Punters' pick of the sharemarket

BY PHILIP MACALISTER

The choices for investing in the New Zealand sharemarket have just got a little more complex.

Before, the two main options were to invest in an unlisted unit trust, or to buy and sell shares directly.

The unlisted trust could either be of the active type, such as those run by BT Funds Management, Fisher Funds and ING, or passive funds, like TeNZ from the NZ Stock Exchange, AMP Capital's Passive Share fund or the MidNZ fund.

Now there is a third option, which is in some ways a cross between the two - the listed investment company.

Many readers will have noticed that this week two new listed investment companies - Colville Equities and Salvus Investments - have been rolled out for their first public inspection. An earlier offering, the Kingfish fund, hit the showroom several months ago and is now doing well, after raising nearly $60 million from punters.

These aren't the first such investment companies. The Britain-based New Zealand Investment Trust has been around for years and has just over $60 million under management. The trouble is, it hasn't had a high profile among investors and its performance has been mixed over the years.

What is interesting about all these new model funds is that they are raising a significant amount at a time when unlisted managed funds have been languishing.

Despite several consecutive years of strong performance by the New Zealand sharemarket at a time when international markets were going backwards, investors' money has not flowed into unlisted trusts.

This is particularly odd, given that money usually chases returns - if a market or asset class has done well, people will pile into it.

All of which poses the question: have unlisted share funds had their day?

Listening to some of the people behind the new listed companies indicates some antipathy towards the managed funds industry. Colville's Brian Gaynor is critical of the level of fees fund managers charge and their lack of profile. He has described managed fund fees as "hellish".

"The fee structure for retail funds in New Zealand is very bad," he says.

However, Fisher Funds chief executive Carmel Fisher provides a more mellow tone - understandably since she has a foot firmly planted in both camps. Her view is that there are a group of investors who don't want managed funds, and much prefer a listed investment company.

The head of managed fund research house FundSource, David van Schaardenburg, paints an altogether different picture.

His view is that the advent of listed investment companies is an example of the managed funds industry and sharebrokers working together.

He says brokers can sell lots of product, but have been reluctant to sell managed funds. However, they will embrace investment companies because they are listed on the sharemarket.

Van Schaardenburg does not agree with the proposition that the $150 million being raised by the new listed investment companies is a large proportion of the money in New Zealand share funds.

He estimates that investors have $830 million in unlisted New Zealand share funds and, on top of that, 20 per cent of the money in diversified funds is invested in the local market.

By his reckoning, that adds up to $2.2 billion already invested in the New Zealand sharemarket through retail managed funds.

So if you want to invest in the local market, how do you go about it? Do you choose a listed company over an unlisted fund?

Van Schaardenburg says the first thing to do is make a quality assessment of the manager. This question remains whether you are picking between listed and unlisted funds or even picking from within one of the groups.

One benefit of the unlisted funds is that they have been around for some time and their style, process and skills are well known and demonstrated through the returns produced and the research published.

Of the three listed investment companies, he argues that Kingfish is in the strongest position as Fisher Funds, the manager, has been operating for more than five years, has $200 million under management, and the boss of the business - Carmel Fisher - has been managing money in the New Zealand market since the early 1990s.

Colville and Salvus are quite different, he argues. Undoubtedly the managers have knowledge and experience, but that experience is not necessarily in the New Zealand market.

"The Fisher offering is the easiest to assess," he says. The other two are "relatively unknown".

He says they have no demonstrable track record in this market and their processes and their systems have not been tested locally.

Rather, these organisations are selling themselves, on the reputations and "brand" of two commentators - Colville's Gaynor, who writes for the Business Herald, and Press and Dominion-Post commentator Roger Armstrong, who is involved with Salvus.

Van Schaardenburg says another key issue is the cost structures of the various offerings.

His warning is that everything is not necessarily what it appears.

He believes that investment trusts "hide" some of their expenses in the profit and loss accounts, as opposed to including them in the management fee, and that investors wear some of the costs themselves.

Part of Colville's proposition to investors is that it is the low fee option, charging an annual management fee of 1 per cent, while retail funds are charging between 1.25 per cent and 1.65 per cent.

Just as contentious is the cost of getting in or out. With listed companies, brokerage is paid on both sides of the transaction, while with unlisted funds there is a maximum entry fee of generally 5 per cent but the financial planner can fully reduce this to zero.

The third issue which investors need to consider is tax - and getting a straight comparison on this one is tricky at best.

One reason some people use to explain why unlisted New Zealand share funds have been going backwards in terms of funds flow (though not performance) is that managed funds are considered tax ineffective.

The problem is simple and twofold. One issue is that Inland Revenue treats managed funds as traders, which have to pay capital gains tax.

In theory, any investor who is a trader should pay capital gains tax, but the reality is that the IRD, while occasionally giving warnings, never does anything about enforcing them.

The reality is you can be a trader and there is - at the moment - little chance you will get whacked for capital gains tax.

To compound the situation, managed funds are taxed at 33 per cent, so any investor who uses these vehicles, but is on a lower marginal tax rate, is essentially being overtaxed.

Passive funds are one answer to this conundrum, because they don't have to pay tax on any capital gains. However they are not ideal as the manager has to mirror the index it tracks - dogs and all.

Of the four listed investment trusts, it is easiest to sort out the best and the worst positions. The NZIT is the most effective because of its British domicile. Colville is at the other end, as it has said it will be an active investor and will pay tax.

In the middle are Kingfish and Salvus. Kingfish has come up with a cute solution which was tried by managers a decade ago. That idea is that it splits its portfolio in two - a fully taxed active portfolio and a passive buy-and-hold one which is not taxed on capital gains.

The fund does not have a binding ruling from Inland Revenue, but it has an expert opinion saying this structure will work - others are not so sure.

Salvus said during its press conference that it was a buy and hold investor, as opposed to a full-on trading one, and this strategy may have tax benefits.

An investor looking at any of these options, listed or unlisted, needs to be clear of the implications of each strategy.

BT Funds Management acting chief executive Mike Newton sums up the situation quite well. He says one of the drivers of these new funds is that "the market has been running hot".

"The market is being supported quite well. People are coming back to equities."

There is a place for all three types of investment, whether a listed investment company, an unlisted fund or direct shareholdings. Investors have to work out what is the best option for their circumstances.

* Philip Macalister publishes personal investment websites ShareChat and GoodReturns.

* Email Philip Macalister