Tam­ing a mort­gage the size of Africa

Afore­cast prop­erty bust raises fears about neg­a­tive eq­uity

Weekend Herald - - MARY HOLM -

The Herald re­ported this week that there is a 40 per cent chance of the New Zealand prop­erty bub­ble burst­ing in the next two years. This sounds a lot like the roulette table, when you bet on red or black — or the flip of a coin. You could lose a lot if it goes against you

prop­erty bust wouldn’t mat­ter if you are mort­gage- free. Your prop­erty goes down like ev­ery­one else’s, so you could still sell and move if you wished. How­ever, if you have a mort­gage the size of Africa, what hap­pens then? What would you ad­vise?

Have a cuppa, sit tight, and in some cases watch your pen­nies.

The 40 per cent comes from global in­vest­ment bank Gold­man Sachs. It looked at the ra­tios of house prices to rent and house prices to house­hold in­come, as well as house prices ad­justed for in­fla­tion, in the coun­tries with the 10 most- traded cur­ren­cies in the world.

“Us­ing an av­er­age of these mea­sures, house prices in New Zealand ap­pear the most over­val­ued, fol­lowed by Canada, Swe­den, Aus­tralia and Nor­way,” it said. “Ac­cord­ing to the model, the prob­a­bil­ity of a hous­ing bust over the next five to eight quar­ters is the high­est in Swe­den and New Zealand at 35 to 40 per cent.” The first thing to note is that fi­nan­cial fore­casts are of­ten wrong. Just this past week, Re­serve Bank as­sis­tant governor John McDer­mott said in a speech, “More of­ten than not, the world does not turn out as we forecast.” Note that he didn’t say some­times, but more of­ten than not.

Sec­ond, Gold­man Sachs de­fines a bust as house prices fall­ing 5 per cent or more af­ter ad­just­ment for in­fla­tion. A 5 per cent drop wouldn’t be too up­set­ting for most of us — although of course the drop could be much big­ger.

Even so, as you say, those with a low or no mort­gage haven’t got much to worry about. If you’re plan­ning to sell in Auck­land and buy some­where cheaper — as our next cor­re­spon­dent did — and prices drop more in Auck­land than else­where, you’ll be worse off.

But most peo­ple in that sit­u­a­tion will still do pretty well.

Of course, it’s more of a con­cern if your house be­comes worth less than your mort­gage, so you have what’s called neg­a­tive eq­uity. But even then it’s okay if you keep pay­ing down your mort­gage, prefer­ably faster than you have to. Af­ter a while, prices are sure to sta­bilise and then rise again.

Our graph shows how volatile New Zealand house prices are. They have fallen no fewer than five times over the past three decades. But they al­ways re­cover.

The big worry is if you can’t meet your mort­gage pay­ments — keep­ing in mind that mort­gage rates could well rise. If you’re forced to sell for less than your mort­gage, you’ll end up with no house and a debt to the bank. Ugly.

With that in mind, own­ers of homes or rental prop­er­ties with Africa- sized mort­gages would be ad­vised to live more fru­gally — per­haps cut­ting back on travel, cars, clothes or en­ter­tain­ment — and at­tack your mort­gage. Talk to your lender about com­mit­ting to larger reg­u­lar pay­ments to get that bal­ance down.

If you’re re­ally wor­ried, con­sider trad­ing down now to a cheaper home — or sell­ing a rental prop­erty. But don’t panic. Des­per­ate sellers do badly.

Mean­while, let’s not over­look those who are strug­gling to buy a house, or have given up. Fi­nally, things might be look­ing up for them.

Pig­gy­back­ing on Su­per

I am re­tired and still in KiwiSaver. I’m pig­gy­back­ing on the wife’s Su­per till 2019 when I’ll be 65. Since I joined, in 2009, I’ve gone 100 per cent with a growth in­vest­ment.

I re­tired in 2014 and we sold our Auck­land prop­er­ties and live in a small Waikato town with a cou­ple of rentals, all debt- free.

I con­trib­ute the min­i­mum to KiwiSaver to get the tax re­bate. Since the sum I ac­cu­mu­late is never go­ing to be huge ( cur­rently $ 28,500), should I stick with growth to max­imise the amount I do get? Most peo­ple your age would be in a lower- risk KiwiSaver fund. They plan to spend the money soon, and don’t want to take the risk that, right when they with­draw their money, the markets are down.

In your case, though, I can see two pos­si­ble other sce­nar­ios:

You’re get­ting enough in­come from your wife’s Su­per and the rental prop­er­ties, so you don’t ex­pect to spend the KiwiSaver money within the next 10 years or more.

You might spend the money sooner, but it doesn’t mat­ter hugely if the bal­ance has fallen. If you’re short, you can al­ways sell a rental. So you’re pre­pared to take a punt. If ei­ther of those ap­plies, stick with the growth fund. There are no guar­an­tees that will max­imise your amount, but it’s a good bet.

Ac­tive in­vest­ing

In­ter­est­ing to read NZ Su­per Fund chief ex­ec­u­tive Adrian Orr’s re­cent opinion piece in the Herald. This must be one of the bet­ter ad­ver­tise­ments for ac­tive in­vest­ing.

He says, “The fund has also sig­nif­i­cantly out­per­formed a sim­ple pas­sive fund- equiv­a­lent ( our ref­er­ence port­fo­lio) by $ 5.5 bil­lion, and did so by get­ting more re­turn per unit of risk than the pas­sive al­ter­na­tive. The data on re­turns, bench­marks, and in­vest­ment risk ap­petite is on the fund’s web­site.” Do you have any com­ment on Mr Orr’s anal­y­sis?

Sure do. But first, to put this in con­text, I have for years rec­om­mended long- term in­vest­ing in a pas­sive or in­dex fund, which in­vests in the shares or bonds in a mar­ket in­dex. This is cheaper than ac­tive in­vest­ing — where the fund man­agers choose what to buy and sell — so pas­sive fees are lower.

Every year maybe half ac­tive man­agers do bet­ter than in­dex funds and half do worse. But only a small num­ber keep out­per­form­ing year af­ter year. And It’s prac­ti­cally im­pos­si­ble for an or­di­nary in­vestor to judge in ad­vance which they will be. Given the fee dif­fer­ence, it’s bet­ter to stick with in­dex funds.

More back­ground: the NZ Su­per Fund was set up to help pay the ris­ing costs of NZ Su­per in the decades to come. The Gov­ern­ment put in money from 2003 to 2009, and is sched­uled to restart con­tri­bu­tions from 2020/ 21. The fund is worth a lit­tle more than $ 34 bil­lion.

Okay, now for your ques­tion. Adrian Orr made that state­ment in re­sponse to com­ments that, “NZ would be bet­ter off man­ag­ing the NZ Su­per Fund as a pas­sive fund.” Soon af­ter, Orr’s chief in­vest­ment of­fi­cer, Matt Whin­eray, re­sponded to the same com­ments in more depth. And you may be sur­prised at what he says, as fol­lows: “Ac­tive in­vest­ing is dif­fi­cult and not worth do­ing in many markets, and we agree that ac­tive in­vest­ing costs more.

“This is why the ma­jor­ity of the fund is man­aged pas­sively — twothirds is in­vested in line with an in­dex- linked ref­er­ence port­fo­lio. This is a di­ver­si­fied growth port­fo­lio ( 80 per cent shares, 20 per cent bonds) that is fully im­ple­mented pas­sively at a low cost.” In short, most of the Su­per Fund is pas­sive.

But, adds Whin­eray, “Ac­tive in­vest­ment has some big ben­e­fits: in our case, it al­lows us to in­crease di­ver­si­fi­ca­tion and fully utilise our nat­u­ral ad­van­tages. As a re­sult, we have earned sig­nif­i­cant re­wards with lit­tle ad­di­tional risk.” He then quotes two of the Fund’s “rel­e­vant in­vest­ment be­liefs”:

“True skill in gen­er­at­ing ex­cess re­turns ver­sus a man­ager’s bench­mark is very rare. This makes it hard to iden­tify and cap­ture con­sis­tently.” As I said above, it’s dif­fi­cult to pick long- term ac­tive win­ners.

“In­vestors with a long- term hori­zon can out­per­form more short- term fo­cused in­vestors over the long run.” The Su­per Fund has an un­usu­ally long hori­zon. It’s ex­pected to sup­ple­ment NZ Su­per pay­ments over many decades start­ing in the mid2030s. The fund’s size is ex­pected to peak in 2071. Whin­eray says the fund’s ac­tive in­vest­ments fit into three broad cat­e­gories.

“The first con­tains in­vest­ments that help di­ver­sify the fund’s port­fo­lio. Ex­am­ples in­clude our New Zealand tim­ber and ru­ral as­sets. These in­vest­ments ex­ploit the fund’s long in­vest­ment hori­zon and known liq­uid­ity pro­file.”

In the sec­ond cat­e­gory, “which also ex­ploits the fund’s long in­vest­ment hori­zon”, the fund buys as­set classes that are rel­a­tively cheap — such as shares dur­ing the global fi­nan­cial cri­sis — and sells what looks rel­a­tively ex­pen­sive.

The third cat­e­gory “con­tains in­vest­ments that rely on the abil­ity to se­lect in­di­vid­ual as­sets that will out­per­form rel­e­vant bench­marks. This is what is usu­ally re­ferred to by de­trac­tors of ac­tive in­vest­ment. We agree with the con­tention that pick­ing stocks in ef­fi­cient markets is a zero- sum game ( what one man­ager gains, an­other loses, and ev­ery­one pays fees). This is why we use very lit­tle of this type of ac­tive in­vest­ing and, where we do, it is fo­cused on spe­cific op­por­tu­ni­ties where there is per­sis­tent ev­i­dence of mar­ket in­ef­fi­ciency.”

My com­ments? In the first cat­e­gory are in­vest­ments that aren’t avail­able in pas­sive funds. In the sec­ond and third cat­e­gories, NZ Su­per Fund man­agers make judg­ments that most in­vestors are ille­quipped to make. And even the fund gets it wrong some­times. Note, too, that the fund does “very lit­tle” in the third cat­e­gory.

Whin­eray adds, “Ac­tive in­vest­ing, within well- de­fined con­straints, is both pru­dent and com­mer­cial for an in­sti­tu­tional in­vestor with a long hori­zon and the dis­ci­pline to stay the course.”

Many in­di­vid­ual in­vestors have nei­ther. They ex­pect to spend at least some of their money within a decade or two. And they grow un­easy when an in­vest­ment per­forms badly, and move their money at the wrong time.

So is the Su­per Fund’s per­for­mance “one of the bet­ter ad­ver­tise­ments for ac­tive in­vest­ing,” as you put it?

If any­thing, it’s the op­po­site. Most of its in­vest­ments are pas­sive. And the rest are ei­ther in as­sets such as tim­ber or they are the re­sult of so­phis­ti­cated de­ci­sion mak­ing by an ex­tremely long- term, dis­ci­plined in­vestor — a very dif­fer­ent in­vestor from most New Zealan­ders.

Forex trad­ing woes

For your cor­re­spon­dent last week in­quir­ing about forex trad­ing, here are a few facts from an ex­pe­ri­enced trader. I have been trad­ing real money for 3 ½ years and I’m not prof­itable yet.

There is an over­whelm­ing amount of mis­lead­ing in­for­ma­tion on­line, and there are many bro­kers ready to trade di­rectly against their clients.

My first two years as a trader cost me plenty, and I have spent the past year un­learn­ing what I learnt in the pre­vi­ous two years.

My men­tor re­cently wrote about trad­ing your real money ac­count like it was a demo ac­count, and how you would see a big im­prove­ment in re­sults if you take emo­tions out of the trade.

You may pass my de­tails on to your cor­re­spon­dent, as I have spent weeks re­search­ing this sub­ject and per­son­ally have had some bad ex­pe­ri­ences in the past.

Thanks, but I’ll skip your kind of­fer. I’m hop­ing the reader has de­cided against trad­ing for­eign ex­change af­ter the read­ing I sug­gested for him. And your let­ter hardly boosts the case for trad­ing.

You sound op­ti­mistic that you’ve now learnt how to trade prof­itably. But I doubt if any­one can trade in­vest­ments — as op­posed to buy­ing and hold­ing — with­out get­ting emo­tional. Please don’t put good money af­ter bad.

Mary Holm is a free­lance jour­nal­ist, a di­rec­tor of the Fi­nan­cial Markets Author­ity and Fi­nan­cial Ser­vices Com­plaints Ltd ( FSCL), a sem­i­nar pre­sen­ter and a best­selling au­thor on per­sonal fi­nance. Her web­site is www. mary­holm. com. Her opin­ions are per­sonal, and do not re­flect the po­si­tion of any or­gan­i­sa­tion in which she holds of­fice.

Mary’s ad­vice is of a gen­eral na­ture, and she is not re­spon­si­ble for any loss that any reader may suf­fer from fol­low­ing it. Send ques­tions to mary@ mary­holm. com or Money Col­umn, Pri­vate Bag 92198 Vic­to­ria St West, Auck­land 1142.

Let­ters should not ex­ceed 200 words. We won’t pub­lish your name. Please pro­vide a ( prefer­ably day­time) phone num­ber.

Sorry, but Mary can­not an­swer all ques­tions, cor­re­spond di­rectly with read­ers, or give fi­nan­cial ad­vice.

Pic­ture / Michael Craig

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