Spread those eggs around

Mangere and other parts of Manukau City are a good place to buy rentals. Photo / NZ Herald

Making smart money moves takes guts as well as smarts in the most volatile environment facing the world economy and financial markets since the Great Depression.

For more than 15 months, economists and fund managers have been trying to pick the bottom of markets that keep sliding as investors walk a tightrope between minimising losses and priming to exploit the inevitable upturn.

Investor preference is shifting to equities instead of fixed-interest investments as they perceive light at the end of the tunnel offshore. Money's flowing into sharemarkets and prices for fixed-interest assets are falling.

The Warehouse, Restaurant Brands and Sky City Entertainment feature among favoured New Zealand stocks, but the best buying may be offshore where markets have been beaten up even more.

Reducing losses in falling markets and being poised to profit when they rally hinges on diversification, says John Atkinson, chief executive of Plan B Wealth Management.

If you put your investment eggs in a number of different baskets - such as shares, property, bonds and cash - even when one is dropped the impact doesn't dramatically affect your entire investment.

Diversification is also the key to making the most of rising markets - and it does not mean spreading your investments over a range of finance companies or even a range of fixed-interest investments.

Risk is inherent in all investments, and with fixed interest there is a risk your interest payments will not be met and your capital will not be returned.

Harrowing stories of people who've invested their life savings in various fixed-interest products, only to see the companies implode, show what happens when all the investor's eggs are in one basket, says Atkinson.

Jeff Mathews, investment adviser with Spicers, doesn't recommend investing in finance companies even while they're under government guarantee - it's like "sleeping with an ugly person just because they used a condom".

Financial adviser and author Liz Koh says government guarantees on some investments have helped mitigate these risks in the short term, but a good long-term portfolio will have exposure to all four asset classes and a good mix of investments within each.

Typically, 45 per cent will be in fixed interest and government bonds, and the rest in property and shares, although people in their 30s and 40s should have a larger property and share component.

Shares form a major part of many people's total investments, and these especially require diversification, or a balance of exposure to different industry types.

Mathews says while investing strategies must be individually tailored, someone prepared to invest "fairly aggressively, taking a three to four-year time horizon" should cash in if they buy well.

He recommends "dollar cost averaging" or drip-feeding money into shares rather than investing large lump sums while the market stays volatile.

Atkinson says that, typically, large mature blue chips provide regular dividend income, but smaller to medium-sized companies give better capital growth.

Investment opportunities in the latter are thin on the ground locally, says Mathews. "You really have to look overseas for investing in those young, fast-growing companies - here they tend to be private." Emerging markets will also deliver fast growth - he has money in an Asian share fund managed out of Australia.

Investors with shares in New Zealand and Australia and some investment property believe they have well-diversified portfolios - although all their assets are tied up in two countries, which comprise less than 2 per cent of the global economy.

True diversification should include all the world's major markets. Compounded over 10 years, $100 invested in the S&P 500 would grow to $224, while the same amount in a fully diversified portfolio would grow to between

$247 and $316. That's a difference of between 10 and 40 per cent more.

Overseas sharesMathews is buying shares in Barclays Bank, Wells Fargo Bank and the Bank of America because he believes they are underpriced.

"These are world-class companies that will survive this downturn," Mathews says. "There are only two banks in the world with an AAA credit rating: Wells Fargo and Rabobank."

While Australian bank shares are off their price highs by 40 per cent, Mathews says big international banks are off by 70 per cent.

On March 6, Wells Fargo shares hit a low of US$8.50 ($14.74), down from their peak three years ago of US$44.60. "There have been some crazy discounts as people have been overly pessimistic," Mathews says.

He expects to double or treble his money within the next three years, with Wells Fargo shares back to US$15.50 last week.

He also bought General Electric shares on March 6 for US$6.70, which are now sitting around US$10.40 - almost a 50 per cent return in three weeks. A year ago they cost US$38.50. Mathews admits it's "tempting" to borrow money to buy more at the moment, but leverage is a double-edged sword and ultimately, "it has to be money you're prepared to kiss goodbye".

New Zealand sharesFirst NZ Capital research analyst Robert Bode says dividend yields on New Zealand shares now offer "significantly superior" income to long-dated bonds and short-term fixed-interest investments.

With dividend yields almost twice the yields on government stock and better than corporate bond issues, Bode believes some shares are good investments if their earnings and balance sheets are sufficiently robust, giving investors a better long-term inflation hedge.

Excluding listed property vehicles, the current estimated New Zealand market dividend for this financial year is 8.3 per cent gross or 6.2 per cent net and the average payout ratio is 84 per cent.

The listed property sector offers a weighted average yield of 13 per cent gross, 850 basis points above 10-year government stock, compared with a normal yield gap of around 250bp since 1995.

Bode says the most attractive stocks for yield are Restaurant Brands, Steel & Tube, Kiwi Income Property Trust, ING Medical Properties, The Warehouse and Sky City Entertainment. These shares do not necessarily offer the highest available yield, but Bode believes they "offer the most robust yield stories, all factors considered".

Listed property trusts If investors can live with some fluctuations, real estate investment trusts (REITs) such as AMP Property Trust, ING Property Trust, Goodman Property Trust, Property for Industry and Kiwi Income Property Trust offer reasonable returns compared with bank deposit rates, yielding 7 to 12 per cent.

Jason Lindsay, First NZ Capital research analyst, says the New Zealand Property Gross Index continues to outperform the NZ 50 Index Gross. Since December 31, 2007, this outperformance has measured 22 per cent, and since December 31 last year has measured 4 per cent.

New Zealand continues to screen as the best performing REIT market of the major markets. "Following the recent plunge in interest rates, we appear to be in the middle of another mini commercial property boom," Lindsay says, "although this is limited to the $20 million value and lower".

Corporate bondsFor those who live off their investment returns, Mathews recommends the new corporate bonds issued by Fonterra, Contact Energy, ANZ, ASB and Westpac banks that have an AA or A credit rating.

They offer 7 to 7.5 per cent interest for the next three to four years and they're also easily liquidated. Whether acquiring shares, property or fixed-income investments, look for quality, Mathews urges.

Financial planner Lisa Dudson cautions that Kiwis tend to think if a company has a good brand name, it's a good company to invest in - they don't understand how to price risk and read corporate balance sheets to discern this properly. Money mentor Anton Nadilo advises novice investors in any assets to educate themselves before parting with cash.

New Zealand residential real estate BNZ chief economist Tony Alexander says population growth will lift by between 15,000 and 30,000 over the coming year, which will boost the housing market.

The population will surge on the back of a world economy undergoing its worst recession in six decades. People have stopped leaving New Zealand to seek barkeeping experiences offshore and expats are flooding back, as are foreigners.

Last month's net migration gain of 3582 people is the strongest since 6692 in February 2003. "The numbers are turning even more strongly than we have been forecasting - and the coming year could produce a migration surge akin to what we saw from the middle of 2001," Alexander says.

In the three months to February the number of people leaving was down 5.8 per cent and numbers moving to New Zealand permanently were up 4.8 per cent from a year ago. At the same time, construction has fallen to levels not seen since the early 1970s, worsening the supply constraint every month.

Real estate turnover has bottomed out and it's possible we are near the average price stabilisation point, says Alexander. Canny investment purchases need to be made before the middle of the year, he advises. "After mid-year the good stuff will perhaps have been snapped up and the best bargains secured."

But with the unemployment rate set to jump and a lot of the weakness evident offshore yet to hit here, there are no timely prospects of good capital gains.

House prices soared on the back of a trebling of debt in the past 10 years when "the place got pumped full of money", Spicers' Mathews says.

Now, with massive global deleveraging, it's more difficult to come by, which will keep the property market flat for a long time.

Given property investing is a long-term strategy, this doesn't mean you shouldn't acquire now - if you buy well you can get good returns from the outset. The idea is to buy below valuation so you start out with equity.

For example, a property worth $300,000 bought for $260,000 creates an equity gain of $40,000 on settlement. Added to a 10 per cent deposit of $26,000, the cash on cash return is more than 150 per cent.

Professional property investor Kent Leicester calculates long-term returns using a 10-year property cycle, as properties generally double in value over this period. If you put in a 10 per cent deposit and your property doubles in value in 10 years, assuming your mortgage remains the same your equity gain is 10 times what you originally invested or an average 10 per cent a year return.

Mathews warns that the numbers may stack up while interest rates are at 6 per cent, but not if they climb to 8 per cent in two years. And you have to be able to subsidise the mortgage if your tenant loses their job.

"Most of the damage that happened last year was to financial markets - they took a pasting. This year is the flow-on as redundancies and mortgagee sales bite."

Leicester says that the most secure places in which to invest are main centres where there is strong population growth. Avoid smaller towns dependent on only one or two main employment sources, such as Tokoroa.

Ninety per cent of New Zealand's population growth in the next 20 years is forecast to occur in the North Island, with the four cities of Auckland accounting for more than half that growth.

Auckland remains New Zealand's fastest growing region. Most people moving to Auckland are settling in Manukau City, so this is where future growth is going to be. The population is expected to grow by 350,000 in the next decade.

Leicester, who is also the director of property investing strategy consultancy Polaris Group, says Manukau has the capacity and land to provide for new housing demand and is providing more infrastructure, developing the new Flat Bush town centre and several schools.

"We advise investors to take advantage of the great buying opportunities, and purchase there where demand for good-quality, affordable housing will continue," he says.

Yields and cash flow are good on rentals in Papatoetoe, Otara, Manurewa and Mangere, Leicester says, and he looks for properties with two dwellings on one title so one investment produces rent from two sets of tenants.

The market's spectacular collapse after a long period of capital growth last year cut land cost, so investors don't have to pay a premium for larger sites on which an additional dwelling can be built later.

"You can buy these properties for about the same price as what the house would be on a half-site, so you are getting extra land you can build on later free," Leicester says.

INVESTMENT OPTIONS

Kent Leicester of Polaris Group has some suggestions for property investing options to suit different budgets:

For an investor with $5000
* Partner with family members or friends, and pool your funds to go towards a deposit.
* When buying a property, try negotiating with the vendor to leave 20 per cent of the purchase price in the deal so that the deposit is covered.
* The $5000 could then be used to fund interest costs on the vendor finance option or to renovate the property and increase its value.

For an investor with $20,000
* Use the $20,000 as a 10 per cent deposit on a $200,000 property in the Manukau district rented for $300-$320 a week, providing positive cash flow (the rent covers the property outgoings).
If you can't get 90 per cent finance, again try to negotiate some vendor finance.

For an investor with $100,000
* Buy more than one positive cash flow property in the Manukau district.

For example, two "home and income" properties - those with two houses or flats on the same title - worth $350,000 to $360,000 that you can secure for about $330,000.

Finance of 85 per cent would be needed, which a few banks are still providing.

This would give you property worth around $700,000, with mortgage finance of only $560,000.

With two sets of tenants paying rent on each property, your rental income should be around $550 a week on each property, generating positive cash flow of $10,000 a year.

This strategy creates an income of $20,000 a year on top of $40,000 to $50,000 gained as a result of buying well.