With the return on Australian shares expected to be in the single digit figures for the next decade, many investors are looking for ways to add some extra Alpha to their portfolios. Alpha is the extra gain you get by beating the market average. It comes from active risk or stock selection.

The thing is, for every win which produces Alpha return, there is someone who has made a corresponding loss. So if you add the net outcome from all active investors in the market place an amazing thing happens - the Alpha disappears. There is no such thing as net Alpha.

Beta, on the other hand is the average market return. This is what passive or index investors receive. Passive investing essentially means waiting for the dust to settle after all the active investors have made their play and then copying the average of all their portfolios.

Alpha is what gets active investors, fund managers, financial planners and stock brokers really excited. The challenge for investors seeking Alpha is to ensure that they are on the right side of a transaction more often than on the wrong side. To achieve this an investor needs to make good fund or stock selections. This is where quality research is very important.

In recent years, fund managers have been creating less and less Alpha as is
demonstrated by the following graphs. One of the key factors in this phenomena are the constraints that are placed on investment managers by corporate management, government regulators and the market. Most of the constraints on fund managers are necessary and important for the minimisation of risks but some constraints actually limit performance and tend to remove alpha. This leads to a flattening out of performance.

One of the key constraints that impacts on a manager’s ability to create Alpha is the “no shorting” constraint. Most investment funds only allow the manager to hold a “long” position. This simply means that by buying and holding an investment the manager has a positive view about it. If the manager considers a share to be highly overvalued, it can exclude it from the portfolio or reduce the holding. It cannot employ a strategy that would enable it to benefit from the identified overpricing.

“Short selling” means using options to make a gain when a stock falls. That is, selling investments for an agreed price now and delivering on the sale at a later time when the price has fallen.

There are times when, riding on positive investor sentiment, a company’s shares become clearly overvalued. It is on these occasions that a manager using short selling strategies can make a gain. Sometimes the opportunities are quite obvious but only those managers that can short sell will be able to benefit.

Financial Keys recently attended a presentation by Bob Litterman - Director of Quantitative Resources at Goldman Sachs Asset Management, New York. Analysis conducted by Bob and his team has shown that if a manager can short sell up to 40% of their portfolio and match that with a corresponding long position, a significant increase in Alpha can be gained within reasonable risk parameters. The benefit is further enhanced where a wider investment universe is selected.

Backing their convictions, Goldman Sachs J B Were have recently launched a series of long/short funds titled Global Flex Funds. They are not the only managers espousing this view. We recently ran an article on the Platinum range of funds. Platinum is an Australian based manager that also runs long/short funds with considerable success.

We support an approach where quality managers based on sound analysis and research can act on their convictions and target higher returns using well defined shorting strategies as part of a broader portfolio of holdings. We will include such funds in our more growth focused portfolio recommendations and will offset the higher risk through portfolio diversity.

Andrew Condell

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Maybe it’s me but it seems everywhere I look these days there are more babies and expectant mothers. My observations were confirmed when I read that the birth rate in Australia has risen following the introduction of the Governments maternity payment. After the recent birth of my second child I thought it would be time to revisit an area that we often discuss with our clients – how can your financial plan cater for a growing family.

Budgeting
Raising a child is an extremely expensive exercise. To give your child the best opportunities in life you need to plan ahead. There are day to day living costs, medical costs, home renovations, future child care and education costs. When a parent leaves the workforce to look after their children, the level of household income will be reduced. It’s important to budget for the expected reduction in income and the increase in household costs, with a view to ensuring that the household lifestyle is adjusted to within the household means. Planning is the key.

Investment Issues
The cost of raising children, particularly if you are considering private schooling is incredibly high. In order to save for the cost of education or other financial requirements for your children, many parents take the opportunity of setting up a long term investment plan. This is typically a regular investment plan in to managed funds or insurance bonds. Investment gearing (borrowing to invest) is another popular investment strategy for long term investing for education.

Government Benefits
Parents should make themselves familiar with any social security benefits they may be eligible for, including Maternity Payment, Maternity Immunisation Allowance, Family Tax Benefits, Child Care Benefit and Parenting Payment.

Insurances
With children comes dependency, and it is important to re-evaluate the parent’s life insurances prior to the birth. Often parents will have a significant mortgage at the time of childbirth.

It is very important to ensure there is death cover in place for both partners and income protection insurance for the working partner (it is also worth noting that income protection insurance is tax deductible). Parents should also consider total disability and/or trauma cover to provide additional protection against unforeseen tragedies. Contact our office and we can provide quotations for these insurances. Private health insurance is also an important consideration.

Taxation
Where one partner in a couple is out of the workforce for any length of time, this may provide an opportunity for income splitting, and therefore a reduction in tax. This may involve placing income generating investments in the name of the non-working partner (you will need to be aware of any capital gains tax implications). In addition, where possible any tax deductible expenses, such as donations, should be made in the working partner’s name.

Non-working parents should also remember that franking credits on dividends are fully refundable where the taxpayer does not have a tax liability in a particular year.

The arrival of a new baby also may herald the arrival of significant medical bills. A medical expense rebate of 20% is available to taxpayers where more than $1,500 is spent on non-reimbursable medical expenses for the family.

Other rebates that may be available are the dependent spouse rebate, the low income rebate and the rebate for a spouse super contribution.

The impending birth of a child should also serve as a reminder for parents to review and, where necessary, adjust their wills and any powers of attorney.

Brendan Gallagher


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The US economy slowed in late 2005, however both the US and Japanese economies are showing signs of strong growth in the current year. In Australia, the record 15 years of economic growth continues, albeit at a slower pace than recent years.

In the US, recent economic growth has been hampered by weaker consumption following Hurricane Katrina. Indicators for early 2006 are positive. Job growth in the US has been strong with unemployment falling from 5.4% 12 months ago to 4.9%. One concern in the US is the housing sector, with some commentators predicting a bursting of the US house price bubble, as experienced in the Australian and UK markets.

As expected, the US Federal Reserve raised interest rates to 4.25%, the 14th successive increase since June 2004. This was the final meeting chaired by Alan Greenspan, and was also significant due to a signalling of the possible softening of future rate rises.

News from Europe isn’t as positive with German unemployment rising and retail sales falling in December. In contrast, German business confidence as measured by the German IFO, rose. Elsewhere in Europe indicators are more positive.

In Japan, signs are very positive with output and consumer spending increasing and unemployment falling. The internet based conglomerate, “livedoor”, embroiled in controversy, led a three day shock on the Nikkei. Since then however the Japanese market has continued its rise (more than 40% in the past six months).

In Australia, despite a slowing in the rate of economic growth in the later half of 2005, signs for 2006 are positive, with Gross Domestic Product expected to increase from 2.7% in 2005 to 3.2% in 2006. Although interest rates remain unchanged during the past few months, the domestic residential housing market continues to soften.

The Australian sharemarket enjoyed a very strong start to the year with a 3.6% increase for the month, with commodity based firms and banks leading the way.

Overall, the global economy is well placed for continued growth in 2006.

Brendan Gallagher

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Super splitting has arrived!

ATO clarifies treatment of Workforce Pensions!

The ability to split super contributions between spouses is one of the most significant changes to super law in recent times delivering substantial benefits to couples that continues throughout retirement.

The ATO has removed doubt surrounding the use of transition to retirement pensions, also known as workforce pensions. This paves the way for strategies that allow employees to substitute employment income for pension income before retirement delivering significant tax savings. The benefits can also apply to the self employed.

Super Splitting
The Super Splitting legislation has now been passed with the details as follows:

• It is optional for super funds to offer splitting. Members will have to check with their respective funds, however with super choice it should not be difficult to find a fund offering splitting.
• Splits take place via a transfer from one spouse’s account to another.
• Only contributions made on or after 1 January 2006 may be split.
• Members can elect to split contributions made during a given financial year after the conclusion of that financial year by completing the relevant form obtainable from their superannuation fund.
• Splitting applications can be made from 1 July 2006 at the earliest.
• The member’s spouse receiving the transfer must be aged less than their relevant preservation age (from age 55 to 60 depending on their date of birth) or aged between their preservation age and 65 years, but not permanently retired.
• Up to 85% of deductible contributions (including SG, salary sacrifice, personal deductible or allocated surplus amounts) can be split.
• Up to 100% of undeducted contributions can be split.

Super splitting can deliver significant ongoing tax savings to couples in retirement as 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);

In addition, super splitting also provides a further mechanism for the financial security of non working spouses.

Transition to Retirement Pensions
The transition to retirement legislation allows over 55’s to access their super benefit before retirement in the form of a non-commutable pension. This can provide a useful income supplement for those wanting to phase in retirement and wind down their working activities. It also provides an opportunity for those still committed to the workforce to increase salary sacrifice or deductible super contributions and make up the shortfall with “lower taxed” pension income.

In our August Quarterly Newsletter (www.financialkeys.com.au) we calculated that employees on a $200,000 salary can add over $7,000 of tax savings to their super account by starting a non-commutable pension of $78,350 and salary sacrificing the maximum allowed, $100,587. In this example the employee’s net income remained unchanged. The tax savings result from the difference between the marginal tax rate of 48.5% and the 15% rate applied to super contributions.

This strategy is available to employees and the self-employed who are over 55. To implement this strategy employees need to roll their superannuation benefit into either a non commutable term allocated or allocated pension (by completing their superannuation fund’s transition to retirement pension application form) and enter into a salary sacrifice agreement with their employer. It is important to note that salary sacrifice agreements have to deal with prospective income entitlements and can not apply retrospectively. Also some superannuation funds may not offer transition to retirement pensions.

For the self employed personal deductible contributions should be made as they cannot salary sacrifice.

As always its important to get advice before acting so please give us a call.

Patrick Hegarty

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