment deals are reneged on,” Lamont said.

Allowing kids to live at home rent-free is the most common form of assistance. This is followed by 32% that have provided money for a deposit, 14% acted as guarantor and 10% helped pay the loan repayments.

Of those that acted as guarantor, 26% said their child had defaulted on their loan and one in five had missed repayments.

Of those parents that requested to be paid back, close to 20% said it hasn’t happened.

As a result of their generosity, one in four parents said they are at risk of financial hardship and stress.

And it’s not just property parents are helping out with; 46% have helped buy a car, 39% have paid for educational costs, 33% are assisting with ongoing bills and 26% have paid for household items.

The Bank of Mum and Dad’s growth as a lender may be due to a wider inbalance within the Australian economy, the research suggests.

“It could be argued that such a dominance in family assistance is feeding into a greater inequality in this country with many first home buyer hopefuls without financial aid remaining locked out as property prices rise faster than they can feasibly save a deposit,” she said.

The new Banking Code of Practice was expected to curb this via more scrutiny. fs

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

28

Vantage point

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Key indicators

Source:

Monthly Indicators

Feb-20 Jan-20

Dec-19

Nov-19 Oct-19

Inflation

Consumption

CPI (%y/y) headline

1.84

1.67

1.59

1.33

1.78

Retail Sales (%m/m)

-

0.11

CPI (%y/y) trimmed mean

1.60

1.60

1.60

1.50

1.80

Retail Sales (%y/y)

-

-

2.66

3.25

2.24

CPI (%y/y) weighted median

1.30

1.30

1.30

1.40

1.80

Sales of New Motor Vehicles (%y/y)

-

-12.52

-3.76

-9.75

-9.11

-

-0.54

1.02

Employment Employed, Persons (Chg, 000’s, sa) Job Advertisements (%m/m, sa) Unemployment Rate (sa)

-

13.53

28.72

37.06

-22.44

0.71

4.05

-5.57

-1.78

-1.14

-

5.29

5.08

5.17

5.31

Output Real GDP Growth (%q/q, sa)

-

0.44

0.62

0.52

0.16

Real GDP Growth (%y/y, sa)

-

1.74

1.61

1.72

2.14

Industrial Production (%q/q, sa)

-

0.19

1.36

0.69

0.49

Survey Data

Housing & Construction Dwellings approved, Tot, (%m/m, sa)

-

-

-0.14

6.03

-5.34

Private New Capex, Total, Chain, Vol, (%q/q, sa)

Dwellings approved, Private Sector, (%m/m, sa)

-

-

-0.18

10.93

-6.28

Financial Indicators

Housing Finance Commitments, Number (%m/m, sa) -

-

-

-

-

Housing Finance Commitments, Value (%m/m, sa)

-

-

-

-

-

Survey Data Consumer Sentiment Index

95.52

93.38

95.10

97.00

92.80

AiG Manufacturing PMI Index

44.30

45.40

48.30

48.10

51.60

-2.79

-0.44

-0.93

-1.76

1.51

28-Feb Mth ago 3mth ago 1yr ago 3 yrs ago

Interest rates RBA Cash Rate

0.75

0.75

0.75

1.50

1.50

Australian 10Y Government Bond Yield

0.82

0.95

1.00

2.10

2.72

Australian 10Y Corporate Bond Yield

1.62

1.74

1.81

3.02

3.36

NAB Business Conditions Index

-

2.61

2.71

4.33

4.19

Stockmarket

NAB Business Confidence Index

-

-0.82

-2.48

-0.09

1.83

All Ordinaries Index

6511.5

-8.27%

-6.52%

4.14%

13.03%

Trade

S&P/ASX 300 Index

6395.6

-7.99%

-6.17%

4.54%

12.97%

Trade Balance (Mil. AUD)

-

-

5223.00

5518.00

S&P/ASX 200 Index

6441.2

-7.91%

-6.16%

4.41%

12.76%

Exports (%y/y)

-

-

8.27

5.13

4.95

S&P/ASX 100 Index

5345.3

-7.88%

-6.12%

5.27%

12.69%

Imports (%y/y)

-

-

5.84

-2.73

1.49

Small Ordinaries

2728.2

-8.90%

-6.59%

-1.32%

16.11%

Quarterly Indicators

Dec-19 Sep-19

Jun-19

3965.00

Mar-19 Dec-18

Balance of Payments Current Account Balance (Bil. AUD, sa)

-

7.86

4.67

-1.75

-6.45

% of GDP

-

1.56

0.94

-0.36

-1.34

Corporate Profits Company Gross Operating Profits (%q/q)

-3.45

-0.61

4.46

2.07

3.71

Employment

A$ trade weighted index

57.00

60.30

60.00

60.70

66.70

A$/US$

0.6448 0.6753 0.6765 0.7115 0.7689

A$/Euro

0.5870 0.6138 0.6146 0.6248 0.7236

A$/Yen

69.55 73.70 74.10 79.20 86.02

Commodity Prices S&P GSCI - commodity index

358.44

400.39

420.34

426.35

402.22

0.62

Iron ore

82.93

93.60

84.42

87.33

91.50

0.39

0.46

Gold

0.46

0.46

WTI oil

Average Weekly Earnings (%y/y)

3.24

-

3.02

-

2.48

Wages Total All Industries (%q/q, sa)

0.53

0.53

0.54

0.54

Wages Total Private Industries (%q/q, sa)

0.45

0.92

0.38

Wages Total Public Industries (%q/q, sa)

0.45

0.83

0.46

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

Exchange rates

1609.85 1574.00 1454.65 1319.15 1255.60 45.26

53.33

58.12

57.21

54.00

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 08 Issue Issue04 01 || 2020 2019

29

Taxation & Estate Planning:

30

Wealth management after liquidity events

By Sean Abbott, Koda Capital

30

Taxation & Estate Planning

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Sale of a business is often a time of emotional upheaval for its owner. There is much scope for advisers to guide clients through the mindset transition in relation to risk, investing, and family relationship dynamics following a liquidity event.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Wealth management after liquidity events Seizing the opportunity Sean Abbott

Key insights from the research

he total or partial sale of a privately held business—also known as a ‘liquidity event’— is usually the culmination of years of hard work, considered risk taking, determination and tremendous energy. In many circumstances, the proceeds of the liquidity event may be sufficient to provide long-term financial security to not only the business owners and their immediate family but also the next generations.

It is also often a time of powerful emotions, as the result of a lifetime of work changes hands.

Financial security does not always mean financial peace of mind, and it is for this reason that many entrepreneurs seek specialised, independent and dispassionate advice about: • How to prepare for a liquidity event, including maximising tax efficiency and net after-tax proceeds.

• How to sensibly invest, preserve and transfer the wealth which has been realised by the liquidity event.

• When and how to engage the family to form a shared purpose for part of the wealth and minimise the risk of the new-found wealth damaging family relations.

The content of this paper is based on a series of ongoing interviews conducted with Koda Capital’s clients who have sold their businesses.

It also includes input from their families and the corporate advisers who have assisted in the sale process. The research highlighted the common wealth management concerns shared by entrepreneurs following the sale of their business and the critical role of specialised wealth management advice in addressing these concerns and providing the peace of mind to entrepreneurs as they enter their next phase of life.

The four key insights provided by the entrepreneurs interviewed fell into one the following categories discussed in this paper: • The major issues do not change.

• The entrepreneur’s investment mindset after the sale.

• The entrepreneur’s intergenerational mindset after the sale.

• Financial security does not always mean peace of mind.

T

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

1. The major issues do not change The key concerns identified were: • Tax management: The desire to maximise the after-tax value of sale proceeds.

• Investing wisely: The objective of protecting and growing sale proceeds sensibly.

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

• Family impact: Ensuring the family is not adversely affected by the proceeds.

• Giving back to the community: Potentially forming a framework to give back to the community based on the family’s values.

Perhaps unsurprisingly, these key concerns were evergreen and very much shared by the latest round of interviewed entrepreneurs.

2. The entrepreneur’s investment mindset after the sale The emotional intensity of the road to liquidity affects how entrepreneurs wish to approach their next life stage and, in particular, how they want to manage the wealth created by the liquidity event.

The business owners’ typical journey to liquidity can be illustrated through the timeline in Figure 1. This timeline, which is certainly not to scale given the buildbusiness phase is significantly longer than reflected, provides some insight into the demands associated in successfully selling a business.

The relevance of this context is that following the sale, a period of reflection needs to begin and a significant mental shift for the entrepreneur needs to occur—from one of, ‘How do I make it?’ to one of, ‘What do I do with it?’.

The entrepreneur has typically built their wealth through a single business which they have controlled. A sale opens new opportunities, including to ‘de-risk’ their wealth (through diversification), and personally reset and invest their wealth in a manner which aligns with what is important to them.

Koda’s research reveals that while most business owners understand this opportunity, a lack of understanding of what to do next combined with the challenge of releasing control, often led to two common adverse outcomes:

Taxation & Estate Planning

31

• An investment strategy which does not de-risk their position in the way they expected (in other words, a portfolio of good ideas rather than a good portfolio).

• A lack of diversification in the investment portfolio.

A portfolio of good ideas: avoiding the trap

The interviewees all confirmed that personal wealth management and advice is generally new and unknown territory. It was also made clear that for most entrepreneurs, it can be challenging to identify both what good advice looks like and whom to trust. There is often also a significant underestimation of the time it takes to appropriately manage the wealth, and to establish the required new relationships, knowledge and thought processes.

While there can be a natural entrepreneurial instinct to maintain full control and/or avoid fees, the downside of no (or poor) advice, a lack of time and the ‘blind spots’ from which all humans suffer, often led to personal balance sheets featuring the following suboptimal characteristics: • No cogent framework linking tax structuring, portfolio management, asset protection and a robust estate plan.

• Insufficient diversification, resulting in an unnecessarily risky portfolio that does not provide multiple sources of return throughout economic cycles. This lack of diversification can come in the form of high cash balances or investments in limited asset classes.

• Limited access to institutional/private investment opportunities.

• A portfolio which is very difficult to transition to future generations.

Often the result is what we term a ‘portfolio of good ideas’ rather than ‘a good portfolio’. This concept is illustrated in Figure 2.

Sean Abbott, Koda Capital Sean Abbott is an adviser and partner of Koda Capital, and has been a financial adviser since 1998. Sean has a comprehensive knowledge of wealth management from an investment, structuring, asset protection, and estate planning perspective. For Sean, sound planning, structuring, and patience are the keys for clients making the most of their circumstances.

Figure 1: The entrepreneur’s liquidity journey

Source: Koda Capital

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

32

Taxation & Estate Planning

The quote

A founder, having been so focused on building their business, will generally not know what issues need to be considered from a private wealth management perspective.

Koda’s experience is that a sensible ‘balance sheet’ allocation—which aligns with the key goals held by a founder—is to develop investment weightings which broadly resemble those shown in Figure 3. The key benefit of this approach, in addition to a lower time involvement for the individual, is a more appropriately weighted balance sheet exposed to global asset classes.

The benefit of this structured approach is a lowering of risk through multiple sources of return while retaining appropriate exposures to investments in an individual’s areas of interests/strengths/networks.

It is a portfolio structure which can also move neatly and equitably to the next generation. Further, and importantly, it provides protection and opportunities from the accelerating pace of digital innovation and other sources of disruption occurring in and across most industries.

The entrepreneur’s challenge with good diversification

One of the common characteristics seen on an entrepreneur’s personal balance sheet following the sale of their business is a high exposure to both property and cash.

The exposure to real estate is often the result of entrepreneurs acquiring properties over time and, on some occasions, property being used to house the business.

The cash, meanwhile, is generally present by virtue of the business sale. For this reason, the business owner is typically comfortable with these asset classes.

This perceived comfort, however, means business owners often miss out on the real benefit that comes with investment in a truly diversified portfolio.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Key insights are as follows: • From one year to the next, the best-performing and worst-performing asset classes appear to follow an almost random walk.

• Over the 30-year time period, cash has the lowest instance as the best-performing asset class and the highest count as the worst.

• In any given year, there is a wide divergence between the best and worst performing asset class.

Applying these insights to portfolio management, the following conclusions were reached: • Assets should be put to work. Cash has the lowest average return across all asset classes.

• Diversification is the only ‘free lunch’ in investing.

There is no reliable basis to predict which asset class will perform the best or worst in any one year, though there is a logical acceptance that the higher the risk taken, the higher the expected return. The value of advice requires ensuring that returns are proportionate to the risk taken.

• Portfolio optimisation and good diversification require an investor to hold an exposure to all asset classes. A spread of all asset classes is the academically* proven method (modern portfolio theory) of maximising return and minimising risk. *Economist Harry Markowitz introduced modern portfolio theory in a 1952 essay, ‘Portfolio selection’, for which he was later awarded a Nobel Prize in economics.

For many entrepreneurs, the concept of investing in any area that may not be ‘the best performing’ is completely counterintuitive. The entrepreneur has been used

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Taxation & Estate Planning

33

Figure 2. A portfolio of good ideas rather than a good portfolio

Source: Koda Capital

Figure 3. ‘Smart money’ balance sheet: after a liquidity event

Source: Koda Capital

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

34

Taxation & Estate Planning

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

to taking large, single risks. They have an intolerance of underperformance and are used to running towards assets that are not performing and either fixing or removing them.

Harnessing the benefits of good diversification require business owners to make a fundamental shift in mindset to accepting that, from a wealth management perspective, good diversification means investing in strategies that deliberately will not ‘fire’ together at all times. This can be a difficult mindshift, but diversification is unarguably the right approach from a personal wealth management perspective—and the role of a trusted adviser cannot be overestimated in helping with the process of shifting to the correct mindset.

3. The entrepreneur’s intergenerational mindset after the sale The impact of wealth on future generations is a material concern for business owners. Many of the business owners we interviewed could cite familiar examples of family breakdowns following a liquidity event, and most articulated a vision for the future where the family ‘stayed together’ and were bound by a shared set of values.

However, most indicated a general lack of understanding on how to make this happen while keeping the family aligned around shared values and family vision.

Sadly, the root cause of family relationships breaking down is a failure to communicate and agree what the plan is from one generation to the next. If ‘Generation I’ is not communicating the 20-year plan, ‘Generation II’ will start second guessing and a splintering of relationships can follow.

We often observe breakdowns in communication that can lead to damaged family relationships. Money is a sensitive issue. Wellintentioned parents are often reluctant to discuss wealth—aware of the saying, ‘The first generation makes it, the second generation spends it, and the third generation blows it.’

Often the problem with this approach is that in the absence of any communication, inaccurate conclusions are often inferred from parents’ behaviour, and a disconnect occurs. Communication is critical to avoid such situations.

Tip: An effective approach is to meet, talk, explain the situation and the broad plan. Seek each family member’s thoughts and input.

Generation I should run a structured, objective process to have Generation II informed and engaged with the family strategy.

Example. Onboarding the next generation If the family decides to allocate a portion of their investable capital to forming a charitable foundation, we have seen significant benefits of having the children get involved with the family’s foundation.

Generation II should meet with investment advisers, learn about risk, return, tax, cash flows and measuring outcomes. They should be taught how to form a policy to professionally ward off well-meaning friends seeking the family’s financial contribution to causes or business ‘opportunities’.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

Taxation & Estate Planning

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Over time, responsibilities can be increased as expertise and financial maturity builds, as illustrated in Figure 4.

We see this approach as far more beneficial than the common annual cash allocation, with minimal communication and involvement.

4. Financial security does not always mean peace of mind The sale for the (oftentimes exhausted) entrepreneur will generally mean navigating a large shift from the very familiar and comfortable position of running their own business to the unfamiliar and uncomfortable position of considering how to manage the proceeds, steward their family and, at the same time, consider a future without the most significant influence on their past.

Our interviews revealed this is a source of significant anxiety and stress. The lack of clarity on what steps to take next, the lack of awareness of where to find trusted advice and support, combined with an entrepreneurial mindset that doing nothing is not an option leads to the insight that financial security does not always mean peace of mind.

•

•

•

•

The wealth management approach Following is a best practice overview of how to manage clients’ financial affairs and execute on investment philosophy: • Put the client first: This is the foundation for the right business model.

• Data is key: The starting point is spending a disproportionate amount of time understanding clients’ needs, goals and prefer-

•

35

ences, as well as researching all investment asset classes. Data and insight, not gut instinct, should drive recommendations.

Grow wealth gradually and strive for patient capital: Academic and statistical evidence confirms that the key to growing wealth is to target consistent returns by compounding gradual positive gains and seeking to avoid periodic large drawdowns.

Upside vs downside: Long-term wealth creation and capital preservation is best achieved by targeting portfolio participation in 80% of market upside in exchange for less than 50% of the market downside.

Stronger returns with less risk: Whether clients are individuals, families or mission-based organisations, wealth built up over time needs to be protected from large losses and grown sensibly to meet each client’s ongoing needs. A sound investment approach is to focus on capturing positive returns sensibly, avoid unnecessary risk and provide protection from downside (negative) returns.

Bespoke construction: Each client has had a different journey and different aspirations for the future. An effective investment approach involves a sophisticated and rigorous research program to identify compelling strategies that can complement each other to form a robust portfolio to meet each client’s needs. Importantly, the role of the adviser is to help ‘balance’ any client bias— whether toward increased conservatism or risk.

Asset allocation is key: As identified through the 1986 Brinson, Hood and Beebower study, ‘Determinants of portfolio performance’, asset allocation accounts for 90% or more of invest-

Figure 4. Involving the family

Source: Koda Capital

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

36

Taxation & Estate Planning

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. What did the author find to be at the core of family breakdowns after a liquidity event? a) Overlooking the merits of an annual cash allocation to children b) Failure of families to communicate future plans c) Parents being too open in discussing wealth with their children d) Parents assuming their children have strong business acumen 2. According to the author, one of the key functions of an adviser is to help clients: a) Avoid unfamiliar investment mindsets b) Target returns similar to previous ones c) Take greater risks for required returns a) Balance their investment biases 3. Which of the following approaches does the author believe to be effective in managing a client’s financial affairs? a) Grow wealth gradually and aim for patient capital b) Recommendations should be based on data c) Asset allocation is the key to consistent performance d) All of the above 4. What barrier did the author cite regarding entrepreneurs and investing? a) They want to overly derisk their portfolio b) They are used to taking large, multiple risks c) They do not tolerate underperformance d) They readily tolerate underperformance 5. Entrepreneurs were found to be typically at ease with property and cash as asset classes. a) True b) False 6. Many business owners were challenged by portfolio diversification after a liquidity event. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

ment outcomes. Most market noise in the short term focuses on market timing and security selection. Both of these are important, but with the wrong asset allocation these two factors will not offer sufficient protection. Active management of asset allocation through market cycles is critical to delivering consistent performance, maximising returns and mitigating capital loss.

Conclusion Continuing to invest the time it takes to understand what is important to clients following the sale of their business goes hand in hand with consistently refining advice and improving on the ability to deliver on what is important to each client’s unique situation.

A founder, having been so focused on building their business, will generally not know what issues need to be considered from a private wealth management perspective. They simply ‘don’t know what they don’t know’. Accordingly, good advice will succinctly lay out and clarify the issues that need to be considered both immediately and for the longer term.

Following years of first building the value of the business and then completing the sale transaction, the focus from a wealth management perspective very much becomes one of ensuring the wealth is put to good use and is underpinned by a suitably conservative approach.

Data conclusively shows that avoiding large negative losses and growing wealth gradually is the most effective approach to increasing wealth. The investment process should be first and foremost focused on protecting and growing wealth while avoiding unrewarded risk.

Entrepreneurs will and should continue to be involved in other businesses or personal investments. These areas can include investing in start-up businesses, venture capital opportunities or commencing new businesses which, if unsuccessful, should not compromise the core family wealth and therefore the family’s ongoing standard of living.

The key value in the advisory process is not targeting returns similar to the founder’s (often leveraged) operating business returns, but rather providing the discipline to keep to the agreed framework, to only take as much risk as is required to meet required return objectives and to keep a client’s financial house in order.

The communication from Generation I to Generation II regarding the family’s financial position, if not handled well, is where relationships can fray. Ironically, it is often the wellbeing of the family that is a primary motivator of entrepreneurs when building their business, and the liquidity event that crystallises family tensions.

As outlined in this paper the engagement, education and involvement of all family members, at the appropriate time, will help bind the family with a shared purpose for the family wealth. The willingness of Generation I to communicate the 20-year plan, is generally far more highly valued by family than a ‘please ask no questions’ annual cash gift or distribution. fs

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 08 Issue Issue04 01 || 2020 2019

37

Ethics & Governance:

38

Cognitive biases in ethical decision-making

FS Private THE JOURNAL Wealth OF FAMILY OFFICE INVESTMENT•

By Paul Sills, barrister and mediator

THE JOURNAL OF FAMILY OFFICE FS Private INVESTMENT Wealth •

38

Ethics & Governance

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Cognitive bias has many manifestations. This paper helps advisers recognise the impact of client biases on their choices, and the influence of one’s own biases, judgments and disposition on advice recommendations.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Cognitive biases in ethical decision-making

M Paul Sills

ost people consider themselves rational, openminded thinkers, making ethical decisions in an objective, non-biased fashion. Sadly, that is rarely true as we are all susceptible to a multitude of cognitive biases. Our decisions are shaped by emotional attachments, misleading memories or self-interest.

What is cognitive bias?

Cognitive biases are errors in our thinking that influence the decision-making process. They are patterns of behaviour that draw us to particular conclusions. Our brains form these conclusions based on information gathered and stored from the past. Our decisions are subconsciously based upon factors such as: • Previous decisions involving similar subject matter • Information we have selected that suits our preconceived ideas • Emotional attachments • Self-interest Pattern recognition and emotional tagging are two processes that contribute to cognitive bias. Both relate to the idea that our brains resort to information already stored, rather than evaluating each decision as an individual and fresh task. Heuristics encompass this idea, being mental shortcuts which aim to simplify our decision-making processes. Heuristics save time when reaching conclusions, but can

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

result in cognitive biases leading us toward making false assumptions about new information and circumstances.

While cognitive biases can be good survival tools – making sure we stay safe – they can detract from logic, leading to suboptimal, unethical and poorly informed decisions.

Background

Psychologists Amos Tversky and Daniel Kahneman developed the term ‘cognitive bias’ to illustrate flawed patterns of responses to decision-making and judgment problems. Through a series of studies they determined that people make decisions based on heuristics and common-sense principles. In other words, people do not make decisions based on rationality or logic.

Tversky and Kahneman’s experiments resulted in the development of the ‘two way system of thinking’. System one (thinking fast) is the intuitive, faster thought process which can be said to be the ‘gut reaction’ way of making decisions. In comparison, system two (thinking slow), is the more idealised way of decision-making and involves critical and analytical thinking. Most people who were tested thought they were system-two thinkers, but were in fact system one.

The pair’s findings are significant as they deconstruct ideas about the quality of our thinking and demonstrate that although we think we are making careful decisions, our brains are merely post-rationalising decisions that have been made previously. Identifying these flaws in our thinking can improve our ethical decision-making.

FS Private Wealth

Ethics & Governance

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

How cognitive bias manifests itself

Anchoring bias

Confirmation bias, anchoring bias and the overconfidence effect are three key biases that can be used to explain why good people might make bad decisions.

These three appear frequently throughout our lives and in business.

Anchoring is a form of cognitive bias where we tend to rely on only one piece of data we have received, using this to shape our decision-making. We do this rather than looking for and adopting a wider range of inputs.

The original retail price of an item on sale is an instance of anchoring bias when we want to justify our shopping decisions. The opening bid in negotiations can form an anchor for ensuing discussions.

The primary cause of anchoring bias is our need to begin with a starting point in our decision-making. It is easier for us to start with a figure or idea and work from that, rather than to explore and research a variety of factors, without preconception, in order to reach a conclusion.

Secondly, anchoring is caused by uncertainties.

As humans, we do not like making decisions without an influence of some sort. When making difficult decisions, existing values, prior memories and similar decisions become anchoring points to ease this uncertainty.

Confirmation bias American psychologist Raymond Nickerson defined confirmation bias as “the seeking or interpreting of evidence in ways that are partial to existing beliefs, expectations, or a hypothesis in hand”.

This occurs when we ‘cherry pick’ information that supports our preconceived beliefs, rather than researching and evaluating information from a range of sources and viewpoints.

American business magnate Warren Buffett summarised confirmation bias as: “What the human brain is best at doing is interpreting all new information so that their prior conclusions remain intact.”

There are two key reasons why we use confirmation bias when making decisions: • Confirmation bias often occurs because the human brain cannot carefully process all the information at hand. Confirmation bias is instinctive, acting as a reflex in tough situations. Selecting and basing our decisions on information we have pre-stored in our brains saves time and energy.

• Protection of self-image. It is important for our selfesteem that our preconceived ideas are shown to be correct. Being proven wrong is a blow to our confidence and our egos. We seek to find information that justifies our preconceptions in order to achieve self-gratification.

FS Private Wealth

Overconfidence bias We often think confidence is an admirable characteristic and a sign of strength, control and leadership. However, overconfidence can result in ignorant decision-making.

A consequence of overconfidence includes a strong belief that our opinion is superior, displaying an inability to see the potential risks or negative aspects of our decisions.

Negative consequences of cognitive bias Without recognising cognitive biases in our decisionmaking, irrational and illogical judgments are made.

39

Paul Sills, barrister and mediator Paul Sills, LLB (Hons), has 25 years’ experience as a barrister, arbitrator and mediator. Paul is on the panel of mediators for the New Zealand Law Society.

He carries out independent investigations into complaints concerning the conduct of elected officials in New Zealand local government.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

40

Ethics & Governance

Case study: Mt Everest, sunk costs, biases and tragedy ‘Lessons from Everest: The interaction of cognitive bias, psychological safety and system complexity’ is an article written by then Harvard Business School management academic Michael A. Roberto. The article focused on the tragedy of experienced mountaineers who died during their descent of Mount Everest in 1996. Rob Hall and Scott Fischer were the leaders of the two expeditions. Both died along with three of the people they were leading.

Roberto used three key biases to explain his reasoning for the tragedy.

1. Sunk cost effect Roberto described the sunk cost effect as “the tendency for people to escalate commitment to a course of action in which they have made substantial prior investments of time, money or other resources”.

As experienced climbers, the leaders would have been aware of the risks, but persisted with the expedition. Perhaps they could not ignore their sunk costs; to turn back would have been a ‘wasted investment’. It may also have been their desire for success which made them fail to take appropriate action in the dangerous storm conditions.

Our desire to ‘win’ or achieve our goals often overshadows the need to take appropriate steps to mitigate potential harm.

2. Overconfidence bias Overconfidence bias also contributed to the tragedy.

A climber on the expedition questioned whether the expedition leaders were ‘clinically delusional?’ and their confidence so overpowering that it interrupted their required risk assessment.

Without confidence, the group could never have set out to take on such an ambitious feat. After all, positivity and confidence were required in taking on the challenge of Mt Everest in the first place.

However, the climbers seemed to have developed an overly positive assessment of the risks compared with their abilities and the conditions.

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Our brain’s focus on certain specific memories, predictions, and information causes us to ignore other important factors when making decisions. Further, our ethical decision-making process is tainted due to the fact that we struggle to make decisions by drawing from a range of different viewpoints and sources, instead letting personal influences take control.

Positive consequences of cognitive bias Our brain’s storage of previous emotions and memories of experiences can act as positive guides when making decisions. We can learn from our mistakes. The memories of our previous bad experiences warn us against making similar decisions again.

So, it is not all bad news for our biases. For instance, a bias against the presence of a sabre-toothed tiger did wonders for our ancestors.

Moreover, research shows there are benefits in being biased towards optimism.

Optimism bias This bias encompasses the idea that people overestimate the probability of positive events, ignoring any possibility of negative incidence occurring. Optimism bias can be defined as the difference between our expectation and the outcome.

Neuroscientist professor Tali Sharot evaluated whether optimism bias is healthy, and established that it is, based on three reasons: • Interpretation matters: People with high expectations typically feel better.

• Anticipation is satisfying: The thrill of the wait matters. People want something to look forward to. Optimists are excited about what is to come.

• Optimism changes reality: If someone expects to do well, they will put in more effort which will, in turn, influence the outcome.

3. Availability bias Decision-makers may place too much trust in information that is readily available. This relates back to the overarching characteristics of cognitive biases—that our brains seek to use the information most easily accessible rather than taking the time to research, obtain and consider a broader range of information.

What can we take away from this event?

When faced with challenges, it is important that we act decisively, yet gain a range of perspectives. Trust in our own instincts must be balanced with taking on board a variety of different ideas.

As leaders, we must manage the competing interests of confidence, dissent and potential risks when making decisions and acknowledge the fact that our decisions affect a wide group of people.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

Ethics & Governance

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Tip: When making ethical business decisions, optimism bias can be useful as it encourages hope as well as promoting a success mentality. However, it is important to recognise the pitfalls of the optimism bias in order to ensure our decision-making process is realistic.

41

Reflection

Ask yourself how you came to your conclusion? What influenced your decision? What data did you use? With more data/facts would your decision have been made differently?

Being aware of the cognitive biases that can affect our decisions is a big step toward minimising their effects. The key is to slow down your thinking and get into a system-two mindset.

How to improve our decision-making

Relational impact

Data

Ask yourself who will be affected (or not) by your decision. Evaluating the effects your decisions have on other people helps to clarify whether you are making an ethical choice.

University of Houston research professor Brene Brown found that in the absence of data, the stories that we tell ourselves are a combination of our fears and beliefs.

To counter such behaviour, we need to ‘fill the gaps’ in our thinking with data—facts, not pre-conceived ideas or assumptions. Data analysis requires system-two thinking.

Availability

We must be open to the ideas and opinions of others and balance these against our preconceptions. Diversity is essential to good decision-making.

We must include outside knowledge and views in our thought processes and not be afraid to challenge our preconceptions or to ask for advice. Our preconceptions and the views of others can coexist if we properly consider the merits of both.

Environment

Do not rush into making decisions. A tool to ensure that you are not leaping into irrational decisions as a result of your environment is HALT. That is, if you are hungry, angry, lonely or tired, do not make that decision.

FS Private Wealth

Awareness

Recognising that you demonstrate cognitive biases improves ethical decision-making. Once we accept that our decisions are affected by biases then we are able to work towards minimising their impact on our judgments.

Conclusion It is crucial that we recognise and negate cognitive biases in our decision-making. We need to ensure our decisions are a result of objective and broad system-two thinking. Awareness of our biases and how they affect others enhances the success of making ethical decisions. We can increase the quality of our decision-making by expanding the scope of our cognitive processes to include the factors discussed earlier, especially the search for facts with which to challenge our fears and beliefs.

French Philosopher Henri Bergson famously said: “The mind only sees what the mind is prepared to comprehend.” When making decisions, be humble, be prepared to accept your mistakes and seek out new perspectives. fs

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

42

Ethics & Governance

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. Which of the following traits are associated with cognitive bias? a) Pattern recognition and emotional tagging b) Choosing ineffective survival mechanisms c) Discounting the value of previous decisions d) Slow thinking and procrastination 2. Research cited in the article found that optimism bias occurs because: a) Interpretation matters b) Anticipation is satisfying c) Optimism can change reality d) All of the above

4. S abine’s instincts tell her that the new neighbours she has never met will cause trouble. This is an example of: a) Awareness b) System-one thinking c) System-two thinking d) Relational impact 5. Common-sense principles are: a) A manifestation of idealised thinking b) Closely aligned with rationality and logic c) Not necessarily aligned with rationality or logic d) At loggerheads with heuristics 6. Confirmation bias involves selecting information that validates existing beliefs. a) True b) False

3. A nchoring bias tends to rely on considering a crosssection of data. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

43

Investment:

44

Impacts of coronavirus

By Chris Kushlis, T. Rowe Price

47

Investors’ increasing allocations to unlisted infrastructure

By Nicole Connolly, Infrastructure Partners Investment Fund

51

Why sustainability matters in real estate

By Chris Nunn, AMP Capital

57

The rupee as a diversifier

By Mugunthan Siva, India Avenue Investment Management

44

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: This paper examines a range of indicators to gauge the near-term impact of the coronavirus on various asset classes, and assesses the likelihood of a post-economic rebound in today’s environment compared with the SARS outbreak of 2003.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Impacts of coronavirus Markets likely to remain on edge in the near term

T Chris Kushlis

he recent bouts of market volatility across the globe triggered by the coronavirus outbreak are likely to continue in the near term. The full and lasting impact on economies and financial assets remains unclear.

In this environment, it is important to remember that various asset classes and regional economies will perform differently as the situation unfolds. It is necessary to monitor a range of indicators to understand the potential impacts across asset classes and portfolios.

Uncertainty to drive near-term volatility across asset classes Markets are likely to remain volatile as the virus spreads and uncertainty remains high. After a positive start to the year, global equities and risk sectors of fixed income sold off, notably in mid‑January when the seriousness of the coronavirus threat began to emerge.

Many Asian markets then sold off sharply on February 3 due to pent-up concerns unleashed on the first day of business following Chinese New Year holidays.

We do not expect a meaningful rebound in the short term. It will likely be at least several weeks [at the time of writing early February] before any clear signs emerge that the outbreak is under control and markets can more confidently assess the full impact on

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

the Chinese and global economies. In the absence of a significant escalation in the outbreak, markets could stabilise following the recent sharp drops, helped by short-term monetary stimulus from Chinese authorities.

Broken down by asset class, our near‑term outlook is summarised as follows.

Equities

Global equity markets declined significantly since the middle of January. Markets had seen a sustained risk rally in previous months, meaning valuations had become stretched in some places, exacerbating near-term volatility.

We expect continued volatility and weakness in the near term. The severity of the outbreak is likely to cause, at minimum, a short-term drag on Chinese growth, which will spill over into other areas of the global economy.

Fixed income

A period of risk aversion across global markets has exerted downward pressure on core government bond yields. US Treasury and German Bund yields have already fallen to levels not seen since October [2019] and will likely remain suppressed until there is more clarity on the coronavirus spread.

Risk sectors of fixed income, including emerging markets and higher-yielding corporate bonds, could see near-term volatility similar

FS Private Wealth

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

to equity markets. However, most emerging-market debt sectors, apart from China, have only seen modest losses.

Within Asia, investment-grade corporate bonds, in particular, should continue to display relative stability.

Currencies

The expected impact of the coronavirus on global growth is likely to influence currency markets, including downward pressure on the renminbi. The post‑holiday market sell-off saw the Chinese currency move below RMB 7 to the USD. We expect the People’s Bank of China (PBoC) to help smooth any abnormal volatility during this period. China may want to avoid raising potential objections from the US authorities in the event of a sharper currency depreciation.

During the severe acute respiratory syndrome (SARS) outbreak in 2003, many Asia-Pacific (APAC) currencies were more heavily managed, which limited their volatility at the time. Today, there could be more fluctuations, with countries most exposed to tourism and trade with China being the hardest hit. Fundamentals in most APAC countries remain healthy, which should provide a supportive influence.

Chinese growth could see postoutbreak rebound The spread of the coronavirus has already reached a level where it will have a noticeable impact on China’s economy. We expect to see a meaningful drop in China’s first-quarter growth rate and potentially future quarters if the outbreak persists.

The last major comparable outbreak, SARS, first appeared in late 2002. The peak of the economic impact came around March and April 2003, with the seasonally adjusted annual growth rate dropping sharply from 12% in the first quarter to 3.5% in the second quarter of 2003. It is worth noting that many aspects of the Chinese economy are different today than in 2003. The services sector constitutes a larger share of China’s gross domestic product (GDP) than in 2003. This could result in a larger overall impact than SARS had.

Yet, if the pattern of the SARS impacts are a guide, there is the potential for the Chinese economy to rebound with an above-potential growth rate once the outbreak subsides. In 2003, China’s growth rate climbed to 15.5% in the third quarter as pent-up demand saw consumption rebound as the SARS outbreak waned.

A similar rebound following the coronavirus could help keep the longer-term track of the Chinese economy on a relatively even keel. Likewise, equity and credit markets could recover as sectors hardest hit from the outbreak benefit from pent‑up demand.

That said, outbreaks of this sort remain unpredictable and prone to a range of factors that govern the spread and duration. There is a risk that the coronavirus outbreak could persist longer and with a larger economic impact than SARS.

FS Private Wealth

45

Short‑term stimulus provides support China has already responded with a wide-ranging set of short-term stimulus measures to counter any initial market panic. The policies include a 10-basis-point cut to the reverse repo rate (reverse repurchase agreement rate is a method the PBoC can use to add liquidity to the market), and additional liquidity to maintain market functionality, as well as other measures to support the financial sector. Additionally, China has announced an RMB 300 billion lending program to support Wuhan, the city at the epicentre of the outbreak.

Looking longer term, we expect Chinese authorities to take a restrained approach to any sustained stimulus. In recent years, China has focused on deleveraging and will not be overly aggressive in deviating from this path. The PBoC will likely remain reactive to weakness in growth data. Fiscal stimulus rather than monetary measures could be the primary tool to support growth. Overall, we think the aim will be keeping the full-year growth rate broadly in line with targets while tolerating a degree of temporary weakness in the near term.

Key features of the epidemic to watch The speed and spread of the coronavirus outbreak could change quickly. Key features we are monitoring are examined in the following discussion.

Chris Kushlis, T. Rowe Price

Rate of spread

We are certain that the number of confirmed cases will grow as authorities improve their ability to locate and diagnose people, and those who are already infected begin to show symptoms. However, Chinese authorities have implemented aggressive containment measures. How markets react will depend on whether the spread appears to reach a peak in the near term or accelerates.

Recent signs that infections in the Hubei province are levelling off suggest that containment measures could be having their desired effect. We will be watching for signs that the spread does not reaccelerate.

Location of spread

Most international cases have been among people who have visited Wuhan, and recent data shows that the incidence of new cases outside China have eased. However, as the virus has a reported incubation period of between one and 14 days before symptoms appear, this trend could change. The number of cases across China could grow substantially in the near term. The extent of spread within China and international infection rates will guide analysis of wider impacts.

Risk of mutation

So far, the reported number of cases and deaths from the coronavirus indicate that it has a lower mortality rate than SARS. However, there remains a risk that the virus could mutate to a more lethal form or becomes more easily transmittable among people.

Chris Kushlis is an emerging market sovereign analyst in T. Rowe Price’s Fixed Income Division, and vice president of T. Rowe Price Group, Inc. and T. Rowe Price International Ltd. He has 19 years’ investment experience. Prior to joining the firm, he was an adviser to the US executive director at the International Monetary Fund.

Chris holds a BA from Middlebury College, an MA from the Johns Hopkins School of Advanced International Studies, and the CFA designation.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

46

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Impacts beyond Asian economies

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1.What does the author highlight in terms of the coronavirus’ near-term impact on asset classes? a) Equity markets have declined moderately since mid-January 2020 b) Non-Chinese emerging-market sectors have seen heavy losses c) Bond yields will likely remain supressed d) All of the above 2. What does the author predict in terms of the coronavirus’ impact on markets? a) Higher-risk assets and industry sectors are likely to stabilise b) Near-term market volatility is likely to persist c) Near-term market volatility is likely to subside quickly d) The Chinese real estate sector will remain robust 3. How is a possible economic rebound in light of the coronavirus different from that of the SARS outbreak? a) China is more embedded in the global economy than it was in 2003 b) The services sector in China constitutes a larger share of GDP than in 2003 c) During the SARS outbreak, many APAC currencies were more heavily managed d) All of the above 4. What does the author see as the state of play in terms of likely coronavirus impacts beyond Asia? a) The European Central Bank will change policy direction b) Countries benefitting from lower oil prices could see relative stability c) Countries benefitting from lower oil prices could see decreased stability d) The long-term growth outlook in the US could be severely weakened 5. The author believes traditional bricks-and-mortar businesses will be strongly affected by the coronavirus. a) True b) False

It is too early to accurately assess the longer-term impact on global economies. Compared with SARS, the impact on the rest of the world could be greater, simply because China is more embedded in the global economy in 2020 than it was in 2003, and its output forms a much larger share of global GDP. The lower demand due to slower growth could weigh on oil prices. Countries and companies that typically benefit from lower oil prices could see relative stability, while those more directly affected could experience more volatility.

We expect exports and travel from the APAC region to suffer.

This could make a noticeable dent in developed market growth data in the coming months, including lower quarterly GDP figures.

At this stage, changes in policy direction from the Federal Reserve or European Central Bank appear unlikely.

Overall, the spread of the coronavirus globally has not reached a level that we believe will severely weaken the long-term growth outlook in the US and other developed economies.

What to watch next The duration and spread of the coronavirus will govern longerterm impacts.

Looking deeper at idiosyncratic impacts on individual market sectors and asset classes as the virus spreads, industry sectors more directly exposed to the disruption caused by the virus will likely suffer the largest price swings. Specifically, we are closely watching the Macau gaming sector amid travel restriction and casinos suspending operations.

In the retail sector, traditional bricks-and-mortar businesses will likely bear the brunt of the pain, whereas companies focused on online delivery could perform better. The Chinese real estate sector is also coming under pressure due to pauses in home sales to reduce public gatherings in some regions of China.

It is worth looking closely at which names are best suited to withstand these pressures and how Chinese authorities respond with any potential sector-specific stimulus.

Conclusion To summarise, the following key points need to be kept in mind: • Near-term market volatility is likely to persist as the coronavirus outbreak will remain a concern in the coming months.

• Higher-risk assets and industry sectors most closely linked to the impact of the outbreak are likely to underperform.

• The impact on the Chinese and global economies remains unclear.

• The SARS experience indicates that a rebound could follow once the outbreak dissipates. fs

6. In the long term, the author expects a restrained approach from China to any sustained stimulus regarding the coronavirus. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

47

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Unlisted infrastructure returns are typically stable and consistent. This paper examines the structure, performance and asset valuation criteria for infrastructure funds, and compares its risk-return profile with other asset classes.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Investors’ increasing allocations to unlisted infrastructure ecord-low interest rates and the increasingly uncertain equity market outlook are prompting many investors to seek new ways to generate reliable income returns.

One beneficiary of this interest is unlisted infrastructure, due to its typically stable, reliable returns and low correlation to equities. Investors allocated US$85 billion to unlisted infrastructure funds in 2018, up US$10 billion on 2017, according to industry researcher Preqin.

We expect 2020 to be another bumper year for infrastructure investment. Infrastructure falls between government bonds and equities in terms of risk and return, making it an excellent portfolio diversifier (see Figure 1).

Its potential for stable, reliable income and capital growth is derived from long-term, stable and predictable cash flows, typically underpinned by long-term contracts or a regulated asset base; with high visibility of income and revenues often linked to inflation.

This is one reason why unlisted infrastructure investments accounts for between 7–12% of major institutional investor portfolios, such as the Future Fund and AustralianSuper.

The key, for both investors and managers, is to determine which assets and projects will provide the greatest, and most consistent, returns.

Unlisted infrastructure investment returns are typically generated by stable, reliable and protected income streams, which are derived from tangible, long-lived assets with monopolistic-like pricing power. Many are regulated and may feature income linked directly to inflation (although this may involve a lag).

Figure 1. Risk-return profile of infrastructure

Private capital Equities Unlisted commercial property Unlisted infrastructure

Return

R Nicole Connolly

Corporate bonds Government bonds Cash / bank deposits

Risk

Why the increase in investor demand?

Infrastructure returns have historically been plus-9% p.a., including capital growth and yield.

FS Private Wealth

Source: IPIF

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

48

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

A core infrastructure asset is defined as an asset for which the cash flows to equity owners are forecastable, with risk to these cash flows considered low. Core infrastructure aims to provide a return premium over a reference long-term bond rate, to reflect limited business risk and an illiquidity premium.

We would expect the equity risk premium for core infrastructure to be lower than the broad equity market over the long term, given the lower risk. A skill premium can also be expected, given the unique capabilities required; from originating deals through to navigating complex regulatory environments.

Nicole Connolly, Infrastructure Partners Investment Fund (IPIF) Nicole Connolly is IPIF’s founder and chief executive. She has over 20 years’ experience in the superannuation and funds management industry, and is a former director, alternative investments, of Russell Investments. She has extensive experience in the design, implementation and management of the infrastructure asset class.

Defensive or growth asset?

Given the nature of unlisted infrastructure returns, investors often question whether the categorisation of the asset class should be defensive or growth.

The certainty around cash flow streams of many infrastructure assets, given their ‘essential’ nature, supports a defensive categorisation. However, we consider unlisted infrastructure to be a growth asset, as capital values can still be at risk during times of economic uncertainty, even though income is reliable.

In our view, although the asset class may be more defensive than equities, it still requires a growing economy to deliver on its capital growth and overall income return objectives. Increasingly however, we are seeing a number of our investors and their advisers consider unlisted infrastructure as a ‘bond proxy’. This rationale is understandable in the current environment. However, in true recessionary times, an allocation to traditional fixed interest is a key ingredient in the ‘balance’ of a balanced portfolio.

Structure of funds Unlisted infrastructure funds are commonly structured in two ways: open-ended and closed-ended.

Open-ended funds allow for the periodic entrance and exit of investors during the life of the fund, although there are often entrance and exit queues, depending on the market cycle and market trends. They are the most

common type of fund available in Australia and can offer an attractive opportunity to access highly sought-after, tightly held core infrastructure assets.

In theory, open-ended funds suit the long-life nature of infrastructure assets and would be positioned to avoid the situation where assets are forced into poorly timed sales due to the windup of a fund.

This leads to lower asset turnover than the typical closed-ended fund and is typically why many top-tier infrastructure assets such as the major Australian airports and a number of strategic regulated utilities are tightly held.

Closed-ended funds raise capital at the inception of the fund and then remain closed to new investors until the fund is wound up. The fund will have a specified timeframe in which it will invest the capital before returning all capital to investors at the end of the term of the fund (typically 10 years).

These funds are more prevalent outside Australia and tend to offer the opportunity to access higher-risk strategies or more niche infrastructure opportunities. During the term of the fund, the investor does not have the ability to redeem their capital contribution. Rather, periodic distributions of cash flow and capital events (that is, sale or refinancing) proceeds are the sources of liquidity.

The ‘lumpiness’ of the cash-flow stream associated with higher-risk investment strategies are well matched to the closed-ended fund structure, insulating the fund manager from the distractions posed by cash management aspects of offering liquidity to investors. That is, the fund manager can focus solely on selecting and managing the investments to drive value.

One of the key drawbacks of the closed-ended fund structure is the semi-hard termination date (which typically can be extended for 1–2 years). This can leave assets vulnerable to market conditions at the time the fund is wound down. However, the incentive structure and ‘profit splits’ associated with closed-ended funds does put pressure on managers to drive value during the investment period, supporting active management to deliver target returns.

Table 1. Characteristics of infrastructure investing Characteristic

Advantages

Disadvantages

Long duration of investments

• Most infrastructure assets have long, stable cash flows.

• Concessions for infrastructure tend to be long-term and over 25 years, often lasting 99 years.

• Not all types of infrastructure are appropriate for duration matching.

The inflation relation

• Revenues may be either explicitly linked to inflation and/or may offer inelastic demand patterns.

• Some assets may only partially adjust for inflation.

• While cash flows may be linked to inflation, there may be a lag.

Diversification benefits

• Stable return streams with low-equity beta.

• Potential for high cash flow and growth component.

• Illiquid.

• Capital-intensive and depreciating assets.

• High fees, high costs of bidding for and closing deals.

Provision of essential services result in monopolistic market structures

• Predictable cash flows.

• Higher credit ratings resulting in favourable borrowing costs (typical gearing levels for core infrastructure 30–45%).

• Limited business risks.

• Regulatory uncertainty.

• Political risk.

• P atronage and construction risk for value add or greenfield investments.

Source: IPIF

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Asset valuation The valuation of unlisted infrastructure investments will generally require assessment of their specific cash flows and investment terms by an independent valuer, with the valuation often based on comparable transaction parameters and/or a discounted cash flow (DCF) approach.

As the name suggests, a DCF value is the summation of all future cash flows generated by an asset, where cash flows are adjusted for the time value of money and risk, as well as (usually) tax. For a given set of cash flows, the lower the discount rate, the higher the valuation.

The underlying discount rate is typically derived from a capital asset pricing model and comprises the risk-free rate, plus a risk premium, plus in some cases an arbitrary adjustment factor (sometimes referred to as an ‘alpha factor’). The risk-free rate is usually based on the relevant long-term government bond rate.

Under normal circumstances, the trend to lower bond rates in key countries such as the US, UK and even Australia would be expected to reduce the discount rate for assets located in those countries and, assuming no change in the risk profile, this would in turn bolster valuations. However, evidence suggests that valuers have typically taken a conservative approach and either: • Explicitly adjusted the risk-free rate so that it did not reflect the low bond yields at the time, or • Added an alpha factor to offset the reduction in long-term bond yields. Consequently, there appears to be little evidence of valuations being systematically bolstered by the sustained reduction of long-term bonds over the last 10 years. Likewise, we do not expect significant pressure on valuations if we enter a period of increasing long-term bonds, given other factors at play.

Best practice for valuation is usually a semi-annual valuation, supplemented by quarterly or semi-annual updates.

The quarterly or semi-annual update valuations conducted by the independent valuer following an annual valuation should incorporate any updates to the valuation parameters and the annual valuation model to account for material information available since the previous valuation. This reduces the likelihood of material spikes occurring with the full annual valuation. This only applies where the benefit to an investor outweighs the additional cost of the more frequent valuations.

Performance evaluation Unlike traditional fixed interest and equity asset classes, where performance evaluation is a fairly straightforward process, the evaluation of unlisted infrastructure performance can pose a number of challenges.

Not only are unlisted infrastructure returns publicly unavailable, but the performance data of some of these assets can be relatively short. Further, the emergence of new subsectors of infrastructure such as land titles registry offices (as a result of various state government privatisation programs) adds to the lack of publicly available performance data.

The risk-return trade-off varies significantly by type of investment at different stages, hence no single return metric can adequately capture the whole infrastructure asset class or strategy. There is also no single broadly accepted index for use in performance evaluation.

Infrastructure portfolios are typically measured against a fixed absolute rate of return or a fixed margin above an economic indicator that reflects the performance characteristics of infrastructure investments. The most common evaluation tools currently in use are:

FS Private Wealth

Investment

49

• Absolute rate of return: A nominal flat rate of return typically expressed as either a holding period return p.a. or an internal rate of return (IRR) over a specified period.

• Inflation plus margin: Effectively a real rate of return.

• Bond yield plus margin: The ‘opportunity cost’ of not investing at the risk-free rate.

• (Inflation-linked) bond index return plus margin: Capturing the effects that changes in interest rates have on the capital values of infrastructure businesses.

• Equity return plus margin: The ‘opportunity cost’ of not investing in the listed market plus a premium for asset and portfolio specific risks.

These elements are unambiguous, measurable and can be specified in advance. With regard to the appropriateness of evaluation tools, it is important that this decision is made with reference to the specific performance objectives of the investor and the overall style of the fund. For instance, an inflation plus margin suits entities with the investment objective of achieving real or ‘inflation protected’ returns such as superannuation funds that are seeking to match assets with liabilities.

Bond yield plus margin is more suited to mature-stage infrastructure portfolios where income dominates total return rather than growth portfolios. This is because mature-style portfolios are less volatile than growth portfolios, supported by a more stable yield.

Inflation-linked bond index return plus margin is likely to suit growth-style portfolios rather than mature-style portfolios because the effects of interest rate changes will be more pronounced for growthstyle assets, where the capital return component dominates total return.

Equity return plus margin is intuitively more appropriate for growth-style infrastructure portfolios, which are dominated by early-stage infrastructure businesses. These growth-style portfolios with medium-term investment horizons have risk levels comparable with the equity market and the majority of their total returns typically come from capital return as opposed to income return.

For investors adopting an after-tax investment focus, choosing between evaluation tools also means favouring the ones which reflect the impact of tax on investment returns. Some approaches more readily accommodate after-tax considerations than others.

In addition to these common approaches, investors have the following alternative approaches at their disposal.

Infrastructure shares common traits with bonds, private equity and real estate. As a result, depending on the risk-return profile of the infrastructure investments, performance can be evaluated against a combination of these traditional and alternative asset classes.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

50

Investment

CPD Questions

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Peer group of unlisted infrastructure funds involves identifying and comparing against a range of peer portfolios with similar management style, investment horizon and approach to sector and geographic diversification as the selected portfolio.

Conclusion Earn CPD hours by completing this quiz via FS Aspire CPD 1.Which of the following characteristics apply to infrastructure investing? a) M ost infrastructure assets have long, stable cash flows b) S ome assets may only adjust partially for inflation c) H igh fees, high costs for bidding and closing deals d) A ll of the above 2. A core infrastructure asset is an asset for which cash flows to equity owners are: a) U npredictable, with risk to these cash flows considered low b) F orecastable, with risk to these cash flows considered low c) F orecastable, with risk to these cash flows considered high d) Unpredictable, with risk to these cash flows considered high 3. Unlisted infrastructure: a) F alls outside government bonds and equities in terms of risk and return b) H as a high correlation to equities c) H as a low correlation to equities d) Is typically underpinned by short-term contracts 4. Which evaluation tool is more suited to mature infrastructure portfolios? a) E quity return plus margin b) B ond yield plus margin c) I nflation-linked bond index return plus margin d) None of the above 5. Open-ended infrastructure funds have lower asset turnover than closed-ended ones. a) True b) False 6. Unlisted infrastructure fund performance data is readily available. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

Australian unlisted infrastructure managers have produced compelling returns for investors over the past two decades, generally making a positive contribution to the diversification of portfolios and delivering relatively stable and predictable income yields.

Looking forward, demand for local infrastructure development, including those projects being funded under the latest Federal Budget, presents significant opportunities for all investors. A key is to determine which projects and assets will provide the greatest and most consistent returns. fs Investment example: The Australian airport sector Airports have been a strong driver of returns for unlisted infrastructure portfolios. The sector in Australia has a strong track record of longterm growth, with only one year of negative passenger growth over the past 25 years. This compares to four years of negative growth for Australian equities over the same period.

The airport sector performed relatively well through the global financial crisis, with airlines managing the downcycle through a range of initiatives including discounted ticket prices and reduced services.

The resilience of the Australian airport sector is due to a number of other factors, including the diversity in revenue streams which includes aeronautical, car park services, trading (retail), property and security; and is also reflective of the economic environment in Australia.

Although performance of airports may slow with a further downturn in the Australian economy, resulting in a slowdown in passenger growth, they have sound and sustainable capital structures. Those with near-term debt maturities are well advanced and well positioned to roll over and/or extend out debt maturities.

Regulation is an important factor when considering the future attractiveness and risk of the sector. The Australian airport sector is lightly regulated.

The current system promotes commercial pricing negotiations between the airlines and airports. However, it includes a provision for arbitration in relation to access charges, should commercial negotiations falter. (The Australian Competition & Consumer Commission (ACCC) has a price monitoring role in relation to aeronautical services and facilities, including car parking services.

The ACCC in the past has raised concerns over the level of airport parking charges.)

FS Private Wealth

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

51

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Australia has largely got on board incorporating sustainability measures and ‘green alpha’ into buildings.

Not only do these ESG measures align with broader global concerns, but they also make sense in terms of investment returns and community expectations.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Why sustainability matters in real estate

A Chris Nunn

s Australia’s largest employer of 1.4 million people, and its biggest industry, representing 13% of Australian gross domestic product (Property Council of Australia), the real estate industry has a tremendous opportunity to lead the way on addressing key environmental, social and governance (ESG) issues and support a sustainable future. With access to the necessary technology and insights, along with the knowledge of what is cost effective and known pathways to clean energy, it is in a unique position versus other asset classes to act now.

This paper explores the material ESG issues faced globally, the key drivers for action, and the important role that the real estate industry, asset owners, customers, partners and the community have to play in driving change that delivers positive outcomes.

It also explores the financial benefits or ‘green alpha’ that environmentally sustainable buildings can offer investors for the long term, which is an important consideration in an increasingly challenging ‘lower-for-longer’ returns environment.

Drivers for action Sustainability as risk mitigation

There is increasing recognition from substantial global bodies, like the World Economic Forum, that sustainability is a business megatrend, one that carries substantial risk if we collectively fail to act.

FS Private Wealth

The World Economic Forum’s Global Risks Landscape Report 2020 lists the top 10 global risks (of any kind) by likelihood and impact, the top five of which are sustainability risks: • Extreme weather events • Failure of climate change mitigation and adaption • Major natural disasters • Biodiversity loss • Man-made environmental damage and disasters • Massive incident of data fraud or theft • Large-scale cyberattacks • Water crisis • Global governance failure • Asset bubbles in a major economy Climate change and directors’ duties

It is now accepted in Australian corporate law that directors’ duties encompass a positive obligation to understand climate-change-related risks and opportunities, take appropriate action to transition to a zero-carbon future, and manage the risks associated with the physical impacts of climate change.

These positive obligations to understand and disclose climate change implications have been reinforced by the G20 through the Task Force on Climate-related Financial Disclosures (TCFD).

This will require Australian real estate companies to have quantified the potential investment implications of the transition to zero carbon.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

52

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

This may include costs related to: • Ongoing energy efficiency improvements • Installing on-site solar generation • Procuring 100% renewable electricity • Buying carbon offset credits to compensate for any unavoidable residual emissions (e.g. from diesel generators or refrigerants) It will also require the industry to develop methods to predict and disclose estimated costs associated with rises in insurance premiums from increased climate-related risks, and changes to valuation outlooks associated with the physical impacts of climate change.

• 92% of Australians expect their superannuation or other investments to be invested responsibly and ethically.

• Four out of five Australians would consider switching their superannuation or other investments to another provider if their current fund engaged in activities inconsistent with their values.

• 69% of Australians would rather invest in a responsible superannuation fund that considers ESG issues and maximises financial returns, rather than a fund that only considers maximising financial returns.

• 87% of Australians have important issues they avoid investing their money into, and 82% of Australians consider social issues when investing.

Investor sentiment

Chris Nunn, AMP Capital Chris Nunn is AMP Capital’s head of sustainability, real estate, responsible for integrating the company’s environmental, social and governance considerations throughout its real estate investments. He has 19 years’ experience in sustainability.

His memberships include the Property Council of Australia, and Investor Group on Climate Change.

According to the PERE ESG Investor Survey 2019, there is strong evidence that globally, sustainable investing is on the rise, with 70% of institutional real estate investors having an explicit ESG policy in place, and nearly all respondents reporting that ESG principles have some role in shaping their investment decision-making.

The survey also found that 35% of investors already expect ESG action from their investment managers, with a further 13% saying they will require ESG initiatives in the next three to five years.

Investors’ ESG analysts increasingly expect full sustainability performance disclosure, and evidence of high performance relative to peers in third-party sustainability benchmarks.

These benchmarks include the: • Global Real Estate Sustainability Benchmark (GRESB) • United Nations Principles for Responsible Investment (UNPRI) • Carbon Disclosure Project (CDP) • Task Force on Climate Related Financial Disclosures (TCFD) • Asian association for investors in Non-listed Real Estate Vehicles (ANREV) An increasing power of choice is also creating competitive pressure on pension funds to demonstrate their ESG credentials to members, by selecting responsible and sustainable fund and asset managers.

The Responsible Investment Association Australia’s (RIAA) From values to riches: Charting consumer attitudes and demand for responsible investing in Australia report of 2017 found that:

Sustainability targets and ESG screens

Many institutional clients have set themselves ambitious sustainability targets, and cascade those expectations through to their fund and asset manager. Moreover, more clients are becoming members of bodies such as the RIAA or the Global Impact Investor Network.

Most investors are applying some kind of negative ESG screen and divesting from sectors or activities with known significant environmental or social harm.

Further, many are now applying positive ESG screens, earmarking some or all of their funds to invest only in highly sustainable investments. In real estate, this might mean only investing in funds with a zero-carbon target, or portfolios that exceed area weighted average National Australian Built Environment Rating System (NABERS) Energy targets.

Many investors have explicitly committed to support the objectives of the Paris Agreement and the transition to a low-carbon economy through their investment activities. They are also aligning to global sustainable investment frameworks such as Australian Sustainable Finance Initiative, voluntary commitments such as UN Asset Owner Alliance through investors commit to net zero-carbon investment portfolios by 2050, Climate Action 100, or Renewable Energy 100, Energy Productivity 100, and participating in green bonds, climate bonds and other sustainable finance instruments.

Increasingly, investors are also looking to see alignment to the UN Sustainable Development Goals and concepts such as the ‘circular economy’ and the ‘Just Transition’ framework.

Table 1. Some key issues of interest for investors

• ESG in investment decision-making and transactions.

• Stakeholder engagement.

• Climate change mitigation targets and initiatives.

• ESG due diligence.

• Health and wellbeing.

• Supply chain issues (e.g. modern slavery and materials safety).

• Resilience to the physical impacts of climate change.

• ESG team headcount and seniority.

• Participation in ESG benchmarks (GRESB, PRI, Green Star etc).

• Equity and diversity.

• ESG credentials of new developments.

• Social impact assessment.

• T hird-party data verification.

• Aboriginal reconciliation.

• Energy, waste and water efficiency programs.

• Renewable energy installations.

Source: AMP Capital

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Customer sentiment

There is evidence from AMP Capital’s tenant satisfaction surveys that sustainability is also increasingly of interest to customers.

Office

Office customer sentiment is measured using an annual third-party survey which included findings that: • 90% of office tenant representatives support eliminating singleuse plastic from the building.

• 78% of customers consider NABERS Energy ratings important when selecting an office.

• Most customer organisations have their own corporate sustainability commitments (58%), which our buildings help them to achieve.

Retail

Evidence of retail customer sentiment in support of sustainability initiatives from AMP Capital’s 2017 Recommended Retail Practice Report From A to Gen Z: Shopping with the Future Generation found: • 68% prefer brands that give back.

• 62% prefer brands that stand for something.

• 59% are willing to pay more for sustainable products.

Industrial

Progressive industrial customers approached AMP Capital’s management team to carry out tenant-initiated base building sustainability measures, including: • The installation of solar panels at their facility.

• Innovative use of instruments such as third-party-financed, sitespecific power purchase agreements or environmental upgrade agreements to finance and install solar panels, batteries, LED lighting, new building management systems and heating, ventilation and air conditioning upgrades.

Public concern about climate change and waste

Public awareness of sustainability is growing through increasing news media coverage of the unfolding impacts of climate change, marine plastic pollution and popular TV and documentary series like Blue Planet and The War on Waste. This public sentiment is translating into increasing consumer pressure to demonstrate strong commitment and action on climate change. It is triggering calls, for instance, to introduce bans on single-use plastic items. The progressive introduction of plastic bag bans and the introduction of container-deposit recycling schemes has been successful in raising public consciousness at a key customer touch point.

Investment

53

Beyond cost savings, stronger ESG performance is insurance against future energy price spikes and helps tenant retention

From a real estate perspective, maximising portfolio returns is primarily linked to boosting rental income and keeping operational costs down. Reducing the outgoings of an asset by cutting energy costs is an important, and a relatively simple method to boost income yields. According to market evidence and international studies into green buildings, this can make significant differences to the return an asset delivers over its life (Australian Property Institute).

Sophisticated energy procurement strategies can also insulate customers from energy price shocks, which can happen with previous energy procurement methods involving three-or-five-year fixedprice contracts. As the contract came to an end, in an era of rising energy prices, customers felt the full effect of years of price rises as they were moved to the new energy contract. During 2018 and 2019, some were exposed to a doubling of their energy costs.

Asset valuations and returns are already starting to reflect a growing divergence between high-standard green buildings, and their less-green peers that can add as much as 50bps p.a. to a total return. According to the MSCI Green Property Investment Digest, over the past three years, Prime CBD Office buildings with a NABERS star rating higher than four stars (the maximum is six) have delivered a total return to their investors of 13.4%, versus 12.9% for all other assets in this category.

Green alpha and the positive boost it provides to total returns has become a greater part of an asset manager’s toolkit in maximising returns. Greener buildings, apart from delivering superior returns, tend to offer investors lower systemic risk with a more stable income profile, lower incentives and enhanced tenant ‘stickiness’ which can reduce the vacancy of a portfolio.

Australian leadership and competitive pressure on sustainability

The Australian real estate sector is globally highly competitive on sustainability performance. This leads to continuously rising expectations and performance levels among the leading institutional asset owners.

Green alpha: stronger financial performance for more sustainable buildings

There is growing evidence in the Australian market of higher sale prices, stronger rents, lower vacancy rates, reduced outgoings and better returns for more sustainable buildings (Australian Property Institute).

Some reasons for this include: • Higher NABERS ratings (for office) ensure that these properties are attractive to the widest range of prospective and incumbent tenants.

• Reduced resource use reduces operating costs for tenants.

• Strong sustainability performance correlates with lower vacancy rates, longer weighted average lease expiry and higher rents.

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

54

Investment

In the 2019 Global Real Estate Sustainability Benchmark results, Australian real estate companies were global sector leaders in nine out of 26 categories (34%). To be sustainability leaders in one-third of all available asset class positions in this global benchmarking system with over 1000 property company participants, covering over 100,000 assets, is hugely disproportionate to the Australian region’s size and scale.

The Australian region GRESB average has outperformed other regions for the past nine years. The Australian region average (81%) is about 10% higher than the global average (72%).

This level of global competitiveness means that domestic players are pushed to a greater performance level, which has seen the Australian real estate market characterised by high levels of innovation.

Key sustainability challenges Key sustainability insights from recent megatrends papers distributed by PwC, EY, KPMG, Deloitte and the World Economic Forum, show the scale and breadth of sustainability challenges globally. They also confirm that sustainability is more than a niche activity. Rather, it has become a dominant global economic risk and business thematic megatrend that will transform business, industries and society.

Some of the key challenges highlighted include: • Resource efficiency • Climate change • Water supply • Plastic waste • Biodiversity • Modern slavery Solutions from the real estate sector

The sectoral opportunity of commercial real estate to positively contribute to sustainability outcomes is also highlighted by the United Nations Sustainable Development Goals (SDGs)—a collection of 17 global goals set by the United Nations General Assembly for the year 2030 that were adopted by all UN Member States in 2015. In each country, governments are tasked with translating the goals into na-

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

tional legislation and implementing initiatives. Each of the top-level 17 themes has a separate list of targets—totalling 169 in all. The 169 targets are matched, with no less than 232 performance indicators.

Given the breadth and detail of the targets, notwithstanding that the SDGs were drafted with governments in mind, they have been widely embraced by the corporate sector. This is because they represent such a wide range of themes covering social, economic and environmental development issues.

These themes include poverty, hunger, health, education, gender equality, clean water, sanitation, affordable energy, decent work, inequality, urbanisation, global warming, environment, social justice and peace. Analysis of the sustainability targets from leading Australian real estate companies reinforces the range and type of sustainable solutions available in the commercial real estate sector.

These targets are examined in the following discussion.

Zero net carbon targets

These are almost universally adopted by Australian real estate companies. Target dates and scope of coverage vary somewhat, with some moving to zero carbon as early as 2020 or 2025, and others opting for targets as late as 2040 or 2050 for existing buildings. Typically, however, dates around 2030 have been chosen as the target timeframe by which real estate portfolios will have become carbon neutral.

Targets also typically include gas and electricity (scope one and two) emissions, with some also including relevant less direct (scope three) emission sources such as tenant energy consumption, methane emissions from decomposing landfill, and carbon emissions associated with water treatment and disposal. Few are currently opting to offset embodied carbon or other supply chain impacts, but this is often discussed as ‘next frontier’ once relevant operational and incontrol emissions are addressed.

Energy efficiency targets

These targets are universal, with most in a Australia using the NABERS Energy standard as a convenient performance benchmark.

Portfolio area-weighted NABERS average energy rating targets are

FS Private Wealth

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

being used quite widely to set top-level targets, such as five-star NABERS average without green power by 2020.

Renewable energy targets

Such targets are increasingly common, with many Australian real estate companies recently having completed or initiated large rooftop solar photovoltaic installations. These are particularly well suited to shopping centres with large expanses of available roof area, sevenday trading, and peak energy demand generally occurring during the day when the sun is shining and the panels are generating.

In addition to onsite renewable energy installations, some companies have commenced—and most are considering—various ways to cost effectively procure renewable energy through the grid, typically using power purchase agreement models.

Peak energy demand reduction strategies

This is a relatively new and increasingly promising area of investigation, with many property companies considering how generators or curtailment of cooling or heating could be used to reduce total energy consumption at times of grid or asset-level peak energy consumption.

This is an emerging demand-response market in Australia, which is well established in other countries, particularly the US. Electrification of buildings

There is increasing recognition that zero-carbon buildings necessitate the long-term phase-out of direct fossil fuel combustion (gas and diesel). Promises of a future transition to a hydrogen-based gas network seems too remote to counter electrification.

The use of biodiesel in generators is not yet widely discussed, and may be rendered moot by the reducing cost of batteries as backup power.

Batteries for backup power (versus generators) also have the cobenefit of the ability to more rapidly respond to calls feed into demand-response markets, which may contribute to the business case for battery adoption in commercial buildings.

55

Waste avoidance and recovery

Commercial real estate owners and managers have a significant role in reducing the waste generated by building users, and influencing them to adopt more sustainable consumption behaviours. Construction waste targets (including new buildings, refurbishments, as well as fitouts and stripouts) and operational waste targets are universal across real estate companies.

Water efficiency initiatives

Similarly universal, but beyond water-efficient fixtures and fittings, drivers to undertake more rainwater collection, grey- and black-water recycling, landscape infiltration and other sustainable drainage systems are weak relative to the strength of the economic and other incentives on energy and waste. This is anomalous, given the prolonged drought conditions in Australia, which are exacerbated by the effects of climate change.

Biodiversity initiatives

These typically focus on site-level actions in urban contexts, with many property companies setting targets to plant only native species and create relevant habitats for threatened species as part of their developments. Given the alarmingly high rate of species extinctions in Australia, and the disproportionate number of threatened and endangered species in Australia, this is an area where the real estate sector could do more.

Health and wellbeing

This is a major focus of most real estate companies, as a natural adjunct to providing building users with an optimal indoor environment. Metric rating systems for evaluating the contribution of the building to occupant productivity and wellbeing are increasingly common, as is the deployment of Internet of Things (IoT) sensors and surveys to test the effectiveness of interventions.

Social sustainability

Refrigerants

Refrigerants are a relatively small emission source that ‘punches above its weight’, with very high global warming potential per kilogram. Sustainability guru Paul Hawken’s Drawdown: the most comprehensive plan ever proposed to reverse global warming, a book of 100 climate change solutions published in 2017 ranked refrigerant management as the number one solution to climate change.

The transition to climate-friendly refrigerants is incentivised by the refrigerant phasedown by 2036 associated with the Kigali Amendment to the Montreal Protocol. This is quietly influencing new build chiller selection, and we can expect a practical phase out of hydrofluorocarbon (HFC)-based refrigerants by 2040.

Resilience to climate change analysis

Australian real estate companies are all in the process of carrying out, or have already undertaken analysis, of exposure to the physical risks associated with climate change impacts, the worst of which in Australia are expected to be heatwaves and severe storms.

New asset acquisitions are being screened for climate resilience, and this will start to be reflected in valuations as property companies become more sophisticated at quickly evaluating capital works and valuation implications of an asset’s exposure to climate risk.

FS Private Wealth

Social sustainability is a major growth area in Australian real estate, with many of the initiatives being documented in the Property Council of Australia’s A Common Language for Social Sustainability report.

Many companies are conducting social impact assessments of assets, supporting social enterprises, deepening charitable partnerships to create shared value, conducting more stakeholder engagement, and getting better at monitoring and reporting the tangible outcomes achieved through social sustainability initiatives.

Inclusion and diversity efforts

In Australian real estate there has been a heavy focus on gender equality, with many companies adopting the target to have greater than 40% of all staff, and senior executive positions held by women.

Reconciliation Action Plans to recognise and celebrate Aboriginal and Torres Strait Islander culture and promote Indigenous employment are increasingly common, but there is a long way to go.

Accessibility

Australian real estate players are generally good at encouraging walking, running or cycling to and from workplace buildings, and ensuring people can find out how to get there using public transport. Best-practice change rooms, cycle racks, lockers and showering facilities are com-

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

56

Investment

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. Which of the following sustainability innovations are now evident? a) G reen bonds to secure finance based on sustainability credentials b) G reater incorporation of energy services as part of property management c) N ew funds to attract impact investors or deliver enhanced ESG outcomes d) All of the above 2. In terms of energy-efficiency challenges, the article reported that in Australia: a) S ocial sustainability remains an abstract concept in real estate b) W ater collection and recycling initiatives have surpassed other energy and waste measures c) W ater collection and recycling initiatives are weaker than other energy and waste measures d) R eal estate companies have been slow to adopt zero net carbon targets 3. Tenant satisfaction survey research cited in the article found that: a) A round 40% of respondents considered NABERS ratings important b) A round three-quarters of respondents considered NABERS ratings important c) M ost respondents were yet to embrace eliminating single-use plastics from buildings d) Most respondents piggybacked on third-party sustainability commitments 4. Evidence cited in the article found that the growth in ‘green’ buildings resulted in: a) A slight increase in operating costs for tenants b) A melding of high- and low-standard green workplaces c) L ower systemic risks and more stable income for investors d) Greater demand from a niche clientele 5. Directors’ duties are yet to be linked to climate-changerelated responsibilities. a) True b) False 6. The Australian real estate sector is a mid-range performer in terms of global sustainability performance. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

mon, but more could be done to improve accessibility and functionality of buildings. In this context, it is important to note one in five Australians have some form of disability. This will likely involve increasing the numbers of adult changing facilities and catering better environments for people with visual or hearing impairments, dementia or ADHD. Electric vehicles

There are a series of market factors indicating an increasing need for Australian commercial building owners to plan for the installation of electric vehicle (EV) charging infrastructure. These include declining battery prices contributing to EV prices coming down in line with combustion engine vehicles, a growing range of EV models becoming available and increasing performance of new models.

Governance issues

Such issues have tended to focus on the strength of sustainability teams within real estate, the sophistication of environmental and sustainability management systems, the application of ESG screening as part of transaction due diligence, strong reporting, public disclosure of performance, transparent benchmarking, and the widespread application of rating tools and third-party assurance regimes to give confidence in reported results.

‘Green lease’ wording is now relatively common and will remain an important way to elicit the cooperation of building users in whole building sustainability initiatives. Supply chain governance is the hot topic in this area.

The introduction of modern slavery legislation in Australia in 2018 prompted significant focus on sustainable procurement governance mechanisms, development of enhanced supplier screening and prequalification criteria, contract clauses that explicitly reference avoidance of modern slavery, and supplier questionnaires to provide ongoing assurance that modern slavery risks are being managed.

Innovation

This is occurring in a variety of areas, including increasing use of green bonds to secure favourable finance based on the strong sustainability credentials of Australian institutional real estate, the creation of new funds focused on attracting impact investors or delivering enhanced social and environmental outcomes, and experimentation and scaling up of solutions like cross-laminated timber structures.

Further, we can also see the increasing incorporation of energy services as part of property management (through embedded networks, solar power purchase agreements, and district scale utilities), increasing deployment of IoT sensors, advanced building management control systems using machine learning and artificial intelligence and a variety of other prop-tech initiatives. There are also experiments with zero-carbon buildings emerging and advanced design and construction methods, like Passive House Certification.

The ultimate goal Realising a vision of a sustainable future is all about creating enduring value. Achieving long-term sustainable outcomes across real estate assets, supply chains and communities means buildings that use less and give more back, stand the test of time and are resilient to change. Further, it is about caring for the land and protecting and restoring the natural surrounds, building social capital in the communities and curating vibrant and inclusive places. fs

FS Private Wealth

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

57

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: This paper discusses reasons for the low INR/AUD correlation and provides a case for having a basket of currencies in investment portfolios, particularly as a hedge against falling commodity prices.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

The rupee as a diversifier Something to think about for Australian investors

A Mugunthan Siva

ustralian investors generally have significant exposure to the AUD (through locally based investments like Australian-based shares, property, infrastructure, fixed income and cash). The other currency to which they have substantial exposure is likely to be the USD through their global share, property, infrastructure and fixed income investments.

Typically, a default superannuation fund option has around 50% invested in listed equities, of which there is an approximate 50:50 split between Australian and international shares. Given that approximately 50% of the MSCI World Index is US-domiciled, it can be said that most of our allocation to equities (75%) provides AUD or USD exposure. However, there are certain currencies that can have a diversifying impact on an Australian-based investor’s portfolio.

The Australian economy and commodities Given the significant impact of commodity exports on Australia’s economy, its economic wellbeing is often dictated by improving ironore, coal, gold, aluminium, copper, petroleum and wheat prices.

Australia has profited from the industrialisation of China, giving rise to significant demand for our local resources. This is expected to continue, with other economies across Asia and Africa also having a significant need for Australia’s natural resources.

FS Private Wealth

There are other economies with similar profiles to Australia, such as Canada, South Africa, Brazil, Russia, Norway and the Middle East, which profit from commodity exports. Some of these economies have looked at sovereign fund exposure to a country like India to diversify their economic risks. India’s currency, the rupee (INR) is linked to the country’s economic fortunes. As a significant user and therefore importer of commodities, particularly crude oil, iron-ore and coal, India’s currency provides a hedge against falling commodity prices.

History of the INR The INR has origins back to the 6th century BC. At the point of its independence in 1947, India’s currency was on par with the USD. Since then, external borrowings to finance welfare and development led to a devaluation of the INR. A fixed-rate currency regime was put in place from 1948–1966, pegging the rupee at INR 4.79 per USD. Post-wars against China and Pakistan (which needed funding), the peg was reset to INR 7.57 per USD. From 1966–1991, the INR was continually devalued due to high inflation, low growth and low levels of foreign reserves, ending with a peg level of INR 17.90. A significant change was seen in 1993, with the currency being free-floated, leading to speedy depreciation to INR 31.37.

Since 1993, the currency has continued to witness steady depreciation, trading recently at just over INR 65 per USD. However,

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

Investment

Correlation in Aussie, Indian stocks The correlation between Australia’s and India’s equity markets is surprisingly low. In fact, it is far lower than the long-term five-year rolling correlation between Australian equities and emerging markets (EMs) as a basket. There are some specific reasons for this, which include the trajectory of the AUD and INR being quite different. The AUD is far more cyclical currency, which is linked to the commodity cycle – akin to several EMs like Brazil, Russia and South Africa. Hence, its currency is highly linked to the EM currency basket.

Looking at Figure 3, the following points need to be kept in mind (MSCI, Bloomberg and India Avenue Research): • India is a commodity importer, particularly seeking crude oil, copper and iron-ore for its internal demand and growth.

• India has a large, young population and is an importer – everything Australia is not.

• Australian equites are a high-yield-paying asset class, with a payout ratio greater than 70%. India’s yield is 1.5% and the payout ratio is closer to 26%.

• Australian equities’ correlation to Indian equities is 0.36 compared with its correlation to EMs of 0.66.

• EM equities contain significant exposure to commodity-producing economies (for example Russia, South Africa and Brazil).

A large part of the lower correlation has to do with the economic breakup of India’s growth story. A lot of its growth has been driven by internal demand, rather

Figure 1. India’s inflation (40-year-plus forecast)

16 14 12 10 8 6 4 2

2024

2020

2016

2012

2008

2004

2000

0 1996

Mugunthan Siva is co-founder and managing director of India Avenue Investment Management, a boutique investment firm based in Sydney.

The firm focuses on providing investment solutions and advice to those seeking to invest in India.

Mugunthan has 26 years’ investment and research experience across Australia (ANZ, ING, Westpac and Macquarie) and India (India Avenue and ING).

Throughout history, countries with higher inflation tend to have a depreciating currency relative to lowerinflation countries. However, India’s inflation now appears to have structurally dropped from an average of 7.6% over the past 38 years, to 6.3% over the past 10 years (Figure 1). In fact, the Reserve Bank of India’s inflation target is now 4%, with a range of plus or minus 2%, indicating a structural fall in inflation expectations as supply and demand forces have become less volatile.

Therefore, the observed history of an average depreciation of 2.7% p.a. of the INR versus the AUD (since the turn of the century) is not linear (Figure 2). In fact, the AUD is far more cyclical than the INR, given the nature of Australia’s economy.

The AUD peaked in 2013 against the USD, hitting $1.10 and close to INR 60 per AUD. Today, the rate has moved to INR 49, and the decision to hedge away the currency risk would have been a mistake (over the past six years) not only from a return perspective, but also from the need to diversify.

The period of significant depreciation in the INR against the AUD was 2009–2012 when the INR went through a fragile period as the Indian economy experienced weak GDP growth and high inflation.

1992

Mugunthan Siva, India Avenue Investment Management

The AUD/INR currency pair

1988

The AUD has been far more volatile against the USD than the INR has been.

a free-float currency has led to India becoming more competitive, which significantly increased foreign investment inflows and boosted economic growth (averaging 7% over the last 28 years since the 1991 reforms).

1984

The quote

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

1980

58

Source: IMF, World Economic Outlook, April 2019

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Why a basket of currencies is better Australian investors tend to own a significant proportion of their exposure on AUD or USD. While this makes sense from a home bias and matching of assets and liabilities, as well as an exposure to the reserve currency (USD), it could be more diversified with a focus on the future. The future is that developing economies like India are growing at a faster clip, and with positive macro fundamentals, will be more supportive of its currency. This will particularly be the case as structural inflation reduces and foreign investment flows continue to seek growth.

As India’s capital markets expand and its reliance on oil reduces, it is likely that the volatility spikes in currency will also reduce – already experienced over the past five to seven years. This will make investing in progressing developing nations more tenable for investors based in developed countries. fs

55 50 45 40 35 30 25

1/10/19

1/8/18

1/4/16

1/6/17

1/2/15

1/12/13

1/10/12

1/6/10

1/8/11

1/4/09

1/2/08

1/12/06

1/6/03

1/8/04

1/10/05

20

1/4/02

Volatility of currencies shows an interesting result. The AUD has been far more volatile against the USD than the INR has been. Its annualised volatility is 12.4% since 2000 (in comparison, the INR/USD volatility is 7.3%). A basket approach to currencies is preferable when the home currency is relatively volatile in nature.

In essence, the AUD/USD as a pair has more volatility than INR/USD (Figure 4). This is not as surprising as one may think, given Australia’s reliance on cyclical commodity exports. Even if one should choose to hedge out the AUD/INR, it is likely that the cost of this (we approximate 4–5% p.a. from the current interest rate differential) would make it unprofitable, unless one held a high conviction on the AUD’s upward direction.

60

1/2/01

Currency volatility: perception vs reality

Figure 2. AUD/INR

1/12/99

than demand for its exports. This is like saying that India compared with most export-driven economies, marches more to the beat of its own drum.

59

Source: Bloomberg

Figure 3. EMs and India’s five-year correlation with the S&P/ASX 200 1.0

Rolling 5 Year Correlations

0.8

0.6 MSCI EM

0.4

MSCI India

0.2

0.0 1997

2001

2004

2008

2011

2015

2018

Source: MSCI, Bloomberg and India Avenue Research

Figure 4. AUD/INR, USD/INR, USD/INR: rolling 12-month volatility 30% 25%

AUD/INR USD/INR

20%

AUD/USD

15% 10% 5%

1/9/19

1/3/18

1/12/18

1/6/17

1/9/16

1/12/15

1/6/14

1/3/15

1/9/13

1/12/12

1/6/11

1/3/12

1/9/10

1/12/09

1/3/09

1/9/07

1/6/08

1/12/06

1/6/05

1/3/06

1/9/04

1/3/03

1/12/03

1/9/01

1/6/02

1/12/00

0%

Source: Bloomberg

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

60

Investment

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. Which of the following statements is correct? a) A UD is more strongly linked to the commodity cycle than the INR b) C orrelation between Australian and Indian equity markets is surprisingly high c) C orrelation between Australian and Indian equity markets is surprisingly low d) I NR is more strongly linked to the commodity cycle than the AUD 2. From the mid-1960s to early 1990s, the INR was continually devalued due to: a) H igh inflation

b) L ow growth

c) L ow foreign reserves

d) All of the above

3. Indian equites are a high-yield-paying asset class with a payout ratio greater than 70%. a) True

b) False

4. The AUD/USD currency pair has been: a) S lightly less volatile than the INR/USD b) F ar less volatile than the INR/USD c) F ar more volatile than the INR/USD d) Slightly more volatile than the INR/USD 5. Which of the following statements is correct? a) I ndia’s average inflation has increased over the past 10 years b) O ver the past 28 years, the INR has appreciated steadily c) O ver the past 28 years, the INR has depreciated steadily d) India’s average inflation remained largely unchanged over the past 38 years 6. The INR can be used as a hedge against falling commodity prices. a) True b) False

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 08 Issue Issue04 01 || 2020 2019

61

Technology:

62

CRM systems and financial advice

FS Private THE JOURNAL Wealth OF FAMILY OFFICE INVESTMENT•

By Dylan Navra, Praemium Asia

THE JOURNAL OF FAMILY OFFICE FS Private INVESTMENT Wealth •

62

Technology

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: An effective CRM system greatly enhances the adviserclient engagement process by freeing up resources to concentrate on what really matters, and enabling an advice practice to harness greater business efficiencies.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

CRM systems and financial advice

E Dylan Navra

very adviser is acutely aware of their mounting administration burden. Not only do advisers have to provide sound advice, they must also show how and why they have provided it. To do this manually for every individual client is an administrative headache that inevitably places a limit on the number of clients an adviser can successfully support.

It is frustrating to think that upper limits are set, not on the capacity to advise or the availability of new clients, but by interminable tasks and the need to generate pages of compliance blurb, which is often impenetrable or meaningless to the average investor.

For those unwilling to accept this status quo, embracing automation and becoming paperless is an increasingly likely solution.

Advisers need to look beyond the traditional back-office systems that only store contact information, create a single view of client holdings and monitor remuneration. While they may have served an adviser well to date, even the most sophisticated back-office system is unlikely to make the necessary difference for an adviser trying to operate in today’s environment.

Focus on service The Future of Financial Advice reforms and more recently the Royal Commission into Misconduct in the Banking, Superan-

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

nuation and Financial Services Industry have placed a far greater emphasis on the service proposition advisers are providing clients.

Advisers not only need to provide greater transparency on fees, but also clearly demonstrate that the advice they provide is suitable for a client’s needs. In short, advisers need to show the value they provide to clients and they need to do it regularly.

In addition to demonstrating the value of their services, advisers also have a large administrative burden. They need to disclose their fees and get client opt-in regularly, produce statements of advice following delivery of advice, and make sure they are on top of all their compliance requirements, just to name a few. This can be tough to scale with a back-office system that only records activities rather than focusing on the client’s experience.

The real question to ask is: Does the client value, or even see, all the effort that occurs in the back office? Probably not. To our mind, simple back-office systems just cannot deliver in this new environment. Advice businesses need customer relationship management (CRM) systems if they want to grow their client base and provide a strong level of service that a client sees and values.

CRM systems offer a tool to build and manage the adviser-client relationship, rather than simply being a mechanism to keep everything in one place. They are used to help deliver the service to the client, rather than just store the history of it.

A good CRM system assists from the very beginning of the client relationship, at the introductory call or fact find stages, through

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

subsequent meetings, implementation and ongoing service. Online engagement tools will assist throughout the entire lifecycle of the client journey.

Establishing a workflow The right CRM system provides advisers with an opportunity to evaluate and streamline their workflow. It helps advisers consider how they can deliver their client proposition efficiently while eliminating cumbersome processes. The more an adviser ‘rinses and repeats’ the model they build within a CRM system, the more they become aware of areas that have been inefficient and are able to tweak their workflow accordingly.

With a healthy workflow established, an adviser can work out the time and cost to deliver their service proposition for different types of client – silver, gold, platinum, for instance. The CRM system then supports that service, issuing reminders for client meetings or updates at the appropriate intervals. This maximises time spent with the client rather than on the client.

High-touch engagement A CRM system also allows the adviser to create a factory-repeatable process. Advisers can communicate at scale because they no longer need to contact each client to take action because the CRM system does it automatically. It allows a high-touch service without additional work for an adviser.

The adviser’s focus then becomes about the delivery of the service rather than the production of it. CRM systems have built-in tools to deliver on that engagement through online portals where it is possible to view investment positions, update information digitally and communicate freely with the client. This creates new, modern ways for advisers and their clients to interact.

Be entirely digital No matter the industry, every business has a digital experience, whether they consider it or not.

More than five years ago, mobile/tablet eclipsed traditional computers when it came to connecting to the world. If an advisory practice has not considered and

FS Private Wealth

Technology

invested in its digital experience, it may already be creating a negative outcome for clients.

A simple and highly effective way to create a digital experience is with an online engagement platform such as an investor portal. Investor portals can allow for instant and secure adviser-client communication. Further, with investors having access to their wealth information in realtime, there is the opportunity for advisers to engage with their clients in a more meaningful way. Many also provide a shared document hub to allow the facility to manage ongoing requests or activities between the parties.

Further, with digital signatures becoming more widely adopted, the entire onboarding process can be delivered through a digital platform. From fact finding and risk profiling to delivery of statements of advice, investors now can input and receive this information digitally and provide the necessary authorities to process the same way too.

Embrace AI and learn from your data Artificial intelligence (AI) is finally reaching the everyday market by providing worthwhile insights into client engagement. Utilising a CRM system allows advisory businesses to store the full history of every contact point with clients. In turn, this will greatly streamline any auditing obligations.

Within CRM systems, AI can help business owners and advisers better understand the common patterns in their business model. For instance, whether there is a certain part of a process that takes too long in the onboarding stage, or if activity has dropped below the average. It can even let an adviser know which clients have not been contacted and the risk that this may bring.

Each insight can help drive greater business efficiency and alert businesses to maintain high levels of engagement with particular clients.

With well-defined digital portals, businesses can also track investor logins and how their clients are perceiving and interacting with their financial situation. This can create worthwhile insights on client comfort levels, alerting advisers to make contact if need be. For instance, if suddenly an investor logs in far more fre-

63

Dylan Navra, Praemium Asia Dylan Navra is Praemium Asia’s managing director and heads its financial advice software arm. He has over 12 years’ experience in the financial services industry, including several years as a financial adviser.

Dylan is passionate about helping advice practices increase their client engagement and business efficiency through the use of practice management and wealth management tools.

A key part of his role at Praemium is driving the growth of its adviser software and digital solutions globally.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

64

Technology

quently than their average, it may indicate that their stress levels have changed. Be it market conditions, or a need to make a withdrawal for personal reasons, AI can alert the adviser to contact the client to offer support and guidance.

Every login and interaction on digital portals offers advisers insights into their clients and provides the opportunity to facilitate more personal support than ever before.

Integrating platforms and CRM The reality that CRM systems and investment platforms will be able to work harmoniously, creating the ideal experience for the adviser and the investor, is perhaps one of the most exciting aspects to come in 2020.

Integrating a practice’s CRM system with the investment platform provides a complete set of data about the client’s financial situation and enables a holistic view of the client base and their wealth management experience.

Today, the implementation and actual execution of advice takes

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

the longest time in the financial planning process. Advisers need to create the advice, and investors need to approve it before the adviser then submits the request to the platform provider to execute. If this is all done on paper, the amount of double entry can be as high as seven instances in relation to the same information being input between paper and systems. Moreover, the time delay and the risk of error can be substantial.

With an integrated experience between the CRM system and investment platforms, the input of data can be reduced to just the one entry, with acceptance being the trigger to pass information between systems. Time and error should shrink substantially, thus offering an even better experience for the client.

Entering a new decade, the shift in focus from ensuring the job is done to ensuring the job is done well is a welcome change. The more businesses can focus on the client’s experience, the better the outcome will be for everyone. Embracing relevant technological capabilities will give advisers not only more time, but the potential for more clients to engage with. fs

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. An effective CRM system assists at the: a) E arly stages of an adviser-client relationship b) mplementation stage of an adviser-client relationship c) M ature stage of an adviser-client relationship d) A ll of the above 2. Which of the following is a key strength of CRM systems? a) T hey help deliver service to the client, rather than just store the history of interactions b) T hey are most effective as a means to keep all client information in one place c) T hey help clients appreciate the amount of back-office work undertaken by advisers d) T hey help to reduce categorisation of clients and service propositions 3. A CRM system does not readily lend itself to factoryrepeatable processes a) True b) False

4. Which of the following is a key benefit of AI? a) I t can help advisers better understand common patterns in their business model b) I t can alert advisers to sudden changes in client behaviours c) I t provides the means to deliver a greater level of personalised service to clients d) A ll of the above 5. Which of the following statements regarding digital portals is correct? a) T hey are limited in terms of securing authority to proceed b) T he allow real-time access to wealth information c) They are best suited to larger advisory practices d) T hey are subject to a time lag regarding wealth information.

6. Though beneficial, an integrated CRM system and investor platform increases data entry. a) True b) False

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

www.fsprivatewealth.com.au Volume 09 08 Issue Issue04 01 || 2020 2019

65

Philanthropy:

66

Best practice principles in philanthropy

FS Private THE JOURNAL Wealth OF FAMILY OFFICE INVESTMENT•

By Caitriona Fay, Perpetual

THE JOURNAL OF FAMILY OFFICE FS Private INVESTMENT Wealth •

66

Philanthropy

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Recognising non for profits and community partners as ‘experts’ and giving them the necessary latitude can greatly help philanthropists achieve the most from their funding.

This paper provides a collection of recommendations and considerations from NFP leaders and chief executives to achieve this aim.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Best practice principles in philanthropy

C Caitriona Fay

aitriona Fay, general manager, community and social investment at Perpetual Private offers some reflections on the lessons for philanthropy and the not-for-profit (NFP) sector. She also asks some leading CEOs for advice on how to best work with NFP organisations to achieve the greatest impact and benefit to the community.

A year of scrutiny for the NFP sector There is much to mull over in what has been another 12 months of scrutiny for ‘big’ philanthropy internationally. Much of that attention has focused on the decision-makers, their power and what they choose to (or choose not to) support. This is amplified by a fractured global political landscape, where the gaze has sharpened on all things – philanthropy included – that may be perceived or very real threats to our democracies.

In response to scrutiny, we need to build a philanthropic sector that is open, transparent and seeks to work in service of our communities and their ambitions. Traditional structures and operating models in philanthropy have often led NFP organisations down a path of conforming to the ambitions of funders, rather than the other way around.

So, how do we help funders understand more about how their nonprofit partners wish to see them fund? Working in an advisory capac-

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

ity, I often think about the best way to ensure that clients we work with hear from a diverse range of voices when it comes to the impact of giving—and whose voices do we position as experts in good-giving practices?

Some of this thinking has come to a head while reading Philanthropy, systems and change: perspectives, tools, and stories to help funders find their best-fit contribution to change by the Australian Centre for Social Innovation (TACSI). In this report, some of philanthropy’s most respected and thought-provoking practitioners—in Australia and globally—discuss the role of philanthropy in addressing the deep-rooted problems that policy, financial, democratic and digital systems are creating for our communities. The lesson here is that many philanthropists felt their best practice came when they moved towards granting strategies that positioned communities and NFPs as expert advisers, as opposed to the other way around.

Best practice funding tends to be patient, persistent and intuitive Philanthropists who are seeking to make significant change for the communities they care about have some common traits. Based on insights from the TACSI report and my own observations, they tend to be: • Patient funders: Understanding that real change moves with the pace of the communities that they are working to support.

• Persistent: Standing behind and encouraging their community partners in the face of numerous challenges and barriers to change.

FS Private Wealth

Philanthropy

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

• Intuitive: Recognising their community partners as the experts and seeking to support and add value to their work in ways their partners invite and value.

I reached out to some NFP leaders and asked if they would be willing to share a single piece of advice for philanthropists and those who want to work in the best possible way with non-profit organisations.

These responses were grouped into seven key themes: • Develop trust and partner for the long term • Offer untied or operational capacity funding • Ask the hard questions and take educated risks • Invest in development, not just ‘doing’ • Build relationships • Understand the impact and hear human stories • Ensure the right alignment

“Social change takes time and happens best in collaboration with partners who understand and trust in shared objectives. For this reason, my advice is to be bold, patient and be prepared to walk alongside your chosen partner(s) with multi-year commitments that support the organisational capacity to achieve individual projects. Funding project by project can’t deliver transformational change that funding organisational capacity in a multi-year commitment will. It takes time and committed partnerships to achieve deep and lasting social change.” (Mitzi Goldman, chief executive, Documentary Australia Foundation) “A great grant-maker develops a true partnership with the organisations they support. A partnership means that there is a deep level of trust, respect for roles and expertise, and the capacity for both parties to be honest. Social change is extremely challenging.

The best relationships I’ve had involve the grant-maker really understanding what we are trying to accomplish and then giving us the scope to take risks and try new things. Grant-makers who want to hear that not everything went to plan but that we learnt important lessons.

Grant-makers who understand that the most useful grants are untied and are spent on staff who make projects happen. Grant-makers who are open to feedback and will give us honest feedback too.” (Amanda McKenzie, chief executive, Climate Council) “Look for charities that have long-term, wellthought-through plans with clear outcomes and accountability. Fund them for over five years for measurable outcomes and insist on annual reporting as you would your own business. I think philanthropists can expect to receive a great deal more if they de-risk outcomes through the provision of sustainable funding support.” (Rosie Simpson, chief executive, the Children’s Hospital Foundation, Brisbane)

Develop trust and partner for the long term

Offer untied or operational capacity funding

“Charities go where markets will not and overstretched governments cannot. Services in the ‘hard’ places take time to build, and a partnership over a longer period is more desirable than trusts changing charities yearly.

This also enables the partners to develop trust, service design and growth together.” (Scott Chapman, chief executive, Royal Flying Doctor Service, Victoria)

“Give core funding, not funding tied to a particular project. Too many funders want to own a program, and not pay for the rent, the admin person, the electricity or any other essential items. Core funding allows an organisation to direct funds where they are most needed.

It can be a lifeline.” (Dr Catherine Keenan AM, executive director and co-founder, Sydney Story Factory)

How to position community partners as the ‘experts’ Following are two quotes from the TACSI report that resonate with me when philanthropists consider how to best work with NFP organisations to achieve the greatest impact for the community: “The best thing funders can do is to shift the focus from them and what they are funding to looking around and seeing themselves as part of an interconnected whole. Most foundations think it’s them that are responsible for making change.” (Alice Evans, deputy chief executive, Lankelly Chase (UK)) “We invite our grantees to share their expertise to help us make funding decisions. We ask them, ‘What are you dreaming about that we could help you with?’ We understand that they know best what it takes to make real change happen.” (Emily Tow, president, Tow Foundation (USA))

How to fund NFPs for impact: leading CEOs weigh in

FS Private Wealth

67

Caitriona Fay, Perpetual Caitriona Fay is Perpetual’s general manager, community and social investment.

With more than 15 years’ private family and institutional grant-making experience, she oversees approximately $4 billion in community funds across Perpetual’s work with philanthropists, non-profits and Native Title groups. Caitriona is a founding board member of The Channel, Australia’s first sexuality- sexand genderdiverse giving circle; a founding member of the Melbourne Women’s Fund and an International Women’s Forum member.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

68

Philanthropy

“Invest in our greatest asset – our people and our capacity. We live and breathe our business every day. We know it inside out, but to fund it through philanthropy, sometimes we find ourselves shifting or tailoring our focus to attract dollars. With operational capacity funding, we can scale our mission, stay on strategy and deliver better outcomes for our beneficiaries.” (Julie McDonald, chief executive, The Funding Network) “If you really want to understand impact, ask your charity how they measure the connection of outcomes with their theory of change. Secondly, allow for – even insist – that your grant is used to fund intelligent overhead[s]. [An] intelligent, but almost always unfunded, overhead includes data collection, insights, and practice reform to continuously build better practice that is evidence informed.

The alternative option, which may be just as valid, is just give money to your favourite cause and have faith that it will make a difference.

And it likely will.” (Paul Edginton, chief executive, SYC Limited) Ask the hard questions and take educated risks

“Successful philanthropists are the ones that take risks and encourage NGO [non-government organisation] partners to do so too.

Whilst they need to analyse what to support with their head, they need to decide with their heart what initiatives to back and then provide flexibility to the NGOs to ensure they succeed.” (Dermot O’Gorman, chief executive, WWF Australia) “I’d suggest asking, ‘What is the hardest thing for your organisation to fund that would have the biggest impact on your mission?’

The answer may lie outside of your granting remit. It may be too early in the relationship to take a risk, however, it may just be the thing that allows you to play a transformative role in the life of the non-profit and the people or environment they serve.” (Stacey Irving, chief executive, the Karrkad Kanjdji Trust)

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

Invest in development and innovation, not just ‘doing’

“I would like funders to support organisations to develop the capability to plan, develop and grow, not just do. All successful projects need a strong planning and induction phase if they are to develop the ability to shift to new paradigms to meet social impact demands.” (Gildi Carty, chief executive, Life Education) “Complex social policy issues like mental health and suicide prevention often aren’t ‘tidy’. Innovations in prevention and early intervention span far beyond the health and service systems into all parts of people’s lives; where we live, work, learn and play. And results are often harder to measure over the short term. I’d love philanthropy to spend time talking with us and coming up with innovative and different investment ideas with us.” (Georgie Harman, chief executive, Beyond Blue) “Strong sustainable organisations are built by high-functioning, adaptable and motivated people. Yet, many smaller organisations struggle to provide any professional development for their staff. Invest in staff development by requiring it to be incorporated as a percentage of project funding.” (Jo Pride, chief executive, Hagar Australia) Build relationships

“Build relationships with organisations you wish to support so you can see the motivations of the leadership and staff. You’ll more easily find organisations that have an outcomes-focused culture that way. Those are the right organisations to invest in.”

(Carmelo Arto, chief executive, Breast Cancer Research Centre, Western Australia) “Take the time to build relationships with the NFPs you support. The best grant-makers encourage and enable dialogue which builds trust and confidence for the long term and enables

FS Private Wealth

Philanthropy

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

knowledge-sharing. Multi-year grants provide funding certainty for NFPs and create greater social impact, as programs have the space to evolve and refine. Increase your appetite for risk – philanthropy can enable greater innovation where government grants can’t. Philanthropy can venture into areas that corporate and government funding can’t; giving birth to fresh innovation and tackling ingrained social problems in a new way.” (Rob White, chief executive, Cerebral Palsy Alliance) Understand the impact and hear the human stories

“Once engaged, a good philanthropist should seek to understand the impact their support will provide and look to build an intellectual and emotional bond with the recipients of their support. This can be done in person or with anonymity.” (Anthony Ryan, chief executive, Youngcare) “The use of application forms and reports in philanthropy can prohibit non-profits from demonstrating the value of work. We need to communicate our value and impact through stories. Data and evaluations do provide a certain perspective, however, facts can turn people ‘off’ and stories turn them back on and engage them in the life changing impact they can enable. Providing an engaging story is virtually impossible within the constraints of a tightly worded response to an outcome and metrics-focused question. By insisting on this format and never hearing the human stories of the lives changed, funders may be depriving themselves of the true joy of philanthropy.” (Louise Baxter, chief executive, Starlight Children’s Foundation) Ensure the right alignment

“Invest in organisations that are aligned to the change you are attempting to achieve and give them the freedom to tell you what they need. There’s always a risk that non-profits will apply for funding that meets the needs of the philanthropist but not the mission of their organisation. Ensure that alignment is right both for the sake of your funding and the sake of the organisation seeking the grant.” (Mara-Jean Tilley, director, Garvan Research Foundation)

Final thoughts and looking ahead In summary, the key takeaways for philanthropists are: • Invest patiently • Fund the core • Find organisations that measure • Trust the organisations you fund I am incredibly lucky to have colleagues across the NFP sector who feel comfortable to tell me about the philanthropic practices that help – or hinder – their organisations in achieving impact for the communities they serve.

I draw on these experts often and rely on them to inform my own thinking on practice. fs

FS Private Wealth

69

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. According to interviewee opinions cited, funding is most effective as: a) Multi-year commitments b) Six-monthly commitments c) Project-by-project commitments d) Government-aligned commitments 2. As highlighted by the author, what is the key tenet of philanthropic best practice? a) Positioning funders as experts b) Positioning NFPs as experts c) Making funding conditional d) Prioritising ‘quick victories’ 3. What approach is recommended to communicate the value philanthropy? a) Using third-party reports b) Using facts and metrics c) Using human stories d) Using cost-saving initiatives 4. What key takeaways does the author offer philanthropists? a) Invest patiently b) Find organisations that measure what they do c) Trust the organisations they fund d) All of the above 5. Effective funding should accommodate operational items such as utilities. a) True b) False 6. Philanthropy is not immune from a certain degree of risk-taking. a) True

b) False

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

Finished reading?

Content from this journal is CPD accredited.

Go to FS Aspire CPD and search ‘FS Private Wealth’ to start earning CPD hours.

Available for individual and corporate subscribers Administrators can upload exams and build training plans FASEA reporting functionality Access to hundreds of hours of FPA and CPE accredited content Content from Australian and international thought leaders Claim CPD from events Track your progress via the live dashboard Device-friendly user interface Access to whitepapers, video, audio and event material Access to FS TechZone, your technical resource library

To request a demonstration call 1300 884 434 or visit www.financialstandard.com.au and click ‘FS Aspire CPD’

Don’t just do your CPD, discover your professional potential

72

Quick reference

www.fsprivatewealth.com.au Volume 09 Issue 01 | 2020

News and opinions Australian Ethical

White papers 11

BetaShares 12 BlackRock

10, 11

Channel Capital

9

Colonial First State

9

Commonwealth Bank of Australia

6

Coolabah Capital Investments

8

CoreData 8 Credit Suisse Private Banking

6

Crestone Wealth Management

6

Dalton Financial Partners Discovery Asset Management

12 6

Taxation and Estate Planning Wealth management after liquidity events Ethics and Governance Cognitive biases in ethical decision-making

Impacts of coronavirus

44

Investors’ increasing allocations to unlisted infrastructure

47

Why sustainability matters in real estate

51

The rupee as a diversifier

57

Technology CRM systems and financial advice

10

Philanthropy

Fox & Hare Financial Advice

12

Best practice principles in philanthropy

6

The Impact Fund

9

International Monetary Fund

7

Julius Baer

7

Macquarie Investment Management Magellan Asset Management

38

Investment

Financial Adviser Standards and Ethics Authority (FASEA) Harper Bernays

30

62

66

11 8, 11

Morningstar 11 Natixis Investment Managers

7

Netwealth 10 Pendal Group Pinnacle Investment Management Pzena Investment Management Rainmaker Information

6, 11 8 11 9, 11

Regal Funds Management

6

Revolution Asset Management

9

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

FS Private Wealth

58% of High Net Worth Investors claim they have unmet advice needs.* We’re here to empower advisers in this space.

The only Australian wealth management platform tailored to the needs of High Net Worth Investors.

* Powerwrap/Investor Trends High Net Worth Investor Report 2019

w: www.powerwrap.com.au

p: 03 8681 6458

34.7789246 119.6962572

EXACTITUDE. It’s what enables you to extract strong returns from the small companies market.

We offer investors the expertise needed to pinpoint superior opportunities within the tricky small company universe. Being one of Australia’s leading investment managers, specialising exclusively in Australia’s small and emerging companies, we apply proprietary research, rigor and fundamental analysis. This maximises client returns and limits losses.

What’s more, if our 1st quartile performance across all time periods, since inception is anything to go by, this is the edge you’ll need.

To seize superior small companies opportunities for you or your clients, visit flindersinvest.com.au or call 02 8651 3490