Equities What are Equities Shares are equity securities Shareholders are part owners with ownership rights Cash flows associated with investment are uncertain Shareholders Can only withdraw from their investment by selling their shares at the market price; and Receive an income, consisting of dividends and capital gains that can vary considerably for year to year Greater volatility of return than investments in debt securities Historic Market returns 10 years to June 06 Average Annual return Australian Shares 13.2% Australian listed 13.3% property Australian bonds 7.4% Cash (money market) 5.5% Standard Deviation – measure of the market risk of an asset class 10 years to June 06 Average Annual return Australian Shares 11.5% Australian listed property 4.2% Australian bonds 4.3% Cash (money market) 0.6% Share Price Cycles Follow a different pattern to that of the business cycle The movements in the share price cycle fluctuate more often and are volatile because of a number of factors including: Influences form overseas share markets Market ‘mood’ factors – share price is often a reflection of what a group of not necessarily informed people are prepared to pay for a stock, not a reflection of its true value. Greater market risk The Australian Securities Exchange (ASX) Greatest advantage of listed equities is their liquidity- can be easily and cheaply converted to cash 30 June 2006 there were 1,764 companies listed on the ASX & total capitalisation of the market was $1,722 Billion Australian Market represents only 2% of the global market Movements in share market prices are indicated by the All Ordinaries Index (All Ords) S&P/All Ordinaries Index All Ords is now known officially as the S&P/All Ordinaries Index Movements in the All Ords are based on the movement in the prices of shares in 500 companies. These companies comprise more than 99% of the market- by- market capitalisation All Ords was established with a base rate of 500 on 1 June 1980 S& P/ASX Indices S& P/ASX 50 Traces price movement for the 50 largest listed companies S& P/ASX 100, S& P/ASX 200, S&P/ASX 300 indices perform similar functions for a larger group of companies These indices represent the market as a whole If the value of the index goes up the value of such a portfolio would have increased. If the index goes down, it would have decreased Eg, If the S& P/ASX 50 moves from 5500 to 6000 it has moved 9.1% ((6000-5500)/5500). Sector Indices Separate indices are constructed for different industries using the ‘Global Industries Classification Standard’ These indices are: GICS Consumer Discretionary; GICS Consumer Staples; GICS Energy; GICS Financials; GICS Financials excluding Property Trusts; GICS Health Care; GICS Industrials; GICS Information Technology; GICS Materials; GICS Property Trusts; GICS Telecommunication Services; and GICS Utilities These indices are useful for benchmarking the performance of portfolios that are not representative of the market as a whole Dividends & Reinvestment Shares are traditionally seen as ‘growth assets’ – potential for higher returns comes from capital growth through a rise in share price Shares provide income through the payment of dividends which rise or fall with the fortunes of a company When a company makes a profit it can: Pay a % of the profit to shareholders as a dividend payment; Buy back shares; or Reinvest the profit back into the company Reductions in dividends can have a signalling effect to the market causing a company’s share price to fall Dividend Reinvestment Plans allow the shareholder to choose to receive dividends in the form of shares in the company instead of a dividend cheque. The new shares are usually offered without brokerage costs and often at a small discount to the market Risks of Investing in Shares There are many risks that can affect a business operation and therefore the value of a company’s shares: External Market Forces – state of the economy, interest rate levels, competitive movements Internal Market Forces – wage pressures, capital expenditure, level of dividends paid, price a company receives for its products Diversification is the process of spreading your investments across different classes or assets. Diversification of investments into a larger number of companies reduces exposure to poor performance of any one investment greatly affecting their overall returns Specific Risk and Market risk Specific Risk (unsystematic risk) Caused by internal market forces relating to the company or industry rather than the share market as a whole Can be reduced by holding a diversified portfolio Market Risk (systematic risk) Caused by external market forces Cannot be reduced through diversification Can be reduced by diversifying into another market as the fixed interest market or property market Diversification benefits can also be achieved by adding international shares to a portfolio of Australian Shares Portfolio diversification A famous research study of American companies listed on the NY Stock Exchange found that specific risk is almost entirely eliminated with a portfolio size of b/w 30 & 40 shares Most funds with equities tend to hold at least 30 shares, so if a fund is well diversified across different industry sectors specific risk is not an important consideration Could be argued 30 shares should be considered the ideal portfolio on the ground. Beyond that point the admin costs involved with a larger portfolio outweigh the risk reduction benefits of further diversification International Equities Market Investing in international equities can provide: a hedge against downturns in the Australian economy; and Take advantage of economic growth in other countries In 2005 The US S & P 500 was not the place to invest as it returned -3% while the ASX 200 provided a healthy 17.6% return outperforming the US by 20.6% The Japan NIKKEI grew by 43.5% outperforming the ASX by 25.9% Dubai grew by 131.23% and Egypt 146.13% Benefits of Diversifying Internationally International managed funds make it easier for individual investors to gain exposure to offshore companies Managed funds and superannuation funds that invest in overseas shares present the investor with the following benefits: Greater diversification by spreading share investment not only across many industries but also different share price cycles Access to market dominant players gives investors access to some of the world’s best known companies eg Nokia, Microsoft and Samsung Access to developing economies which present higher growth potential than most developed countries eg China & India Access to industries not available in Australia eg rubies mining &mobile phones Investors may benefit from Foreign Tax Credits in countries where tax treaties have been negotiated with Aust Australian Companies with International Exposure Company Sales from overseas NAB 35% About 30 to 40% of the revenue of Australia’s BHP Billton 90% largest companies comes from overseas Amcor 75% QBE 75% An example of a company that specialises in Rinker 80% international share broking is Fortrend Securities CSL 90% (www.fortrend.com.au) Billabong 75% International share funds Computershare 85% include: Barclays international Australia's largest 30%-40% share fund listed companies CreditSuisses (S&P/ASX200) International Fund MLC Platinum Global Fund Risks of Diversifying Internationally Regulatory risk Governments are known to change rules once a large multinational corporation has built state-of-the-art facilities in that particular country Political Risk Some emerging market countries have unstable governments that can create a high degree of uncertainty in relation to business operations Currency risk Changes in exchange rate may affect an investor’s return Investments made overseas must be paid in that overseas country’s currency therefore if the $AUS appreciates relative to that currency, the value of the overseas investment will decline when converted back to $AUD Managed funds may protect themselves against adverse movements in the exchange rate by hedging Hedging is a form on insurance which involves the use of forward exchange, or futures contracts that effectively ‘lock in’ an exchange rate until a particular time in the future Dividend Imputation Resident shareholders receive a credit against their tax equal to the amount of tax already paid by a company on its profits Formula to calculate Imputation credit = Dividend received* (tax rate/(1- company tax rate)) Therefore if the fully franked dividend received was $500 Then the IC =500*30/70=$214 Shares Vs term Deposit Investments both with 5% net return Shares Term Deposits Initial Investment $10,000 $10,000 Dividend income $500 Interest return $500 Plus IC $214 Taxable Income $714 $500 Tax at 46.5% $332 $233 Less IC $214 - Tax Payable $118 $233 After tax (dividend $382 $267 return-tax payable) Potential for Yes No Bull Vs Bear Markets The use of "bull" and "bear" to describe markets comes from the way the animals attack their opponents. A bull thrusts its horns up into the air. A bear swipes its paws down. If the trend is up, it's a bull market. If the trend is down, it's a bear market. Bear Market A market condition in which the prices of securities are falling or are expected to fall. Although figures can vary, a downturn of 15-20% or more in multiple indexes (Dow or S&P 500) is considered an entry into a bear market. When you see a bear what do you do? Tuck in your arms and play dead! Fighting back can be extremely dangerous because it is quite difficult for an investor to make stellar gains during a bear market unless he or she is a short seller. Short sellers make money if the stock goes down in price. This is an advanced trading strategy with many unique risks and pitfalls. Novice investors are advised to avoid short sales. Short selling Short sellers make money if the stock goes down in price. This is an advanced trading strategy with many unique risks and pitfalls. Novice investors are advised to avoid short sales. For example, an investor who borrows shares of stock from a broker and sells them on the open market is said to have a short position in the stock. The investor must eventually return the borrowed stock by buying it back from the open market. If the stock falls in price, the investor buys it for less than he or she sold it, thus making a profit. Bull Market A financial market of a group of securities in which prices are rising or are expected to rise. The term "bull market" is most often used to refer to the stock market, but can be applied to anything that is traded, such as bonds, currencies and commodities. Bull markets are characterized by optimism, investor confidence and expectations that strong results will continue. It's difficult to predict consistently when the trends in the market will change Margin Lending Margin lending is atype of borrowing to buy shares which requires you to maintain the lender’s proportion of your portfolio value above an agreed level. If the portfolio value falls, the lender will issue you with a margin call, which requires you to provide securities or cash to maintain the lender’s proportion. Margin Lending Example Jean buys a share in Universal Widgets SA for $100, using $20 of his own money, and $80 borrowed from his broker. The net value (share - loan) is $20. The broker wants a minimum margin requirement of $10.Suppose the share goes down to $85. The net value is now only $5 ($85-$80), and Jean will either have to sell the share or repay part of the loan (so that the net value of his position is again above $10 When the stock markets recently plummeted, the net value of the positions rapidly fell below the minimum margin requirements, forcing investors to sell their positions Protected Equity Loan Interest only loan used to buy a limited range of shares with a capital guarantee Made possible by embedding a put option that acts as a hedge (or insurance) against a fall in the share’s price Interest rates are 1-2 % above margin loan rates and up to 85% of the interest costs are tax deductible Managing the risk of a margin loan As a financial adviser you need to ensure your client: Is aware of the risks associated with a margin call; Has sufficient reserves available to pay a margin call; and Takes a prudent lending ratio (say 50:50) to provide a buffer in the event of falling share market ABC Learning Centres & Margin Loans Problems at ABC – A negative profit surprise; – A lot of debt; – A poor return on equity; – A major shareholder with a big margin loan (himself). The company Groves started in 1998, floated in 2001 and built into a $3.5 billion international childcare leader is a shell of its former self. Yesterday, the stake owned by Eddy Groves and his wife Le Neve was worth $140.6 million. Now their shares are worth a bit more than $79.6 million. ABC & Margin Loans ABC & Margin Loans ABC Learning has confirmed that its founders and senior executives, the husband and wife team of Eddie and Le Neve Groves, were forced to sell more than half their holding on Tuesday because of margin calls on their stock loans, and may have to sell the rest. Le Neve Groves sold 11 million shares at a price of $1.83 each, while Eddy Groves sold 8.03 million shares at an average price of $1.85. ABC & Margin Loans The forced sales came after both directors bought heavily last year. Eddy Groves made two separate purchases of one million shares in May, with one stake going through at an average price of $7.25 and the other at $7.17. He bought a further 1.2 million shares in June and July in six separate transactions ranging from $6.70 to $7.02, and a further 200,000 shares in November at an average price of $5.28. After Tuesday’s forced sales, he is left with 12.17 million shares and 308,880 options. ABC & Margin Loans Director, David Ryan, had been forced to sell his entire stake of 249,000 shares and . Director Martin Kemp, another heavy buyer last year, had been forced to sell 7.6 million shares, leaving him with 2.76 million shares. A further 21.7 million shares, including the Groves' and Kemp's interest, are also subject to margin calls. The stock last traded at $2.14.