Gareth Morgan slates Colville Equities

[biker]

The following was posted under the topic 'Moral hazard and the IPO' and I missed it. Here it is again for those who did also. Apologies to those who didn't. I have no axe to grind on this but I found it an interesting point of view when considering a possible investment.Would it be an understatement to say that Morgan and Gaynor don't see eye to eye?:)The gloves are off in the fight for the investment dollar!

This from Gareth Morgans recent column in some of the Southern papers.

Gaynor Beguiles the Gullible
investment - 14 May 2004 - 1048 views
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Near the end of a bull market in shares you always see a plethora of floats come to the market with the quality of those offerings plummeting. The reason is that most investors invest on the basis of hindsight and with good results under its belt for a couple of years now, the New Zealand sharemarket is being swamped with new offerings – more than we’ve seen since just before the 1987 crash. The promoters are competing to hoover up the bellhop’s money.
Let’s just look at one of these offerings on the block at the moment – it has an additional level of interest because it involves Brian Gaynor, a competent analyst and a champion of the rights of mum and dad shareholders.

Would you fall over yourself to invest in something where you gave 14% of all you make to a middleman and then 33% of what’s left after that to the taxman – leaving just 58% of the return for yourself? On the face of it this seems a bum deal, on a detailed look it could be far worse. The public may be stupid at times but the offering from Mr Gaynor’s Colville Equities seems a particularly easy way for naïve investors to end up with meagre returns, yet again.

Companies normally come to the market because their business makes a profit, has wonderful prospects for growth espoused for all to hear by the promoters, the public can identify with what they do, and the promoter wants to either exit for a profit or use the money for expansion. An IPO is often called the capital-raising of last resort. In the case of an investment trust like Colville the business case is that these guys are better investors than the market generally. Such a promise is really hard to consistently deliver on and that’s why 70% of professional fund managers return less-than-market-average returns over time. So the promise to the bellhop from Mr G is ambitious – and high risk.

The public is being told that if it gives Colville $75m of its funds now Mr Gaynor’s company company will pocket $2.2m of it no matter how he performs. The promise to the mum and dad investors is that, despite the fact they will get only get 58% of returns made, they will still beat the market average. It wouldn’t be rational to promise less-than-average returns! No manager ever has delivered for very long after such a drain, but we are told in the ads that, “you take note of his opinions, now trust his judgement”.

The core problem with Colville is that it is singularly unattractive to investors from a taxation perspective. Mr Gaynor has not done his homework and provided a structure where the investing public do not have to pay tax on all gains. This, combined with management fees set at around 14% of market average returns, produces the 42% leakage investors face.

The only similar fund that has been in the market for many years, is the New Zealand Investment Trust, which as it happens Mr Gaynor is a director of. As the graph shows, its track record is not inspiring!



Now Colville isn’t alone being a bad quality offering. There are a number including Aquiline that has been absolutely taken to task by analysts for the poor value it offers the investing public. Mr G just two weeks ago was particularly savage in his criticism. It light of the poor deal Colville represents for retail investors, it is curious that the pot should be calling the kettle black in this way. Obviously the offerings market is very crowded right now and of course it’s not surprising to see competitors bad-mouthing each other

[Lawso]

Thanks for posting this, biker.

I don't carry a brief for BG and am not planning to invest in Colville, but I respect Gaynor as a person and as a commentator.

Morgan's highly personal attack on him is just about the most petty and mean-minded thing I've read for a long time. It borders on the irrational. What's his agenda?

I couldn't be bothered getting into a point-by-point rebuttal. Remember Morgan is the economics guru (??) who, for at least the last three years of negative global and positive NZ market performance, has been advising his unfortunate clients to get out and stay out of NZ stocks and to invest in Wall St. etc. This while he has been happy to pocket the fees for sitting on the board of a listed NZ company (PFI).

To repeat, what's his agenda?

[CAM]

Maybe Morgan is just p*ssed that Gaynor got in first and he didn't think of it.

[rawdata]

Gareth Morgan as in ' Be Patriotic and Invest Overseas' in Nov 1999 - 4 months before the offshore markets peaked and collapsed.

Gareth and Brian Gaynor are as bad as one another - birds of a feather flock together.

[willy_wonker]

Giving your money to any fund manager is like asking my kids to throw a dart at the NZSE board on investment decisions.

[Halebop]

The article is definately harsh but it's hard to discount what Mr Morgan actually says. As an "Active Investor" Colville does need to outperform market averages by the tax rate plus management fees. At least with a passive index you know you will underperform but only need to worry about fees, which would normally be lower to boot. On the balance of probability the Beta is more likely to be consistently lower with an wide index style fund as well.

Lawso - For me your comments about respecting Gaynor's opinions are at the heart of GMs article. If Colville performs poorly (And GM is correct in pointing out this is a statistical likelihood regardless if it happens or not) will Gaynor be bagging his own management? To me this is the only new "moral" risk as other forms of conflict already exist given Mr Gaynor is already an investor in his own right.

However, talking something up in the media and profiting because you have already bought is one thing. Good luck to you if people are that stupid. The conflict between being a manager of your or my money and a commentator brings into sharp focus issues surrounding jurisprudence and ethics. And here there is only one possible outcome. Mr Gaynor would have to perform one roll but not the other. Irrespective of legal requirements smart money will always temper Gaynor's opinions with knowledge of his potential conflict.

But then, this isn't about smart money is it? Little wonder people keep buying houses.

[Gryffyn]

More press opinion...

Jenny Ruth: Three ways of showing investment trust

21.05.2004
COMMENT At the heart of the three investment funds which have raised or are aiming to raise money from the public and list on the stock exchange is a deceptively simple proposition.
All are saying: "Trust us with your money."

Of the three, Carmel Fisher, who floated Kingfish in March, is the only one with a track record in funds management in New Zealand.

Kingfish sought up to $75 million and raised $58.5 million.

Trading of Fisher's fund so far is one positive sign - the shares were trading at 91c and the warrants at 15.1c, a total of $1.061 compared with the $1 investors paid.

In recent years, the few listed investment companies on the NZ exchange have tended to trade at a discount to net asset backing.

Brian Gaynor's Colville hasn't got a track record and neither does its management company, Milford, which was founded only last December.

It did have $61 million under management at May 1 and a further $46 million committed. Colville aims to raise up to $75 million.

Gaynor has a high profile as a Herald columnist, shareholder advocate and investment analyst and is also on the board of the UK-based New Zealand Investment Trust.

All this is related, but it isn't funds management.

The other two members of Colville's investment team are Alan More, who has been in funds management 35 years, including with Guardian Trust, ACC and Westpac, and Graeme Thomas with 23 years' experience, including at National Bank and Mercers.

But it is Gaynor's face in the advertisements.

In some ways, Gaynor's high profile is a double-edged sword. He admits he's had little support from stockbrokers - he is mainly promoting Colville through investment advisers.

Partly, that's because stockbrokers have similar competing unlisted products, but they also complain about Gaynor's negative attitude in his columns.

"Maybe in every fourth column I'm negative, or maybe one in every three, but they're the ones that get remembered," he says.

The third company, Salvus, which is seeking to raise up to $50 million, has two experienced fund managers, Andrew Couch and Simon Wilson - although their experience is not in the New Zealand market.

Couch has had 12 years at British institutions, most recently managing pension funds totalling US$2 billion.

Wilson, a New Zealander, spent four years with Edinburgh Fund Managers in Britain.

Couch points out that both he and Wilson have been in New Zealand since 2002 and have been researching the market since then.

But Salvus does have another analyst and newspaper columnist, Roger Armstrong, on its board.

Armstrong has recently been appointed to the New Zealand Exchange's disciplinary panel.

Armstrong is quick to point out he will be only a director, not a manager of the fund, and bristles at suggestions that he is on the board because of his high profile.

"I'm on there because I think I've got a lot of expertise," he says.

I would be the last to deny he has a strong reputation as an analyst, most recently at Deutsche Bank before he went independent.

But it is disingenuous to say his high profile has nothing to do with his presence on Salvus board.

Armstrong says he accepted the position because he was impressed with Couch and by his CV - he hadn't known Couch until he was approached before Christmas.

It seems Salvus will definitely be listing.

Four British and two domestic institutions - all unnamed- have committed funds to it, and with the support of broking firms Forsyth Barr and Direct Broking, the fund has almost raised its minimum $25 million, Armstrong says.

Listing such funds has a major advantage over the many unlisted equity funds already in existence (totalling more than $800 million in New Zealand) in that the managers don't have to keep hefty floats of cash to satisfy investors who want to cash in. The listing means managers can use all the money for the fund's fundamental purpose: investing in equities.

Gay

[Nimble]

"Would you fall over yourself to invest in something where you gave 14% of all you make to a middleman and then 33% of what’s left after that to the taxman – leaving just 58% of the return for yourself."

I must be lacking a little on the maths department but how does Gareth Morgan calculate his 14% to the middleman? Colville's portfolio manager, Milford Asset Management, is claiming only a 1 percent annual fee. There would of course be one off set up fees (Salvus' set-up costs amount to 2.3%). Or is he alluding to the 15% discount that investment trusts generally trade at to the market. But the issue of options with the shares are designed to compensate for this or have done so in Kingfishers case. Although Colville are only issuing 1 option for every 2 shares.

[Wiremu]

Nimble,

If I see it correctly the manager takes their fee, but Colville also has all of the expenses and costs of operating the company.

Gareth can be deliberately controversial, but most often he has an annoying habit of being correct.

[Halebop]

quote:Originally posted by Nimble

...But the issue of options with the shares are designed to compensate for this or have done so in Kingfishers case. Although Colville are only issuing 1 option for every 2 shares.


Short term trading opportunities aside, options at best represent an expense to shareholders of the issuing company and at worst a demand for more capital to avoid dilution.

[maxine]

Nimble, I had the same question re how GM gets to 14%. I think the answer is either by accounting for the upfront issue costs (which I think were $2.2 million), or, as you say, the likely discount. If it is the later (and one might argue they are related anyway, I don't see how he can be so precise).

In either case, GM is slightly naughty, because these are one off costs, not annualised ones, so it only looks that bad in year one.

Now I have been drawn into posting on this topic, my tuppence on the GM comments are that I loved it. I think it is great to see a bit of quantitive, gloves off sceptical commentary. Gaynor gets to dish out ill informed prejudices all the time and is inapprorpriately revered by many, so it is great to have GM raise the arguements he does. He is not making an ad homenum attack - it just looks that way because Gaynor has set himself up for it by positioning himself as the reason to invest in COL....therefore if GM shows the numbers, track record, and philosophy of COL/ Milford don't stack it comes across as an attack of Gaynor.

Ultimately you can't fault GM's closing comment to the effect that if you must invest in this sort of thing buy in at a discount in a year or so.

:-) Maxine

[Halebop]

14% might not actually be far off. It depends on performance:

Invest $1000
"Earn" $130 (13% pre tax)
Pay 1% Management (1% of 1,130) -$11.30
Pay 33% Tax (33% of 118.70) -$39.17
Net Gain $79.53
Management as a % of Gain ($11.30/$79.53x100) 14.21%

Using whole pre tax, pre fee percentage gains from 10% to 20% per annum, the management fee as a proportion of returns is as follows:
Gross = Fee
10% = 18.45%
11% = 16.75%
12% = 15.36%
13% = 14.21%
14% = 13.23%
15% = 12.39%
16% = 11.67%
17% = 11.03%
18% = 10.47%
19% = 9.97%
20% = 9.53%

Of course, if they earn 168% per annum then they are well worth the money! [:o)] Better hope they are high up in the top quartile to make it worth while though. That tax bill alone requires a +50% out performance.

[maxine]

Halebop, thanks for that - that makes sense. Alarming really, cos it means that if 14% looks grim, you have to also account for the upfront costs and/or discount!

[biker]

At last,and thats the sort of information the "heartland investor" needs before making an investment decision and they are certainly not getting it from brokers or financial 'advisors'.

[Gryffyn]

Guess this is why the likes of Mary Holm and many others espouse index trackers. Usually no cap gains tax and very low (<1%) fee. I find them useful for o'seas markets where I can't keep up with the info to manage shares as I can in NZ.

[Halebop]

Thanks Maxine & Biker

Keep in mind though that I wasn't taking into account franked dividends or any capital gains that for some reason might not attract tax. With the numbers of permutations it is not possible to actually forecast what the numbers might be (not even Mr Gaynor will know until after it happens).

Bottom line though: Management fees will take a high proportion of gains. Probably not something Mr Gaynor will mention in his column.

In the specific "historical" (Cringe) example of the NZ market returning 13.1 per annum including 7.1 dividend and 6% gain it would work something like:

Invest $1,000
Capital Gain $60
Dividend $71 (Assume all dividends are Fully Franked)
Management -11.31
Tax -19.80
Net Gain $99.89 (or 10%, not bad)
Management as % of Gain: 11.32%

A 10% gain isn't too bad but how come the article offered the example of 11.1%? Are they forgetting the management fee already? I'd be interested to see their methodology.

Also, if the average NZ gross return is 13.1%, why not just invest in an index fund and pay 1% and no tax instead. 12.1% is better than 11.1%. You'd be almost 10% better off after 10 years and 20% after 20 years! On $1,000 the difference is $269 after 10 years and $1,611 after 20 years.

I'll stick to doing it myself. I only hope those who don't want to DIY question what they are gaining for the management "expertise"?

Disclosure: OK I'll be suitably humble if Milford and others do substantially outperform the markets. I'm just not planning on needing to.

P.S. Why don't these things ever get off the ground in a bear market when they'll actually create more value for investors?

P.P.S. Doing something, even high-fee-capital-gains-tax-paying-in-at-the-market-peak-style-funds is still better than doing nothing.

[Gryffyn]

HB: As regards your PS I wonder the same thing. These guys are on a hiding to nothing if (big if of course) the market tanks for a while. Also, if they attract mom and pops into sinking a whole lot in now it may increase the alreday negative sentiment that Kiwis have for shares.

No-one seems to be pointing out a dollar-cost averaging approach for the typical invester.

[Lawso]

A much more balanced article by Jenny Ruth from today's NZH. Thanks for posting it, Gryff.
She is a good analyst.

I think we'll see Gaynor bow out of his media commitments in the NZH and TVOne because of conflict of interest. He can't possibly be an objective commentator and a high-profile market participant at the same time.

Still don't understand why Morgan chose to attack BG only, instead of doing a balanced assessment of all three of the new LICs. Unless it was a personal thing, which I suspect is the case.

[Tim]

You are forgetting the real advantage of this type of fund is instant diversification in the small company area. There is index fund that mirrors this area. Surely this is much safer than picking 2 small company stocks

[Nimble]

Tim,
What is the name of the index fund you refer to that mirrors this area? (NZ smallcaps)

[Tim]

Nimble, typing area, there is no index fund. Perhaps it would be great if there was.

[Halebop]

quote:Originally posted by Tim

...the real advantage of this type of fund is instant diversification in the small company area... ...this is much safer than picking 2 small company stocks

This is the crux of it. It leads to certain points. What do you pay to have this diversification managed? And what is the cost of portfolio insurance (diversification)?

In the case of active management somewhere around 1% plus potential additional tax liabilities. Passive indexing would definately seem a more cost effective way of acheiving diversification (particularly for a Kiwi investing in NZ)

Portfolio Insurance is the biggest gripe I have. Often espoused by Mary Holm with reasonable argument and a well qualified pedigree. By purchasing the widest possible basket you have guaranteed yourself a measure of capital stability and an average performance. If small caps achieve 10% for the year, you will get 9.5% (10% less the management fee). If small caps return -10% you will earn -10.5%.

While not in the same league as Buffett, either in funds, experience or talent, I am one of his card carrying zealots. I have some differing views and interpretations but overall to me it just makes sense to use funamental analysis and pick winners. This means a smaller, more focused portfolio. While having to endure a higher Beta (volatility) from having fewer investments, a well picked small portfolio widely outperforms the indexes. A poorly picked one can however be catastrophic... which is the problem inherent in picking winners.

As an aside: My girlfriend was showing off a little to her boss when a conversation turned to shares and she told her boss what we did and how well we were doing etc. The next time I saw her boss she asked me how I could stomach the risk of buying shares? (This was just today in fact). Her boss owns a mortgage free home and recently bought a second home worth almost 2.5 times the value of the first, borrowing the sum total and renting out her original home. This mortgage is to the extreme limit of her borrowing capacity. In the long run she'll do well just because she's doing something but I rattled her cage a little by highlighting the "risks" of leverage and overinvesting in a single asset category (un-diversified), peak of the market blah blah blah.

Bottom line though is that a major chunk of the challenge is perception. People who build businesses will always be the richest. People who actively manage their investments for sustained periods will do well to. How they get there will vary according to a myriad of factors like education, culture, upbringing, contacts, luck etc. And these factors all contribute to our perceptions of risk. I beleive it's a bigger risk to be diversified, because I can't stomach the prospect of the certain "average". Others (like Mary Holm) will shudder at the thought of exposing themselves to the vagaries of picking just a handful of "risky" shares. But I'll say it again - the act of doing anything is better than doing nothing.

[skinny]

Interesting comments Halebop!
Risk is certainly in the eye of the beholder. A brother of mine just bought his second house and now wants to get into coastal real estate to diversify !!

Since this is a link inspired by M. Morgan thought I would bring up the investing strategy that he espouses, which is somewhat like my own. It’s a mix between index investing and picking winners. A middle ground if you like which suits me well given my economics background and relative (sometimes complete) lack of skill in FA [B)]

The "core" of the portfolio is a well-diversified index. In my case the world MSCI which I contribute to each month, but it could be a high yielding income fund for example. The "satellites" involve picking winners - either individual shares or sub-indexes. I currently have 10 satellites orbiting, the largest of which is a sectoral play (US oil&gas stocks).

The twist is that unlike true passive investors you have to be prepared to change core holdings if you feel market conditions dictate it. E.g. at the end of 2003 I moved the core from a fully NZD-hedged MSCI fund to an unhedged one.

[SEC]

quote:Originally posted by Halebop

While having to endure a higher Beta (volatility) from having fewer investments, a well picked small portfolio widely outperforms the indexes.

People value volatility becauses it increases the probability of above average returns. Just look at how derivatives are valued - price goes up with volatility.

So it doesn't make sense to put your money in highly diversified funds with low volatility if you are seeking above average returns. In fact it's preferable to own as few stocks as possible.

SEC

[skinny]

Sec, if I remember my distant finance lectures well you only get the result that volatility is valued because equity prices are log-normal (bounded at zero). My concern about too much eggs in once basket is that I choose too many bad ones and end up in the left hand tail [:o)]

[SEC]

I thought volatility has value because as volatility (= standard deviation) increases, so does the probability of achieving the strike price (or getting improved returns). Doesn't matter if the distribution is normal or log-normal.

Anyway, I have no desire to invest in any fund - Colville or otherwise - that invariably track the market whilst you pay fees for the privilege.

Not so sure about your orbiting satellite analogy Skinny - inevitably they come crashing to earth or end up as space junk :D

SEC

[skinny]

Ha, good one Sec. Actually at the moment its a more like a binary star system with the ammount of oil stocks I hold. No comets as yet but ST's own Halebop is onto a thing or two with the porn business so may get it going nova soon. Ah well yes its the Casillero del Diablo Chilean chardonnay getting the best of me - as buzz says to infinity and beyond !

[Tim]

Skinny, good points. Research shows long term 90% of fund managers are unlikely to beat the index. Why spend so much time trying to identfify winners which may only be successful for some years but very unlikely to outperform 10 years or more.

[SEC]

quote:Originally posted by maxine

Halebop, thanks for that - that makes sense. Alarming really, cos it means that if 14% looks grim, you have to also account for the upfront costs and/or discount!


14% management fees look a bargain compared to what other fund managers have been getting away with for years, 35-36% in some cases. From the NZ Herald:

Report cites excessive fund fees
Exorbitant fees have left thousands of investors in superannuation schemes and unit trusts worse off than if they had left their money in the bank, says the Consumers Institute.

http://www.nzherald.co.nz/business/businessstorydisplay.cfm?storyID=3568061

Managed funds are for the gullible and ignorant, period. I hope I am preaching to the converted on this site.

SEC

[zyreon]

the only reason for buying managed funds is if you can't be bothered doing it yourself

[Halebop]

quote:Originally posted by skinny

...Actually at the moment its a more like a binary star system with the ammount of oil stocks I hold. No comets as yet but ST's own Halebop is onto a thing or two with the porn business so may get it going nova soon...

Since we're talking the interplanetary here...

Halebop - more of a comet than a Nova (http://24.116.161.34/astro/astroalbum/35mm%20Images/slides/halebop.html)

[Nimble]

quote:Originally posted by Halebop

14% might not actually be far off. It depends on performance:

Invest $1000
"Earn" $130 (13% pre tax)
Pay 1% Management (1% of 1,130) -$11.30
Pay 33% Tax (33% of 118.70) -$39.17
Net Gain $79.53
Management as a % of Gain ($11.30/$79.53x100) 14.21%

That tax bill alone requires a +50% out performance.


After having a closer look at the investment statement I think the above calculations need some reworking.

Colville states that their target is to outperform the NZSX All Gross Index by at least 3% per annum after allowing for all fees and costs except tax. First point is that their target is after fees and costs. Over the last 12 years the index has an average total gross return of 13.1%, comprising an average gross dividend return of 7.1% and an average capital return of 6.0%. Lets assume they achieve their target, which would be 13.1% + 3% = 16.1% after fees and costs except tax. Lets work out the tax to get to the net return.

Earns $1,000 * 16.1% = $161
7.1% or $71 of this is tax paid dividend income as imputations are attached to the dividends, Point two no more tax to pay on this amount
Taxable amount $161 - $71 = $90
Tax $90 * 33% = $29,70 (18.5%)
Net Return $161 - $29 70 = $131.3 or 13.1%

This is exactly the same as the index and better than any (if there was) passive fund tracking the index, which would return 13.1% - 1% management fee = 12.1%.

Whether Colville can achieve their target is another question but either way tax doesn't have as big a drag as you might initially think.

By the way Salvus and Kingfisher have tax opinion's giving them exemption on some capital gains, which if accepted by IRD will help returns even further.

[Tim]

Which of the three ITs are the best ; Kingfisher, Coville, Salvus

Tim do you really care which is the best of three Lemons.

[winner69]

IPO pulled .... due to current market sentiment they say in one paragraph but also the decision not to go ahead ".... was influenced by the concern that investors would experience a loss in value when the company listed,"

Don't you guys feel horrible for killing this?

Or does everybody believe Gareth?

Well, one thing is it wont be a lemon

[Capitalist]

It shows Gaynor has a lot of integrity I reckon Winner.

Give that man a coconut :)

[David Renwick]

Tim's asked "pick the Best of Colville, Kingfish or Salvus."

Kingfish wld be my pick. Didja hear Carmel Fisher on Natl Radio
last Saddy? She has a good track record in MF (even though she started out with those wasters in Prudential who may have taught her what not to do[xx(]) and women are better investors.[:I]

[biker]

......was influenced by the concern that investors would experience a loss in value when the company listed,"

But surely they didn't think it would list at par or at a premium? Maybe Gaynor and co's egos were such that they did!

[Morch]

quote:Originally posted by David Renwick

Tim's asked "pick the Best of Colville, Kingfish or Salvus."

Kingfish wld be my pick. Didja hear Carmel Fisher on Natl Radio
last Saddy? She has a good track record in MF (even though she started out with those wasters in Prudential who may have taught her what not to do[xx(]) and women are better investors.[:I]

In The fisher Funds latest News letter they say they have sold out of GPG, The Warehouse, and Sky City. They have also investigated three of current IPOs and believe at least one has potential to become a long term core portfolio stock.
Their NZ unit trust fund is excellent for a wide range of investors including drip feeders. Averaged about 22%p.a. tax paid over about 6 years.

Regards Morch :)