FS Private Wealth v09i03

The Journal of Family Office Investment

Volume 09 Issue 03

Investing in agriculture Riparian Capital Partners

Entitlement trap Squire Patton Boggs

PADDOCK TO PITT STREET

Robert Millner Washington H. Soul Pattinson

Published by

Trusts Structuring social enterprises Compliance for franchisees

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Contents

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

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COVER STORY

PADDOCK TO PITT STREET Robert Millner Washington H. Soul Pattinson

18 VANTAGE

POINT

24

Australia’s headline inflation dropped by 1.9% in June quarter, in the steepest decline in 72 years.

But it is not all doom and gloom, Financial Standard chief economist Benjamin Ong writes.

25

The June quarter flipped the winners and losers in Australian Real Estate Investment Trusts, as retail landlords rebounded strongly from prior losses off the lockdowns.

EUROZONE GROSS DOMESTIC PRODUCT SLIDES

Opinion New tribe of wealth investors

14

IN THIS ISSUE WHERE NEXT FOR A-REITS?

HIGHLIGHTS

25

Featurette Lessons for endowments

16

Eurozone GDP dropped by 12.1% in the three months to June following a 3.6% contraction

Whitepaper Structuring social enterprises

in the March quarter – satisfying the technical definition of a recession.

GOOD QUARTER FOR CHINA INDUSTRIALS China’s National Bureau of Statistics data shows that profits at the country’s industrial firms

25

50

jumped by 11.5% in the month of June – the fastest pace since March 2019.

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

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FAMILY CONNECTION Christopher Page, managing director, Financial Standard If succession planning is on your mind, this edition offers pointers from a fourth-generation patriarch and family office lawyers.

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

06

Associate Editor

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

08

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

NEW CHIEFS AT JBWERE AND NAB PRIVATE MIKE CANNON-BROOKES’ SPACESHIP BET HOW BLACKROCK IS TRACKING ON COAL

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

Welcome note

News

STRUGGLES OF A CHARITY-FOCUSSED LIC LAND TAX VERSUS STAMP DUTY CAPGEMINI’S WORLD RICH INVESTORS TALLY

09

09

News

THE DEMISE OF THE ‘CASH PLUS’ NAME STARTUP WOOING FUNDIES’ FAMILY MONEY

News

CBA PRIVATE BANKING CHANGES BILLIONAIRES IN TWITTER SCAM

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

FS Private Wealth

The Journal of Family Office Investment ISSN 2200-4971

18

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

PADDOCK TO PITT STREET Robert Millner, Washington H. Soul Pattinson What does it take to build a resilient business and preserve family wealth?

Millner shares his journey as the fourth generation to lead the 118-year-old investment house.

ABN 57 604 552 874

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

FS Private Wealth

QUALITY ACTIVE CONCENTRATED Global small and mid cap investing Fairlight Asset Management is a boutique firm investing exclusively in global equity markets. We take an ethically-aware, quality-driven approach dedicated to deep fundamental research of the global small and mid cap sector. Most importantly, we are focused on contributing to superior investment outcomes through exceptional performance.

Global small and mid cap allocation is often underrepresented in the average portfolio, learn more about enhancing client outcomes. fairlightam.com.au

Disclaimer: Fairlight Asset Management Pty Ltd (ACN 628 533 308 Corporate Authorised Representative No 001277649 of AFSL No 000247293) is the product issuer. You should consider your clients’ circumstances and our Product Disclosure Statement (PDS) before making any investment decision. You can access our PDS at fairlightam.com.au. This publication was prepared in good faith and we accept no liability for any errors or omissions.

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WHITE PAPERS Taxation & Estate Planning TRUSTS AT RISK OF INCORRECT DISTRIBUTIONS WITH

SIGNIFICANT TAX CONSEQUENCES

By Alexis Kokkinos, Pitcher Partners

COVID-19 served as a lesson for trusts on income distributions. The author uses it as an example to highlight tax consequences of under-informed distribution decisions.

34

Family Office Management

THE ENTITLEMENT TRAP

By Daniel G. Berick, Squire Patton Boggs The author identifies, defines and suggests remedies for common issues between family office principals and potential successors.

38

Investment

VALUE IS A PHILOSOPHY, NOT A FACTOR

By Richard S. Pzena, Pzena Investment Management What exactly is value investing and can factor-based strategies emulate it, this interviewformat whitepaper explores.

41

Investment

THE IMPACT OF COVID-19 ON AGRICULTURE

By Michael Blakeney and Patrick Hayden, Riparian Capital Partners What can historical spending data tell us about the direction of agricultural investments?

The authors expect agriculture to be more resilient than other sectors in future recessions.

Technology

CYBERSECURITY RISKS FAMILY ENTERPRISES AND OFFICES FACE DURING COVID-19

By Helena Robertsson, EY Family firms need to protect their names, their brands and the organisations they have built over generations.

Cyberattacks and cyber fraud pose a threat that has grown in COVID-19.

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46

Philanthropy

PURPOSE AND PROFIT

By Sophie Renton, McCrindle The author draws on personal experiences of non-profit leaders to ascertain what makes corporate partnerships work, and how companies can avoid woke-washing.

50

Philanthropy

CHOOSING THE RIGHT SOCIAL ENTERPRISE STRUCTURE

By Regie Anne Gardoce, Sprintlaw Australia doesn’t have a specific legal structure for social enterprises, which are companies that look to combine profit and social impact. This paper looks at five alternative structures.

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THE JOURNAL OF FAMILY OFFICE INVESTMENT•

Compliance

GOOD FAITH IN FRANCHISING

By Ana Haarsma, Haarsma Lawyers This paper explains what the obligation to act in good faith means in light of the Franchising Code, regulatory expectations and case law.

FS Private Wealth

Welcome note

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

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Christopher Page managing director Financial Standard

Family connection or most of us, keeping our next genF erations involved in our business is a dream.

Washington H. Soul Pattinson has been able to do that for over a 100 years and five generations of its extended clan.

Its long-standing chair Robert Millner takes us on a trip through the resilient (it’s never missed paying a dividend!) investment house’s past, present and future in our cover story (pg.18). On the way, we visit his farm in Cowra and to the firm’s offices in Sydney, which recently replaced the 145-year-old headquarters on Pitt Street Mall.

He also offers some pointers on keeping our offspring interested in the family business – or a business with a family connection in case of SOL, as it has about 30,000 other shareholders besides the Millners.

The secret to intergenerational interest seems to be to let your children do their own thing, until they want to put up their hand.

This is how Millner came onto WHSP’s board in 1984 after working as a stockbroker and then a farmer. It is also how his son, Tom Millner came to work at WHSP’s investment management business, after studying industrial design at university.

“It was very similar to my upbringing.

There was no pressure on me to come into the business. I never mentioned to Tom that we’d like him to come in and step into the business,” Millner says.

“He went to university and then worked for a while and then he said to me, you know, he’d like to come and try his hand.”

Millner also touches on how one raises their kids without an inherent sense of entitlement if the household is financially comfortable.

We revisit the question of entitlement in a whitepaper (pg.34) from law firm Squire Patton Boggs in the second half of this edition, alongside other technical but digestible primers on finer points of family wealth.

Lastly, this edition is packed with family office investing news.

We have the latest on how Mike-Cannon Brookes’ investment in startup superannuation fund Spaceship is performing (pg. 6), we introduce you to a Sydney startup that has attracted family capital from three highly-regarded bond managers (pg.9), and we have the details on how Geoff Wilson and others came to pitch in to save the Australian Associated Press’s newswires while expecting no return (pg.13).

Happy reading and stay safe. fs

The secret to intergenerational interest seems to be to let your children do their own thing, until they want to put up their hand.

Christopher Page managing director, Financial Standard

FS Private Wealth

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

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News

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

BlackRock updates on dumping coal

Shifting leadership at JBWere, NAB Private

Elizabeth McArthur

I

BlackRock has offered its first major update on investment stewardship since it said in January it would dump thermal coal from active portfolios.

The investment giant’s voting efforts increased in 2020, with the number of company engagements increasing by 47% in 2019-2020 compared to 20182019.

Looking at environmental engagement, BlackRock engaged 289% more frequently, with the number of engagements on environmental issues increasing from 316 to 1230.

There was a huge increase in social engagements too, up 146% from 353 in 2018-2019 to 870 in 2019-2020.

Governance remains the ESG issue that BlackRock engages on the most. In 2018-2019 BlackRock engaged on governance issues 1931 times and in 2019-2020 that increased to 2835 times (up 47%).

“Our approach employs a natural escalation process. If we are not satisfied with a company’s disclosures, we typically put it ‘on watch’ and give the company 12 to 18 months to meet our expectations,” BlackRock said.

“During the 2020 proxy season, we took voting action against 53 companies for their failure to make sufficient progress regarding climate risk disclosure or management.”

It voted against directors of ExxonMobil due to significant concerns about climate risk management.

BlackRock’s commitment to dumping thermal coal only relates to its active investments. Of the roughly US$7 trillion it manages about US$1.8 trillion are in active strategies. fs

Eliza Bavin, Kanika Sood

The quote

We have an ambition to grow our marketleading business bank by helping our customers grow, and our offering for high-net-worth clients is a core part of our strategy.

n June, JBWere appointed replacements for former general manager of advice Neville Azzopardi and former chief investment officer James Wright, who both resigned in March.

Andrew Bird, who was most recently JBWere’s head of advice for Victoria, moved into the role of general manager, advice after three and a half years with the company.

To fill the vacant CIO role, JBWere hired Sally Auld, J.P. Morgan’s chief economist and head of Australia and New Zealand fixed income and FX strategy. She was slated for a September 7 start date.

JBWere in July announced it will hire 50 new bankers and financial advisers, as it looks to provide high-net -worth clients with a single point of access for their financial needs.

“We have an ambition to grow our market-leading business bank by helping our customers grow, and our offering for high-net-worth clients is a core part of our strategy,” JBWere chief executive and leader for NAB Private Justin Greiner said.

“We are looking to recruit bankers and advisers that have a deep understanding of private wealth and a strong sense of ‘client first’ which is the ethos at the heart of the JBWere culture helping us to serve families and organisations for 180 years,” he said.

JBWere, NAB Private and self-directed wealth have now come together under the leadership of Greiner.

NAB said the new private bankers will also be part of the bank’s new accredited banking career pathway, providing ongoing investment to support their career.

Over at NAB Private, Anthony Healy, the chief customer officer, business and private banking, left in March after 10 years with the bank.

In July NAB Private customer executive Jason Murray also left to join ASX-listed fintech FlexiGroup Limited as its chief financial officer.

Also this year, Mike Baird left as the chief customer officer of the consumer bank effective April 15. Baird has since joined age care provider HammondCare as its chief executive. fs

Good year at billionaire-backed Spaceship Spaceship, which is backed by the family office of billionaire Mike Cannon-Brookes in August raised $10 million from existing investors after a strong year.

Spaceship chief executive Andrew Moore says its managed investments business has been the “single, strongest” source of growth for its $300 million superannuation fund.

Spaceship, which started out as a superannuation fund in 2017, added a managed funds business called Spaceship Voyager in 2018, offering two low-cost equities funds with the average investor a 30-year-old worker.

Voyager ended FY20 with stellar returns on both options (its universe portfolio returned 37.39% in the year ending May 31) but also with great customer growth, which Spaceship hopes will transform into growth for its superannuation fund.

The product currently has about 85,000 users,

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

growing from about 45,000 at the start of last financial year. July alone brought 5000 customers to Voyager, Moore said in a mid-July interview.

Moore is excited by the client acquisition for the year, seeing it as a cross-over opportunity to its superannuation product, which is a bigger contributor to the firm’s revenue.

“Our single strongest growth in super growth is coming via voyager customers,” Moore said.

“Superannuation remains a very important product for us. One of things that we have come to understand is that we can build a relationship like [through] managed funds,” he says.

The superannuation offering has about 6000 members, of which half also use Voyager.

Moore says the firm is not contemplating offering external managed funds or individual ETFs on the Voyager platform. fs

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About Innova Innova is a boutique risk-focused portfolio manager that has been managing client portfolios since 2010. Innova was founded on the principles of providing robust and research-intensive insights to help investors meet their financial goals. We focus on managing the multi-faceted nature of investment risk for clients.

Important Information: This document has been prepared by Innova Asset Management Pty Ltd (Innova), ABN 99 141 597 104, Corporate Authorised Representative of Innova Investment Management, AFSL 509578 for provision to Australian financial services (AFS) licensees and their representatives, and for other persons who are wholesale clients under section 761G of the Corporations Act. To the extent that this document may contain financial product advice, it is general advice only as it does not take into account the objectives, financial situation or needs of any particular person. Further, any such general advice does not relate to any particular financial product and is not intended to influence any person in making a decision in relation to a particular financial product. No remuneration (including a commission) or other benefit is received by Innova or its associates in relation to any advice in this document apart from that which it would receive without giving such advice. No recommendation, opinion, offer, solicitation or advertisement to buy or sell any financial products or acquire any services of the type referred to or to adopt any particular investment strategy is made in this document to any person.

Although non-Fund specific information has been prepared from sources believed to be reliable, we offer no guarantees as to its accuracy or completeness. Any performance figures are not promises of future performance and are not guaranteed. Opinions expressed are valid at the date this document was published and may change. All dollars are Australian dollars unless otherwise specified.

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News

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

Hearts and Minds but no ratings at LIC Ally Selby

L

Rich growth faster in US Elizabeth McArthur

For the first time in eight years, more high-net-worth individuals (HNWI) emerged in North America than in the Asia Pacific region.

This is according to the World Wealth Report 2020, produced by Capgemini.

HNWI wealth and population grew by almost 9% globally in 2019 despite a global economic slowdown, international trade wars and geopolitical tensions.

North America and Europe took the lead with around 11% and 9% growth respectively, surpassing Asia Pacific with 8% for the first time since 2012.

Breaking down the HNWI population by net wealth, it was actually those at the very top – with more than US$30 million in investable assets – who continued to thrive.

The ultra-HNWI segment increased most in terms of population, by 9.1% and their wealth grew by 8.2%.

There are approximately 183,000 ultra-HNWI in the world. There are 1.75 million mid-tier millionaires with between US$5 million and US$30 million in investable assets in the world and 17.6 million “millionaires next door” with between US$1 million and US$5 million in investable assets. While the ultra-HNWIs are a tiny population, they account for a third of the total wealth of all HNWIs. However, even the exceptionally wealthy could not to avoid the impacts of the COVID-19 pandemic.

The World Federation of Exchanges estimates that COVID19 erased more than $18 trillion from markets in February and March 2020 before a slight recovery. fs

The numbers

17.6m

Population of “millionaires next door” in the world, with US$1m to $5m in investable assets.

isted impact investment vehicle Hearts and Minds Investments has returned more than 26% on a 12-month basis, while also donating $4.1 million to medical research. Yet, the fund has faced major roadblocks when it comes to receiving a rating.

Fund managers working on a pro bono basis for the fund include Caledonia Investments, Cooper Investors, Magellan Financial Group, Paradice Investment Management, Regal Funds Management and TDM Growth Partners.

The fund has donated 1.5% of its net tangible assets to beneficiaries such as the Victor Chang Cardiac Research Institute, the Black Dog Institute, the Charlie Teo Foundation and Westmead Children’s Hospital.

Despite its strong recent performance and altruistic actions, getting a rating has been hard for the fund.

Independent research house Zenith, in particular, cannot rate the listed investment company, as its founder is also Hearts and Minds’ chair – a potential conflict of interest.

“I’ve got a little bit of a bugbear that to get on an approved list for financial

advisers you’ve got to have particular reviews done of you,” Hearts and Minds Investments chief investment officer Rory Lucas told Financial Standard.

“When we spoke to some of these ratings agencies, we said ‘Look, we don’t have a three-year track record, but Caledonia do, Magellan do, Paradice do, and we’ve got their best ideas’ – but they struggled to look at it like that.”

Hearts and Minds also does not want to fork out for a rating (often upwards of $50,000), Lucas said, as he believes this money would be better spent by the company’s beneficiaries.

Another ratings roadblock faced by the investment company is that its construction does not meet the typical portfolio “mould”.

While 65% of the portfolio features the best ideas from prominent fund managers, the remaining 35% of the portfolio is made up of Australian and global stock picks from “conference” managers.

“It doesn’t fit into the current mould; it’s sort of an outlier when it comes to how they review funds, so that has been a challenge for us.” fs

Land tax, not stamp duty for property sales Jamie Williamson

A draft report into reforming goods and services tax (GST) and reducing inefficient taxes has reignited calls for the scrapping of stamp duty when buying or selling a home, to be replaced by a broad-based land tax.

The NSW Review of Federal Financial Relations draft report says there is a strong case for reforming GST and reducing the nation’s reliance on more harmful taxes, while re-directing a portion of revenue to lower income households so they do not bear the burden of reform.

This would include scaling back inefficient taxes’ including stamp duty on property transactions.

According to the report, at the height of the property boom in 2017-18, NSW raised almost 28% of taxation revenue from transfer duty before dropping by 14% the following year, showing volatility of revenue collections presents a challenge

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

to governments when it comes to budgeting.

“A discussion spanning close to two decades through a series of tax reviews has laid the groundwork for broad community understanding of the advantages of recurrent land value taxation over taxation of property transfers,” the report reads.

“These reviews have generally recommended abolition of transfer duty and replacement via a broad-based tax on land.”

This is typically down to the economic inefficiency of transfer duty compared to land tax, but there are important equity implications too, the report states.

Of the 2.8 million properties in NSW in 2018-19, less than 200,000 owners contributed to the funding of essential services via transfer duty, and only one in 20 helped to pay for the schools, roads, hospitals and other services that added to the value of all properties. fs

FS Private Wealth

News

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New private trades platform

Cash plus funds shape shift under ASIC

Hedge fund billionaire Paul Tudor Jones backed Clearlist Holdings is partnering to develop a platform for family offices to trade private markets securities. And it will accept Australian rich.

Sharenett, which is a network of over 400 family offices and ultra-high-net-worths around the world, said the launch is a part of its strategy to become the leading regulatory compliant distribution platform for illiquid investment opportunities. “[We are] creating a superdistribution hub that will level the playing field for family offices by giving them unique access to appealing investment opportunities across the entire spectrum of private assets,” ShareNett chief executive and chair Clifford H. Friedman said.

“ShareNett has developed a robust institutional solution that provides a path for families to overcome the inherent challenges of seeking primary and secondary liquidity in private markets.”

ShareNett allows non-US investors to join their network, meaning Australian HNWs can get access to the new platform, a spokesperson said.

The company will collaborate with GTS Securities LLC on the launch of the ClearList initiative, where GTS will make capital commitments for ClearList to facilitate liquidity, which according to ShareNett, is a first in the trading of private market securities.

“A major differentiator of the platform is that similar to public exchanges, ClearList will help create liquid markets for private securities and thereby provide true price discovery,” ShareNett said. fs

T

FS Private Wealth

Kanika Sood

The quote

You can’t treat them as cash.

he corporate regulator is intervening in fixed income funds sold as “cash plus” or “enhanced cash” strategies, as it sharpens its watch on managed funds advertising.

In July, Legg Mason’s Western Asset and UBS shed the term “cash plus” for “conservative income” and “short term fixed income” respectively.

It is understood that ASIC intervened in some cases, but a spokesperson declined to comment on individual funds.

The bone of contention is that some of these funds initially invested conservatively in the 1990s, but didn’t discard the cash plus tag as debt markets expanded.

This scrutiny is part of a wider push from ASIC. In June, it disciplined 13 funds and issued a wider call to the industry, asking them to state clearly capital losses and liquidity risk.

Hamilton Wealth Management financial adviser Will Hamilton has

used cash plus strategies from Realm Investment House for about three years and from Janus Henderson Group for about seven years, allocating five to 10% of client portfolios to them, per risk profile.

“We don’t go by the name, we have always classified them as “diversified credit” in our client portfolios. You can’t treat them as cash,” Hamilton says.

Meanwhile, Diana Saad of Silway Private Wealth says the naming convention change is most relevant to non-advised retail clients who may assume the funds are 100% and advisers should have always dug deeper.

Saad says in the past she would have considered annuities or term deposits as alternatives to cash plus funds.

“However I have not done so for quite some time now, as a result of interest rates reducing over the last several years, combined with the inflexibility of these products,” she says. fs

Bond managers’ family capital piles into Sydney startup It’s back to his roots for Kapstream Capital’s retired co-founder Kumar Palghat, as his family office takes an equity stake in a new fixed income execution fintech.

KPY Pty Ltd has made a cornerstone investment in Liquidity Cube, an ASICregulated fixed income execution market and analytics provider which got its Australian markets licence in December last year.

Palghat joins Kasptream portfolio manager Dan Siluk, Ardea Investment Management portfolio manager Cameron Shaw, and Stuart Plane on Liquidity Cube’s eight-strong shareholders’ register.

Liquidity Cube offers a platform for executing fixed income trades and analytical tools for liquidity matching and market flow.

The company believes it can be a viable alternative to Bloomberg terminals on trading desks.

It will use the Palghats’ investment to grow its business development team, consolidate current offering, onboard bank and buy-side investors expand current capabilities.

Liquidity Cube and Palghat’s relationship goes back more than 15 years, where the fintech’s founders built Kasptream’s systems in its initial days .

Palghat will also act as a consultant to Liquidity Cube.

“Fixed income markets are all over the counter – you have to call a broker and pricing is hard in normal times. They are trying to make fixed income trading more transparent. I think it is an industry that needs to be disrupted,” Palghat told Financial Standard. fs

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News

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

Marianne Perkovic to depart CBA private Ally Selby

Billionaires in Twitter bitcoin scam Eliza Bavin

Billionaires such as Elon Musk, Jeff Bezos and Bill Gates were among the household names that had their Twitter accounts hacked to promote a bitcoin scam.

The official Twitter accounts of many notable people, including former United States of America President Barrack Obama and presidential candidate Joe Biden, were hacked to promote a bitcoin scam to their millions of followers.

The tweets were all incredibly similar and read: “I am giving back to the community. All Bitcoin sent to the address below will be sent back doubled! If you send $1000, I will send you back $2000. Only doing this for 30 minutes. Enjoy!”

United Kingdom’s National Cyber Security Centre said it reached out to Twitter in the midst of the attack, which it said was targeted at Twitter and not the individual accounts.

The Federal Bureau of Investigation (FBI) said it has also launched a federal inquiry into the attack.

Twitter chief executive Jack Dorsey tweeted an apology as the attack was ongoing.

“Tough day for us at Twitter. We all feel terrible this happened,” Dorsey tweeted.

The US Senate Committee on Commerce has requested Twitter brief the committee on the issue no later than July 23.

It is not known how many individuals potentially fell for the scam or how much money was sent to the scammers. fs

T The numbers

$80-$90m Prodigy’s funds under management at time of closure.

he Commonwealth Bank confirmed Marianne Perkovic will leave the business, pointing to the recent transition of its private banking division as grounds for the exit.

CBA’s private banking business recently shifted to sit within the bank’s retail services division. Previously, it had sat within CBA’s business banking unit.

According to a CBA spokesperson, the move was designed to create a better service for the bank’s private clients, whose needs and demands focus predominantly on home buying and deposits, as well as investments and financial advice.

The spokesperson confirmed that the private banking boss would be departing its ranks, but will continue to serve in the role over the coming months as CBA looks for a replacement.

“We can confirm that Marianne Perkovic will be leaving her position as executive general manager of Commonwealth Private, and will finish

up with CBA in October,” he said.

“She has been instrumental in driving multiple improvements within the business to make it simpler and better for our private clients, and will leave it in a strong position when she leaves CBA later this year.”

Perkovic spent more than a decade with the bank, and faced heated scrutiny when representing its wealth management arm during the Royal Commission.

During her testimony, she admitted the bank’s financial advice subsidiary, Count Financial (now a subsidiary of Countplus), had charged ongoing service fees to deceased clients.

Perkovic has spent nearly four years as an executive general manager of CBA’s private banking business, however, previously served as an executive general manager of the bank’s wealth management advice division.

Prior to this role, she worked at Colonial First State as a general manager of distribution, before stepping into a role as the general manager of advice. fs

New multi-boutique launches in Sydney Kanika Sood

The demise of Euroz and Steve Tucker’s joint venture Prodigy Investment Partners has birthed a new multiboutique in Sydney.

Mantis Funds, led by Timothy Cheung as chief executive, picked up Dalton Street Capital as its first client when the latter’s old distribution partner, Prodigy Investment Partners shut down in March. Equity Trustees had decided to wind up Dalton’s funds but Mantis was able to convince it to reverse its decision.

Since then, Mantis has added Firth Investment Management, a Singapore-based Asian equities firm set up by an ex-Schroders team, and is on its way to finalising a third partnership.

Mantis has taken an office in the ANZ Tower on Castlereagh Street. Its lineup includes Cheung, a former head of research for Morphic Asset Management, former FIIG Securities chief executive Mark Paton as chair and former Pengana, CFSGAM

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

and Ascalon sales lead Damien Hatfield as head of distribution.

It will partner with boutiques on a revenue share and/or equity ownership model.

It is currently owned by LSL Partners, a principal investment firm supported by family offices and UNHW Capital where Cheung is a partner and the chief investment officer.

One of LSL’s other investments is Forum 360, a tech platform for online fund manager updates, which Mantis’s boutique partners will use.

“Our view is that it was in the best interests of clients to keep the fund open under a new, more efficient cost structure. Together Dalton and Mantis managed to convince our RE, EQT to retract the closure notice so it is now business as usual with the existing team, fund and trading infrastructure and the majority of clients staying on board,” Cheung told Financial Standard. fs

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News

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

IPOs halve off the back of COVID-19 Annabelle Dickson

New geared, shorting ETFs After BetaShares’ success in attracting investors to its geared, index-shorting ETFs during COVID’s market decline, another player entered the niche in July.

ETF Securities launched new ETFs based on the NASDAQ 100 – one that provides a leveraged long exposure and another that provides geared short exposure.

The level of leverage in the two ETFs is between 200% to 275% of the net asset value, and is actively managed by the firm.

ETF Securities co-head of sales Kanish Chugh says he expects the ETFs to be used more as trading tools by investors who are looking to take a view on the volatility, than as traditional buy-and-hold allocations. “[What] we have seen in the past four months, short and leveraged products have been used by investors, when there is here more volatility,” Chugh said.

“This space in Australian market has traditionally been underdeveloped. A lot of work has been done already on what a short product is or what a geared product is. The markets have really evolved and there is a lot more that will happen in this space.”

The July 13 launch of ETFS Ultra Long Nasdaq 100 Hedge Fund (LNAS) and ETFS Ultra Short Nasdaq 100 (SNAS) comes on the heels of BetaShares’ geared, shorting ETFs catching investor attention during COVID-19 volatility.

BetaShares’ BBOZ and BBUS, which track ASX 200 and S&P 500 respectively with leverage, had tallied up $250 million in inflows (with BBUS) from January to mid-March. fs

I The quote

I cannot remember the last time this level of capital raising was so low.

nitial public offerings (IPOs) on the ASX reduced dramatically as a result of the pandemic in the first half of this year with just 12 new listings compared to 23 in the same period last year, according to the latest HLB Mann Judd IPO Watch report.

Of the 12 IPOs, nine listed during the market peak in February with the remaining three in the June quarter.

Over $87 million was raised in the first quarter compared to $44.5 million in the second quarter.

In addition, nine of the new listings met their subscription targets and performed well for investors, recording an average gain of 16% compared to the 12% loss recorded on the All Ordinaries Index.

HLB Mann Judd partner and author of the report Marcus Ohm said at first glance this look positive however in the six months to June only $132 million was raised.

“I cannot remember the last time this level of capital raising was so low. This time last year the funds raised was $820 million and that was considered a soft year. The previous year was $2.5 bil-

lion so this is a very quiet year,” he said.

This was due to only one large cap listing, Atomo Diagnostics, compared to the 10 large cap listings raising a combined total of $663 million in 2019. The majority of entrants were from the small cap sector which is consistent with previous years.

In conjunction with fewer listings, there was a significant reduction in the average amount of funds sought by the new listings which sat at $11.5 million compared to $98.7 million in 2019, reflecting the nature of the market as a result of the pandemic.

“There were multiple listings which were subsequently withdrawn during the period amidst difficult market conditions. This is not surprising as market uncertainty and share price volatility do not generally provide a listing-friendly environment given the significant costs involved in undertaking an IPO,” Ohm said.

As a result, only 17% of listings were underwritten compared to 39% of all listings in the same period in 2019.

Future IPO pipeline was soft as well, with only six companies looking to list. fs

Fund manager outflows spill to June quarter Kanika Sood

Outflows at ASX-listed funds management businesses like Pendal, Platinum and Perpetual slowed in June quarter but continued, with Magellan the only one in net inflows.

Pendal Group reported net outflows of $2.5 billion in June quarter, followed by $723 million at Platinum Asset Management and $400 million at Perpetual. Magellan Financial Group saw $779 million of inflows in the period.

While markets wiped off 7-16% of total funds under management at ASX-listed fund managers in the three months ending March, June quarter’s market movements increased funds FUM by 3-8%, according to Macquarie.

“With the sector having re-rated ~20% since the end

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of March, there is diminished absolute valuation appeal, however relative valuation appeal to broader market is evident (~30% discount to industrial ex banks),” Macquarie analyst Brendan Carrig said in a July 22 note.

Macquarie moved Magellan Financial Group (MFG) to “underperform” from neutral.

“MFG’s performance and flows continue to drive its premium multiple, but at ~25x 1yr forward P/E, 52% above peers, we see scope for the relative value premium to unwind and downgrade to Underperform.”

Its July 22 order of preferences for the sector was: Janus Henderson Group (outperform, $36 price target), Pendal Group (outperform, $7), followed by Perpetual (neutral, $33), Platinum (underperform, $3.5) and Magellan (underperform, $57.50). fs

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News

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

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AAP’s white knight saviours not expecting a return Ally Selby

T

he consortium that saved Australian Associated Press’ newswire are not expecting a return on their investment, with contributors donating anywhere between $3000 and $1 million at the close of the financial year.

Led by impact investor Nick Harrington and philanthropist John McKinnon, the new AAP will be run as a not-for-profit – without shareholders.

Only 15% of the consortium’s 35 funders will receive some financial gain from their investment, lending upwards of $1 million in unsecured loans in the capital raise. For those who donated to the cause, the average contribution was around $100,000, Harrington revealed to Financial Standard.

The new AAP will continue what it has always done, McKinnon said – producing quality, independent journalism, but at a smaller scale.

“The media landscape is changing dramatically and AAP needs to transform with that landscape,” he told Financial Standard.

“Free from the constraints of big shareholders, it can be far more nimble and it can evolve to suit the changing landscape.”

Those who have come out of the woodwork to publicly admit to donating – not investing – to save the newswire include Samuel Terry Asset Management’s Fred Woollard, Australian Impact Investments’ Kylie Charlton and Wilson Asset Management’s Geoff Wilson.

“As an investor, the strange thing is to put money in and there be no return,” Wilson told Financial Standard.

“There is zero possibility of profit; I have no say, no influence and no return on investment with this donation. It came down to wanting to be involved in AAP surviving and supporting media diversity in Australia.”

Over the next two to three months AAP will recruit a board representa-

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tive of the Australian community, McKinnon said, including professionals from media, finance and law.

The 35 members of the consortium won’t have any control over the news outlet, he said, with the company set up so that no one could ever benefit from a future sale.

“The company is governed by a constitution that very clearly spells out a charitable purpose, and the people who have donated money are relying on the members of the board to uphold that charitable purpose,” McKinnon said.

Harrington, who was slated to begin with the publisher as its head of strategy on August 4, said the concessional loans had been structured to support the business as it goes through this transformational period.

“Independence is at the heart of AAP and it will now be structured as a not-for-profit, so there’s absolutely no investor ownership and lenders have no say in the business,” he said.

“They bought into that independence and the role that AAP plays in providing media diversity and factbased reporting.

“That’s what they are supporting – and they are supporting that by way of either a donation or loan.”

He is hoping AAP will be able to pay back the lenders over the next five to 10 years.

The idea of impact investors buying up and saving distressed media assets came up in casual conversation between Harrington and McKinnon over a year ago, the latter revealed.

“Over the last year I’ve had numerous conversations with people as media assets became distressed, as the increasing concentration and lack of diversity became more obvious, as the ABC budget was cut. It just became a bigger issue in my mind,” McKinnon said.

“I had actually looked at some other media assets and wondered if it was possible to buy them…and then set

The quote

As an investor, the strange thing is to put money in and there be no return.

them up as a not-for-profit or at least guarantee their independence through some mechanism.”

Initially, the two impact investors had planned on buying the whole AAP business, including its Medianet and Mediaverse divisions. However, it rapidly became clear that McKinnon and Harrington weren’t going to be able to raise enough capital before the outlet’s closure date on June 26.

They subsequently pivoted to acquire only the AAP Newswire, with the new deal, framed as a philanthropic opportunity, receiving “a lot of enthusiasm”.

Now, having saved the outlet from closure, Harrington said he hopes media owners see the investment as a “beacon of hope”.

“I think this shows that there are different ownership models,” Harrington said.

“I hope that more media owners consider transforming their businesses to be purpose-driven rather than for-profit. I am hopeful that people take a leaf out of our book and see that being purposedriven and being mission-aligned is hugely important to society.”

He disagreed that investors could have been motivated to donate to save the newswire for tax deduction purposes.

“Everyone’s donated money for the purpose of saving the newswire,” he said.

“It could have been any period of the year and I think we would have had the exact same response.” McKinnon agreed.

“Some of these donations are tax deductible – that’s true – but they would have gotten a tax deduction if they donated to one of the thousands of charities in Australia,” he said. fs

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Opinion

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

Nelson Lam principal and executive director Berkshire Global Advisors

A new tribe of investors in asset and wealth management ince the Global Financial Crisis, S there has been an escalation of mergers and acquisitions activity and an increase in the amount of capital raised by a new breed of investor focused on asset and wealth management firms. These new type of investors commonly refer to themselves as longterm or permanent capital providers.

Traditionally, investors were classified as either financial or strategic.

Financial investors, commonly private equity firms, typically provide capital for a combination of working capital, growth equity or acquisition capital, and occasionally for seeding new funds, but had limited ability to offer operating value.

Strategic investors, on the other hand, offer capital with the intention of providing additional scale benefits, and business and operational support, such as technology, distribution, marketing and/or product development. Both these types of investor usually looked for control stakes.

Unlike private equity investors who typically seek to exit their investments in five to 10 years, long-term capital providers are able to consider investments without planning an exit as they fundraise via their balance sheet or through perpetual funds. As such, they do not operate on a set divestment horizon, like as is true with the typical private equity funds. To adjust for the commercialisation of the economics, given the absence of an exit window, permanent capital provid-

ers will often seek yield through dividends or a revenue share. The revenue share formula has the benefit of permitting management to continue operating independently while ramping EBITDA by leveraging the new capital base. Additionally, this alignment of interest usually eliminates the need for representation at the board level, a distinction from traditional financers.

Table 1 illustrates some common key features across the three classifications of buyers.

Better alignment for “people business” The permanency of this new style of capital has been well received globally for businesses with a fiduciary responsibility and where management is keen to remain and continue to build out the business under its existing culture and operating style. The longterm nature of the shareholder aligns well culturally with the long-term interest among management, clients and shareholders.

With the increasing regulatory constraints and distribution barriers in the asset and wealth management sectors, there is an increasing demand for boards to consider alignment between shareholders, management and clients in building a sustainable and enduring business model. For many founders, the ability to capitalise a minority stake facilitates further growth to assist with co-investment

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requirements and establishes a valuation discipline and metrics for ongoing sales to the next generation of the team.

Examples of long-term capital providers’ activities in asset and wealth management market Dyal Capital Partners, Goldman Sachs’ Petershill and Landmark Partners acquire a minority stake in Clearlake Capital • On 29 May 2018, Clearlake The quote

Berkshire has domestically seen the rise of family offices investing more into the wealth and asset management sector, including team liftouts and incubation of early-stage boutiques.

Capital Group, L.P, a leading global private equity and alternative asset investment firm, announced that Dyal Capital Partners and Goldman Sachs Asset Management’s Petershill program, along with existing partner, Landmark Partners, made a strategic minority investment in Clearlake.

• Under the terms of the transaction, the passive, non-voting minority stake will provide permanent capital to significantly increase the firm’s investments in its own funds and to support the development of initiatives that capitalise on the firm’s sector-focused approach coupled with its unique integration of private equity, special situations and credit capabilities.

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Opinion

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

Lincoln Peak Capital acquires a minority interest in RWC Partners • On 29 October 2019, RWC Part-

ners Ltd, a provider of traditional investment management services in the UK, announced that Lincoln Peak Capital had acquired 27% of a minority stake in RWC previously owned by Schroders.

• The minority stake will provide capital to RWC to further develop its concentrated investing style, specifically within convertible bonds, emerging markets and international equities, with strategic support from a leading distributor and partner.

Rosemont Investment Group acquires a minority interest in 1607 Capital Partners • On 19 September 2019, 1607 Capi-

tal Partners, a boutique investment

management firm specialising in closed-end funds, announced that Rosemont Investment Group had acquired a minority equity interest.

• Under the transaction, the minority investment will support the longterm transition of equity within the firm, while providing a valuable strategic and financial partner in the growth of the company.

Refreshing solution for businesses needing succession and growth capital The rise of permanent capital providers represents a refreshing approach to solving succession problems in people-oriented businesses.

Berkshire has domestically seen the rise of family offices investing more into the wealth and asset manage-

The quote

In the Australian context, as this capital competes...against the more traditional... players, it will be interesting to see how support in distribution plays a role in seller’s decision making.

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ment sector, including team lift-outs and incubation of early-stage boutiques. In the Australian context, as this capital competes for opportunities against the more traditional multi-affiliate platforms and larger global strategic players, it will be interesting to see how support in distribution plays a role in seller’s decision making.

Increasingly, Berkshire is working with offshore permanent capital providers that have the strategic objective to build a global and diversified portfolio and see the current weakness in the Australian dollar as an opportunity to increase their exposure to the Australian wealth and asset management market. fs

Table 1 Traditional financial investors

Description

Benefits

Strategic investors

• Sale of a minority /majority stake including management company earnings and future performance fees, if applicable, for mainly secondary consideration

• Sale of a majority stake including management company earnings and future performance fees, if applicable, for mainly secondary consideration

• Performance fees from existing vehicles may or may not be sold but are generally ommitted

• Performance fees from existing vehicles are generally not sold

• Potential for access to incremental capital to fund acquisitions/growth or short-term seed capital for new products

• Typically provides enhanced distribution and operational support • Potential for access to seed capital for new products

Long-term capital providers • Typically, a minority stake sale including management company earnings and future performance fees, if applicable, for a combination of primary and secondary consideration • Performance fees from existing vehicles are also usually sold • Minimal governance rights • Potential for highest nominal valuation when capitalising existing performance fees • Possibility of seed capital and additional strategic support

• May cede control of the board

Cons

• Two-step process requiring another transaction in five to 10 years

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• Potential for integration into the investors’ existing platform • Ongoing employee ownership depends on organisational style

• No cost synergies due to lack of integration • Usually lack distribution support or leverage

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Featurette

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

Lessons for endowments from COVID-19 The pandemic and accompanying volatility is forcing endowments to rethink how they invest, govern and grant. Kanika Sood reports.

S

ue Dahn is one of Australia’s best-known financial advisers. She also wears many hats in the philanthropic world.

To count a few, she advises private endowment clients at Pitcher Partners, acts as the responsible person for multiple private ancillary funds and is a director for a public ancillary fund. She also sits on a notfor-profit investment committee.

Dahn said her endowment clients had returned about -8% in FY20 to March end. By April end, the number sat at -5%. She expected them to finish FY20 with about -2% in returns.

The mayhem of the last few months does not need much exposition. But to recap – equities markets were down over 20% before rebounding strongly, credit markets faced a liquidity squeeze in March, oil traded in the negative

territory for the first time in history in April, property and infrastructure asset values were revised down and ASXlisted companies reigned in dividends.

On a panel in early July organised by Philanthropy Australia, Dahn was one of the four participants sharing how they navigated COVID and lessons for future.

Among the issues that came up were: Best policy for rebalancing investment portfolios during extreme volatility, the most effective way of making grants (out of income, as is traditionally done, or via total portfolio return), considerations for using balance sheet for granting, the future role of franking credits and whether governments’ COVID-19 specific incentives for distributions out of ancillary funds are good enough.

To rebalance or not Dahn said the big question was – how disciplined the endowments need to be

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

The quote

The more aggressive foundations or particularly those with founders still alive and still contributing looked to rebalance a little bit more aggressively.

about rebalancing back to their strategic asset allocation after drifting away from it during the March volatility.

“Because on some of those days, you could have been churning through a lot of transactions costs, if you rebalanced one day back up from a big market fall, when the market might have done that for you all on its own,” she said.

“So the governance model was tested. Investment policies were tested to see whether the ranges around rebalancing were, in fact too tight.”

She said some endowments decided to suspend rebalancing completely in March to avoid the higher transaction costs.

Perpetual Private partner Daniel Tomé’s clients fell in both camps – those who rebalanced intensively and those who didn’t.

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Featurette

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“The more aggressive foundations or particularly those with founders still alive and still contributing looked to rebalance a little bit more aggressively. And those that perhaps have been around for a long time with co-trustees looked at being prudent,” he said.

For Jenny Wheatley, the chief executive of Vincent Fairfax Family Foundation and Cambooya, the conversation with trustees had to go from short-term performance to long-term returns. Meanwhile, the investment team rebalanced cautiously.

Best way to grant: Income or total return?

Endowments have traditionally made grants out of the income they generate. But, Dahn thinks that approach is “somewhat outdated” and the sector needs to shift to taking a total return approach, especially as income sources dry up in a world of reduced dividends and low interest rates.

“And that’s been a really useful philosophical and intentionality conversation with endowments. If the policy is we can grant 4%, we have 1% to run the show…we have 1% to maybe grow the capital base,” she said.

“If we think about the last five years, we’ve actually been making an average of 6%...and it’s very likely that the next five years will be much the same. And we can continue with those granting levels to run each of our operations and still grow the capital base.”

Perpetual’s Tomé and Cambooya’s Wheatley agreed with Dahn’s comments. Tomé added that legacy trusts may have restrictions that only allow them to distribute income.

“There’s a case to be made [for] skewing portfolios towards Australian equities, most definitely, but certainly [in] a more diversified approach. And a total return approach is going to provide a better risk-adjusted return over time. So having those discussions with co trustees and founder about how they’re investing these funds for total return approach is critical,” he said.

New ways endowments donated in COVID-19 Tomé said Perpetual’s philanthropic

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clients became more flexible in their giving during the pandemic.

This included untying grants, paying them sooner, using their own capital or even lending them money – all of which must be linked to investment and governance response, he said.

“From an investment perspective, it has forced a re-evaluation of risk tolerances in investment as well as the giving side – clients have been willing to push the envelope a bit more on the investment side and on their spending policies in the face of this unprecedented need,” he said.

“Ultimately my counsel is that the purpose of the funds should drive the investment decision making. If that shifts to the circumstances, then the investment policy should be reviewed and shifted as well.”

Using balance sheet A May 2019 survey from Philanthropy Australia asked endowment decisionmakers if they would consider using their balance sheets to offer non-grant financial support to an organisation?

Less than 10% said yes, about 25% said they were considering it and the majority at just under 70% said no.

Wheatley revived the question.

Dahn was in favour, citing Ford Foundation which on June 25 became the first US non-profit foundation to raise money in the taxable corporate bond market, raising US$1 billion by issuing bonds.

“They’ve used their balance sheet to leverage [it] to raise bond capital, at obviously historically low [interest rate] levels…They can effectively, with a reasonable to higher degree of conviction, make more money on the equity side of their balance sheet that will more than cover the repayment of the debt,” she said.

JBWere director of philanthropic services Luke Branagan said while he supports similar endeavours in Australia, they might be hard to come by.

“We hear discussions of people [in Australia] wanting to do it or explore it, but they’re not really sure how to achieve it…but I just don’t think there’s a provider to come in and assist foundations – the foundation of your sophistication [Fairfax] I think can enter into

17

this world – but many don’t have that capability,” he said.

Franking credits

The quote

If we think about the last five years, we’ve actually been making an average of 6%... and it’s very likely that the next five years will be much the same.

Wheatley also asked the panelists what value franking credits added to their portfolios.

Dahn suggested between 70 and 90bps, depending on the asset allocation, but she noted that was subject to tax changes. Branagan and Tomé said they have tilted towards international equities in recent times, seeking growth.

“It really is a material amount of the of the total return, which is, of course received in cash after a lag [when tax returns are processed]…trustees need to be [aware], this isn’t the end of the change or the end of what we need to adapt to,” Dahn said, referring to potential changes in the tax system arising from stimulus debt.

“Definitely skewed towards alternative asset classes, as well as towards international equities, which inherently have a bit of a buffer as well, with the currency differential and our currency is a pleasant buffer when markets go into volatility mode because of how our currency reacts to the sort of risk off events,” Tomé said.

Lastly, on the subject of whether the government’s provision for future credits to encourage endowments, and public and private ancillary funds to bring forward their donations are good or bad, the panel was split.

Dahn said the credit could have been more or better aligned.

“It’s not a restriction on freedom, but it is a bit of a dictation as to, you should be giving now versus you should be giving later,” Tomé said.

“And that might be a little bit dangerous in terms of providing incentives for people to actually create these foundations in the first place…I think that’s absolutely useful, but certainly shouldn’t be mandated in my opinion. fs

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Cover story

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

PADDOCK TO PITT STREET Robert Millner exercises immense influence in corporate Australia as the chair of Washington H. Soul Pattinson.

He speaks to Kanika Sood about what’s next for the business and how his family invests.

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Cover story

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Cover story

A

bout 308 kilometres west of Sydney is the council of Cowra.

Its 12,500 residents work mostly in agriculture, manufacturing, healthcare, education and wholesale trade, generating a gross regional product of about $437 million each year. The average dweller makes $773 a week in wage.

One of Cowra’s frequent visitors is Robert Dobson Millner, the chair of the 118-year-old Washington H. Soul Pattinson, a conservative investment company whose holdings span from coal, resources, telecom and pharmacies to many other sectors. The Millner family’s net worth is reportedly north of $1 billion.

When our photographer shows up to his property one Saturday afternoon in July, Millner meets him in mud-stained blue jeans, a chambray shirt and Blundstones that look like they could use a scrub.

The look is a far cry from Millner’s sharp city suits.

Driving across the property in an all-terrain vehicle, the two drive past cows grazing near a dam, tall silos in the older, flat-bottomed style and a shed where a tractor idles with hay forks attached to its front. It is beautifully green, our photographer says.

“It’s a very intense farm, we’ve got irrigation and we run cattle. So I’ve got three and a half men that look after that for me,” Millner says. “[We] predominantly grow Lucerne Hay [alfalfa] with popcorn at some stage. We tried poppies but we did not grow any last year. I didn’t have enough water for it.”

“No, to tell you – it’s quite a big enterprise.”

Millner is the fourth generation of the extended Pattinson clan to lead the business. His son, Tom Millner, also sits on the WHSP board and is a partner and co-portfolio manager at an Australian equities boutique partly-owned by WHSP. Highfield, as the farm is called, was initially bought by Millner’s parents when he was nine years old (he expanded the land holding later). He attended boarding school in Sydney’s inner-west at Newing-

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ton College and had a brief career as a stockbroker before returning to work on the farm, which sells its produce, up until the age of 34.

The company started life in 1903 as a pharmacy when Millner’s great grandfather Lewy Pattinson bought out fellow pharmacist and friend Washington Soul’s business [reference to his family in name is honorary].

Over the century the leadership has passed from Lewy Pattinson’s son William Frederick Pattinson (chair in the 1950s and 1960s) to Jim Millner in the 1970s, 80s and 90s.

A call from his uncle Jim Millner, then chair of WHSP, in 1984 inviting him to join the board as a director catapulted Millner out of the farm and onto its board, first as a director and then in 1998, as the chair.

Today, WHSP owns over $5.5 billion worth of assets and Millner chairs the boards of seven publicly listed companies (though he is quick to point out they were all once a part of WHSP, if you question whether he has too many board positions).

Back in Sydney and in a necktie at Washington H. Soul Pattinson’s new headquarters on Clarence Street, Millner sits down for this interview two weeks after the $16.5 billion merger between TPG and Vodafone finally got through after stewing for more nearly two years.

WHSP had a 25.3% stake in TPG. He has also just resigned off the board of Australian Pharmaceutical Industries to go on the board of TUAS, the Singapore mobile operations of TPG which were spun out as a part of the merger.

Another major holding, New Hope, is transitioning to a new chief.

The offices are new and sprinkled with memorabilia, including pharmacy bottles, framed floor plans and the front plaque from WHSP’s headquarters for 145 years in Pitt Street Mall. WHSP sold it for $100 million in 2018, taking the view that the heritage-status made it hard to service and the new tram going down George Street could knock down property prices in the mall.

“It’s a sad day when you cut ties with your past, and I was disappointed last week [July 9], when I had to retire off the board of API…

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As I said, pharmacy was the start of the company’s business, but it’s only a small part of our business now compared to what it was,” he says.

“You’ve got to be realistic in this world. We all move on. We got a very, very, very good price of that building. And we are growing.”

The building is new but it is business as usual. WHSP’s investment bankers (it has its own investment bank, Pitt Capital Partners) are working flat out to scout for new investments to home about $600 million.

The company reported $307 million in net profit after tax for FY19. About 75% of this came from just two holdings, TPG Telecom and New Hope.

Millner says WHSP has been investing in smaller businesses such as Aquatic Achievers, Palla Pharma and assets like agriculture, water and grapes, which it hopes will one day complement bigger holdings.

But right now, it is switching focus to larger acquisitions once again.

“I’m quietly confident that we’re going to see another downturn,” Millner says.

“Maybe not as drastic on the stock exchange but economy-wise.

I think when people first start paying back some of this debt, we’re going to see some good opportunities and we’ve probably got $700 or $800 million that we can move with tomorrow to buy an attractive business.”

“That’s what we’re sort of working on at the moment. If it all comes to fruition and there is quite a bad downturn in the economy, we’re looking to buy a bigger business; we’re [not] going to put too much money into smaller businesses. We’d like to get over $600 million business that we, as you said, buy long term.”

WHSP’s long-term track record is nothing short of stellar. It was one of the first companies to be listed on an exchange in Australia, has paid a dividend every year in its 117-year history and in times of economic stress has raised them.

Up until recently, it was tied with Ramsay Health Care, as the only two companies that have increased their dividend each year since 2001.

As at December end, WHSP’s share price had increased by 16% p.a. over the past 40 years. Total shareholder return of 11.6% for last 15 years has been 2.6% higher than that of the S&P/ASX All Ord Accumulation Index, according to Ord Minnett.

WHSP’s share price and Millner’s 22-year-long tenure as its chair means he is often likened to hallowed value investor Warren Buffett, whose Berkshire Hathaway has beat the S&P 500 each year since 1968 by a wide margin. “…Of course we are miles, miles smaller [$4.8 billion versus $676 billion] but you have to remember in America, Berkshire Hathaway does not pay a dividend,” he says.

“To use an example here, if Soul Pattinson earned a hundred million dollars every year, and we reinvest that hundred million dollars every year – you can see how quickly that compounds. We’re paying probably 80-85% of our profits out to shareholders. So we’re not getting the growth that some of those American companies are getting.”

Nevertheless, Millner has travelled to Omaha for five of the last six years, as one of its 40,000 attendees and says Buffett and Munger seem to get better as the seven-hour plus day rolls on. More recently, he’s lined up the trips with Brickworks’ meetings as it expands into North America.

While Millner gets laudatory comparisons, he is no stranger to bad press. He has long locked horns with anti-coal campaigners over

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Cover story

21

New Hope and was in the papers last year after reportedly shutting down WHSP’s annual general meeting after being asked to justify the holding by shareholder activist group, Market Forces. Former journalist and now a shareholder activist Stephen Mayne also routinely heckles Millner-chaired companies. As this publication went to print, Mayne had just nominated himself as a director at Milton Corporation.

WHSP and many of its individual holdings (including Brickworks and New Hope) invest in each other, under a decades-old cross shareholding structure. Perpetual Investments, in 2017 tried unsuccessfully in the courts to break the structure, saying it was oppressive to minority shareholders, depressed share prices and kept the firm in control of the Millner family. But the courts did not agree.

Meanwhile WHSP’s resilience has translated into extraordinary wealth for the Millner clan.

The family’s personal wealth figures at $1.3 billion on the AFR Rich List 2019 (that included a bump from last year’s higher coal prices).

If the numbers are correct, he won’t confirm.

“Obviously, I’m not keen when that comes out,” he says “They send me a number and I don’t go back to them…I don’t think people should be able to…go and do a Google search on that.

I don’t think that should be allowed, but it is [and] people love it.”

Millner has been married for 46 years to his wife Janine, whose brother went to the same school as Millner.

The two bumped into each other at a ball when he was living in Cowra and she was training at the Goulburn Teachers College. The couple has three children together – two daughters and a son, who now have eight grandchildren.

Both daughters trained as teachers, and the younger one still teaches physical education part-time. They or their husbands (who work in hotels and Westpac’s leasing business respectively) are not involved in Washington H. Soul Pattinson at all, according to Millner.

“Well, yes, I guess they haven’t shown any inclination. Michael, my cousin who served on the board of Souls for a while also sat on the Brickworks board for quite a while. One of his boys came in and worked with Pitt Capital Partners for a few years and then he went

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Cover story

back to the country,” he says when asked if any of the women from the family have ever been involved with the business.

Outside of work, he likes to travel to Europe for two or three weeks a year with his wife. The couple also tries to sneak in long weekends in Bali during his six or so trips to Singapore annually.

Millner makes a point of how his family doesn’t like to go overboard with its wealth. They don’t like to own boats or private planes.

He says he will talk to anyone, and definitely won’t roll into say, a Brickworks plant in a Rolls-Royce to meet a factory manager.

“We’re very common sort of people, we don’t go to cocktail parties, hob and nob around the town and in the social pages,” he says.

He grew up wealthy but at the same time, in an environment where not many people travelled, entertaining was limited to home and things were pretty rough in rural Australia. And that, he reckons, addressed the potential problem of growing up with a sense of entitlement.

“You know, we were able to send our kids to private schools and things like that and they know that there were some quite harsh times on the rural scene in the late 1960s early 1970s, things were pretty tight,” he says.

The family is keen investors outside of SOL shares, which it also buys.

“We’re basically equity investors. I think that’s a very easy, good way for people to run their money. We don’t do it to dodge tax but... with equities you pay very little tax,” he says.

“We’ve just made a small investment in the rural property in Queensland through one of the family companies, but generally we’re basically long-term equity holders in companies like BHP, Commonwealth Bank…and we’ve bought some CSL and those shares as well over a period of time.”

Millner also keeps away from financial advisers, using just PwC in Canberra and his personal assistant [Kate Upson] to do the backroom work.

“I manage that…obviously Tom assists...and we have a couple of family meetings a year, which my generation and some of the younger ones sit in,” Millner says.

“Well, I think within our expertise, Milton’s a $3 billion market cap [LIC], BKI’s over a billion, SOL have got an equity portfolio of

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over $500 million…I can see no point in paying somebody to manage it when we can do it ourselves.”

When it comes to philanthropy, Millner has remained loyal to the Royal Flying Doctor Service of Australia and St Vincent de Paul Society. He does not have a private ancillary fund, preferring to make ad hoc donations.

“My great grandfather, Lewy Pattinson helped donate the first plane to the Flying Doctors…We’ve got very good relations with St Vincent’s and of course we’ve got a soft spot in our heart for Flying Doctors,” he says.

Looking to the future, Millner turned 70 in September, so succession planning is the elephant in the room.

He says he is not doing any more than he was 25 to 30 years ago. Is he doing any less? No, he says. “…There’s no way I want to go into that [being a chair at 94 or 95].

But now, I might stick around for the next few years if people want me,” he says.

While WHSP has been listed for over a century, the chairmanship has usually passed on within the family.

Asked if his son Tom will succeed him as the chair, he is reserved, saying it will be the independent board’s decision. “…it will be up to the board to decide who becomes chairman, whether Tom is chairman or sits on the board, he will still have some input into the business. And as I said before, Todd [Barlow, chief executive of WHSP] is a very good operator, we’ve got some good financial people here.”

The younger Millner was the chief executive of listed investment company BKI Investment Company for eight years. About four years ago, he partnered to start a new Australian equities boutique, Contact Asset Management.

“They are growing that business nicely. He’s put a good team of people together. And they’re in that stage now where they’re looking to go outside and do some other things…I mean, he now needs to grow that business into something bigger than what it is at the moment,” he says.

Millner and his son’s initiations to the WHSP business were similar.

Both went and did their own thing (the older Millner as a stockbroker and then a farmer, the younger studied industrial design at University of Newcastle) before expressing interest at their family meetings in Canberra (Rob to his uncle Jim and Tom to his father).

“It was very similar to my upbringing. There was no pressure on me to come into the business. I never mentioned to Tom that we’d like him to come in and step into the business,” he says.

“He went to university and then worked for a while and then he said to me, you know, he’d like to come and try his hand.”

Both are also the oldest of their generations.

“I guess being a head of the next generation I will always have responsibilities. The same as Tom, he’s the oldest in his generation as well. So there’s a lot of responsibility on us,” Millner says.

How will he spend his time when he does retire?

“I’ll be well occupied,” he says.

“I think my wife will get a shock. At the end of March when we had the sort of the lockdown here, I went back to the property for six weeks and it’s the longest I’ve been in one spot for decades...”

“I’ve got plenty to do and I’ve also got the family investments to look after.” fs

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We’re very common sort of people, we don’t go to cocktail parties, hob and nob around the town and in the social pages.

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Vantage point

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

Benjamin Ong director of economics and investments Financial Standard

Sector review Coronavirus-induced deflation own, down, prices are down … big time!

D The Australian Bureau of Statistics (ABS) reported that the country’s headline inflation

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.

dropped by 1.9% in the June quarter – the largest quarter on quarter decline in the 72-year history that the federal statistician had been tracking consumer prices.

This takes the annual inflation rate down from plus 2.2% (almost at the mid-point of the RBA’s 2%-3% target band) in the March quarter to minus 0.3% by the end of the June quarter – only the third time Australia has been in deflation.

“The previous times were in 1962 and 199798.” (ABS) Consumer prices fell the most (-1.8% in the year to the June 2020 quarter), followed by Sydney (-1.0%), Brisbane (-1.0%) and Canberra (-0.6%).

Hobart (+1.3%), Adelaide (+0.8%) and Melbourne (+0.3%) recorded higher prices.

For sure and for certain, you, I and Irene and our uncles love a bargain.

This is the reason why online trade had taken off even before the coronavirus bit its first human (they are cheaper than bricks and mortar stores), why consumers the world over are buying cheaper “Made in China” products and services, and why western countries have established manufacturing and call centre hubs in countries where wage costs are cheaper.

It may seem counter-intuitive but falling prices are bad news bears for the economy, any economy.

Just like John Maynard Keynes’ Paradox of Thrift – savings by individuals during recessions lead to a general decline in aggregate demand and therefore, even slower overall economic growth – deflation has nasty consequences for the economy.

THE JOURNAL OF FAMILY OFFICE INVESTMENT•

This is because cheapening prices of goods and services, if it goes on long enough, would spark decreasing inflation expectations.

Unless a necessity (like toilet paper and/or pasta in our current pandemic circumstance), consumers of whatever colour, creed or political affiliation would postpone purchasing new everything (home furnishings, clothes, shoes, TV, even houses) on expectations that tomorrow and the day after, prices would be cheaper.

Consumer spending accounts for around 60% of the economy – most economies.

Declining inflation expectations will discourage consumer spending that, in turn, becomes a drag on overall economic growth.

But have no fear, Australia’s headline deflation may just be a one-off.

As ABS chief economist Bruce Hockman explains, “The June quarter fall was mainly the result of free child care (-95.0%), a significant fall in the price of automotive fuel (-19.3%) and a fall in pre-school and primary education (-16.2%), with free pre-school being provided in NSW, Victoria and Queensland … Excluding these three components, the CPI would have risen 0.1% in the June quarter.”

Similarly, while the annual headline CPI measure has fallen into deflation, core inflation measures remain positive – trimmed mean inflation slowed to 1.2% in the year to the June quarter from 1.8% in the March quarter; the weighted median measure eased to 1.3% from 1.6%.

This is good news, suggesting that the June quarter’s deflationary conditions are temporary and should prevent a persistent drop in inflation expectations. fs

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www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

25

News bites

Eurozone GDP

RBA holds

China industrial profits

Preliminary estimates of the Eurozone’s June quarter economy underscore the extent of the lockdown and social restrictions imposed by governments of member nations in efforts to contain the spread of coronavirus infections.

The single currency region’s GDP dropped by 12.1% in the three months to June following a 3.6% contraction in the March quarter – satisfying the technical definition of a recession.

The June quarter plunge was the sharpest on record and is worse than consensus expectations for a 12.0% decline. The region’s top four economies all suffered sharp quarterly drops: Spain contracted by 18.5%; France by 13.8%; Italy by 12.4% and Germany by 10.1%.

The Reserve Bank of Australia (RBA) kept monetary policy settings unchanged – cash rate target at 0.25% and the target yield on three-year Australian government bonds at 25 basis points – at the conclusion of its August 4 meeting.

In his statement, RBA Governor Philip Lowe noted that: “This recovery is … likely to be both uneven and bumpy, with the coronavirus outbreak in Victoria having a major effect on the Victorian economy and reporting that “the board considered a range of scenarios at its meeting”.

The baseline scenario is for output to contract by 6% over 2020 before growing by 5% in the following year.

China’s National Bureau of Statistics (NBS) released data showing that profits at the country’s industrial firms jumped by 11.5% in the month of June – the fastest pace since March 2019 and quickening from May’s 5.5% increase (from declines of 4.3% in April and 34.9% in March). NBS figures also showed that 37 out of 41 major sectors registered stronger growth or smaller rates of decline. This followed sequential improvement in other domestic activity indicators such as retail sales, industrial production and fixed asset investment. fs

Property

Where next for A-REITs? Stuart Cartledge, managing director, Phoenix Portfolios

Prepared by: Rainmaker Information Source: Cromwell Property Group

ince the onset of COVID-19, the listed S property sector has been amongst the most volatile core asset classes both domestically and globally. The 35.1% fall of the S&P/ASX 300 Property Accumulation Index in March 2020 was swiftly followed by a 20.2% rally in the June quarter.

Outperformers over the quarter were broadly those that had previously underperformed due to exposure to COVID-19 restrictions.

Domestic retail landlords were particularly exposed to this theme and rebounded strongly from prior losses. Vicinity Centres (VCX) moved 38.2% higher over the quarter. Scentre Group (SCG) provided an up-

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date, suggesting customer visitation for the weekend of June 27-28 was 86% of comparable dates in 2019.

Performance among office owners was very divergent as debate over the future of office utilisation continues amongst market participants. Both Growthpoint Properties Australia (GOZ) and Centuria Office REIT (COF) outperformed, as each provided updates to the market demonstrating resilient earnings and rent collections. Alternatively, Dexus (DXS) Mirvac Group (MGR), Cromwell Property Group (CMW) and GPT Group (GPT) underperformed.

However, large capitalisation fund managers were strong performers in the June quarter. Charter Hall Group was up 43.9% as it managed to grow assets under management and reaffirmed strong earnings guidance amid an uncertain economic backdrop.

Goodman Group (GMG) also outperformed, up 24% as global demand for industrial property remains robust.

Smaller property fund managers had more mixed performance, with Elanor Investors Group (ENN) rising 40.3%, while others gained less than 10%.

Smaller residential property developers were underperformers for the quarter as residential property transactions slowed materially.

In Phoenix’s view, a lot of earnings deterioration is now priced into listed property stocks providing some downside protection from today’s levels.

With the GFC still fresh in the minds of many property trust managers, gearing levels are much lower today and the diversity of debt source and tenure positions the sector well to cater for all but the most extreme environments.

This is not GFC. Phoenix does however remain cognisant of the structural changes occurring in the retail sector. Recent events will likely accelerate these changes. fs

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www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

Key indicators

Source:

Monthly Indicators

Jul-20

Jun-20

May-20

Apr-20 Mar-20

Inflation

Consumption

CPI (%y/y) headline

-0.35

2.19

1.84

1.67

1.59

Retail Sales (%m/m)

-

CPI (%y/y) trimmed mean

1.20

1.80

1.60

1.60

1.50

Retail Sales (%y/y)

-

8.52

5.79

-9.18

10.07

CPI (%y/y) weighted median

1.30

1.60

1.20

1.20

1.20

Sales of New Motor Vehicles (%y/y)

-

-6.44

-35.29

-48.48

-17.85

2.72

16.86

-17.67

8.47

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

-

210.83

-264.14

-607.40

-3.14

16.75

41.38

-0.09

-53.32

-9.20

-

7.45

7.08

6.37

5.23

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

-

-0.31

0.52

0.55

0.61

Real GDP Growth (%y/y, sa)

-

1.39

2.16

1.80

1.56

Industrial Production (%q/q, sa)

-

-0.09

1.25

0.39

1.07

Survey Data

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

-

-5.68

-4.05

2.42

-0.58

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

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

-

-4.94

-15.76

-2.36

-1.39

Financial Indicators

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

Survey Data Consumer Sentiment Index

87.92

93.65

88.10

75.64

91.94

AiG Manufacturing PMI Index

53.50

51.50

41.60

35.80

41.60

NAB Business Conditions Index

-

-7.48

-24.14

-33.84

-21.99

NAB Business Confidence Index

-

1.47

-20.33

-45.76

-65.36

Trade Trade Balance (Mil. AUD)

-

8202.00

Exports (%y/y)

-

-14.90

-16.93

-6.28

6.99

Imports (%y/y)

-

-19.31

-23.22

-16.15

-9.52

Quarterly Indicators

Jun-20 Mar-20

Dec-19

7864.00 10631.00

Sep-19 Jun-19

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

-

8.40

1.72

7.26

4.87

% of GDP

-

1.66

0.34

1.44

0.98

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

-

1.11

-3.47

-1.15

5.20

Employment Average Weekly Earnings (%y/y)

-

-

3.24

-

3.02

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

-

0.53

0.53

0.53

0.54

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

-

0.38

0.45

0.92

0.38

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

-

0.45

0.45

0.83

0.46

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-1.65

-2.58

-0.55

-1.43

31-Jul Mth ago 3 mths ago 1 yr ago 3 yrs ago

Interest rates

-

7341.00

-

RBA Cash Rate

0.25

0.25

0.25

1.00

1.50

Australian 10Y Government Bond Yield

0.82

0.87

Australian 10Y Corporate Bond Yield

1.64

1.80

0.89

1.19

2.63

2.17

1.96

3.16

Stockmarket All Ordinaries Index

6058.3

0.95%

8.23%

-12.16%

4.93%

S&P/ASX 300 Index

5894.1

0.61%

7.49%

-12.84%

3.97%

S&P/ASX 200 Index

5927.8

0.51%

7.34%

-12.99%

3.62%

S&P/ASX 100 Index

4898.8

0.52%

7.26%

-13.06%

3.26%

Small Ordinaries

2633.7

1.33%

9.50%

-11.07%

10.75%

Exchange rates A$ trade weighted index

61.90

A$/US$

0.7172 0.6885 0.6547 0.6893 0.7984

60.00

57.80

59.50

67.30

A$/Euro

0.6065 0.6130 0.5977 0.6190 0.6771

A$/Yen

75.82 74.28 70.01 74.84 88.21

Commodity Prices S&P GSCI - commodity index

339.82

325.48

257.04

422.44

388.07

Iron ore

108.05

102.95

83.84

120.02

73.10

Gold

1964.90 1768.10 1702.75 1427.55 1267.55

WTI oil

40.25 39.27 19.23 58.53 50.21

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Taxation & Estate Planning:

28

Trusts at risk of incorrect distributions with significant tax consequences

By Alexis Kokkinos, Pitcher Partners

28

Taxation & Estate Planning

www.fsprivatewealth.com.au Volume 09 Issue 03 | 2020

CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: COVID-19 highlights the need for trusts to check the accuracy of their distribution calculations as getting estate income wrong can have substantial tax repercussions for years to come. This paper explains how it is calculated, income equalisation clauses in trust deeds, and the effects of restrictions on paying entitlements.

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

Trusts at risk of incorrect distributions with significant tax consequences

U Alexis Kokkinos

Background

nderstanding the definition of ‘income’ for trusts has always been important. However, for 30 June 2020, it has been more critical than ever due to the coronavirus (COVID-19) pandemic.

The Australian Taxation Office (ATO) retains its view that trusts must determine a cap on the ‘income of the trust estate’ that can be distributed to beneficiaries under draft ruling TR 2012/D1 Income tax: meaning of ‘income of the trust estate’ in Division 6 of Part III of the Income Tax Assessment Act 1936 and related provisions (TR 2012/ D1). Failure to consider these issues may result in a risk of having no income of the trust estate (potentially resulting in a trustee assessment of 47%) or grossly under or overestimating the income of the trust (potentially resulting in taxpayers being attributed more or less taxable income for the year under the proportionate approach).

Further, COVID-19 may result in restrictions being placed on unpaid present entitlements (UPEs) or requirements to refinance.

Both of these issues can result in a trustee assessment. As distribution resolutions had to be made before the end of the financial year, these issues must have been identified and dealt with as part of year-end planning.

A beneficiary is generally liable to pay tax on their proportionate share of a trust’s net (taxable) income. This is determined by calculating the share of the ‘income of the trust estate’ to which the beneficiary is presently entitled (otherwise referred to as the “distributable income” of the trust).

While there has been much debate on how to determine the distributable income in the past, COVID-19 has brought into focus a number of key issues that had to be considered as part of year-end planning. As trust distribution resolutions were required by 30 June 2020, significant tax may become payable if these issues were not considered and addressed before year end.

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What are the risks of getting distributable income wrong?

Getting the distributable income amount wrong can result in: • Tax being payable by the trustee at the top marginal tax rate (for example where the trust has no distributable income) • Beneficiaries being liable for a higher than expected proportion of the trust’s net (taxable) income • The need to deal with disclosure of any difference between accounting and taxable income in the financial statements.

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How is distributable income calculated?

Generally, where the income of the trust estate is determined in accordance with trust law concepts, the amount is determined having regard to generally accepted accounting principles.1 Accordingly, if proper accounts are kept in line with this principle, the amount recorded in the profit or loss statement would generally be a good starting point in determining income of the trust estate.

This concept does not allow for ‘creative accounting’, as court decisions have looked to determine the appropriate accounting treatment for the purposes of ascertaining the income for trust law purposes. For 30 June 2020, the accounting profit may have been impacted by a number of provisions that had to be recorded (for instance, asset impairments), which could have resulted in there being no amount of income under ordinary concepts.

In other cases, the trust deed may have a clause that essentially equates income of a trust (as defined in the trust instrument or by the trustee acting in accordance with a power granted under the trust instrument) to the net income of the trust within the meaning of section 95 of the Income Tax Assessment Act 1936 (ITAA 36) (an ‘income equalisation clause’). This can have the effect of increasing the distributable income beyond the extent of the trust’s realisable assets or net assets available for distribution.

What does TR 2012/D1 say about calculating distributable income?

In TR 2012/D1, the Commissioner considers three principles that apply in relation to the distributable income.

These are that the income of the trust estate must be: • Measured in distinct years of income • A product of the trust estate • An amount a beneficiary can be presently entitled to.

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Taxation & Estate Planning

These principles are supported by various cases, and we believe that these concepts are broadly defensible.2 However, in determining the ‘amount’ for the purposes of principle 3 above, the ATO has established a complex methodology of calculating a cap on distributable income that may be (in part) somewhat questionable. However, the ATO’s view remains, and ignoring this view may result in future disputes. TR 2012/D1 outlines the Commissioner’s view that the income of the trust estate cannot exceed (that is, places a cap on the distributable income of) the sum of:3 • Accretions to the trust estate (of property, cash or value) • Less accretions to the trust estate that have been allocated to capital, and • Less depletions to the trust estate that have been allocated to income.

What are the consequences of a limit to the distributable income?

The tax consequences of the ATO applying TR 2012/ D1 to limit the amount of the distributable income of the trust can be significant in certain cases. For instance, where year-end resolutions are drafted on a quantum, rather than a proportionate, basis, the ATO’s view can reduce the overall distributable income, resulting in a higher or lower proportion of income being attributed to beneficiaries. This can result in more tax being payable by those beneficiaries.

Moreover, if the cap results in the trust having no distributable income, excess franking credits may be trapped in the trust, or the trustee may be required to pay tax at the top marginal tax rate on the trust’s net (taxable income).

In addition, where the net distributable income of the trust (that is required to be distributed) exceeds the re-

29

Alexis Kokkinos, Pitcher Partners Alexis Kokkinos is a partner in Pitcher Partners’ tax advisory division and has over 19 years of experience providing taxation advice to corporate clients. Kokkinos leads Pitcher Partners’ national association’s tax technical division and is heavily involved in consultations with the Australian Taxation Office and Federal Treasury.

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Taxation & Estate Planning

ported accounting income in the financial statements, the difference may need to be dealt with in the accounts, and could cause the trust to go into a negative net asset position (or compound an existing negative net asset position).

What happens when there are permanent differences?

One may find that there were permanent differences recorded for 30 June 2020. Illustrations include provisions for impairments of capital assets held on capital account or non-deductible legal costs. These items may be recorded as an expense for accounting purposes but may not amount to a tax deduction. Accordingly, accounting income may be less than taxable income in these cases. This is demonstrated in Example 1.

Example 1 Assume that the Brisbane Family Trust derived $50,000 in rental income from its various residential properties during the 30 June 2020 income year. The trustee also incurred $10,000 in legal fees that were not deductible for tax purposes, resulting in an overall accounting profit of $40,000 and taxable income of the trust equal to $50,000. Before 30 June 2020, the trustee resolved to distribute the whole of the distributable income of the trust to Robert, an adult resident beneficiary.

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Analysis and discussion of example

This example outlines a concern mainly where there is an income equalisation clause in the deed. In such a case, the effect of the deed is that the rental receipts (but not the legal expenses) would be included in calculating the distributable income of the trust. Accordingly, the distributable net income of the trust would first be equal to $50,000.

TR 2012/D1 would not appear to limit the amount of the distributable income to less than the accretion ($50,000) as the legal expenses, while a depletion of the trust estate, are treated as capital expenses under the trust deed.

Therefore, under the resolution, Robert would be entitled to $50,000 of trust income (and would be liable for tax on the whole amount). The trustee would need to account for the excess $10,000 entitlement that arises as a result of the income equalisation clause, which in effect reduces the corpus of the trust by $10,000 and may result in net assets being a negative amount.

If the trustee is required to distribute $50,000 in this case (being the distributable income), this will result in the trust having a deficiency of assets, relative to the start of the year, equal to $10,000.

This is represented by the expenses that have been applied as a capital amount. The accounts would need to record the distribution of the whole of the income of the trust estate.

What happens when there are large timing differences due to COVID-19?

One may also find that there are large timing differences that must have been recorded for 30 June 2020. Illustrations include provisions for debt write-downs, provisions of impairment of investment

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values or provision for non-collectability of income derived (such as rental income under a contract). Most of these items may have been recorded as an expense for accounting purposes but may not have amounted to a tax deduction in the 30 June 2020 income year. Accordingly, accounting income may be significantly less than taxable income in certain cases. This is demonstrated in Example 2.

Example 2 Assume that the Brisbane Family Trust had taxable income of $100,000 for the 30 June 2020 income year but, after adjusting for accounting provisions, there was an accounting loss of $50,000. Before 30 June 2020, the trustee resolved to distribute whole of the distributable income of the trust to Robert, an adult resident beneficiary.

Analysis and discussion of example

This example presents two problems. If the trust deed defines income according to trust law concepts, then there may be no income to distribute to beneficiaries.

Accordingly, Robert may be entitled to no amount and the trustee may pay tax at 47%.

Alternatively, if the trust deed has an income equalisation clause, the trust may need to distribute $100,000, even though there is no accounting profit. As with Example 1, TR 2012/D1 may not result in a cap being applied in this case as the non-deductible expenses are likely to be treated on capital account by virtue of the trust deed only including ‘deductible’ amounts as part of the determination of income of the trust. This may require the trustee to distribute $100,000 to Robert under the resolution, which may result in a further deficiency of assets equal to this distributable amount.

Taxation & Estate Planning

Care must be taken with this approach. For instance, an over recharacterisation of capital expenses to income account could result in there being no ‘income of the trust estate’, even though the trust has taxable amount for the year (such that it would assessable to the trustee). Further, careful examination of the trust deed would be required, as there are often limitations on the recharacterisation clause. For instance, it may only apply to payments, which could allow the ‘legal expenses’ to be recharacterised but may not allow ‘market value movements’ to be recharacterised.5

What happens if restrictions are placed on paying entitlements?

As a result of COVID-19, financial institutions may request that restrictions be placed on unpaid entitlements (both new and existing). One should be mindful of any restrictions that may be imposed on the trustee. A present entitlement is a present legal right of a beneficiary to demand and receive the payment of income. Adding restrictions to a present entitlement may give rise to issues of the validity of a trust distribution for income tax purposes.

In such cases, consider whether this situation is overcome by refinancing UPEs as loans by way of legal offsets between the trust and the beneficiary (for instance, by the beneficiary agreeing to lend the amount to the trust and setting-off this promise against the trust’s obligations under the present entitlement).6

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It may be possible that the trust deed allows for non-deductible expenses (that are recorded in the profit and loss statement) to be allocated against ‘income’ and thus be taken into account in determining the distributable income for the year.

Can this issue be managed?

It may be possible that the trust deed allows for nondeductible expenses (that are recorded in the profit and loss statement) to be allocated against ‘income’ and thus be taken into account in determining the distributable income for the year.

In Example 1, assuming that the clause in the trust deed allows the trustee to validly recharacterise the expense, this could allow the trust income to be reduced to $40,000.

In Example 2, under the ‘ordinary income’ deed this could also allow some of the expenses to be recharacterised as being on capital account, so that there is at least some amount of income to distribute to Robert.4 Alternatively, under the income equalisation clause deed a recharacterisation of expenses from capital to income may enable the trust to reduce the distributable amount, and thus the extent of the deficiency caused by a distribution.

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Taxation & Estate Planning

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. Calculating distributable income of a trust estate: a) Allows for creative accounting b) Has regard to general accounting principles c) Uses a gross-income equalisation clause d) None of the above 2. If there are permanent differences to distributable income: a) The trustee need not account for excess entitlement from the income equalisation clause b) Accounting income may be less than taxable income c) Legal costs are not treated as capital expenses under the trust deed d) Impairments of capital assets held on capital account will amount to a tax deduction 3. In terms of capping distributable income, the effects of the ATO applying TR 2012/D1 include: a) Trapped excess franking credits if the cap results in the trust having no distributable income b) Release of excess franking credits if the cap results in the trust having no distributable income c) Reduction of distributable income if year-end resolutions are drafted on a proportionate basis d) A negative net asset position if net distributable income equals reported accounting income 4. According to TR 2012/D1, income of the trust estate must be: a) Measured in distinct years of income b) A product of the trust estate c) An amount to which a beneficiary can be presently entitled d) All of the above

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This is because restrictions on a loan account (that is, debt subordination) do not affect the ability for the beneficiary to receive payment of the present entitlement, which would have already been satisfied by way of refinance into a loan.

However, other issues should be considered in a refinancing case, including Division 7A of the ITAA 36 (for any changes that are made to UPEs) as well as the trust stripping provisions (for instance, section 100A of the ITAA 36, which could have applied if the reimbursement agreement, being the refinancing, was arranged prior to 30 June 2020).

What other issues should a trustee consider?

Where a trust has negative assets and external liabilities, trustees may need to consider issues with the administration of the trust, such as questions of solvency and whether it is in the best interests of the beneficiaries of the trust to pay trust distributions or pay creditors of the trust.

Trustees may also need to consider whether income of the trust needs to be first applied to make good losses incurred as a result of COVID-19, or whether instead it can be distributed to beneficiaries (for instance, the rule in Upton v Brown (1884) 26 Ch D 588). To the extent that a trustee is concerned with making distributions to beneficiaries for 30 June 2020, we recommend that the trustee seeks legal advice. Beneficiaries may need to consider refinancing their UPEs as subordinated debt (via a repayment of the debt) as outlined earlier.

It is critical to consider one’s position and how the rules may apply to one’s circumstances. fs Notes 1 Zeta Force Pty Ltd v FC of T [1998] FCA 728.

2 However, there is some concern about the extent to which amounts that form part of the trust estate at the start of the year can be taken to be income derived by the trust during the year (see comments by the ATO in paragraphs 11 and 92 of TR 2012/D1).

3 See paragraph 13 of TR 2012/D1.

4 Robert should then be taxed at his marginal tax rate on the whole of trust’s net (taxable) income as he is entitled to 100% of the income of the trust estate.

5 Most modern deeds allow the trustee to determine whether market value movements are treated on income or capital account. See, for example, the decision in Clark v Inglis [2010] NSWCA 144.

6 See, for example, East Finchley Pty Ltd v Commissioner of Taxation [1989] FCA 720.

5. Debt subordination affects a beneficiary’s receipt of a present entitlement, which would have already been satisfied by refinance into a loan. a) True b) False 6. Over-recharacterisation of capital expenses to income account could result in the trust having no income, even though the trust has taxable amount for the year. 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.

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Family Office Management:

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The entitlement trap

By Daniel G. Berick, Squire Patton Boggs

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: This paper cites reasons for generational misalignment within family offices, suggests ways to enhance connectivity between principals and potential successors, and highlights types of intergenerational issues encountered and why some may be unsolvable.

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 entitlement trap

R Daniel G. Berick

ecognising and taking steps to address the ‘entitlement trap’ is a challenge that is as old as the family unit itself.

The problems that can be caused within a family unit by the entitled child of privilege, and the intra-family resentments that can be created by the proverbial ‘prodigal son’, do not admit of

any easy solution.

Families that are sensitive to this issue struggle to inculcate a sense of responsibility, discipline and balance in their children, who grow up in conditions of privilege, and to convey to them the message that creating and maintaining wealth is difficult and requires work and dedication.

Communication among the wider family group, and with it the transmission of family heritage and values, has helped families instil a sense of broader responsibility and purpose in succeeding generations. Likewise, providing visibility into the work required to oversee and direct a family’s investments, and even providing early opportunities to participate in that investment oversight process, can help convey a sense of what is involved in the stewardship of family wealth. Family retreats and other avenues for education can help families prepare junior generations for their roles as responsible stewards.

The ‘problem child’ problem An equally perennial issue for wealthy families is how best to address the circumstances created by the ‘problem child’, and the ripple ef-

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fects caused in a family arising from criminal behaviour, substance abuse or similar issues, improvident personal relationships, or other problematic personal matters.

A structured approach to wealth preservation and generational wealth transfers can provide some insulation against the financial effects of problem child behaviour, by interposing legal protections and formal entity structures between the problematic family member and the family’s assets.

Analogous to this problem are the complications that can arise from divorce, remarriage and multiple marriages, as families look to navigate the sometimes difficult wealth transfer and succession issues involving ex-spouses, step-siblings and half-siblings. A family that has a rigid tradition of fixed succession parameters (firstborn child, eldest son or any similar formulaic approach) is especially vulnerable to problem child risk, as it does not have either a history of, or any commonly accepted process for, dealing with leadership succession when that mechanical approach produces a patently unsuitable candidate for family leadership.

This unsuitability can manifest itself in ways that are less dramatic, but equally require an ability to come to a consensus within the family regarding the leadership of the family or a family business enterprise. It can be a difficult and painful process for a family – and, particularly, the family member in question – to accept that a family member is not suited for the role that traditionally had devolved on the person with their position in the family.

Trusted outside advisers and family office professionals can play a crucial role in effecting the changes in leadership that those situations require.

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Lack of connection While the entitlement trap and the ‘black sheep’ problem focus on issues relating to individual family members, the issues caused by lack of connection among family members are both less obvious and more insidious.

As discussed earlier, transmitting culture and fostering cohesion are key elements in creating the connectivity that keeps wealthy families from splintering over time. It is a huge challenge for a family whose successor generations do not have that sense of connectivity to deal with family leadership succession and to find a common ground from which to work collaboratively to steward their family’s wealth. That sense of connection is extremely difficult to manufacture when needed – it either is developed organically over many years of planned and purposeful communication and engagement or, in most cases, it simply will not exist.

In our experience, families that are unable to develop and maintain that connection across the generations are much more likely to fracture over time, leading, at a minimum, to the ‘Balkanisation’ of a formerly unified vehicle of family wealth into a number of much smaller, separate units and, at worst, to the dissipation of family assets in protracted, painful and expensive intra-family litigation.

Building relationships among members of successive generations early gives them the mutual familiarity and relationships that allow for cohesion and resilience in the face of change and transition.

Alignment of goals Part of maintaining unity and successfully stewarding wealth across generations is communicating a sense of unified mission and shared goals to family members in those successive generations. This, in turn, can require a family to periodically undertake a process of identifying and assessing those goals and ensuring that they remain aligned with the goals and objectives of those new generations.

Family leadership needs to recognise that successive generations may have different values and priorities than those of their predecessors. In recent years, we have found that this value shift has frequently manifested itself in junior generations’ strong interest in impact investing – for instance, in environmental and social governance projects – with such interest being reflected in both venture investment projects and philanthropic priorities.

As the millennial generation comes to the fore, families seeking engagement with their millennial family members increasingly look to strategies such as impact investment to find a basis for alignment of goals, connection and a sense of family mission and purpose.

Conversely, the failure to transmit that sense of family connection and purpose, and the failure to develop an alignment of goals across generations, can lead to fracture and disunity. Members of a junior generation who do not feel that their voices are heard or that their

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goals are taken into consideration are less likely to feel a sense of engagement with, and connection and commitment to, the family as a unitary cross-generational entity, and thus, are less likely to maintain that unitary family when they succeed to seniority.

The failure to find alignment and compromise regarding investment strategy and goals among family members, even absent generational shifts in emphasis, can be equally problematic.

Example. Competing priorities One member of the family may be interested in shortterm liquidity to finance lifestyle ambitions, while other family members might be more interested in holding investments for longer-term wealth creation, or to enable substantial philanthropic endowments or the like.

Misalignment can also occur when there is a pressure from a family member to devote significant family assets to a vanity project – investing in an asset that is not of interest to the family members more generally, or engaging in high-profile and expensive philanthropic or political activity. Finding a way to mediate these individual priorities in the context of a more broadly based family strategy can take creativity, patience and no small measure of diplomacy.

Daniel G. Berick, Squire Patton Boggs Daniel G. Berick is the Americas chair of global corporate practice and co-chair of global family office practice at Squire Patton Boggs. His expertise includes mergers and acquisitions, securities law, corporate finance and corporate transactional matters. He also advises private equity and venture capital firms and family offices in connection with portfolio company investments, acquisitions and dispositions, fund formation and structuring, and securities and corporate law matters.

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Training and education

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1.What does the author see as a key to addressing divergent generational values?

a) Participation b) Education

c) Communication d) All of the above 2. The author highlights that a catalyst for generational misalignment can be: a) O ver-mediation b) Vanity projects c) Over-appeasement d) Lack of choice 3. What caveat does the author provide regarding handing over a business to the next generation? a) Training and education programs often fall short b) Outside advisers and family office professionals play a peripheral role at best c) Failure to develop and align goals across generations can undermine cohesion d) Building relationships among members of successive generations early can fuel apathy 4. According to the author, family office leaders could have difficulty accepting that: a) Their children fail to appreciate that wealth maintenance is hard b) A family member is not suited to a conferred role

A family puts wealth preservation at risk when successor family members have not been prepared for their stewardship roles. That preparation can take many forms, depending on the specifics of the family and its assets. However, without adequate training and education, successor generations can find themselves in positions of responsibility for their family’s wealth without having been provided with the tools to discharge that responsibility successfully.

In our practice, we have seen family education and training events cover a wide range of topics, depending on the family and its particular activities. Families frequently use educational programs to provide family members with a measure of basic financial literacy on investment and accounting topics, but also use training and education sessions to provide family members with a fundamental understanding of the family’s operating businesses and philanthropic activities.

Assumptions and expectations Among the most challenging and sensitive issues in effective generational wealth transfers are those arising out of assumptions and expectations concerning family members’ roles. These issues can arise in various contexts, but in each case, demonstrate the importance of open and honest assessment of skills and aptitude when considering family governance.

Assumptions regarding roles of, and expectations for, sons versus daughters can be a challenging mindset to change, and can vary widely across cultures. Family-controlled businesses that have ‘always’ had a family member as chief executive officer (CEO) can be faced with difficult succession issues where there is no suitable family candidate, particularly where a family member has an expectation of assuming that role.

Conversely, a family member can feel an obligation, because of those same assumptions and expectations, to assume a role for which they are not suited and that would be better filled by an outside executive. The addition of sons- and daughters-in-law to the mix can make those succession questions even more complex.

c) Their children have different values and priorities

Conclusion

d) All of the above

Divergent values and financial objectives among family members can dissipate a family’s assets. Particularly as successive generations become more removed from the generation that accumulated the initial wealth, a sense of entitlement and lack of familial ties can threaten the success of generational wealth transfers. Leadership that encourages transparency within the family and buy-in of a shared philosophy across the generations can help overcome these pitfalls. fs

5. According to the author, issues caused by lack of family member connection may not be readily obvious. a) True

b) False

6. The author believes that ‘problem child’ risk can be alleviated by non-pliant succession parameters. 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.

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Investment:

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Value is a philosophy, not a factor

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By Richard S. Pzena, Pzena Investment Management

The impact of COVID-19 on agriculture

By Michael Blakeney and Patrick Hayden, RCP

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Stock selection and ascertaining ‘value’ is nuanced and requires fundamental research and human judgment in addition to quantitative analysis. This paper examines the differences between value investing and factor investing, and evaluates their influence on investor decisions.

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

Value is a philosophy, not a factor

V Richard S. Pzena

alue investing is dead.

Or so, the authors of a recent academic paper titled ‘Explaining the Recent Failure of Value Investing’ would have us believe. They claim value investing has detracted from returns for the past 30 years (with the obvious exception of the early 2000s). This paper joins the value-is-just-a-factor bandwagon claiming that, “the value strategy had already lost its potency in the late 1980s and yielded negative returns in the 1990s.”1 Of course, many of these studies point to book-to-market price data to determine what makes a ‘value stock’.

We assert that stock selection based on a single metric is an overly simplistic approach to investing – it is factor investing. The value factor, as introduced by [Nobel laureate Eugene] Fama and [Kenneth] French, is one of the two most prominent approaches to value investing. The other approach made famous by [the ‘father of value investing’, economist, academic and investor] Benjamin Graham takes a more extensive view of a company and requires not only quantitative analysis but also fundamental research as well as the critical element of human judgment. In other words, value is not a factor; it is a philosophy.

This paper comprises a reproduction of an interview with Richard Pzena [conducted by Pzena’s in-house writer Allison Emmert] on this topic.

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From your perspective, what’s the difference between the value factor and value investing as a philosophy?

Put simply, value investing means that you’re trying to buy something for less than it’s worth. Most people would say, ‘That’s what every investor does’. This may be true, but most investors don’t really do detailed analyses to support their belief of what a company is worth.

They may buy simply because the stock’s going up, because they think the incremental news flows will improve, or because they love the concept. This is buying based on characteristics, which is one way to invest.

For instance, I could buy a company’s stock because I think it will grow by 20%, or it has a high return on capital or a good management team, or because the products are good. But that doesn’t mean it is a good value.

Buying based on characteristics has historically been a bad way to invest.

What are some alternatives?

Well, there is buying based on momentum, which is a totally valid way to invest that’s been proven academically. This approach assumes that the things that have done well will continue to do well.

And there’s buying based on valuation, which is merely the fundamental calculation of its present value. If future cash flows were already known, then there would be no question that you could calculate a company’s value and decide whether it’s cheap or overpriced.

So, if value investing means buying companies that are cheap based on their long-term cash flows, then to say that ‘Value is dead’, is absurd. That’s like saying ‘Arithmetic is dead’.

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If valuations are mere mathematical calculations, then why do stocks get cheap?

Stocks generally get cheap for behavioural reasons, because something is going wrong currently and investors don’t believe that the long-term investment case remains intact. Or there can be fear that something may go wrong in the future.

So how can you distinguish if a company’s stock represents value?

There are some typical characteristics of companies that become cheap. When a business hits a problem, the market doesn’t know if the issue is permanent or temporary. So, the stock gets sold off because there’s discomfort in uncertainty.

As value investors, we accept that we may not know the full extent of the problem. But we can research a company, and the industry in which it operates, to understand what the business issues are that we believe will skew the potential range of outcomes in our favour.

The issues to consider vary by industry or company.

Is there a long history of an established market position with high barriers to entry? Perhaps management expanded the business too rapidly or hired too many people or made an unreasonable acquisition. Or maybe a regulatory decision went against the company. It could just be the economic cycle. These are all examples of the things that value investors consider collectively.

The practice of value investing explores the range of things that could happen if a company succeeds at restoring profitability to its former lustre, the upside case, with the possible downside if the company fails. And what’s the most likely outcome. If there’s a big divergence between these two outcomes, then there’s potential value.

How can one replicate that with a factor-based model?

What do you say to people who believe that value investing is inherently risky?

Well, the original Fama-French study on price to book (P/B) worked off the inherent assumption that markets are efficiently priced. For low P/B stocks to outperform high P/B stocks, there’s an implication that those with lower valuations have some risk that hasn’t been identified. If risk is defined as stock price volatility, we would have to accept that value stocks may appear risky.

But what if we defined risk as the chance of losing money on an investment? By paying a low price for a stock that already reflects uncertainty, an investor inherently reduces risk. The reason people shy away from companies that have declined in value is they don’t like uncertainty. I don’t view that as a real risk. I’d argue that the best investors gain comfort in uncertainty.

Then isn’t this the argument for factor investing and buying stocks at low valuations?

Anybody in the world can create a low P/B or a low priceto-earnings (P/E) portfolio. It doesn’t take any skill. You

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can take a sophisticated quantitative model and combine multiple factors, which may even be better than a single factor. Maybe they are, but it’s certainly possible to find a value stock that’s cheap and still trades at a high P/B or high P/E, or both.

As an investor, you simply cannot look at numbers in a vacuum. I mean, P/B is flawed for obvious reasons; the book value is based on historical costs that don’t reflect the reality of the company’s true assets. Price to earnings is flawed because earnings can be highly cyclical. Just because a company’s earning something today doesn’t mean it will earn that in the future. Similarly, price to sales is just a snapshot of the company’s sales and doesn’t tell you anything about the margin structure of the business or its future sales. So, none of these things are value investing. They’re factor investing.

In the end, just because you can buy a buggy-whip business [a business that fails to keep up with the times] at a low P/B or at a low P/E, it’s still probably a bad idea.

And you could have bought Google at a high P/B when it was clearly cheap.

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The quote

It’s easy to buy ‘cheap stocks’ based on mathematical factors, but we argue that relying solely on quantitative data can lead to erroneous conclusions and crowded trades that eventually reverse.

When was that?

About five years ago. Everything was going mobile, and Google was a purely desktop search engine with a fledgling mobile presence. Apple was flexing its muscles and knocked Google Maps off the iPhone platform. Most people believed that either Apple or the carrier (AT&T or Verizon) would control all the advertising revenue. Google had a lot of cash and, net of its cash, traded down to just over 12x current earnings for a business whose share of the market was something like 85% and growing – in a world that was continuing to move toward digital.2 Yes, mobile was becoming increasingly important, but Google’s valuation implied it would capture none of the mobile business or that the toll placed on it by Apple would eat away at Google’s profits. And even if this assessment was 100% correct, an analysis of Google’s share price versus its long-term ability to generate earnings still would have concluded that the stock was cheap.

So, what you’re saying is that value investing is more nuanced than looking at a snapshot of a factor. A company like Google (Alphabet today), with its proven ability to generate long-term earnings, could be considered clearly cheap when priced at 12x earnings. Meanwhile, a business priced below book value may still be overpriced.

Is that correct?

Of course. A factor model is merely a snapshot of a factor. It cannot replace human judgment or common sense.

A good example would be buying a commodity company in the wake of the China-driven super cycle of the 2000s.

Consider what happened with iron ore miners, who scrambled to add capacity when strong Chinese demand led to skyrocketing iron ore prices. Throughout the 100-

Richard S. Pzena, Pzena Investment Management Richard S. Pzena is the founder, managing principal, co chief investment officer, and portfolio manager at Pzena Investment Management. Prior to forming the firm in 1995, he was director of US equity investments and chief research officer at Sanford C. Bernstein & Co. Previously, he worked for Amoco Corporation in various financial and planning roles.

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Investment

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. According to the author, value investing encompasses: a) Price to book b) Price to sales c) Price to earnings d) None of the above 2. What recommendation does the auhor make regarding investment decisions? a) Embrace knee-jerk reactions as they can validate judgment b) Rely on formulas to remove the emotional aspect of investing c) Scrutinise all aspects that define a ‘good’ investment d) Examine selective aspects that define a ‘good’ investment 3. In terms of gauging a prospective investment, value investing: a) Focuses on what has happened b) Considers issues and traits collectively c) Examines issues and traits in isolation d) Assumes absolute knowledge of red flags 4. The author sees the factor investing model as a: a) Snapshot of a factor b) Montage of factors c) Replacement for human judgment and ‘common sense’ d) Methodology for discovering nuanced information 5. According to the author, buying a stock based on its characteristics is a sound practice. a) True b) False 6. The author believes that the foundation of value investing is cheap stocks. 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.

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year history of the data, the real price of iron ore had been relatively stable, about $50 per [US]ton. The cost to miners, too, had remained remarkably consistent at about $40 per ton. They typically pocketed a $10 profit margin. However, with the iron ore price jumping to $180 a ton and the cost remaining at $40, miners’ profit margins jumped to $140 per ton.

So, what did they do? They produced as much as they possibly could by expanding mines and getting more capacity online before the price fell.

In a situation like that, it’s human nature to throw away all long-term investing principles. Although it usually costs $100 a ton to build a mine, it’s suddenly going to cost $200 a ton because everybody’s trying to develop at the same time competing for the same engineering and labour and everything else. But do they care about these added costs if they’re going to make $180 a ton and $140 profit margin?

In the middle of that kind of a cycle, greed and optimism kick in, and people assume a new paradigm has materialised.

Yes, and the valuations get bid up as a result.

Eventually, the iron ore prices came down, and most of these stocks traded at less than book value. But remember that the miners were putting new assets on the balance sheet at an inflated $200 per ton versus a history of closer to $100 a ton. The book value of the new assets was twice the long-term economic value of the assets. To someone deciding to buy the stocks based on accounting book value, it looked like they were trading at a significant discount. But if you step back and ask if book value represents economic value, you arrive at a very different investment decision.

Investors don’t need to be brilliant, but they should avoid knee-jerk reactions and use judgment about all the things that define a good investment. Is there a sustainable business model? Is there a margin of safety in the stock? Is there something that suggests the industry is going away?

That’s the difference between value investing and factor investing.

We can see the appeal of using formulas to remove the emotional element from investing. It’s easy to buy ‘cheap stocks’ based on mathematical factors, but we argue that relying solely on quantitative data can lead to erroneous conclusions and crowded trades that eventually reverse.

Factors cannot determine whether a business is priced irrationally or evaluate all the other qualitative features that come together to make a solid investment. Finding value is so much more than buying ‘cheap stocks’. The key lies in judgment about the sustainable, long-term earnings power of the business. As much as the quants try, they cannot use factors to replicate the benefits of human judgment informed by research. fs Notes 1. L ev, B & Srivastava, A, ‘Explaining the Recent Failure of Value Investing’, Stern School of Business, New York University, August 2019 [https://papers.ssrn.com/ sol3/papers.cfm?abstract_id=3442539].

2. Price-to-earnings history for Alphabet (Google), Capital IQ, Inc., a division of Standard & Poor’s; Pzena analysis.

Editorial note : All references to $ in this whitepaper refer to USD.

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: COVID-19 presents challenges for agriculture not necessarily echoed by previous recessions. This paper takes a granular view of spending pattern data for durable and non-durable goods to gauge the sector’s prospects against this background.

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 impact of COVID-19 on agriculture

M

Michael Blakeney and Patrick Hayden

any economists, much better positioned than we are, have provided forecasts on the future prospects of the global economy.

Our simplified analysis leads us to believe that it is very possible that the economy will set new records over the coming months and the longer it takes to reach the new normal, the higher the potential for deep structural implications that may have an outsized influence on economic prospects.

Certainly we have already seen markets set new records. The Australian Securities Exchange’s All Ordinaries Index has recorded the greatest daily loss since 1987, combined with the most substantial daily gain on record.

In March 2020, Australian markets also recorded three of the 10 largest daily losses and gains. This is combined with the biggest monthly drawdown since Black Monday in 1987, exceeding the interim drawdowns of the global financial crisis (GFC) (Riparian Capital Partners analysis, April 2020).

As long-term investors in real assets producing essential goods, we are less concerned about the short-term movements in equity markets and are focused on the functional components and longterm prospects of the food and agriculture sector.

This paper shares insights on the impact of the coronavirus pandemic (COVID-19) on this sector. In doing so, we purposely

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avoid formulating specific predictions for economic growth into the future and are acutely aware that observations made today [April, 2020] may well be redundant tomorrow, given the depth and speed of the disruption.

The historical and present demand for durable and non-durable goods The historical divergence in consumption of durable goods (generally defined as goods that have utility over a long period, and range from toasters to cars) and non-durable goods (single-use products such as food and beverages) during periods of economic contraction provide a foundation for the potential, but not guaranteed, resilience of the agriculture sector across business cycles.

The Reserve Bank of Australia (RBA) 2010 report titled Durable Goods and the Business Cycle, noted that: “Spending on consumer durable goods and machinery & equipment investments has been highly correlated with GDP [gross domestic product] growth in both Australia and the United States over the past 50 years.”

Further, the RBA identified that: “During deep recessions, spending on consumer durables and capital goods in Australia has fallen sharply ... In contrast, growth in household spending on non-durables and services slowed on average but remained positive. The experience in the United States has been similar.” (see Figure 1).

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Figure 1. Australia and US durable and non-durable goods: long-term consumption

Michael Blakeney, RCP Michael Blakeney is a managing partner and board chair of Riparian Capital Partners (RCP).

He holds an MSc, a Bachelor of Agricultural Economics, and is a graduate member of the Australian Institute of Company Directors and Agribusiness Executive Program.

Patrick Hayden, RCP Patrick Hayden is a co-founding managing partner of RCP with primary responsibility for strategic business development and investor relations. He holds an MBA, a Masters of Economic Studies and a Bachelor of Agribusiness.

Source: Australian Bureau of Statistics, U.S. Bureau of Economic Analysis

The International Monetary Fund (IMF) in its World Economic Outlook, October 2010: Recovery, Risk and Rebalancing report, referencing the GFC noted that: “The contraction in final demand during the recent crisis was asymmetric across sectors, with demand for durables falling by considerably more than demand for nondurables or services. For example, demand for durables in the United States … fell by more than 30 percent … whereas demand for non-durables and services fell by only 1 to 3 percent.”

These historical spending patterns are broadly consistent with expected spending patterns of consumers globally following COVID-19. Spending on non-durable goods of fresh and organic foods, healthcare and vitamins/supplements is expected to increase over the coming six months while spending on durable goods including cars, toys and games and athletic equipment is expected to decrease (Boston Consulting Group, ‘COVID-19 Consumer Sentiment Snapshot #3’, 2020) In terms of consumption trends during the early stages of COVID-19, anecdotal evidence and reports suggest a short-term boost in retail demand for non-durable goods.

This short-term demand spike has been witnessed globally (BCG, 2020). Export demand for non-durables and the operational capacity of supply chains is less clear.

Longer-term, historical precedence, assuming a period of economic contraction, suggests demand for food and beverages (non-durable goods) in aggregate will remain robust relative to durable demand.

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The variable impact across the food and agriculture sector Consistent with historical precedence, we should not expect aggregate food demand to decrease significantly, but rather we should be aware that inter-industry shifts in demand may occur as a result of changes in the economic prospects and lack of consumer mobility resulting from COVID-19. Research from the United States Department of Agriculture (USDA) and U.S. Bureau of Labour Statistics (summarised in the following paragraphs) suggests this expectation is consistent with changes through the 2007–2009 recession.

In the USDA’s Food Spending Adjustments During Recessionary Times report of 2011, analysis shows during the 2007–2009 recession, Americans of all income levels tightened their belts, primarily by eating out less.

Food-at-home sales also declined during the recession.

By contrast, restaurant and food service sales fell significantly during March 2020, outstripping changes seen in 2007–2009.

Further, the USDA report found that food expenditure fell 1.3% between 2006 to 2009. Importantly, it was also found that the fall in at-home spending consisted of initiatives that emphasised a decrease in costs including substituting comparable but lower-cost foods; taking advantage of sales, promotions and coupons, and seeking lower-cost stores.

Analysis of data from the U.S. Bureau of Labour Statistics Consumer Expenditure Survey over the same period (2007–2009) highlighted the variable impact of recessions across agricultural commodities. Unsurprisingly, expenditure on discretionary items (for instance, alcohol) fell more than essential food products.

Early indications, as reported by the Australia Trade and Investment Commission in March 2020, suggest similar trends, have been evident in China recently, as “some dairy suppliers saw strong demand”, “demand for wine remains very soft, especially at the premium end” and “around 56,000 tons of beef were exported in the first three months of 2020 … a 7.7% increase by volume [from the prior year]”.

Commodity price volatility is generally ever-present in agriculture. In theory, agricultural commodity prices are driven primarily by supply and demand which makes the attribution of GDP growth alone to price movements in commodity markets challenging.

That said, they provide another data point. Rudimentary analysis of agricultural commodity futures markets between 1990 and 2009 suggests that the impact of economic contractions varies across commodities and that prices of inputs used in the production of durable items (in this case, cotton) and discretionary items (in this case, sugar) typically decreased more than non-durable, non-discretionary commodities of corn and soybeans.

Commodity market movements since late February 2020 illustrate commodity price trends consistent

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with recessionary periods between 1990 and 2009 (see Table 1, noting that sugar in the 2007–2009 period reflected short supply, and corn currently influenced by ethanol prices).

Table 1. Agricultural commodity prices, recessionary periods 1990–2009 and COVID-19

Period from

Period to

Jul-90

Mar-91 –9.7% –7.1% –10.5% –29.3%

Mar-01

Nov-01 –3.4% –2.5% –30.3% –15.7%

Dec-07

Jun-09 –3.8% 7.3%

–18.6% 64.2%

21 Feb-20

24 Jul-20

–14%

–13%

Soybean

–2%

Cotton

Sugar

–23%

Source: RCP

Longer term it is possible, and [multinational Dutch rural lender] Rabobank makes the argument in its Coronavirus and the Impact on F&A report of April 2020 that the sustained trend we have seen in recent times toward healthy eating may be accentuated as a result of COVID-19, benefiting organic producers, fresh fruit and vegetables producers and generally companies and countries with reputations for ‘clean and green’/safe food production.

COVID-19’s unique potential to impact the food and agriculture sector COVID-19 will have a significant impact on the global economy, and the next quarter will confirm that some economies are in recession. Historical analysis of prior periods of economic contraction can provide a reasonable guide to what we could expect in the future. However, the abrupt and widespread impact of COVID-19 on everyday life for billions of people will potentially have a unique impact, not seen in prior recessionary periods, on the food and agriculture sector.

Restrictions adopted globally in an effort to contain COVID-19 will hit some segments of the food and agriculture sector harder than others. Restaurants and, by implication, supply chains and commodities reliant on restaurant trade (and, by extension, food service generally) have seen a sharp and dramatic fall in sales.

Restaurant expenditure was estimated to account for 34% of food expenditure in Australia in 2015–16 (Department of Agriculture, Water and the Environment, Food demand in Australia: trends and issues 2018).

The fall in restaurant sales and hence demand for French fries has resulted in a drop in demand for Canadian potatoes that is not expected to be filled by an increase in sales via grocery stores.

Australian watermelon and fresh salad producers have seen a similar fall in demand from food service. Australian flour millers have seen an increase in demand. The closure of labour-intensive meat processing plants will impact producers and consumers. The reduced use of vehicles has resulted in lower consumption of gasoline and, for certain countries, will result in lower demand for ethanol, impacting corn and sugar-cane farmers. Likewise, fresh seafood, which is typically transported globally by air, has seen imports fall by up to 80–90% (RCP analysis; Australian Trade and Investment Commission, COVID-19: Support for Australian Businesses, 2020).

Arguably, the potential of disruption to supply chains is greater in the current pandemic environment than what we would expect

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from analysing recessionary periods of the past. Planting decisions, the supply of inputs, access to labour (particularly for crops reliant on manual labour for harvesting or processing) and the ability to get goods to market may have implications for what consumers find on store shelves for some time yet.

Agricultural sector asset prices

Recessionary period Corn

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Rabobank’s Australian Rural Commodity Index of March 2020 saw the impact of current and future business and economic conditions on agricultural sector asset prices as being of particular importance.

Given the current strong agricultural commodity prices, the recent improvement in climatic conditions for vast areas of Australia and the historical consumption of non-durable goods during recessionary periods, it is plausible, although not guaranteed, that tangible (farmland and water) agriculture sector asset prices will be more resilient to COVID-19 than many sectors.

The actual impact of COVID-19 on asset prices will likely be delayed and vary by commodity and supply-chain segment. Initial indications are that farmland vendors in Australia are yet to be significantly influenced by COVID-19 impacts, however, the lag associated with farmland values limits the veracity of this position.

Since February 2020, Aither’s southern Murray Darling Water Index has softened –6.34%. The drivers and reasons for these movements are not directly attributable to COVID-19. Rather, they reflect supply and seasonal timing. Given the valuation cycle and liquidity of Australia’s water markets, it is possible that the values of Australian water entitlements will provide an early indication of the resilience of the agriculture sector to COVID-19.

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Looking ahead with guarded optimism

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. The authors believe that the impact of COVID-19 on food and agriculture will: a) Peak in the medium term b) Reflect previous recessions c) Be unique and unprecedented d) Be most felt by holders of water assets 2. According to data cited, global restrictions to curtail COVID-19 will impact Australian: a) Fresh salad producers b) Corn farmers c) Seafood producers d) All of the above 3. In terms of COVID-19’s impact on agriculture, that authors concluded that the sector will be: a) Impacted severely in the long term b) More sensitive than other sectors c) Less sensitive than other sectors d) Impacted much the same as durable goods 4. What did the authors highlight in terms of commodity price volatility and agriculture? a) It is constant b) There is a lack of Australian data c) It is sporadic d) There are no discernible patterns 5. Analysis cited found that discretionary non-durable item purchases grew during recessions as consumers sought ‘little luxuries’. a) True b) False

Consistent with past commentary, we anticipate that the agriculture sector will be less sensitive to a future period of economic contraction than many other sectors. We also expect participants who hold diversified portfolios of agricultural or water assets, that provide exposure to multiple commodities (particularly if the majority of these commodities are produced using mechanised farming systems and are inputs into non-durable goods), servicing both domestic and export markets will be well placed in the medium term. That said, it is possible that certain factors unique to COVID-19 will create headwinds for the sector which may also present distinctive opportunities for further investment.

Australian agriculture is an export-dominated and capital-intensive sector. We are well aware that factors not discussed in detail in this paper are likely of greater risk to the outcomes of diversified agriculture sector investment strategies. Examples of such factors include, sustained disruption to international trade, reduced access to bank credit, or a sustained elevated Australian dollar (which occurred post-GFC).

What remains to be seen is whether the medium-term impacts of COVID-19 elevate any, or a combination, of these factors and in turn adversely affect the sector more than others.

Conclusion The agriculture sector produces essential goods. The IMF’ World Economic Outlook, October 2010: Recovery, Risk and Rebalancing report found that in past periods of economic contraction, demand for non-durable goods has been more resilient than demand for durable goods, and select agricultural sector assets – which have shown to be uncorrelated to traditional markets – have been defensive in nature.

We expect that the agriculture sector will be less sensitive than other sectors to periods of economic contraction resulting from COVID-19. fs

6. According to the commentary, COVID-19 may result in inter-industry shifts for aggregate food demand. 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.

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Philanthropy:

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Purpose and profit

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By Sophie Renton, McCrindle

Choosing the right social enterprise structure

By Regie Anne Gardoce, Sprintlaw

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Today, for-profit organisations are increasingly taking on a social enterprise function. Not-for-profit organisations are optimistic about the partnership opportunities this creates.

However, in some cases, ‘purpose’, ‘mission’ and ‘social good’ have moved into the marketing realm, meaning less clarity for consumers.

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

Purpose and profit

T Sophie Renton

‘Purpose’ as a marketing strategy

his paper comprises an extract from McCrindle’s The Australian Communities 2020 report, based on the results of respective online surveys of Australian charity workers and those who had given to a charity in the past 12 months. It also draws upon in-depth interviews with not-for-profit leaders. Data was collected between October 2019 and January 2020.

“In recent years we have been talking more about social enterprise, and issues around environment and human dignity. The social conversation now expects for-profit organisations to make some meaningful contribution to our social and physical environment to positively impact the world.” (George Savvides, former chairman, World Vision Australia) The expectations of society are shifting. The public expects corporates to not just operate for profit, but for the triple bottom line of people, profit and planet. Not-for-profit leaders, Australian givers, and charity workers alike are becoming aware of this changing trend. Two in five Australian givers (40%) and charity workers (38%) strongly/somewhat agree they have observed an increase in for-profit organisations running social projects and awareness campaigns. Not-for-profit leaders believe this is a positive step for society as more organisations are operating with a social conscience.

“It is a good thing for society that a broader part of our marketplace is endeavouring to pursue community objectives and social objectives as part of their everyday work and organisational activity.” (Savvides)

Despite the growing popularity of commercial organisations operating for purpose and profit, not-for-profit leaders have concerns about the Australian consumer navigating the changing landscape. There is a sense that organisations can interpret ‘purpose’ in many different ways and what is presented as their ‘purpose’ may not necessarily bring about social good.

“When it comes to social enterprises and the term purpose, there’s just so much grey area right now.

“A lot of corporates are using the term purpose, as a replacement for their mission, but what that is might not necessarily make the world a better place.” (Richenda Vermeulen, chief executiveand founder, ntegrity agency) Others have concerns that the for-purpose approach is used more as a marketing strategy rather than an internal shift within the organisation around its mission, values and objectives. Where it is used as a marketing strategy, the Australian public may feel like their purchases are achieving some sort of social good, almost an activist act, but they may be misled in the process.

“What I am seeing is commercial organisations woke-washing [using social issues, purpose and awareness as a marketing strategy]. There’s a strong social flavour to their marketing and their propositions to the public, which if you scratch the surface, is only symbolic at best.

I worry about the lines blurring and the public being misled about the true motivations of commercial companies reporting to be social enterprises.” (Sarah Pennell, general manager and company secretary, Foodbank Australia)

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Greater regulations for commercial organisations running social projects When it comes to for-profit organisations running as social enterprises, Australian givers are more cautious than charity workers. Half of Australian givers (50%) have concerns around for-profit organisations operating as social enterprises, while two in five charity workers (39%) feel the same. Australian givers are slightly less concerned about for-profit organisations operating social projects and awareness campaigns (38% cf. 31% charity workers).

More than three in five Australian givers (64%) and charity workers (62%) strongly/somewhat agree with this, believing there should be disclosure or regulatory requirements on for-profit organisations running social projects and awareness campaigns. They are both less likely, however, to believe that for-profit organisations running social projects and awareness campaigns should receive the same tax benefits as charities/not-for-profits for those projects.

Not-for-profit leaders agree with charity workers, believing there is a need for greater regulation and clarity around social enterprises, so that givers and consumers are clear on the impacts of their engagement.

“There needs to be more self-regulation around social enterprises and the impact they are making. It’s easy to mark yourself as a social enterprise but it’s becoming harder for customers to discern the impact that is, or isn’t, being made.” (Vermeulen)

Partnership opportunities “The appetite for corporate partnerships is only going to increase. Corporates are not going to start their own charities. That’s something we used to fear but corpo-

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rates are showing they understand the complexity of impact, charity, and giving and staying within their zone of what they know they are good at. They want partners on the not-for-profit side. This is a big opportunity for notfor-profits to productise their value for corporates and build shared value.” (Vermeulen) In a time where the societal expectation of commercial organisations operating for purpose and profit is increasing, organisations will potentially be looking to partner with charities to help them fulfil their corporate social responsibility. The rise of organisations operating for purpose and profit may in fact not encroach on the charities/not-for-profit sector but provide the opportunity to increase impact through corporate partnership.

“Partnering with corporate organisations is in our DNA – that’s what we do. We exist because of the food and grocery industry, they are our partners. They give us our supplies and we engage with them on promotional programs to help raise awareness of the issue we address.” (Pennell)

Shared values are essential to partnerships Partnerships with corporate organisations can produce great results. For these partnerships to be successful, however, they need to be based on shared values. These shared values allow the two organisations to work together to achieve outcomes, allowing both organisations to stay true to their purpose.

“I think we can, and we should [partner with corporate organisations] where the particular values of the organisation are sympathetic to each other. You have got to be careful about partnering with those whose values are quite different where the only reason to

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Sophie Renton, McCrindle Sophie Renton is a social researcher, trends analyst and director of research at McCrindle. As an experienced researcher, Renton understands how evidence-based insights can inform strategy and help organisations to thrive amid change. From her experience in leading the team at McCrindle, she assists organisations by bringing a clearer picture to complex problems.

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The quote

To stay true to the mission, the mission must first be clear and simple.

partner would be financial rather than the cause or the passion behind what we’re doing. If the only reason you’re partnering is money, I think you have to be really cautious about that.” (Tim Hanna, former chief executive, Compassion Australia)

Invest in good governance To enable charities/not-for-profit organisations to maximise the opportunity of corporate partnership, not-forprofit leaders believe there needs to be a level of board maturity for charities/not-for-profit organisations. Although it can be challenging at times, when resources are limited, it is important to think about board composition in order to take advantage of partnership opportunities.

“I see a future where much larger charity partnerships are possible and so the challenge for the governance boards of those charities and not-forprofits is the choice of who they should partner with in a complementary sense, sharing a common mission and purposeful impact that they desire to achieve. That requires a board that is both agile and experienced, with an executive team who are comfortable in

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pursuing strategically challenging partnerships. That might be too much of a challenge to some traditional charities who might not have that kind of capability on team, or on the board.

“In the time ahead it might be important for organisations aware of their limitations to think about the composition of their boards and the capabilities of their executives before they engage with larger organisations who are looking for partners, to fulfil their community contribution and their social licence commitments.” (Savvides)

Avoid mission drift All organisations, whether for-profit or not-for-profit, are susceptible to mission drift. It is the commitment to the mission and purpose, however, that allows organisations to succeed. At a time when opportunities may become available for charities/not-for-profits to partner with commercial organisations, it is important that organisations first and foremost stay true to their original mission. To stay true to the mission, the mission must first be clear and simple. It needs to be well-understood

Figure 1. Survey responses: Australian givers and charity workers

Source: McCrindle

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throughout the organisation and decisions need to be made in alignment with it. Not-for-profit leaders remind us that it is okay to say no to a partnership opportunity if it does not align with the organisation’s mission.

“One of my big concerns is that, at times, control comes from where money comes from. I don't love the reality of that but I think what we’ve noticed is we have to be really careful not to have mission drift, because you’re about to get more money, or access to more people through the corporate partnership. The amount of times we’ve had to say ‘No’ in our 11 years shocks us and would shock many people.” (Daniel Flynn, co-founder, Thankyou)

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Conclusion Society’s expectations are shifting. The public expects corporates to not just operate for profit, but for the triple bottom line of people, profit and planet. This context provides opportunities for charities and not-for-profits to partner with commercial organisations to help them fulfil their corporate social responsibility. Notfor-profit leaders are optimistic about corporate partnerships as they can increase an organisation’s impact. A word of caution is given, however, that partnerships must be formed on shared values, not just financial benefit, to allow organisations to stay true to their original mission of building a stronger society. fs

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. According to the author’s findings regarding Australian for-profits operating as social enterprises: a) Givers displayed more caution than charity workers b) Charity workers displayed more caution than givers c) Charity workers were strongly in favour of taxation benefits d) Not-for-profit leaders did not see a need for greater regulation 2. What concern did the author highlight regarding social enterprise ‘purpose’ and the for-profit approach? a) It is open to interpretation b) It has become a marketing strategy c) It does not necessarily equate to social good d) All of the above 3. A ccording to the commentary, corporates will increasingly seek to start their own charities. a) True b) False

4. T he author believes that successful partnerships between corporates and not-for-profits are based on: a) Shared interests

b) Board autonomy

c) Shared values

d) Financial priorities

5. W hat does the commentary recommend in terms of not-forprofit/charity missions? a) Adopt missions that are flexible b) Remain true to the original mission c) Accept that mission drift is inevitable d) Make missions highly detailed 6. Not-for-profit leaders are largely sceptical about for-profits running social projects. a) True

b) False

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: More and more organisations are looking to combine profit and social impact. This paper looks at how various social enterprise structures can best fulfil this aim, and identifies trends in the uptake of social enterprise structures locally and overseas.

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

Choosing the right social enterprise structure

T

Regie Anne Gardoce

raditionally, businesses are set up to make a profit.

Not-for-profits are set up to do social good. But what if the objective is to do both?

Social enterprises sit right in the middle of this spectrum – they are a rising group of organisations that want to create profit and social impact.

Starting a social enterprise is a great way to create both financial and social value. However, as with starting any organisation, the first challenge is always choosing the right structure.

What is the right structure for a social enterprise?

In Australia, there are legal structures for corporations making a profit, and for not-for-profits. However, in Australia there is no specific legal structure that is called a ‘social enterprise’ or one that is specifically designed for social enterprises.

Instead, social enterprises must use any of the existing legal structures to achieve their objectives.

Choosing the right structure is an important first step, so it is necessary to make sure the structure complements the purpose, growth strategy and sources of finance the social enterprise would like to pursue.

More importantly, a key question is, Does the social enterprise want to make a profit?

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This paper looks at some of the most common structures for social enterprises and discusses how some innovative social enterprises are changing the game in this space and using their legal structure creatively to complement their strategy.

There are also other types of legal structures available to social enterprises, for instance, co-operatives and Indigenous associations, however, only the most common are discussed.

Pty Ltd company

Most social startups and new social enterprises adopt a proprietary limited (Pty Ltd) company structure. This is the most common business structure under which most normal profit-driven businesses operate.

A company is a separate legal identity to its owners, which means that the owners will not be personally liable for any debts that the business incurs.

There are shareholders (the owners of the company) who are paid dividends, while the directors are the people who make the decisions.

A company structure is good if capital needs to be raised to grow a social enterprise because most investors are familiar with the structure.

Companies are regulated by the Australian Securities and Investments Commission (ASIC) under the Corporations Act 2001.

Company limited by guarantee

A common option for not-for-profits is a ‘company limited by guarantee’ (CLG) structure.

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In a CLG structure, there are no shareholders or dividends. Instead, there are ‘members’ of the association who come together for a purpose that is not profit-driven.

A CLG structure is attractive for government grants and philanthropic donations because it has a social purpose. CLGs are also regulated by ASIC unless they are registered as a charity, in which case they will need to report to the Australian Charities and Not-for-profits Commission instead.

Incorporated association

An incorporated association (IA) is another option for not-for-profits and runs a little like a company.

It is a separate legal identity, and its ‘members’ have rights. However, IAs do not have a right to make a profit the same way as shareholders. Instead, those under an IA structure are driven by purposes and rules, and it is run by an elected management committee and secretary.

Therefore, this structure also helps attract grants and donations.

There is a different IA regulator in each state, so relevant information regarding the IA’s purpose and role must be lodged with the relevant one.

[The Australian Charities and Not-for-profits Commission website is a useful source of information on the “different legal requirements imposed by government agencies, at local, state and territory and Commonwealth levels” and the regulation of charities.]

The hybrid structure

While there are structures for not-for-profits on one end, and structures for businesses on the other; social enterprises need to be both at the same time. So, how can this be achieved?

Recently, social enterprises have discovered a new way of looking at this – the hybrid structure. This essentially

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involved setting up a not-for-profit (CLG or IA structure) and a Pty Ltd company separately.

Under this hybrid structure, the social enterprise typically operates under both entities using a web of legal documents to ensure strong governance.

It can be very tricky to manage two entities, so why do social enterprises do it?

This structure is popular because having a private company on the one hand means that it enables capital to be raised from investors. On the other hand, the CLG structure can also attract grants as well as lower administrative burdens. Again, managing two entities can be a substantial challenge.

A new legal structure?

In the United States, there is a ‘benefit corporation’ legal structure that mandates both profit-making and creating social impact and value.

In Australia, however, there is no specific legal structure like this, yet some social enterprises are pushing to make this happen.

Example Australian crowdfunding platform Chuffed is currently pursuing what it calls a ‘social benefit company' structure.

Essentially, Chuffed is set up as a Pty Ltd company, but the social purpose that drives its social enterprises is embedded in its shareholder agreements and company constitution.

This means that it can make a profit and attract capital investment while still upholding the integrity of its social mission.

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Regie Anne Gardoce, Sprintlaw Regie Anne Gardoce is a lawyer at Sprintlaw, helping startups, social enterprises and small businesses navigate their legals. She has worked across traditional law, startups and not-for-profits, gaining skills in the legal, marketing, design and business development fields. She holds law and commerce degrees from UNSW.

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Certifications

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. Irina wants to set up an Australian social enterprise that can receive grants. A possible option would be: a) A company limited by guarantee b) An incorporated association c) A hybrid structure d) All of the above 2. Raffi wants to set up an Australian social enterprise with profit-making capacity. A possible option would be: a) An incorporated association b) A hybrid structure c) A benefit corporation d) None of the above 3. A company limited by guarantee: a) Issues dividends to shareholders b) Has members with a non-profit-purpose c) Cannot be registered as a charity d) Is precluded from receiving donations 4. What is the most popular business structure for Australian startups and new social enterprises? a) Social benefit company b) Hybrid c) Pty Ltd company d) Cooperative

On top of legal structure or rules embedded in legal documents, certification of a social enterprise may also be a consideration.

In Australia, it is possible to apply for B-Corp certification which is administered by a US-based organisation called B Lab. To encourage using business as a ‘force for good’, and also push for a Benefit Corporation model in Australia, B Lab certifies social enterprises to verify their leadership credentials in social innovation and entrepreneurship.

Benefit Corporations are active all around the world, with big names such as Ben & Jerry’s, Patagonia and Etsy all certified as BCorps.

To attract investors, community awareness and also support the move towards a Benefit Corporation model, B-Corp certification is a great way to help a social enterprise’s growth.

What to take away Choosing the right structure for a social enterprise is important to get right from the outset. The structure will determine what kind of finance can be sourced, whether it is possible to make a profit, and how decisions are made.

In particular, there are a number of regulations stipulating what can and cannot be done, depending on the structure. Therefore, it is necessary to make sure a social enterprise’s structure also suits its long-term strategy.

Further, there are different regulators with a range of reporting obligations and minimum standards.

Finally, the size and financial position of a social enterprise may also influence which structure is most suitable. fs Founded in 2017, Sprintlaw is a new type of law firm that operates completely online and on a fixed-fee basis. Its mission is to make quality legal services faster, simpler and more affordable for small business owners and entrepreneurs.

5. There is no specific ‘social enterprise’ legal structure in Australia. a) True b) False 6. Incorporated associations are subject to federal regulation. 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.

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Good faith in franchising

By Ana Haarsma, Haarsma Lawyers

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Entering into a franchise agreement requires much awareness and consideration. This paper explains what the obligation to act in good faith means in light of the Franchising Code, regulatory expectations and case law; and discusses the rights and requirements of franchisors and franchisees.

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

Good faith in franchising

T Ana Haarsma

he Franchising Code of Conduct (Franchising Code) is set out in schedule 1 to the Competition and Consumer (Industry Codes—Franchising) Regulation 2014. The Franchising Code includes an obligation that the franchisor and the franchisee act in good faith in their dealings with the other party.

The obligation to act in good faith in franchising applies to all aspects of the relationship between a franchisor and a franchisee, including negotiations before entering into the franchise agreement.

However, the obligation is more than just a general obligation to act in good faith.

Good faith under the Franchising Code The obligation to act in good faith in franchising is set out in clause 6(1) of the Franchising Code, which states that: Each party to a franchise agreement must act towards another party with good faith, within the meaning of the unwritten law from time to time, in respect of any matter arising under or in relation to: • the agreement; and • the Code.

The obligation to act in good faith contained in the Franchising Code extends to negotiations and discussions before the entry by the parties into a franchise agreement.

Clause 6(2) of the Franchising Code provides that: The obligation to act in good faith also applies to a person who proposes to become a party to a franchise agreement in respect of:

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• any dealing or dispute relating to the proposed agreement; and • the negotiation of the proposed agreement; and • the Code.

However, the obligation to act in good faith does not enable a party to make a general claim that there has been a failure to act in good faith.

For example, where a franchisee complains that a franchisor has not acted in good faith the Federal Court held in Australian Competition and Consumer Commission v Ultra Tune Australia Pty Ltd [2019] FCA 12 (ACCC v Ultra Tune) that: ... the focus of an obligation of good faith should ordinarily be on a franchisor's use of powers and opportunities available by reason of the franchise relationship.

What is good faith?

“Good faith” is not defined in the Franchising Code.

The Franchising Code provides that: Each party to a franchise agreement must act towards each other with good faith, within the meaning of the unwritten law ...

The “unwritten law” means the law developed in the Australian courts through case law or common law.

In Commonwealth Bank of Australia v Barker [2014] HCA 32, the High Court of Australia held that good faith involves: Fairness in dealings as between contracting parties ...

Similarly, in Paciocco v Australia and New Zealand Banking Group Limited [2015] FCAFC 50, the Federal Court of Australia held that the obligation to act in good faith means to: … act honestly and with a fidelity to the bargain; an obligation not to act dishonestly and not to act to undermine the bargain entered or the

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substance of the contractual benefit bargained for; and an obligation to act reasonably and with fair dealing having regard to the interests of the parties (which will, inevitably, at time conflict) and to the provisions, aims and purposes of the contract, objectively ascertained.

Australia has accepted that view (ACCC v Ultra Tune).

Consequently, franchisors should keep records of their business goals and objectives and reasons for decisionmaking, so that these records can be referred to later if needed.

Elements of good faith

Conduct that may show a lack of good faith

Some elements of the obligation to act in good faith include: • Honesty • Fairness • Not acting arbitrarily • Co-operating to achieve the purpose of the franchise agreement • Reasonableness • Having regard to the interests of the other party.

While the Franchising Code does not define good faith, it provides that when assessing whether a party has acted in good faith, a court may consider if: • A party acted honestly and not arbitrarily • A party co-operated to achieve the purpose of the franchise agreement.

Legitimate business interests While a party must take into account the interests of the other party, the obligation to act in good faith does not prevent a party from acting in its own legitimate commercial interests.

Consequently, a party is not required to act in the interests of the other party at the expense of its own interests.

The Australian Competition and Consumer Commission’s (ACCC) view is that conduct is prohibited where it harms the franchisee, but it is not necessary for the protection of the franchisor’s interests. The Federal Court of

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The ACCC in its Franchisor Compliance Manual has indicated that the following conduct may raise concerns under the obligation of good faith: • A franchisor treating a franchisee differently to other franchisees because the franchisee has raised concerns about the system.

• A franchisor raising numerous minor and immaterial breaches with a franchisee in an aggressive and intimidatory manner designed to extract concessions or cessation of complaints.

• Franchisees using confidential information provided by the franchisor to compete with the franchisor.

• Franchisees using social media to post negative comments about the franchisor or their dispute with the franchisor.

Penalties under the Franchising Code The maximum civil penalty under the Franchising Code for a failure to act in good faith is 300 penalty units, or $66,000.

Case study: Ultra Tune Australian Competition and Consumer Commission v Ultra Tune Australia Pty Ltd [2019] FCA 12

In early 2015, Mr Ahmed, agreed to purchase the Ultra Tune franchise business located in Parramatta, NSW.

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Ana Haarsma, Haarsma Lawyers Ana Haarsma is a leading franchise lawyer and a director of specialist franchise law firm Haarsma Lawyers. She specialises in franchise dispute resolution for both franchisors and franchisees and is an accredited mediator. She has also been involved in litigation at all levels of the Australian judicial system, including the High Court of Australia.

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During the purchase process, Mr Ahmed had a number of meetings with Ultra Tune, during which a number of representations were made. These representations included representations about how long the franchise had been open, the rent payable and the purchase price.

In September 2015, on the basis that the deposit was refundable, as required by the Franchising Code, Mr Ahmed paid the deposit of $33,000.

During the training period, Mr Ahmed was provided with the disclosure document and the franchise agreement, which he felt contained figures which were inconsistent with the representations.

Mr Ahmed subsequently decided not to proceed with the franchise and on 30 September 2015, requested that the deposit less the training costs be refunded.

Ultra Tune refused to refund the deposit on the basis that the money had been used to pay for signage and equipment and was now non-refundable.

In 2017, the ACCC commenced proceedings against Ultra Tune for a number of matters including the failure to comply with the good faith obligations contained in the Franchising Code.

The Federal Court found the following: • Ultra Tune failed to explain why the orders for the equipment and signage could not have been stopped or why the equipment and signage could not be used by another franchisee or resold by Ultra Tune to another franchisee.

• Ultra Tune had sought a large deposit without giving Mr Ahmed a reasonable time to consider the purchase of the franchise business, particularly given the representations made to him.

The Federal Court also found that Ultra Tune breached its obligation to act in good faith by: • Failing to honestly disclose information about the franchise • Making misrepresentations to Mr Ahmed about how long the franchise had been open, the rent payable and the purchase price • Putting pressure on Mr Ahmed to pay $33,000 before providing documentation relevant to the purchase of the franchise • Requiring the payment of $33,000 and subsequently treating it as a non-refundable deposit without making it apparent to Mr Ahmed that the money would be treated as non-refundable • Making a decision to expend the $33,000 on signage and equipment without the need for urgency • Failing to repay Mr Ahmed the deposit.

The Federal Court ordered that Ultra Tune pay a penalty of $54,000 (the maximum at the time) for the breach of the obligation to act in good faith.

Case study: Pizza Hut Diab Pty Ltd v YUM! Restaurants Australia Pty Ltd [2016] FCA 43

Clause C1 of the franchise agreement entered into between YUM! Restaurants Australia Pty Ltd (Yum) and

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its franchisees contained a standard pricing clause which provided that the: Franchisee will not permit any Approved Product to be sold at the Outlet at any price exceeding the maximum retail prices advised by the Franchisor to the Franchisee from time to time.

In June 2014, Pizza Hut introduced a new pricing model. In particular, Pizza Hut advised its franchisees that certain pizzas were to be offered for $4.95, which was a decrease in previous pricing.

Under Clause C1 of the franchise agreement, the Pizza Hut franchisees were not able to sell the $4.95 pizzas for a higher price.

A number of Pizza Hut franchisees alleged that the pricing was unprofitable and that Yum had breached its obligation to act in good faith in implementing the pricing.

The Federal Court did not agree, and considered ‘the purpose’ of the franchise agreement.

In doing so, in addition to clause C1 of the franchise agreement, the court considered clause 6.2 of the franchise agreement which provided that the: Franchisee will participate in such national and regional advertising, promotions, research and tests as Franchisor from time to time requires and Franchisee will not have any claim or action against Franchisor in connection with the level of success of any such advertising, promotion, research or test.

In respect of the purpose of the franchise agreement, the Federal Court found: An obligation to ensure profits for each Franchisee with respect to a given promotion, including the setting of a maximum price which is particularly low, is not only inconsistent with clause 6.2, it is also commercially unrealistic in the context of different factors ensuring profit.

In addition, the Federal Court considered whether Yum acted “honestly and fairly” and found with regard to Yum’s CEO: He may have demonstrated poor business judgment, particularly with the benefit of hindsight. However, that does not equate to a lack of fidelity to the bargain or to unconscionable behaviour.

The Federal Court also considered whether Yum acted “reasonably”: He made what he considered to be the best decision from the point of the view of Yum and the future profitability of the Franchisees. He and the Yum executives, rightly or wrongly but reasonably, believed in a first mover advantage.

COVID-19 and good faith in franchising In its coronavirus (COVID-19) information release for businesses, the ACCC highlighted the need for franchisors to be aware of their obligation to act in good faith during the pandemic.

When considering whether a franchisor is acting in good faith, the ACCC suggests that potential questions to ask include: • Is the franchisor making timely decisions?

• Is the franchisor consulting with franchisees regarding issues or proposed changes?

• Is the franchisor imposing conditions on franchisees that are not necessary to protect its interests?

• Is the franchisor genuinely attempting to resolve the dispute?

• Is the franchisor acting for some ulterior purpose?

The federal government has also indicated that franchisors should be working with franchisees to waive, reduce or defer franchise fees while their businesses are affected by the COVID-19 restrictions. fs

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CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. In terms of legitimate business interests, while a party must take into account the other party’s interests, it: a) Must prioritise the other party’s interests over its own interests b) Need not prioritise the other party’s interests over its own interests c) Is bound by the court view that conduct is prohibited if it harms the franchisee in any way d) Is bound by the court view that conduct is prohibited if it harms the franchisor in any way 2. The obligation to act in good faith: a) Encompasses “unwritten law” developed through case or common law b) Enables a party to make a general claim regarding a failure to act in good faith c) Is essentially a general obligation to act in good faith d) Is limited to dealings after entry into a franchise agreement 3. T he Franchising Code contains a clear definition of “good a) True b) False

4. In terms of failure to act in good faith, the Franchising Code imposes: a) A minimum civil penalty of $33,000 b) A minimum civil penalty of $63,000 c) A maximum civil penalty of $54,000 d) A maximum civil penalty of $63,000 5. T he Diab Pty Ltd v YUM! (Pizza Hut) case decision found that franchisor: a) F ailed to make the best decision for the franchisees’ future b) Showed poor business judgment, equating to lack of fidelity to c) Had no obligation to ensure the franchisees’ profits regarding d) Had an obligation to ensure the franchisees’ profits regarding 6. The ACCC v Ultra Tune case confirmed that franchisees must bear the risk of non-refundable deposits. a) True

b) False

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Technology:

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Cybersecurity risks family enterprises and offices face during COVID-19

FS Private THE JOURNAL Wealth OF FAMILY OFFICE INVESTMENT•

By Helena Robertsson, EY

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: When it comes to cybersecurity, family office members can be their ‘own worst enemy’. This paper suggests cyber-risk mitigation measures for family office principals, identifies areas of vulnerability, and examines how COVID-19 has affected family offices and enterprises’ cybersecurity focus.

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

Cybersecurity risks family enterprises and offices face during COVID-19

C Helena Robertsson

yberattacks are accelerating as criminals and other threat actors seek to exploit the disruption caused by the coronavirus (COVID-19) pandemic. Businesses have scrambled to implement sweeping remote work practices and online-only interactions with employees, customers and vendors. These changes have come with heightened cybersecurity risks. Some family enterprises and family offices are recognising the danger, and taking steps to increase cybersecurity capabilities, however, others need to catch up quickly.

Even before the pandemic, some family enterprises and family offices were lagging in cybersecurity practices. Historically, cybersecurity in family offices and smaller family enterprises has focused on finances (for instance, making sure money is not transferred mistakenly or fraudulently). But as information has moved to the cloud and social media, the walls of these businesses have expanded – opening many more opportunities for attacks.

Threats from all directions: Phishing, data theft, remote work According to a recent article by EY global advisory cybersecurity

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leader Kris Lovejoy, the rush to remote work and the general sense of panic set off by COVID-19 has opened the door to a wide range of additional cybersecurity risks that family enterprises must attend to urgently, outlined as follows: • Increased remote work: Threat actors are taking advantage of cybersecurity holes caused by widespread telecommuting (for example, increased pressure on IT teams, users bypassing cybersecurity leading practices, and remote administration of critical information).

• Increased phishing and malicious content: Threat actors have significantly increased their use of phishing, malicious sites and business email compromise attempts linked to the pandemic.

• Increased data theft: Threat actors conducting data theft for extortion, disruptive or destructive ransomware attacks, and/or seeking to damage enterprises’ brands have targeted organisations perceived as being under pandemic-related strain.

“COVID-19 has made it more pressing than ever that family firms develop control structures that create a protective stance and readiness to respond.” (Paul McKibbin, family office advisory managing director, EY Americas)

The principal risk Family offices and family enterprises add yet another risk to this list,

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that is, the families themselves. In family offices and smaller family enterprises, the person in charge of IT may not have control over the actions of principals and their family members. There may be no chief information security officer with a tight rein over devices, access and usage, as there is in large enterprises. Instead, there may be a small group of staff that must try to manage IT controls with governance, frequent education and personal influence.

Family members range from tech-savvy teenagers to tech-averse octogenarians and everyone in between.

They may use personal emails or follow substandard mobile security practices, leaving them – and their family firms – open to malware, phishing attacks and wire fraud, all on the rise during the pandemic.

In the COVID-19 environment, loose cybersecurity practices mark family offices, smaller family enterprises and principals as easy targets for attack.

“Much of the reputational risk is in their broader footprint, out in the world, not within a server. That information footprint is less in their control.” (Haris Shawl, cybersecurity senior manager, Ernst & Young LLP)

Reputation and privacy must be protected At their most severe, cyberattacks can be devastating to a family firm’s legacy. An attack could threaten reputation by associating the family’s name and brand with a scam or unreliable product, or it could bring down systems, leading to a serious disruption in customer service or employees’ ability to work. In research completed for the latest EY Global Capital Confidence Barometer, 24% of 394 family enterprise leaders in middle-market companies named reputational damage as their greatest fear related to cybersecurity.

Example. Opening the door for cybercriminals If a principal is dedicated to using a non-supported android phone and routinely downloads non-supported apps from unapproved app stores, they are very likely to accidentally install malware, handing full access over to an attacker.

That attacker may spend months monitoring the victim’s correspondence, their movements and their communication style to mimic them effectively. They can then use this knowledge and access to issue disastrous directions to employees, like ordering an employee to make a seven-figure wire transfer using the principal’s own mobile device and email account.

“Cyber threats are increasingly placing family firms’ reputations at risk in a way that many are not yet sufficiently protected against.” (Adam Wright, cybersecurity managing director, Ernst & Young LLP)

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For many family enterprises, the brand is synonymous with the family name, and that name carries tremendous social capital. When the family name is tarnished, so is the brand. For instance, one very wellknown family name was used without the family’s consent to sell dubious financial products via social media. The family had spent years carefully curating their name and their brand, ensuring that it is associated only with the products, services and causes they believe in. Now the brand is at risk through no fault of their own.

Family offices also carry data privacy risks, and when private family information and correspondence are stolen or leaked, it can create serious reputational damage and risk of litigation. With only a handful of employees, family offices have limited tools and talent to monitor and ensure the data privacy of the principals. Even when they invest in leading-class cybersecurity technology, too often they take a ‘set and forget’ approach. Further, the systems are doing what they are supposed to do, but family offices lack the in-house expertise to monitor and act on what the systems are telling them.

A family office sometimes sits within the family enterprise so it can leverage the resources of the larger organisation. However, that model puts private family information in the same systems as family enterprise business information, where it is subject to additional threats from inside and outside the family enterprise.

Cybersecurity steps for family enterprises and family offices in the short and long term The good news is that there are steps family enterprises and family offices can take to protect their firms and families in order to lower these risks.

“Those organisations that really push for that proactive involvement of cybersecurity are going to see very significant business benefits in both the near term and the long term,” says EY Americas cybersecurity leader Dave Burg. This will require both immediate steps and a long-term change of approach.

In the short term, to fend off the increase of cyberattacks due to the pandemic, family enterprises and family offices should: • Make and keep an inventory of all routers and devices, and sensitive data on them, including those used in family members’ homes • Maintain these devices with updated antivirus and firewall software, and keep all software current and assess for vulnerability at least annually • Use email encryption tools for any confidential messages and ask clients to validate any new account openings, credit requests and similar activity • Monitor (or use an external firm to monitor) all networks 24 hours a day, looking for signs of an intrusion and shut them down if there is an attack

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Helena Robertsson, EY Helena Robertsson leads EY’s global family enterprise platform, comprising a network of trusted advisers who facilitate the success and growth of family enterprises by helping them design long-term strategies and implement the right tools, skills and training to succeed. Her core specialty is tax advisory with more than 20 years’ experience helping clients in Nordic countries and internationally.

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• Store backups offsite or in a secure cloud repository • Conduct financial and criminal background checks on new staff and vendors, and annually thereafter • Create a cybersecurity policy that includes connected devices, passwords, multifactor authentication, social media and payment authorisation steps.

In the longer term, family enterprises and family offices need to: • Change the way they look at cybersecurity • Recognise that breaches and social media threats will happen • Understand that the job of the family enterprise and family office is to respond effectively and minimise the damage.

Further, family enterprises and family offices must work closely with principals, their families, and employees to: • Identify the scenarios that would impact them most, their risk tolerances and their pain points • Analyse the most likely scenarios and rate the risk level for each • Customise a robust controls framework (for example, the National Institute of Standards and Technology

(NIST) cybersecurity framework) for the organisation to measure and mitigate risk to an acceptable level • Explore, create and – most importantly – test business continuity and incident response plans regularly • Continually educate all principals, family members and their households on the importance of adhering to these controls and the risks they face if they do not.

Protecting the legacy Family firms need to protect their names, their brands and the organisations they have built over generations.

Failure to do so can be catastrophic, but the right approach, security technologies and control structures can help them protect their legacies for years to come.

Summary Cyberattacks and cyber fraud are rising rapidly during the COVID-19 pandemic. These can be devastating to a family enterprise’s reputation and legacy. Some family firms are taking steps to increase cybersecurity capabilities, but others are lagging. Family enterprises can protect their legacy if they act quickly and decisively. fs

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. What cybersecurity hurdle does the author highlight regarding the family office environment? a) Owners are reluctant to purchase leading-edge cybersecurity technology b) Family members are older and often not tech savvy c) IT personnel may have no control over the principals and their family members d) IT managers often have too much autonomy and are not held

4. C yber-risk mitigation measures for family offices include: a) Adopting a generic controls framework to expedite proceedings b) Testing incident responses on a needs-only basis c) Limiting education to key principals to avoid any leaks d) Identifying and ranking scenarios with the most impact

2. A ccording to data cited by the presenter, the greatest damage caused by cyberattacks to middle-market family enterprises revolved around: a) Finances b) Reputation

5. M ore immediate measures for family enterprises and offices to address COVID-19-induced cybersecurity concerns include: a) Keeping sensitive data away from family members’ homes b) Monitoring systems during peak times such as core business hours c) Creating an all-inclusive cybersecurity policy

c) Intellectual property

d) Storing backups securely in-house

to account

d) Successor continuity

3. T raditionally, family offices and smaller family enterprises have focused their cybersecurity efforts on: a) Finances b) The broader information footprint c) Vetting new staff d) All of the above

6. The author recommends that a family office should piggyback on the same business information system as a family enterprise. a) True b) False

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News and opinions Berkshire Global Advisors

White papers 14

BlackRock 6 Capgemini 8 CBA

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ETF Securities

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Hearts and Minds Investments HLB Mann Judd

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Taxation & Estate Planning Trusts at risk of incorrect distributions with significant tax consequences

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Family Office Management The entitlement trap

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Investment

JBWere 6

Value is a philosophy, not a factor

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KP4 Pty Ltd

The impact of COVID-19 on agriculture

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Macquarie 11 Mantis Funds NAB Private

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Philanthropy Purpose and profit

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Choosing the right social enterprise structure

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Compliance Good faith in franchising

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Technology Cybersecurity risks family enterprises and offices face during COVID-19

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Intelligent investing for your future

Note: The images of the healthcare property assets in this flyer includes assets not yet acquired by Fund. The Fund currently owns the South Bunbury asset and is in exclusive due diligence to acquire the other assets shown. Apart from the South Bunbury asset, the acquisition of these assets is subject to completion of satisfactory due diligence. Therefore, it is possible the Fund may not acquire those assets.

Healthcare

Starting distribution rate1

5.75 %

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THE L ATEST HEALTHCARE INVESTMENT OPPORTUNITY Monthly distributions2

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Quarterly withdrawals3

Why Centuria for Healthcare?

Risks

Centuria Capital Group (Centuria) is a real estate funds manager whose experience, relationships, skills and track record have created value for investors and positioned it for future growth in the healthcare sector.

Centuria has over 28 years of property fund management experience with our newest healthcare pillar specialising in healthcare since 2013. Centuria is an ASX listed company managing over 200 listed and unlisted properties with assets under management of $9.4bn4.

As the Fund invests in commercial healthcare property it carries the market and property risks associated with investing in healthcare property. As a geared investment, the Fund also carries associated financial and leverage risks. Risks can impact on distribution and capital returns over the term of the Fund. It is important that you read the Product Disclosure Statement and understand the risks of investing.

Find out more and invest today at centuria.com.au/CHPF 1.

2.

3.

4.

The advertised starting distribution rate is calculated on an application price of $1.000 per unit and is therefore subject to change. The advertised starting distribution rate is from October 2020. The advertised starting distribution rate is not a forecast, and merely represents the distribution rate the Fund intends to distribute from October 2020. It is therefore predictive in nature and is subject to assumptions (including the assumption that the pipeline assets will be acquired by the Fund), risks and circumstances (both known and unknown) outside of the control of Centuria Healthcare Pty Ltd and Centuria Property Funds No. 2 Limited. The actual returns may differ from the starting distribution rate. Centuria Healthcare Pty Ltd and Centuria Property Funds No. 2 Limited do not guarantee the performance of the Fund, the repayment of capital or any income or capital return. The actual distributions paid in cents per unit will be updated on a monthly basis and made available at centuria.com.au/CHPF. Distributions will be paid if declared by Centuria Property Funds No. 2 Limited and will be subject to the terms set out in the PDS. Withdrawals are limited to the terms detailed in the PDS and are subject to CHPF’s liquidity policy.

Centuria AUM as at 30 June 2020, Augusta AUM as at 31 March 2020. AUM is calculated assuming Centuria’s offer is successful and Centuria acquires 100% of Augusta, and completion of CIP acquisitions.

Disclaimer: Centuria Property Funds No.2 Limited (ABN 38 133 363 185, AFSL 340304) (Centuria) is the Responsible Entity for the Centuria Healthcare Property Fund (ARSN 638 821 360). This information is general information only and does not take into account the objectives, financial situation or particular needs of any person. You should consider whether this information is appropriate for you and consult your financial or other professional advisor before investing. You should obtain and read a copy of the PDS relating to the Fund before making a decision to invest. Centuria and its associates will receive fees in relation to an investment in the Fund as disclosed in the PDS. Investment in the Fund is subject to risk including possible delays in payment or loss of income and principal invested. Centuria does not guarantee the performance of the Fund. CA-CH-14/08/20-001159

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This advertisement is issued by The Trust Company (RE Services) Limited ABN 45 003 278 831 AFSL 235 150 (Perpetual) as responsible entity of the Qualitas Real Estate Income Fund ARSN 627 917 971 (Trust). This advertisement is prepared by QRI Manager Pty Ltd ACN 625 857 070 (Manager) as the investment manager of the Trust. QRI is a wholly owned member of the Qualitas Group and is an authorised representative of the Qualitas Securities Pty Ltd AFSL 342 242.

The advertisement has been prepared without taking into account your objectives, financial situation or needs, and before making an investment decision you should consider the current Product Disclosure Statement of the Trust and the Trust’s other periodic and continuous disclosure announcements lodged with the ASX which are available at www.asx.com.au.