Profile Blog

 

As markets continue to be wax and wane due to ongoing coronavirus fears and subdued employment and economic recovery numbers, it seems timely to remind ourselves of the types of behavioural and emotional biases that could lead to potentially risky investment behaviour, and how you can avoid them.

 

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As human beings we are not well wired for the rational, dispassionate approach that economists love to think of as “normal”.

Loss aversion

Loss aversion refers to a bias in human psychology where we tend to prefer avoiding loss than acquiring equivalent gains. The principle here is that we'd rather not lose $100 than to gain $100. We tend to focus more on what we might lose, rather than on what we might get. The fear of loss can often reduce our ability to stay the course.

This was evident during the period of market volatility in late March, which saw some investors cashing out in a bid to protect a portfolio's existing value. By realising those losses at that point in time, it meant that those same investors were less likely to have benefited when the Australian sharemarket quickly moved back and regained much of those initial losses.

A way of addressing this is to frame your portfolio gains and losses as wide as possible and over a long term horizon and not take a narrow view at one point in time. For example if you focused on just your Australian share investments you had an emotional roller coaster ride through March/April. But what would it have looked like if you total portfolio view – including international shares, bonds and even your home in your total portfolio view.

Vanguard's Index Chart illustrates the value of a longer-term approach well with historical data showing that markets fluctuate from year to year but those who ignore the emotional swirl of short-term market conditions are inevitably rewarded for their patience and discipline in the long term.

Confirmation bias

This bias entails looking for information that supports our beliefs or choices. And during an ongoing period of market volatility, it can be particularly tempting to start thinking about changing your investment behaviour and in the process, seek out information that we think will help us make better investment decisions in the short term.

But consider this – we are told that the world is bracing for a second wave of coronavirus infections but in the same breath, we are also told that there is an 80 per cent chance of a vaccine before year's end. Would you sell your investments now to avoid another market correction because you are convinced that a second wave of infections is on its way, or would you hold on to your investments because you know for sure that a vaccine is almost here?

The reality is, we have no way of knowing which of the two scenarios will eventuate. Actively seeking out information that confirms your thoughts on any of the scenarios, or subsequently ignoring any data that suggests otherwise and then making an investment decision based on current information, is likely to hinder rather than help achieve your investment goals.

Again, the challenge is to be disciplined and stay the course and understand what you can – and what you cannot – control. In keeping to the investment strategy that you have carefully put in place – one that will endure in both the boon of a bull market and the stress of a bear market – you're still on track to achieve your investment goals over your investment horizon.

Herd behaviour

According to the best minds in psychology, herd behaviour is particularly relevant in the domain of finance and has on occasion, represented a major cause of speculative bubbles. During the March market volatility, it was not uncommon to hear many declare that now is the best time to invest in technology-related shares because they were booming or to invest in the health sector because a vaccine is imminent.

Are you buying bonds and moving into cash because your well-meaning uncle who's not far off from retirement advised you to do what he did, or are you buying equities because your much younger neighbour is convinced that this is 'the way to go'?

Rather than follow the crowd when making investment decisions that impact you alone and not the herd, you should take into account your unique circumstances and investment goals when executing on your strategy.

One strategy that you could deploy during volatile times is to spread your investments over a certain period of time. Rather than time the markets, you could instead try the dollar cost average method by putting regular contributions towards your investments until you get to your target asset allocation.

Cognitive biases are often hard to detect because they occur so naturally but learning and recognising how they can affect your decision making, especially in times of uncertainty, will be useful for every investor. And remember, this is much easier to do if you have taken the time to create an investment strategy tailored to your own risk appetite and investment objectives.

Understanding that we are all subject to biases as an investor is a powerful argument for the value of having a written financial plan that captures why you are investing and what are your personal goals. Then at times of market stress it can be retrieved from the filing cabinet (either real or digital) and used to either adjust or simply stay on course, accepting there may be well be some rough weather ahead.

 

 

Robin Bowerman
Head of Corporate Affairs at Vanguard.
16 June 2020
vanguardinvestments.com.au

 

 

As the 2019–20 financial year draws to a close, a technical expert has highlighted some of the new rules commencing for super funds for the 2020–21 financial year.

 

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For the 2020–21 financial year, SuperConcepts executive manager SMSF technical and private wealth Graeme Colley said the two main changes are the abolition of the work test for those aged 66 and 67 years old and the extension of spouse contribution for those aged between 70 and 75 years.

Mr Colley noted that the industry is still waiting for a change in legislation that will allow access to the “bring forward” rules.

“We remain waiting with anticipation for the extension of the bring forward rule to the age of 67 years to become law when Parliament resumes in the next few months,” he said.

He also reminded SMSF professionals and their clients that the 50 per cent reduction in the minimum pension rate for account-based pensions, due to the COVID-19 pandemic, will continue to apply for the 2020–21 financial year.

Work test changes

Up until 30 June 2020, Mr Colley explained there was no need for a member to satisfy a work test for personal concessional and non-concessional contributions before reaching the age of 65.

“However, once they reached 65 years of age in the financial year, a work test of 40 hours in 30 consecutive days was required to be met at any period during that year, and prior to the contribution being accepted,” he said.

“Providing the work test is met in a financial year, personal concessional or non-concessional contributions can be accepted up to 28 days after the month in which the person reaches the age of 75. However, there are exceptions to the work test where personal contributions are made in the year after ceasing work, or for purposes of downsizer contributions.”

From 1 July 2020, it will be possible for those under the age of 67 years to make personal contributions without needing to satisfy a work test, he explained.

In the financial year a person reaches the age of 67, personal contributions can be made prior to reaching 67 years old. However, a work test must be met at any time during the financial year prior to the contribution being made.

Spouse contributions

Up until 30 June this year, it was only possible to make spouse contributions up until the age of 70 years, Mr Colley said.

Between the ages of 65 and 70 years, the spouse was required to meet the work test of 40 hours in 30 consecutive days for the year in which the contribution was made.

“However, from 1 July 2020, this has now been extended to apply to spouse contributions made between the age of 67 years, and 28 days in the month after the spouse reaches 75 years old, which puts it in line with other personal superannuation contributions,” Mr Colley said.

“The work test must be met prior to the spouse contributions being made to the fund.”

Reduction in minimum pensions for account-based pensions

In late March 2020, Mr Colley said the government amended the minimum percentage required to be paid for account-based pensions by 50 per cent.

“This meant that account-based pensions, transition to retirement pensions, and market-linked income streams would have their minimum pension percentage reduced by 50 per cent for the 2019–20 and 2020–21 financial years,” he said.

 

 

Miranda Brownlee
29 June 2020
smsfadviser.com.au

 

 

SMSF clients planning to provide rent reductions to tenants should review the lease agreement to ensure the provision of rent relief won’t result in a breach of the lease, says an industry lawyer.

 

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Townsends Business & Corporate Lawyers solicitor Jonathan See explained that where an SMSF and its tenant have agreed to a reduction in rent, there are some important steps in implementing and documenting the relief.

It is important, Mr See said, to review the fund’s trust deed to ensure that there is nothing in the deed that could prevent the rent relief being agreed to by the trustee.

“Although it is very unlikely, because the deed is the fund’s rule book, the trustee must be able to say that they have checked the deed and confirmed that it contains no impediment or condition in relation to such a rent relief agreement,” Mr See said.

It is also vital for the trustee to review the lease to ensure the proposed rent reduction will not result in the lease being breached.

“The lease agreement governs the lease relations between the landlord and tenant, so any decision made in respect to the lease must be made pursuant to it,” he said.

“If there are no rent relief provisions, the parties are advised to vary the agreement to include such provisions allowing the rent relief. Although the regulations do not state that parties vary the lease, similar regulations in Victoria require the parties to either vary the existing lease or enter into a separate agreement.”

Varying the lease is important, Mr See added, as it provides an opportunity for parties to agree on the terms of the rent relief so long as it is in line with the regulations and helps clarify the terms of the rent relief actually agreed upon between the parties.

It also provides stability and control of the parties’ respective situations and prevents ambiguity or misunderstanding that could lead to potential disputes, he said.

“The rent relief provisions should contain the matters agreed by the parties such as documents to support a request for temporary rent reduction including proof of loss of income, manner of calculating the temporary rent amount, period when the temporary rent amount applies, treatment of accrued rent arrears as a result of rent relief, resumption of the original terms of the lease once COVID-19 is over, and other matters considered necessary to give effect to the rent relief,” he stated.

“Once the commercial lease agreement allows for the rent relief, the trustee can implement the agreed rent relief. As SMSF trustees have a basic obligation to keep a record of all its transactions, the trustee must ensure that it properly documents the rent relief.”

Although not mandatory, the SMSF client may also want to consider a registration of the variation of lease, he said.

“Registration gives the lease a legal status and recognises the rights of a tenant,” he explained.

“If somewhere down the track the fund decides to sell the commercial property during the lease period, the new owner will be bound to respect the lease and its variation, especially the rent relief.”

 

 

Miranda Brownlee
01 July 2020
smsfadviser.com.au

 

 

It's a natural question about global policymakers' multitrillion-dollar efforts to prop up economies and markets against the monumental threat of the COVID-19 pandemic. And the question has understandably taken a back seat to confronting immediate health and welfare challenges.

 

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Now, as economic activity reemerges even as daily new confirmed cases of the virus top 100,000, we can start to address how governments can pay back their debts.1 For developed markets, at least, the situation may be less dire than some fear.

A rational response

It first may make sense to touch upon just how rational policymakers' moves have been. The more than $9 trillion in spending, loans, and loan guarantees that the world's largest economies have committed to countering the negative effects of the pandemic, while extraordinary, speak to the uniquely consequential nature of the challenge.2

A multitrillion-dollar global fiscal commitment

The illustration shows various countries’ outlays to battle the effects of the COVID-19 pandemic, by percentage of debt to gross domestic product, broken down by spending and revenue measures and by loans, equity, and guarantees. The figures are as follows: Mexico 0.8% of GDP for spending and revenue measures, 0.3% of GDP for loans, equity, and guarantees; China, 2.5% and 0.0%; Brazil, 2.9% and 4.2%; Canada 5.2% and 3.3%; United States, 6.9% and 4.2%; Australia, 10.6% and 1.9%; France, 0.7% and 13.9%; United Kingdom, 3.1% and 15.7%; Japan, 10% and 10.4%; Italy, 1.2% and 32.4%; and Germany, 4.4% and 29.6%.

Note: The bars show announced fiscal measures in selected G20 countries as a percentage of GDP.
Source: International Monetary Fund, as of May 13, 2020.

Few have disputed the potential for serious, long-lasting economic harm in the absence of such programs. That, alongside recognition that such outlays are unlikely to recur and the structuring of much of the fiscal response as loans rather than grants, makes such bold moves more palatable.

Loans and equity stakes can be thought of as government investment in those assets. Thus, any increase in debt from those disbursements could be reversed as those equities are sold or as the loans mature, except for a small percentage of possible bankruptcy losses. According to the International Monetary Fund, more than half the total fiscal response in the largest developed and emerging economies belongs to these categories.

To be sure, instituting such policy in the face of blaring headlines about triple-digit debt-to-GDP ratios requires steely conviction. For the group of major developed economies, the debt-to-GDP ratio jumped 24 percentage points in about two months. In comparison, a similar increase in global debt in response to the 2008 global financial crisis took two years to play out. The average debt level for this group of countries sits at 154% of GDP.

The fiscal math behind debt sustainability

The illustration shows the percentage of debt to growth domestic product for selected countries from 2005 through mid-2020, when the average level after fiscal measures to battle the effects of COVID-19 stood at 154%. The illustration further shows three scenarios. Scenario 1 represents “grow the way out of debt, baseline growth”; Scenario 2 represents “grow the way out of debt, modest growth”; Scenario 3 represents runaway budget deficits.

Notes: Countries included in the calculation are Australia, Canada, France, Germany, Italy, Japan, Spain, the United Kingdom, and the United States.
Scenario 1 represents 4% nominal GDP growth, an average 10-year yield of 1.2%, and a 2% budget deficit.
Scenario 2 represents 3% nominal GDP growth, an average 10-year yield of 1.2%, and a 2% budget deficit.
Scenario 3 represents 3% nominal GDP growth, an average 10-year yield of 1.2%, and a 5% budget deficit.
Source: Vanguard calculations based on data from Thomson Reuters Datastream.

As striking as those figures sound, most policymakers and market participants understand that debt sustainability—the cost of servicing debt compared with economic growth—is far more important than the cold, hard headline number. In that respect, although the health shock led to unprecedented emergency spending, our low-interest-rate environment is a favorable backdrop. It's more than conceivable that developed-market economies can grow out of their newfound debt.

With solid yet realistic growth rates in coming years as economies bounce back from pandemic-induced contractions, we could see debt in these economies returning to pre-COVID levels by the end of the decade (Scenario 1 in the figure above). Moreover, even more muted growth assumptions are enough to put debt on a sustainable downward trajectory, thanks to the sub-1% 10-year yields at which governments are issuing their debt (Scenario 2).

Although fiscal consolidation—raising taxes, cutting spending, or both—is the tried and true method for tackling debt challenges, these scenarios don't depend on draconian assumptions. Only modest fiscal austerity, in the form of budget deficits not larger than 2% or 3% of GDP, is required alongside modest growth to reduce debt-to-GDP levels. But some fiscal discipline is needed; runaway deficits won't work. Not even sub-1% yields would be sufficient for a grow-out-of-debt strategy if fiscal deficits remained systematically above 3% (Scenario 3).

What about central banks?

Central bank actions over the coming months and years will also have important implications for developed markets' debt arithmetic. In fact, everything central banks are doing to help their economies right now increases the odds of a sustainable debt scenario going forward. Although explicit coordination between monetary and fiscal policy would violate the sacrosanct principle of central bank independence, the reality is that the massive monetary accommodations in most developed markets in response to the pandemic will help significantly from a debt perspective.

Beyond policies of zero or negative interest rates, central banks will need to adopt forward-guidance frameworks. Global financial markets no doubt will respond better if they know what's coming. The U.S. Federal Reserve, for example, will need to put a forward-guidance framework in place as soon as the U.S. economy starts to move from contraction to expansion, which Vanguard's base case foresees occurring in the second half of 2020. Guidance could be timeline-driven, or it could depend on data outcomes such as when unemployment falls back toward more typical levels or when inflation rises toward targets around 2% in most developed markets.

Higher inflation could be beneficial, if central banks can finally achieve it. In normal conditions, higher inflation doesn't help with debt reduction because bond markets eventually catch up through higher interest rates. But in rare circumstances like wartime spending or disaster responses, such as in this COVID-19 crisis, higher inflation can erode the value of one-off debt.

Of course, the greatest condition of all is the pandemic's progression. A second wave of infection that requires another round of national lockdowns is a worst-case scenario—from both health and economic standpoints—that we unfortunately can't rule out. On the other hand, a sooner-than-expected development of a vaccine or indications that we've achieved herd immunity would accelerate recoveries.

I don't mean to suggest that everything is rosy. Recovery will take time and be uneven, coming later to sectors that depend on face-to-face interaction. And while our view on developed markets is sanguine, our outlook for emerging markets—which we don't foresee being able to simply grow themselves out of debt—is far more challenging. But considering where we've been in recent months, just being able to discuss recovery in present terms offers promise.

 

 

World Health Organization COVID-19 Situation Report 146, June 14, 2020.
2 International Monetary Fund data as of May 13, 2020.

 

 

Roger Aliaga-Díaz
Chief Economist for the Americas
23 June 2020
vanguardinvestments.com.au

 

 

Several new links have been added to the many already in this article, links that date back to the beginning of the COVID-19 pandemic.  If you have any questions, or require further assistance, please send us an email or phone.

 

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Please click on the following links to access a wide range of Covid-19 related guidelines and resources for both Federal and State Government initiatives. Once done, click on the X (top right) to close the article and you'll return to this list. NB: Internet links are often altered by the source which means some of the following might not link properly. Ongoing testing is done to try and ensure this problem is minimised.

 

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