US economic recovery to be retarded by headwinds, leading American economist Dr Martin Feldstein tells ACFS audiences

Posted on March 18, 2011
Filed Under Banking, Financial Institutions and Markets, Event News, Media Release, Policy | Leave a Comment

In addresses this week to the Australian Centre for Financial Studies in Melbourne and Sydney, renowned Harvard academic Dr Martin Feldstein said that it was unlikely that the United States would achieve growth much above 2% in 2011. Recent consumption-led growth was unsustainable due to pent up demand and a run down in savings.

Moreover, Dr Feldstein identified four headwinds to US economic recovery in 2011.

1. The withdrawal of fiscal stimulus. As the stimulus had been “badly designed” and poorly targeted the detraction from growth would be less than feared. However, the individual states are also cutting back spending and raising taxes.
2. Rising oil prices. A $US30 per barrel price increase could take ¾% off GDP.
3. House prices across are falling again. 30% of all homes with mortgages are underwater with negative equity. More people are likely to walk away from their homes.
4. A major period of refinancing of non-prime regional commercial real estate is likely to require significant write-downs and may stress the undercapitalised community bank sector.

A former chief economic advisor to President Ronald Reagan and a member of President Obama’s Economic Recovery Advisory Board, Dr Feldstein identified a major medium term risk as rising real interest rates. At 1% US real rates may be unsustainably low and could rise as high as 3% given the rising public debt and the need for continuing offshore funding of US deficits.

Dr Feldstein stated that, contrary to popular wisdom, the US could not expect to inflate its way out of its problem as most of its debt is short term; higher inflation would very quickly be reflected in higher market interest rates. Moreover, the issue for US with China may not be China’s trade surplus. Rather a greater issue within five years may be when wages and consumer spending rise, and savings rates fall, that China could move into deficit and no longer be a net buyer of US government securities.

Dr Feldstein said there was some reason to be optimistic about US public debt. He detected a growing bipartisan resolve in Washington to reduce subsidies and strip out costs from health care and social security. However, further quantitative easing (“QE3”) was unlikely except in the case of “a massive downturn”.

In conclusion, Dr Feldstein noted that in the US “the failure of supervisors to do their jobs” was “a key reason” for the financial crisis but he was encouraged by reforms concentrating US bank supervision with the Federal Reserve.

ACFS Director Prof Deborah Ralston stated that “we are delighted to welcome a visitor of Dr Feldstein’s calibre.  As an outstanding academic and one of the world’s 10 most influential economists, he brings keen insight to public debate.” Part of the ACFS brief is to elevate the contribution of finance academics to public policy in Australia.

About the Speaker:
He is currently the George F. Baker Professor of Economics at Harvard University, and the president emeritus of the National Bureau of Economic Research (NBER). He served as President and Chief Executive Officer of the NBER from 1978 through 2008. From 1982 to 1984, Dr Feldstein served as chairman of the Council of Economic Advisers and as chief economic advisor to President Ronald Reagan.  He has also been a member of the Washington-based financial advisory body the Group of Thirty since 2003.

He is among the 10 most influential economists in the world according to IDEAS/RePEc. He is the author of more than 300 research articles in economics and is known primarily for his work on macroeconomics and public finance. He has pioneered much of the research on the working mechanism and sustainability of public pension systems.

“On February 6, 2009, Dr Feldstein was announced as one of U.S. President Obama’s advisors on the President’s Economic Recovery Advisory Board”. “A well-known figure on the Harvard campus, Dr Feldstein taught the introductory economics class “Social Analysis 10: Principles of Economics“ (commonly referred to as “Ec 10″ by Harvard students) for twenty years …. Ec 10 was routinely the largest class at Harvard.” ( Source: Wikipedia)

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Media contact details:
Professor Deborah Ralston
Director, Australian Centre for Financial Studies
(03) 9666 1050
info@australiancentre.com.au

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Jeremy Duffield appointed Chair of the Australian Centre for Financial Studies

Posted on March 8, 2011
Filed Under ACFS Governance, Media Release | Leave a Comment

The Board of Management of the Australian Centre for Financial Studies (ACFS) is pleased to announce that Jeremy Duffield has agreed to become its new non-executive Chairman effective immediately.

Jeremy retired in December as Chairman of Vanguard Investments Australia after a 30-year career at The Vanguard Group.  He founded Vanguard in Australia in 1996. It now manages over an $80 billion investment portfolio.

Duffield is currently a member of the Australia Financial Centre Task Force. He was previously deputy chairman of the Investment and Financial Services Association Limited (IFSA) and served on the Federal Government’s Financial Sector Advisory Council (FSAC), and on the Advisory Board of the Financial Literacy Foundation.

“We are absolutely delighted that Jeremy has decided to join us at a time of great opportunity and challenge for our Centre”, said Professor Deborah Ralston, Director of ACFS.

Duffield is widely admired for successfully transplanting Vanguard’s indexed investment products, its process and its culture to Australia and for making Australia a base for export of financial services into the Asia-Pacific region.  Furthermore, Duffield is credited as an architect of Vanguard’s retail strategy in the US in its early days and was until he retired a key advisor to current management on global strategy.

“Jeremy’s great depth of experience in financial services as well as his international industry and policy-maker connections will be invaluable to the Australian Centre in achieving and exceeding its ambitious goals” added Ralston.

Duffield takes over the chairman role from Syd Bone, Chief Executive Officer of CP2 who continues as the Centre’s deputy chairman with a special focus on building ACFS connections in Sydney. In announcing his own decision Bone noted that the timing was right and that “I am very happy to be able to hand the baton as chairman over to Jeremy while continuing to work with him on key ACFS agendas.”

Ralston commented that “this is a win-win outcome for all concerned. We greatly appreciate all that Syd has done for us as chairman over two years and are grateful that he will be able to continue the work with us on strategic issues and as our representative in Sydney.”

Ralston concluded, “Furthermore I believe that Jeremy’s strong and current connection with US industry and academic circles will help ACFS in raising the bar on academic research quality particularly around investment markets performance.

ACFS is committed to ongoing enhancement of both the quality of Australian financial and business research, as measured by the Excellence in Research in Australia framework, and also to raising its effectiveness as an aid to the international competitiveness of Australian financial services business.

ACFS was established six years ago with the mission to provide a bridge between the academic community, government and the financial services industry. ACFS is known as the publisher of the Melbourne Mercer Global Pension Index, as producer of the annual Melbourne Financial Services Symposium and as a generator high quality research and comment across banking, insurance and funds management.

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Media contact details:
Professor Deborah Ralston
Director, Australian Centre for Financial Studies
(03) 9666 1050
info@australiancentre.com.au

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Off-Market Share Repurchases: Policies Wanted!

Posted on March 4, 2011
Filed Under Banking, Financial Institutions and Markets, Financial Regulation Discussion Paper Series, Policy, Publications | Leave a Comment

FRDP 2011 – 01
March 3, 2011

In this ACFS Discussion Paper, Professor Kevin Davis notes a resurgence of interest in (and controversy about) off-market share repurchases and asks what has happened to changes proposed in 2009 to the tax treatment of such transactions. Of two major proposed changes, one has significant merit and warrants introduction, while the merits and benefits of the other is less obvious.

Off-market share repurchases (buy-backs) have been a significant form of corporate capital management in Australia in recent years. Between 1996 and 2008 there were over 80 such buybacks which returned around $27 billion of cash to participating shareholders. While there was little activity during 2009 and 2010, there are expectations of considerable use of buybacks during 2011, with BHP having announced a $5 billion buyback in February, and Woolworths having completed a $700 million buyback in October 2010.

These transactions are not without their critics, with the main issue of contention being whether they involve equitable treatment of shareholders (and an associated question of whether they are consistent with legal requirements for such treatment). The reason for these concerns lies in the way such transactions are structured enabling substantial tax benefits to be passed to shareholders who participate in the buyback. While that appears to disadvantage non-participating shareholders, competition for these tax benefits leads to the buyback price determined in the tender process being below the current market share price, which is a benefit to non-participants.

In May 2009, a Board of Taxation study of off-market repurchases(1)  was released by the then Assistant Treasurer, with an announcement that the Government planned to introduce legislation to implement the six recommendations of the study. Two of those recommendations were particularly significant, and would have substantially changed the way in which such transactions are conducted – and most likely have reduced their attractiveness to companies and shareholders as a way of distributing surplus cash and franking credits.

A Treasury discussion paper(2) outlining possible legislative changes was released on June 1, 2009, however, no legislative action has yet occurred on this front and buybacks are still operating under the old arrangements.

At least one of two major changes proposed then has merit, and should be implemented as soon as possible, while the other is more contentious.

Off-market buybacks are conducted as tender offers in which the payment made by the company comprises a small amount of capital repayment with the remainder taking the form of a franked dividend. Tax rulings mean that participants in the buyback thus get substantial tax benefits from a capital loss (their purchase price less the small capital repayment component) and from dividend franking credits attached to the dividend component.

Consequently, such buybacks occur at less than the current market price of the shares through competition in the tender for the associated tax benefits arising from selling into the tender. They are particularly attractive to shareholders on zero or low income tax rates (such as superannuation funds), and there is much attention paid to the prospect of such buybacks in the financial advice industry. For shareholders on high marginal tax rates, participation is not worthwhile. (While the capital loss for tax purposes is valuable, there is additional tax to be paid on franked dividends, which makes selling at a below-market price unattractive).

This tax-based discrimination against shareholders on high tax rates has led to concerns about equitable treatment of shareholders and the consistency of such buybacks with requirements that companies should treat all shareholders equally. In effect, the argument is that valuable franking credits are being syphoned to one group of shareholders to the detriment of others.

The shortcoming of this argument is that non-participating shareholders benefit from the below-market price at which shares are repurchased from participants. Thus, both participants and non-participants benefit at the expense of the taxpayer from the realisation, rather than deferral of tax benefits available to the company and its shareholders.

This prompts two questions, answers to both of which would have been affected by the lost tax changes. First, why is there this unusual tax treatment allowing participants substantial capital losses for tax purposes? Second, are the benefits equitably shared between participating and non-participating shareholders?

One of the proposed tax changes was to remove the ability of participating shareholders to claim a tax loss for tax purposes. That would have substantially reduced the appeal of off-market buybacks and led to much lower repurchase price discounts to market price for those which occurred.

Is that an appropriate change? Arguably not. The existing tax treatment can be thought of as equivalent to a partial wind-up of the company involving return of capital (which should not be taxed) and retained earnings (and associated franking credits). Even though the current shareholder may not have contributed capital, having bought shares on-market from previous holders at a higher price than the original issue price, those individuals would have paid capital gains tax on receipts – some part of which correspond to the return of capital in the buyback. But that interpretation is open to challenge and this question warrants greater analysis and discussion.

The second proposed change was to remove the 14 per cent maximum discount to current market price which the ATO effectively imposes on buyback prices. Almost all recent buybacks are constrained by that maximum discount, as is obvious by the substantial scaling back of applications.

Recent research(3) indicates that without the constraint the average discount would have been around 21 per cent. Non-participating shareholders would thus have been better off – because shares were bought back at lower prices.

The 14 per cent discount limit (seemingly plucked out of the air by the ATO) thus means that the distribution of the total tax benefits is biased towards participants in the buyback. Even though these are low tax rate investors, many of them are self managed superannuation funds of well endowed investors.

Removing the 14 per cent discount limit thus is an obvious policy change which should be resurrected from wherever it is languishing. The other proposal (to preclude capital loss tax claims) is in a different category, and warrants further debate. Of course, if it were to be implemented, the 14 per cent limit would, because of the reduced attractiveness of buybacks, most likely become irrelevant.

With the resuscitation of corporate interests in off-market buybacks, it is important to clarify the tax arrangements sooner rather than later, and resolve debates about equitable treatment of shareholders which will otherwise resurface.

This FRDP was prepared by Kevin Davis, Research Director, Australian Centre for Financial Studies and Professor of Finance, University of Melbourne.
info@australiancentre.com.au

(1) The Board of Taxation The Tax Treatment of  Off-Market Share Buybacks, June 2008
http://www.taxboard.gov.au/content/content.aspx?doc=reviews_and_consultations/off_market_share_buybacks/default.htm&pageid=007
(2) The Treasury, Discussion Paper: Improving the taxation treatment of off-market share buybacks
http://www.treasury.gov.au/documents/1550/PDF/Discussion_Paper_off_market_share_buybacks.pdf
(3) Christine Brown and Kevin Davis Tax Heterogeneity and Stock Supply Elasticity: Evidence from Australian Off-Market Repurchases.

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The Financial Regulation Discussion Paper Series provides independent analysis and commentary on current issues in Financial Regulation with the objective of promoting constructive dialogue among academics, industry practitioners, policymakers and regulators and contributing to excellence in Australian financial system regulation. More in this series

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ACFS announces winners of Investment Stewardship Awards & Victorian Innovation in Funds Management Award at Melbourne Financial Services Symposium Gala Dinner

Posted on March 1, 2011
Filed Under Event News, Funds Management & Superannuation, Media Release, Melbourne Financial Services Symposium | Leave a Comment

Both VFMC Investment Stewardship Awards for a Fund Manager and a Super Fund Awards were presented by CEO of Victorian Funds Management Corporation Justin Arter at the 2011 MFSS Gala Dinner last night.

The winner of the 2011 VFMC Investment Stewardship Award for Investment Managers is Goldman Sachs Asset Management & Partners Australia.

The judges felt that Goldman Sachs Asset Management & Partners Australia met all of the selection criteria, combining consistent top quartile performance with a rigorous discounted cash-flow valuation and portfolio construction process risk-adjusted for ESG considerations. ACFS Director Prof Deborah Ralston remarked that “in a market where there is now an array of specialist advisors advising on all aspects of risk, including ESG, our winner does much of this research itself. This firm has demonstrated a high degree of engagement with both investors and companies in which they invest, and have been excellent stewards of their clients money while taking into account the long term.”

The winner of the 2011 VFMC Investment Stewardship Award for Superannuation Funds is Care Super.

ACFS Director Prof Deborah Ralston commented that “CareSuper have long demonstrated good stewardship”. An early signatory of the PRI they are ranked in the top quartile Asset Owners by the United Nations’ Principles for Responsible Investment (UNPRI). “They have consistently ranked in the top quartile of its peer group of funds over 1, 3, 5 and 10 years. And Care is renowned for its service quality”. She also noted recent product innovation with an ASX 200 investment option and by offering enhanced income protection insurance to members

Ralston added, “Pleasingly, we had a record number of entries this year and each of our finalists in both categories of the Investment Stewardship Award is a current signatory to the UNPRI. It is clear that among the best investment managers and super funds, the UNPRI is now a base standard. Furthermore, sustainable investing is not a passive process. Most of our finalists were also able to demonstrate a track record of direct and indirect engagement with companies and assets in which they invest”.

Finally, a number of our finalists were able to demonstrate that their performance of the past 3 years has been enhanced by decisions that flowed directly from implementation of the PR.

The winner of the Victorian Innovation in Funds Management Award is La Trobe Financial Services with their Pooled Australian Mortgages Fund. The Award was presented by the Honourable Kim Wells MP, Treasurer of Victoria.

In acknowledging the winner Prof Ralston noted “they could not be more Victorian in their pedigree, having been established in the Latrobe Valley in the 1950s. LaTrobe is 100% owned by the son of its founder and the fund submitted for the Award has been in operation for two decades.”

“It is different to many other mortgage funds in that it did not freeze redemptions in 2008/09, and this has assisted it to outperform all peers over 1, 3 and 5 years. Despite the recent issues in mortgage investments during the GFC, no investor with La Trobe has lost funds.”

“The core of its innovation is that since 2004, it has had in place a 12 month term for initial investment which has kept out hot money inflow and outflow. This attention to basics is admirable.

“La Trobe is a true boutique in the sense that it operates in a niche of good quality, but non-standard, high margin, not easily securitized loans. In the competitive global world of investing, innovation is a key to productivity growth and to sustainable business.”

Judges decided to offer a special commendation to Wingate Asset Management which is owned by its managers in partnership with Australian Unity and Wingate Group.

Wingate is still small but the judges were impressed by the risk-controlled option-based implementation strategy employed by the management. “This strategy is one of the most innovative seen in recent years and appears to be validated to date by solid performance.”

“The productive investment of our domestic superannuation and savings will be critical to the ability Australians to continue to grow our wealth and to protect our standard of living in retirement. And if we are also able to export that expertise by managing other people’s money from here, then all the better.”

“It is desirable that such well paid skilled work is done close to the source of that saving and that is one reason that the Victorian government kindly sponsors the Innovation in Funds Management Award.

Background

The MFSS Investment Stewardship Award is sponsored by Victorian Funds Management Corporation with one each provided for separate Investment Manager and Superannuation Funds categories. Applicants for the 2011 VFMC Investment Stewardship Award were assessed on their investment performance, governance, risk management, investment philosophy, service quality, and product innovation, and critically the degree to which they actively embedded consideration environmental, social and governance factors into their investment processes.

Applications for the Innovation in Funds Management Award sponsored by the Victorian Government were invited from Fund Managers that: Were established in Victoria; Are predominantly owned and managed by the management team; Can demonstrate a three year investment track record.

Applications for both awards were screened under strictest confidentiality, by Judging Panels of experienced finance professionals both chaired by highly respected industry veteran John Gall. 2011 MFSS sponsors were NOT eligible to apply.

The Melbourne Financial Services Symposium (MFSS) is hosted by ACFS on behalf of the Victorian financial services community. The Symposium together with the Gala Dinner is considered the premier annual event for the Funds Management industry in Melbourne and was held on Tuesday 1 March at Park Hyatt Melbourne. Dinner speaker was Else Bos, Deputy-chairman Executive Committee, Chief Institutional Business at PGGM, Netherlands.

For more details on the MFSS: www.melbournefinancialservicessymposium.com.au/

Media contact details:
Professor Deborah Ralston
Director, Australian Centre for Financial Studies
(03) 9666 1050
info@australiancentre.com.au

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