20180207 - ASX300 size

This piece is inspired by a post on the CWS blog looking at the distribution of companies making up the S&P500 by market capitalisation. You can find it here.

In Australia, we are even more skewed than in size than our US counterparts with the top 20 stocks accounting for 50% of the total market value as of today. Outside the top 50, the remaining 250 stocks account for only 27% of the ASX300. We are very much a country of the big end of town. It also puts into context just how tiny most of the companies listed on the ASX really are when you pause for a moment and realise that there are over 2,000 listed.

The top 20 is dominated by financial and natural resource stocks, a reflection of our consolidation as a country in the former and our intrinsic plenty of the latter, whether in metals, oil or more.

Rank Company Market capitalisation
1 Commonwealth Bank 135bn
2 Westpac Banking Corp 103bn
3 BHP Billiton Ltd 96bn
4 ANZ Banking Group Ltd 81bn
5 National Aust. Bank 77bn
6 CSL Ltd 64bn
7 Wesfarmers Ltd 47bn
8 Telstra Corporation 42bn
9 Woolworths Group Ltd 35bn
10 Macquarie Group Ltd 35bn
11 RIO Tinto Ltd 32bn
12 Woodside Petroleum 27bn
13 Transurban Group 26bn
14 Scentre Group 21bn
15 SOUTH32 Ltd 19bn
16 Westfield Corp 18bn
17 Suncorp Group Ltd 17bn
18 Amcor Ltd 17bn
19 Insurance Australia Group 17bn
20 Resmed 17bn

To echo some of Eddy’s comments it’s easy to get a portfolio of shares that follows the ASX300 closely. To build something vastly different, though, is even easier. So, if you’re an individual stock picker you might consider the below chart and reflect upon just how different your bets are to “the market”

20180207 - ASX300 sectors

This is taken from S&P’s free index factsheet here and neatly summarises the industry concentration we see in Australia.

Speaking for myself, I am making a substantive bet on industrial and IT stocks which puts me vastly at odds with the overall market position. I have to be comfortable with that and knowing that it will probably see me experience vastly different performance to the ASX over time. Just something for you to reflect upon in considering your own market exposure and investment philosophies as this is the sandbox we all play in.

 

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Innovation in banking

This post will take a bit of a different tack and it’s inspired by two things really, one, a talk by one of Society One’s cofounders Jason Yetton and the other this delightful little question from a friend:

If you were given an unlimited budget to innovate in Banking, what would you do?

It’s useful to start with some takeaways from that presentation. The vision Jason presented of the digital economy and banking in that future is where

  • Trust is front and centre. It’s a fickle currency hard to regain once lost but it is everything in a digital economy.
  • Global actors will be a force that the industry will have to confront (think Alipay or even the success ING Direct has enjoyed here) and
  • New government reforms to free up data and empower customers announced by the Treasurer offer far more scope to empower customers in their financial lives. Think back if you would to the days where you could not transfer your phone number when you were changing your carrier and just how brutally effective that lock-in was for your average telecom company.

That being said when I put the question to him as to what incumbents would do if faced with a fintech threat I was reassured the going strategy is “buy it or kill it” and we can probably expect to see this play out in Australia and elsewhere (you could say Westpac’s acquisition of Society One is a case in point).

The problem we want to solve?

So, on this question of innovation I might start with the following:

What problem(s) do you wish to solve?

By this I mean we’re all bright, brilliant and capable of coming up with ideas on the fly but really what is the end issue we’re resolving for customers?

So many successful businesses are born with this at front and centre where they exist to minimise some kind of friction in customers’ everyday lives. Think of what Google does for you, almost the entire font of human knowledge is some text and a mouse click away as opposed to the alternative that many of us grew up with pre-Internet. Not just Google though, just take a moment to lie back and think how much of what we interact with was even a thing five years ago?

But to take a financial example, in the case of life insurance for many decades it existed as one of the few savings vehicles you could access outside of cash and property. You would pay a princely sum for it (more expensive trading costs, paper-based etc) but at the same time it filled a need for consumers at the time to provide for their families in a moment of need.

I think in the case of banking a good starting point would be to look at where these frictions continue to exist and ask whether we wish to solve them. Some areas might include

  • Delays in moving money from one bank to another
  • A lack of transparency in loan rates (aggregators are helping with this)
  • Genuine, honest advice on our finances (rather than starting from us looking like a $$$ pile).

We can now consider the business you wrap around this core purpose. It might sound corny to say “Our job is to make customer lives easier at dealing with X” but that should be what defines you and your actions going forward. If it’s only a sideline to the broader goal of making money, you can still succeed but eventually the skewed priorities will bite you, and bite hard. If you don’t give a damn about clients why ought you expect any better treatment from them?

What path do we want to take?

Some available paths could be:

  • “We’re going to be the lowest cost option”,
  • “We’re going to differentiate our product and our services from everyone else”, or
  • “We’re going to be a platform pairing suppliers and customers in a genuine marketplace for financial products and services”

Each of these items comes with its own pitfalls and benefits

The low cost play

  • This effort is marked by a sacrifice of profits that you make up for with high volumes. You need a lot of sales essentially to shift the bottom line as a business.
  • Low cost can be a virtue of sorts if you look at US asset manager Vanguard which prides itself for passing on savings to its clients and is the second-largest asset manager in the world, amassing trillions in part due to this ethos.
  • Let’s use a toothpaste example – you probably buy the same brand every few weeks, right? Have you ever stopped to think what you’d look like in terms of dollars and cents? You, me, we are all effectively an annuity pumping out more and more cash over time with our regular purchases. The small amounts add up massively over time. As we can see in the success of a company like Unilever or Proctor & Gamble.
  • Low cost doesn’t nor should it mean worthless, it fills a core need of customers but lacks certain features other providers try to differentiate themselves by.

Product differentiation

  • The flip side of a low-cost approach, you offer the brand, the premium features and more necessary to have customers pay more to you on average.
  • Each new customer is especially precious in this dynamic because of the high margins you get to earn over their lifetime.
  • Your luxury good brands, think Gucci or Prada, are cases in point. Brands have real power with some people going so far as to define themselves by their … well love for certain goods. Think about the fervour of Apple fans or to use a different example Jack Daniels tattoos.

Platform/marketplace

  • Get out of the product creation game entirely, open up your
  • That pairing of buyers and sellers requires a real shift in mindset too. You don’t necessarily care about pushing your own products to customers but rather getting everyone’s products to them as you get to collect your commission as a market maker regardless.

Banking examples

  • Low cost play
    • Go all digital, minimise labour costs as much as possible with chatbots, AI etc. If you can you almost want to be at the point where like tech companies you almost have a zero-marginal cost, the additional impost for Facebook to service another advertiser for example is so tiny compared with traditional advertising that it might as well be 0.
    • Pay to be the default provider in different ecosystems i.e. think how valuable it would be to the bank behind WhatsApp if Facebook let you use buy/sell through it? Remember you have minimal costs so volume, volume, volume is the name of the game.
  • Product differentiation
    • Go niche and go hard. What suits the mass market mightn’t work for particular customer segments e.g. High Net Wealth.
    • Present yourself as the alternative able to fulfil every additional financial need or want that they might have.
    • You see this already with the positioning of UBS to really corner this part of the market globally with other rival banks looking to grow in this space as well.
    • On the funds management side as an example you see people espousing the values of active over passive in illiquid assets such as private equity which need more refined expertise → more fees charged.
  • Platform
    • Harder to achieve but examples might include WeChat where banking is but one branch amongst many financial products and other being offered to customers. You can do almost anything for your life through the app essentially.
    • Offer clean interfaces and friendly APIs to encourage developers to build new services/apps with your bank as a centrepiece. McKinsey has a great piece on this.
    • Let your financial advisers offer anything and everything with the main goal to better their clients’ lot.
    • That different mindset I mentioned above tempts me to say that most financial companies that attempt this will fail it because of the conflicting incentives between different branches of the business and the internal divisions that need to be overcome in any organisation to be willing to change (and cannibalise yourself in the bargain).

 

Lastly for this one let’s turn to some other notions that have been considered and employed.

Some of the available strategies

  • “Gamify” the process – who says banking has to be boring? You’re playing a vital role in helping people save and invest, why can’t they have some fun with it as well?
    • Some examples include Acorns, an app that “rounds up” your credit card purchases and invests this loose change in low-cost ETFs. Another might be Stash which simplifies the process and offers you the chance to invest in causes or managers you believe such as renewable energy.
  • Simplify financial products and educate your customers
    • A point of differentiation could be to have truly independent advisers by not creating financial products yourself. This enables the construction of financial relationships without conflict that deepen ties to the company while also helping clients with independent, sound advice.
  • Find and kill causes of financial discomfort/friction as a point of differentiation and bettering customers’ lives

Finally, I’ll end where we began, this idea of trust and how you construct it. The internet frees up so much more information now but at the same time uncovers any misdeeds on the part of your company.

You can build trust though over time by being proactive and engaging. Many companies have started to do this with social media and the like but not enough have explored the opportunity. Blogs are another example where in an interesting way you create your own risk selection by building an audience of like-minded individuals as this blogger did with many of his firm’s leads sourced from the writings of himself and his colleagues and the inspiration they give to their clients.

There was a neat piece on Slate discussing the success of Apple’s Genius Bar with staff there motivated not by sales targets unlike other retailers but rather addressing customer needs first and foremost. That mindset is not an easy one to instil but the appreciation and loyalty it creates can prove invaluable not just as a way of “locking-in” a particular customer but also to help your people feel better. Helping people is a far more enjoyable and constructive cause than finding a new angle to screw them over with.

So to wrap up, we might visualise the approach I’ve discussed in the following way.

20171102 - Banks and innovation flowchart

Note that I’ve cheated a bit in not giving a straight answer but I think there is no need to be prescriptive here. There will be more than one way to succeed and innovate in the future and what I hope I’ve articulated are some of the paths available to reach that state.

Any thoughts/sentiments are most welcome!

RFI Group – Breakfast with the Economists Series 2017 – Sydney

On Tuesday morning I attended this Breakfast event at the Sofitel Hotel in Sydney that showcased the perspectives of leading Australian and international economists. It was quite popular with an audience in the hundreds and a neat Q&A format via website PigeonHole (https://pigeonhole.at/BWTES) that allowed you to post questions and allow other audience members to upvote them (seeing the interest in a cryptocurrency question surge live on screen was rather cool).

I came across the event thanks to a friend’s tip-off on the website https://www.eventbrite.com.au/ which offers a whole range of events (both free and paid) with some very interesting content.

Now here’s just a brief summary of the key highlights.

Paul Sheard, S&P Chief Economist

Raised the prospect of global economic growth across the board for the first time in a number of years and called out the top 5 items to watch out for:

  • Trump administration and signs if any of it finding its feet e.g. new chief of staff was formerly an Army General. Generally, administrations take time to find their feet and if/when they do expect to see some action from the US.
  • Federal Reserve leadership changes – the course of this institution could change radically over the next year with both Chair Yellen and Deputy Fisher seeing their terms end.
  • Brexit – UK through initial shock but more to come from the negotiation process so expect lower economic growth through this adjustment period.
  • China – debt levels within the economy and potential for poorer and poorer capital allocation if it continues on the debt-fuelled investment-driven economic growth path.
  • Japan
    • Bank of Japan has shown a willingness to go to any lengths to pursue its inflation target both in quantitative easing and other means.
    • Some signs of possible wage inflation with the ratio of job offers to job applicants at its tightest since the 1970s.

Bill Evans, Westpac Chief Economist

  • Offered a dim view on immediate Australian economic outlook with the prospect of slower GDP growth, higher unemployment, and either interest rate cuts or no change in RBA policy settings.
  • Noted that the market is not pricing these concerns in with the current positioning implying interest rate increases are more likely. Note that these sentiments reflect the panel more generally with concerns especially on the wage front and the poor levels of consumer confidence.

Panel Q&A

  • Automation as one driver of poor wage growth
    • Anecdote – now we have firms whose mission in life is to put every high-paid person using spreadsheets on Wall St out of business”
  • Cryptocurrency – splitting the “hype” over Bitcoin into its two facets, that of the blockchain and as a currency.
    • Paul was bullish on the former but bearish on the latter as it didn’t in his view function well as a currency (sucked as a store of value e.g. 90% drawdowns in its history as well as a means of exchange though this is changing).
  • Australian house prices – General belief in weaker inflation but low chance of crash due to still robust demand particularly in the Sydney/Melbourne space while Melbourne apartments
  • A new world calls for new responses – discussing the need to adjust to changes across the world in technology and society, the need for new social contracts and new institutions to navigate the future with a general consensus also on the value of investing in education.

My notes are attached.

20170829 – RFi Group – Breakfast with Economists

Personal finance intro

I’m writing this as a starting point for friends, family and whoever might be interested in the choices open to them to deploy their finances and, ideally, grow their wealth.

Basics

Let’s say you earn money whether as a gift, a salary or some kind of bonus from the heavens, what can you do with it? Essentially, you’ve got two choices you can either “consume” it by spending on yourself or others or, you can choose to “save” it as either cash, property, gold or more.

I put “save” in quotation marks here because people introduce some distinctions on savings as opposed to investments (filled with moral overtones where investments = speculation). Best to think of this decision as avoiding consumption of the money in the here and now.

Asset classes a.k.a. stores of wealth

Cash

  • Put simply this is your typical transaction and savings account with the bank of your choice (there are other options but let’s leave those by the wayside for the moment).
  • In Australia, we’ve got pretty poor options (better than Europe, US or Japan not that that’s saying much) for getting a good return on cash.
  • That said there are some interesting options available. Westpac, ANZ, NAB and CBA (the Big 4) offer lower rates (<2% on average) than other institutions with Ubank (a NAB subsidiary) and ING both offering savings rates >2.8% for example. See more examples here.
  • Worth doing your research here as you could be leaving money on the table by sticking with your current bank.

Bonds

  • Bonds are the next level up. Essentially you pay for the bond and in exchange you receive interest payments and the eventual return of your cash when the bond contract ends a.k.a. the bond matures.
  • To take the below example we paid $1000 for a bond (a negative to reflect the outflow of cash) and each year we receive $50 (a 5% annual return) with the return of our initial $1000 plus the last interest payment of $50 at the end of year 5.

20170707 - Bond example

Property

  • You buy a house/apartment either directly or more typically by borrowing from the bank.
  • This could be your place of living or one you take on for investment purposes to earn a return by renting it out and perhaps selling it for a capital gain.
  • Another option might be a share in a fund that will invest in property such as hotels, pubs or industrial estates and pass on the rental income it earns from these tenants net of the costs for running the fund.

Shares a.k.a. equities

  • You buy a share in the ownership of a listed (or unlisted) company that gives you a say in how it acts (1 share = 1 vote),
  • residual entitlement to ownership (i.e. if the company goes belly-up you get a slice of what’s left after all of its debts have been paid out of existing assets), and
  • If the company is profitable you may also receive dividends but note that unlike bonds these are not guaranteed.
    • In Australia, we can get franking credits attached to dividend payments with attractive tax consequences (more on that later)

Alternatives

  • This is a bit of a “catch-all” bucket to describe other investment options that don’t neatly fit into any of the other classes described above. Examples include hedge funds or venture capital (firms that provide funding to help start-ups grow and ultimately succeed. They do so in exchange for a share in ownership to exit these businesses at a healthy return on their initial funds).

Example

  • Lastly, let’s look at an illustration using the example of Legal Super’s Balanced investment option. All of you reading this piece, assuming you are Australian citizens, will have super balances invested in a mix of the above assets.
  • Typically, the default most super fund members find themselves in is a balanced option holding a mix of growth (equities and property/alternatives) and defensive (cash and bonds/alternatives) assets.

20170707 - Super example

  • As we can see this option has a 27% share dedicated to Australian and Overseas shares (i.e. 54% to shares in total), 12% to property and 9% to alternatives – growth.
  • The remainder is allocated between cash, bonds (a.k.a. fixed interest) and alternatives – income. You will find some variation of this weighting with your own super.

Taxes

Let’s take a look at the implications of franking credits you can earn from dividends of Australian companies compared with interest on a savings account.

20170707 - Tax example

You earn $90,000 p.a. so your marginal tax rate for every additional $1 you earn is 37% i.e. for each $1 above $87,000 you must pay 37c as tax.

  • You receive a $500 dividend fully-franked on $10,000 worth of shares (i.e. a 5% yield)
  • You pay 500*(37%-30%) = 500*(7%) = $35 in tax,

OR

  • You receive a $500 in interest income on $10,000 (i.e. a savings rate of 5%)
  • You pay 500*(37%) = $185 in tax.

The difference in income is the amount of the franking credit 30% * $500 = $150

Dividend after-tax return = (500-35)/500 * 5% = 4.65%

Interest after-tax return = (500-185)/500 * 5% = 3.15%

So, your after-tax return is 1.5% lower for the interest income.

This MUST, however, be weighed against the risk you’re taking with the shares as is discussed below. Shares can and will at times incur a capital loss (and may even go to 0 if the business fails). Cash will not (unless the country that issues the currency collapses).

Recap

  • There are a variety of items you can use your money for whether to consume it or not.
  • Focusing on the latter case, a range of assets are on offer each with its own risks, rewards and tax consequences.
  • Lastly, you’ll hopefully have a better idea on how your super gets invested and the unique benefits introduced by franking credits in Australia.

Next up

  • I’ll take a closer look at the risks and the returns on offer from different assets as well as the options you have for investing in them.

 

Note: This piece is intended to be general information only and does not constitute financial advice for you to rely on. Your finances will often be one of the harder aspects of your life to organise and should not be taken lightly. Hopefully, this and other pieces like it can help you start your own journey.