Portfolio construction is an essential element of wealth creation. We consider it to be both an art and a science. To find new opportunities you need the creative flair of an artist and the inquisitiveness of a scientist. You need enthusiasm and a willingness to look outside the square. To manage risk you need the scepticism of a scientist and the protection of a robust scientific process. All these things come together in the workings of the Financial Keys Research Committee to produce what we consider to be exceptional portfolios.

Research – It’s about people and processes!
Quality research is the difference between ordinary and exceptional investment performance. Research plays an important role in the design and make up of an investment portfolio. We are proud of the portfolios we recommend. This confidence is born of a belief in our people and processes.

The Financial Keys Investment Research Committee dedicate much time and effort in constructing portfolios of difference in a market where ordinary is a common offering.

The committee members are well experienced and have complimentary qualifications and skills. The committee meets monthly or more frequently if required.
The List
We specifically seek out those investments that are unique and offer something extra. We are always on the look out for new opportunities but will only include them on our lists if they pass our quality screening process. We do not have the constraints that larger Dealer Groups have in controlling the actions of many advisers. Often this leads to restrictive lists where more exciting investments are excluded and in-house investments are over represented, leading to poor investment performance.

Before any investment can be recommended to a client it must first pass though our rigorous screening process. We have selected a panel of leading research and stockbroking houses. We utilise their qualitative and quantitative analysis as a basis for our initial considerations. We directly interview investment managers, and other industry participants. We also have access to other key information sources which are included in our screening process.

We initially draw up a list of Approved Investments. The Approved List consists of investments that the committee considers of a high enough standard to be included in client portfolios. They are primarily comprised of investments that are recommended by the panel of research and stockbroking houses, but may also include other investments considered suitable by the Research Committee.

The Preferred List
To be included on our Preferred List an investment must display unique qualities that sets it apart from its peers. From the list of approved investments we further refine and filter our selection to come up with the Preferred List. This is our best of breed selection. There will typically be one investment representing each sector, region, style and market segment. Investments are included in this list because they are considered to be the most likely to consistently outperform their peers. This list is constantly reviewed and modified. It is from this list that portfolio recommendations are primarily made.

In drawing up the Preferred list we focus on identifying outstanding qualities through understanding investment manager’s philosophies, processes, people and capabilities. Our process is robust and includes consideration of the following criteria:-

• Ratings and commentary by our panel of research and stockbroking houses.
• Other industry data, reports and articles.
• Size and experience of the investment team.
• Size of fund.
• How the fund operates in different market
  conditions.
• Investment style.
• Sectoral and regional weightings.
• Specialisations and particular expertise.
• Past performance.

The Mix
A portfolio is comprised of a combination of investments. There are many issues to consider in blending a list of Preferred investments into a cohesive portfolio. Investor’s risk profile is one key consideration. Not all investments will suit all investors. For example, hedge funds or direct shares may not be suitable for a conservative investor. Also, mortgages may not suit a growth investor.

Diversity is another key consideration. Diversity is about reducing risk while maintaining returns at the efficient frontier for each client risk type. There are so many aspects which we consider when blending investments:-

• Asset classes (e.g. shares, fixed interest, income and hybrid securities, hedging strategies, property and cash etc)
• Fund Manager Investment styles (e.g. growth, value, garp, style neutral, index, bottom up, top down, quantitive etc)
• The correlation between different investments
• Investment Sectors (small caps, large caps, media, resources, retail, industrial etc)
• Regional allocation (Australian, International including regional diversity Asia, Europe, other emerging markets)
• Fund manager diversity – Ensuring there is no overexposure to any one manager.

Portfolios are changed in response to, or in anticipation of, changing market conditions. It is a dynamic process that requires an ongoing enthusiasm for inquiry and an awareness of what is happening around us. We consider that our enthusiasm sets us apart and enables us to continue to find opportunities for inclusion in your exceptional portfolios.
Andrew Condell and Myle Pham

Andrew Condell and Myle Pham

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Proposed legislation allowing superannuation contributions to be split between spouses can deliver significant ongoing tax savings to couples in retirement. It also provides a further mechanism for the financial security of non working spouses.

It is proposed that contributions made on or after 1 January 2006 will be splitable. The proposed legislation allows 100% of a person’s contributions for a given financial year to be ‘transferred’ from their account to their spouse’s account. The election to split must be made after the end of the financial year.

Super splitting provides significant ongoing tax benefits and also further encourages the accumulation of benefits for a non working spouse. Superannuation invested in two names rather than one provides a couple with access to:

• Ongoing income splitting throughout retirement. Pensions will be paid using the tax free thresholds of each spouse.
• Two Reasonable Benefit Limits. The Reasonable Benefit Limit is the maximum amount of superannuation that is concessionally taxed (currently $648,946);
• Access to the low rate post June 1983 tax thresholds for each spouse. $129,751 of superannuation monies attributed to being accumulated after June 1983 can be withdrawn at a reduced tax rate (in the majority of cases it can be withdrawn tax-free);

The case study below demonstrates the tax savings that would be achieved in retirement for a couple after super splitting for ten years.

Stella is a 60 year old lawyer married to Liam, a 60 year old writer. In 1995 Stella had a $260,000 in superannuation benefits. Liam had $12,000. Stella has contributed $30,000 of her salary into superannuation each year for the past ten years.

The table below shows Stella’s and Liam’s income in retirement under two scenarios. In the first scenario there has been no super splitting. In the second scenario, Stella has transferred her total annual contributions of $30,000 into Liam’s superannuation account. The calculations are based on an assumed earning rate of 8.2% pa over the ten years. In addition, it has been assumed that Stella and Liam draw the minimum annual allocated pension allowable so that their superannuation does not run out prematurely.

The table shows that Stella and Liam would save approximately $5,677 in tax per year from super splitting. This tax saving is a result of Stella and Liam receiving:

• Two Reasonable Benefit Limits. In the no splitting scenario, Stella has $288,470 of her superannuation not concessionally taxed as her benefit has exceeded the current Reasonable Benefit Limits, $648,946. In the splitting scenario, Stella is under the Reasonable Benefit Limit as a result of her splitting her superannuation benefit with Liam.
• Two low rate post June 1983 tax thresholds. A commonly used retirement strategy is to withdraw the low rate post June 1983 tax threshold (currently $129,751) tax free and re-contribute this amount as an undeducted contribution. This is referred to as a recontribution strategy. It provides a higher combined annual tax deduction of $11,090 under the super splitting option as opposed to $5,100. This is due to two recontribution strategies being implemented instead of one.
• By splitting the pension, both Stella and Liam enjoy the lowest marginal tax rate of 0% -15%.

Super splitting provides considerable ongoing tax savings and is a further step towards addressing the imbalance in retirement benefits between working and non- working spouses. We consider this to be an excellent government initiative.

Patrick Hegarty


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Over the last quarter several key issues have impacted the Australian and global economy. High oil prices and hurricanes in the US have had minimal effect to date on otherwise healthy economic growth. However, there is concern these issues may dampen consumer confidence in the future.

In this context, the Australian economy performed well with positive economic indicators persisting through another quarter. That being said, the effects of inflationary fears and persistent high oil prices were evident. High oil prices pushed headline inflation rates to 3.00% in the September quarter but underlying inflation was stable at 2.5%. There were expectations that the Reserve Bank of Australia could raise rates again in their November meeting. The Reserve left rates unchanged in November but have signalled possible future rate rises.

The Australian share market proved to be more volatile over the quarter. The All Ordinaries Index experienced a sharp sell off during the first week of October and has since recovered well. The fall in the All Ordinaries Index was in response to US markets reaction to the Federal Reserve expressing their concerns about inflationary fears and high oil prices which has also been experienced in the US.

In the US, inflationary pressures were driven by the effects of high oil prices,
hurricanes Katrina and Rita and a booming housing sector similar to what was experienced in Australia. Also, economic growth in the US has been driven by consumer spending. This is expected to slow down in the coming months following the US Federal Reserve increased rates from 3.75% to 4.00% on 01 November; the twelfth successive increase.

At least one economist - Dr Ron Woods from Challenger, considers that this further increase could be overshooting the mark; that existing rates were already sufficient to curb core inflation. He considers that headline inflation in the US and Australia for that matter, has been skewed by the presence of high oil prices rather than domestic consumption.

In other corners of the world, China and emerging Asia continue to be the leaders in global economic growth with recent figures showing annualised growth of around 9%. They continue to drive the demand for oil. Bird flu remains an unknown factor with significant ramifications for growth in Asia.

The European Central Bank has reduced expected growth to between 1.3% and 2.6% in 2006 but this was in response to high oil prices and increases in expected inflation.

The Japanese economy remained stable as domestic spending continued to drive the economy. There are signs now that world’s second largest economy is emerging from 10 years of stagnation with property prices and consumer spending on the rise for the first time in as many years.

Looking forward, there is view amongst economic forecasters that the global economy will display growth of around 4% in 2006. We agree with the view espoused by Chris Caton, Chief Economist from BT Financial Group, that there are no clearly undervalued markets or asset classes at this time. Bargains will be hard to find and this makes stock selection even more important in portfolio construction.

The outlook for the Australian economy is steady. Annual employment growth fell 2.9% in October from 4.2%. While unemployment remains at a long term low of 5.0%, the decline in employment growth is another indicator of a healthy slowdown in an economy which has experienced exceptional growth.

Also, although a decline in household spending was experienced in the September quarter, the outlook for household consumption remains positive. Previous Government tax cuts have increased household disposable income and the RBA has left interest rates unchanged at 5.50%. Oil prices falling to below $US60 a barrel in the first week of November will also be a positive contributor to consumer confidence.

Brendan Gallagher and Winnie Butt

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