Brian Gaynor 's Opinion

Investment columnist for the NZ Herald

Brian Gaynor: Great year for investors and future is bright

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Commerce Commission deserves plaudits for Credit SaILS solution.

Prospects for the New Zealand sharemarket remain buoyant. Photo / Amos Chapple
Prospects for the New Zealand sharemarket remain buoyant. Photo / Amos Chapple

This has been a great year for sharemarket investors with the NZX50 Gross Index up nearly 25 per cent at Thursday's close.

Yes, we had the collapse of Ross Asset Management, the continuing saga of George Kerr and Pyne Gould Corporation, the controversial bias to overseas investors in the Fonterra IPO and the relentless pursuit of Chorus by the Commerce Commission.

However, the commission deserves a bouquet for its role in the return of capital to Credit SaILS investors and most of the other investment news during the year was positive.

The NZX has outperformed the Australian sharemarket and the MSCI Global Index this year (see table).

These performance figures are on a gross basis, which includes capital plus dividends. The ASX figures are in Australian dollar terms while the MSCI performance data is in New Zealand dollar terms.

The numbers demonstrate that the New Zealand and Australian sharemarkets have delivered superior returns to Northern Hemisphere markets - in New Zealand dollar terms - since the end of 2000.

The NZX and ASX have had total returns of nearly 140 per cent each over the past 12 years whereas the MSCI, in NZ dollar terms, has been down 26.5 per cent.

The MSCI Index represents the world's major sharemarkets.

The poor performance of non-Australasian markets in New Zealand dollar terms is partly due to the appreciation of the kiwi.

New Zealand investors who hedged their foreign currency exposure would have performed much better than the MSCI's negative 26.5 per cent over the past 12 years.

The story of the NZX over the past few years begins and ends with the global financial crisis (GFC) which was at its worst in 2008.

The NZX50 Gross Index peaked at 4343 in May 2007 and bottomed out at 2411 in March 2009, a decline of 44.5 per cent.

The GFC had a devastating impact on investor sentiment and there was a big exodus to low-risk investments, particularly bank deposits.

The situation was exacerbated in New Zealand by the collapse of the finance company sector.

Investors take a long time to regain confidence after a market collapse and most individuals continued to take a risk-averse approach through to the beginning of the current year.

This is reflected in the low-risk attitude that most KiwiSaver members have adopted towards asset allocation. However, sentiment began to change around mid-2012.

The worst of the GFC seemed to be over, Europe's problems did not appear to be contagious and interest rates were at record low levels.

As two and three-year deposits matured investors began to look for higher yielding opportunities and were willing to take on more risk.

The NZX moved into second gear as it attracted more and more interest and the benchmark NZX50 Gross Index surged 12.8 per cent in the September quarter and a further 6.3 per cent in the current quarter.

The renewed enthusiasm for equities was stimulated by high dividend yields, strong corporate balance sheets, an increase in dividend payout ratios and the low interest rates on alternative investments.

The market's rise has slowed in recent months because we are now in the second stage of the market recovery, which is the sale of large holdings by major shareholders and capital raisings. These soak up surplus cash and curtail market momentum although they usually offer good buying opportunities.

Major stakes in Steel & Tube, Sky TV, Trade Me, Infratil, A2 Corporation and Xero have been sold and the latter two have also had capital raisings.

In addition, there has been the Fonterra Shareholder Fund IPO, which has performed particularly well.

Fonterra is not yet included in the NZX50 Gross Index but if it were then the performance of the benchmark index would have been stronger in the current quarter.

The good news is that offshore shareholders in Steel & Tube and Trade Me have sold their controlling stakes and a number of companies, including A2 Corporation and Xero, have raised new capital to expand.

Facilitating capital raisings is one of the major roles of any sharemarket.

Although investor confidence has increased there is still a widely held view that the market upturn is too good to last, one positive year is about all the NZX is capable of.

If we look at the pre-GFC period the NZX had four good years between 2002 and 2006 and the ASX had five positive years between 2002 and 2008.

There are a number of reasons why the NZX could have two or three positive years.

These include a pick up in domestic economic activity, the impact of KiwiSaver funds, relatively high dividend yields and low interest rates.

Interest rate movements are probably the most important variable as far as the outlook for 2013 and 2014 is concerned.

New Zealanders have a strong bias towards bonds and other fixed interest securities but the domestic sharemarket will remain relatively attractive if interest rates remain low.

However, if interest rates increase then the economic recovery could be checked and higher mortgage rates will impact on consumer spending and company profitability.

In this situation bonds would be more attractive.

Given the current situation total sharemarket returns of between 8 per cent and 15 per cent are achievable in 2013 with the IPO of Mighty River Power having a major impact on market sentiment.

If the Mighty River Power float goes well, attracts a large number of investors and the shares are distributed to New Zealanders then the NZX could sustain its positive performance throughout all of 2013 and into 2014.

Credit SaILS investors received great news on Monday when the Commerce Commission announced that stakeholders would receive $60 million of their $70 million back.

Most investors believed they had lost all of their money and the announcement was a great Christmas present.

The Credit SaILS (Credit Saleable Index Linked Securities) prospectus was registered on May 6, 2006, with the objective of raising $100 million through a CDS (credit derivative swap) structure.

The issue, which was organised and underwritten by Forsyth Barr, raised $91.5 million mainly because it offered an interest rate of 8.5 per cent over its six-year duration.

A large number of charitable organisations invested in the product even though it had an incredibly complex structure whereby it effectively insured a $3 billion international bond portfolio.

This insurance covered bonds issued by Lehman Brothers and Washington Mutual in the United States as well as three major Icelandic banks that subsequently experienced major problems.

Credit SaILS would lose all of its money if the $3 billion bond portfolio experienced losses in excess of $144 million although these losses were capped at the $91.5 million raised.

In mid-2009 Credit SaILS investors were told that the portfolio had total losses of $560.1 million and investors would receive only 1.17c, plus interest, for every $1 invested.

This announcement revealed that the meagre payment would not be made until December 22, 2012.

Investors bombarded regulators and politicians with complaints about Credit SaILS, the way it was marketed and the huge losses experienced.

At first the investigation went down the securities law route but then made an abrupt turn and Credit SaILS came under the scrutiny of the Commerce Commission and the Fair Trading Act.

The commission concluded that "Credit SaILS was marketed and sold in a way that is likely to have breached the Fair Trading Act".

Forsyth Barr and Credit Agricola, which was also involved in the establishment of Credit SaILS, have agreed to pay $60 million of the $70 million still outstanding to the original investors ($21 million was returned to investors before the portfolio deteriorated).

The commission threatened legal action unless Forsyth Barr and Credit Agricola agreed to meet compensation requirements.

The $60 million agreement is a great outcome for Credit SaILS investors and the commission, Forsyth Barr and Credit Agricola deserve bouquets for resolving this issue in such a satisfactory manner.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

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