Home | Newsletter | Business and Services Directory | FAQ | Advertise | Contact Us | Disclaimer

Investment Opinion from John Townsend

• Investing While Living in Germany, Yes You Can
• Investment Opinions - May 2010
• Investment Opinions - February 2010

Investing while living in Germany, Yes you can!

Germany has a strong investment culture, with products ranging from the excellent to the downright dubious; so much so that an investment here should be seen as an entrepreneurial exercise with 'investor beware' as a constant and very serious watchword.

It is often useful to use a 'platform' to administer German investments. Investors always retain the ownership of their assets, but the collection of dividends and payments from stocks, bonds and funds is automated and efficient. Above all, the annual costs of using a platform are low.

US citizens can invest in stocks, bonds and funds as long as they do so via a platform that is willing to make the necessary income reports to the IRS. Most German organisations refuse to do this, being wary of the penalties for making an error or omission. There are however enough professional platforms available to US investors residing in Germany to be able to make a considered selection.

Seeking advice on investments

The tradition in Germany has long been to buy financial products from one of the very many banks here. An investor must be aware of the risks involved in using this source of advice and product. The German commercial and savings banking system is an efficient sales machine, lacking the strong controls or serious supervision from central authorities and happily unencumbered by any but the most minimal consumer protection laws.

Those bank employees with direct customer contact are often judged for the furtherance of their careers by their ability to sell their employers' financial products. Banks have mainly their own and a small selection of other products available for sale to customers; in our experience of unwinding unsuitable investments, these products are placed with clients with scant regard paid to their suitability. It should also be remembered that banks can afford better and more expensive attorneys than most of their customers and the enforcement of investors' rights could be a long drawn out and expensive process.

Very often, depending on an individual's credit worthiness, a bank will suggest extending a loan to allow an increase in the investment in that bank's fund products. Unless a desire for risk lies prominently in mind of an investor, such leveraging should be resisted, as any losses are directly for the client's account and a leveraged position loses money at a much faster rate than simply using available funds.

Some investment advisors are biased, whether legally or emotionally, to the products of a single fund company (or KAG). The emotion all too often has a direct correlation with the level of front end fees paid to the agent. This is fine if an investor knows precisely which stocks, bonds or funds they want to invest in, but is less useful when seeking independent advice. Investor and consumer protection legislation is less advanced in Germany than in many other countries; the result is that an investor can receive assurances that stand little or no chance of becoming reality.

Independent advisors undertake their own analyses of an investor's ability and willingness to take risks, as well as using quantitative and qualitative methods to find the most suitable investments. They will provide an investment concept based on matching the clients' needs with suitable investment products and will give this report in writing for the investor to consider. We strongly recommend that if an investment advisor is unwilling to commit their thoughts to paper by providing such a written concept, a potential investor should look elsewhere.

Beware of popular products with names such as Riester, Rürup or Basis-Rente, which are all too often sold as tax saving vehicles, but are in reality long-term pension products, offering no access to invested funds until you reach the age of 60. If a foreign investor leaves Germany, the funds have to be left behind to accumulate until they mature and will then be paid out only as a life-time annuity.

Investment products to consider

There is a risk ladder which offers broad guidance on investment products for investors of different temperaments; the investment markets should only be used by longer term investors and a time horizon of less than 3 years runs the risk of falling between adverse market cycles. There is no good reason to risk capital losses within a short investment time horizon.

From the least risky to the most adventurous:

• Cash savings plan / Bank deposit with a bank covered by the government guarantee scheme
• Guaranteed pension plan or deposit with an insurance company
• Investment or mutual funds - ranging from Risk Category 1 (the least risky) to 5 (potentially a wild ride)
• Closed-ended funds, (Geschlossene Fonds) with a finite maturity date and all too often a distinct entrepreneurial risk*
• Direct investments in Government subsidised long-term projects
• Investment in residential property
• Zertifikate - certificates or instruments using derivatives to reflect movements in indices or markets
• Hedge funds / Private Equity investments

*Recent changes in German law require an investor to receive an up to date prospectus, which sets out the risks and opportunities of the fund; the potential investor should normally be asked to sign a declaration that the prospectus has been received, read and the risks understood. All prospectuses have to be approved by the German authorities (BaFin) as far as the structure of their contents is concerned. This has ABSOLUTELY NO reflection on the viability of the fund or the chances of it meeting any of its financial goals.

Taxation

Successive governments have worked hard to close the loop-holes that their predecessors might have thought a good idea. Sometimes the volte-face can be retroactive, which causes consternation, but normally there is fair warning of impending changes. Many tax laws have not been as carefully drafted as one might have hoped, with the result that the courts rather than the government end up as the final arbiter of what was intended, and tax laws being newly interpreted.

On 01 January 2009, Germany introduced a 25% investment tax which encompasses all capital gains and income from investments entered into after that date. The change was preceded by a fanfare of new products, but in the end came at the same time as the worst economic crisis in living memory, resulting in a muted response from investors whose portfolio values had fallen so far that it would be some time before a capital gain could become a meaningful prospect. All new investments will however be subject to the new tax structure.

There is an annual 801 Euro (1602 Euros for a married couple) tax allowance on income stemming from interest and investments; this can be divided up between institutions, but the tax authorities seriously object to any attempt at exceeding the overall allowance and the punishments can be painful and are well worth avoiding.

There are some, though very few, exceptions to the general dearth of tax sparing schemes. For instance double taxation agreements between Germany and several other countries, resulting in potentially useful tax allowances or an investment in property. It is important that all foreign investors considering an investment in any German investment market should consult a tax specialist before making a decision.

A tax consultant in Germany, ever mindful of their potential professional liability, will not normally give an opinion on the economic viability of a project, but will give a confirmation (or denial if necessary), of the stated tax implications of an investment.

Basic principles of investing in Germany

1. Treat all complex schemes using multiple products with suspicion; they are rarely designed to be in the best interests of the investor.
2. There are no rules governing the promise of abnormally high returns to potential investors; if an investment scheme sounds too good to be true, it probably is.
3. Beware of imprecise claims regarding the returns from an investment. The magic words 'Chance auf', all too often followed by a very high percentage yield, are almost always based on an improbable combination of events; if the goals are indeed ever achieved, it is probably due more to accident than design.
4. Without regard to your own political views, it pays to be financially conservative.
5. Always consult an independent advisor and insist on receiving a copy of all documentation, including a record and risk analysis of your needs and wishes, an up to date prospectus and any application forms. You will need these in case of a dispute.
6. Investors have a two week cooling-off period after the signing of an application form. This is your right, you should be aware of it and use it if you feel even remotely uncomfortable with a suggested investment.
7. Always spread your investment risks, ideally never having more than 10% of your portfolio with any one fund or strategy, irrespective of the product.
8. Guarantees are only as good as the company that issues them.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de

John Townsend’s Investment Opinions - May 2010

If you keep your eyes so fixed on heaven that you never look at the earth, you will stumble into hell. (Austin O’Malley 1858 – 1932)

The PIIGS (Portugal, Ireland, Italy, Greece and Spain) are causing enough concern to make ill-informed commentators run around like headless chickens, with everyone pointing fingers at everyone else. It is reminiscent of the panic over swine flu. In fact Ireland and Spain have already taken severe economic measures to reduce their own economic vulnerability; Italy, though with fragile public finances, will probably survive as it is and Portugal - a small economic power - looks potentially vulnerable if the crisis worsens and will find increasing difficulty in raising new debt and refinancing existing debt at affordable levels.

It is Greece that is causing deep concern; it is only a tiny economy, but it has used the European financial and economic structures, based on German economic strength, to amass very heavy debts from which it cannot now escape.

From the beginning, the Greek government was less than honest in setting out its true economic position. The entry qualification for Greece to join the European Currency was that Greek debt should not exceed 3% of national GDP. Despite official assurances that this limit had not been breached, in truth the debts had never been close to being that low. This fact was actually reported widely in the financial press at the time, but the European Leaders at that stage were keen to ignore it.

Once in the Euro, Greece – and the other countries of Europe – was able to take advantage of the market’s belief that Europe equated Germany and any European government debt was in fact virtually German debt. The interest rates and yields on Greek paper closely followed those of Germany as money from investors poured in. If Greek paper yielded a few basis points more than German Bunds, so much the better; it was still safe as houses.

The markets forgot; Europe is not Germany, the European Central bank is no Bundesbank and the Euro is not the Deutsche Mark. In normal times no one noticed; however in times of crisis, after it had become clear that a number of countries had used the debt markets to fund their economic growth (Ireland and Spain) or simply their inefficient and corrupt domestic economies (Greece), the picture changed and the structure began to come apart at the seams.

European leaders, with the assistance of the International Monetary Fund, have cobbled together a rescue package of up to 110 billion Euros in order to help Greece restructure its public debt. This was the absolute minimum necessary and may still not be enough. The plan, which bends or breaks existing European charter agreements by allowing the ECB to accept low grade Greek bonds as collateral, requires a deep fiscal retrenchment in Greece, with cuts being forced upon those people who can least afford them and only questionably touching those whose corruption, for instance in the form of highly paid phony jobs in dubious governmental organizations, helped to drain the economy of its already borrowed money.

Greece, as long as it sticks to the agreements, will face years of economic hard times with an 11% cut in its GDP over 3 years and a sharply shrinking economy.

It is worth remembering that in levying taxes as in shearing sheep; it is as well to stop when you get down to the skin.

European support is vital; the problem is not only financial, it relates to a crisis of confidence in the entire region. History shows that crises of confidence are far more difficult to repair than fiscal problems. However as long as Germany provides support over the next 2-3 years, the price of short-term Greek debt will recover.

Interestingly, the new package will require Portugal, Spain, Ireland and Italy as well as all the other European countries to provide support for Greece. This comes at a time when they are trying to reduce their own debts.

It would surely be better to follow the thesis in a paper published on 19 April 2010 by Professor Nouriel Roubini, in which he suggests the implementation of what he describes as an immediate plan B; this would include;

1. A debt restructuring for Greece and the southern Euro zone countries,
2. Far reaching structural reforms of the European financial system,
3. A larger IMF / European Union programme to help Greece and prevent the financial contagion of the other weak regional countries,
4. Further monetary easing by the ECB (even at the risk of short-term inflation),
5. Fiscal and domestic stimulus in Germany to help power the European Economy and,
6. A coordinated effort to address the institutional weaknesses of Europe’s economic and monetary union.

Similar restructurings are not new; Russia faced similar measures in 1998, Mexico in 1994 and Argentina in 2001 – 2002, in fact there are many parallels between Argentina then and Greece today. The Asian Financial crisis of 1997 rocked the financial world, but it is precisely these countries and their currencies that are now desired investments. Memories are indeed short.

The ratings agencies have been accused of exacerbating the Greek crisis by downgrading Greek, Portuguese and Spanish debt. This is nonsense; the agencies followed the financial markets’ recognition that Greek debt was ever more dangerous and it consequently traded at ever lower prices (and therefore ever higher yields). They reflected reality, but were not the cause of the problem.

It is certainly possible that a new European Monetary structure will in time emerge; formed by northern countries, leaving the Mediterranean countries to fend for themselves and decline. Such a new currency would roughly equate the old Deutsche Mark and have immediate credibility.

Get your facts first; then you can distort them as much as you please – Mark Twain

The German press has been focusing on the problems of domestic property funds and a knee-jerk political reaction to them in the form of proposed new legislation. Sadly, a number of the facts are completely wrong.

The property funds that have had problems are mainly closed ended funds aimed at financial institutions. These funds were highly leveraged, for example; a fund with investors’ money amounting to 10 million Euros could borrow another 90 million Euros to buy commercial property. If the property value were to fall by 4% or 4 million Euros, the loans would remain the same, so the investor’s funds would fall to 6 million Euros, a decline of 40%.

Open-ended property funds (Offene Immobilien Fonds), especially those of high quality, are radically different. Of the 4 funds (out of a possible total of now 55) used in our portfolios, all are well managed and stable. Their leverage is very small or nonexistent and their property selection is professional and selective. Therefore a decline in the value of their property portfolio would be minimal in effect. The current annual returns on these funds are between 3.7% and 5%. They continue to be a source of stability for the foundation of a conservative portfolio.

Elsewhere, in China, the central bank is attempting to pull back on the debt-fuelled development surge by restricting the Chinese banks’ overall lending.

In Asia as a whole a number of problems persist. For instance:

• Asian Infrastructure. The market expects money to be made there, but just as no-one made money building canals in Britain or railroads in the US, so little money is to be made building railways in China or expensive toll roads for the relatively few cars outside the region’s cities. The return on capital is likely to be low and infrastructure investment is probably best left to the state sector.
• Chinese Banks were felt to be too aggressive in lending to the property sector, with too many resulting hotels, offices and other white elephants. There will clearly be non-performing loans and these are slowly becoming apparent. They should not in the medium term be enough to de-rail Chinese growth.
• China needs to stabilize its economy – recent central bank action has moved in this way - but the economy needs to become still more consumer driven.
• Chinese consumption is growing, but not as fast as the investment markets there. Most capital is being used to fund state-owned companies in their building of infrastructure projects, which is fine as long as the expected returns are minimal.
• Capital allocation is very inefficient and is still based on political rather than economic decisions.

The Asian markets are complex, with India probably a better investment at this stage than China, though both countries have seen an inflow of capital and maybe short-term over- expansion. Volatility is however a necessary part of achieving acceptable returns and therefore investors should always seek out the best and most experienced fund managers, who know how to judge and act on the risk. At the same time, the most stable results in an otherwise unstable market will probably come from expatriate companies active in Asia.

Countries such as Australia, which were largely unaffected by the crises of the past 3 years, have begun to raise interest rates; this is the beginning of a trend in which the fight to control inflation will become ever more necessary. Investment portfolios need to be positioned to meet this danger, but bond funds are necessary for stability and therefore funds specializing in short duration bonds need to play a bigger role.

Portfolios now need to be much more diversified than in the past, with safety being found in conservative and risk adjusted asset allocation. The days of a 5, 6, or 7 fund portfolio have to be a thing of the past. The 10% rule, where no fund or manager or indeed strategy should account for more than one tenth of an entire portfolio should be tightened in the direction of 5%. Volatility is growing, but will affect the European markets most. There is value to be found in the recovering US and the Far East, but with higher risks than before. Safety can be found in carefully diversifying uncorrelated markets. There is volatility ahead, but also potentially good returns.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de

Investment Opinions - February 2010

Very few things happen at the right time and the rest do not happen at all; the conscientious historian will correct these defects. – Herodotus, Greek historian 484-425 B.C.

The financial crisis which began in 2007 and peaked in March 2009 has not yet ended; much progress has been made in restructuring the western world’s banking system and more progress will be made; however the process of debt reduction, especially in the households and companies of the USA and the UK is slow and painful and will probably cost the existence of many more companies and probably US regional banks.

Government assistance to the banks in the USA and Europe, for instance using the TARP or Quantitative Easing schemes has only partially had the success that was intended. Unemployment in the US is still high, with the suggestion that because of the way data is recorded, true unemployment in the US may be almost 17% instead of the official 10%. The banking system has not expanded its lending to companies and retail clients; instead government assistance has turned into deposits with the central banks which have increased to previously unreached levels. There is a practical logic in this for the banks themselves of course, though it was not the intention of the governments who had hoped to encourage economic growth.

The pendulum which went too far into positive growth before 2008 then fell back too far into negative territory during the crises. Markets have since seen a movement again from the panic situation of 2007 and 2008. This was a correction to an excess, not a sign of a fundamental improvement.  While 2009, after a poor start, proved a good market for those investing in higher risks, this was a market reaction and may not be sustainable. If anything, the pendulum swings in 2010 and 2011 will probably become shorter and more unnerving.

I do not believe in the theory that the second half of 2010 will suddenly be more difficult; even the first half of 2010 will be difficult and volatile. The year will undoubtedly see high volatility in the investment markets, but the overall trend will still be positive. The doom mongers, especially those seeking publicity, will talk of a forthcoming second part of a ‘double dip’; one has to ask where volatility ceases and a new low from the second dip starts. I believe we will see many more dips in coming years as investors react to news which they may or may not understand.

Looking back at the economic crisis and stagnation which affected Japan starting almost 30 years ago, lessons have to be taken to heart. The Japanese government then tried to revamp the domestic economy with a number of support measures, only to cease its support too early, thereby allowing the economy to weaken again. This cycle happened three times. Banks needed to be restructured and digest their bad (mainly domestic) debts. They ceased to lend, further strangling economic growth. In an interesting parallel with China today, the Japanese banks had been tacitly encouraged to lend to unprofitable and inefficient companies by the Japanese government. When the crunch came however, the government could not be turned to for support; the banks then had to digest these losses themselves, a process which took several years, ensuring that an inefficient and politicized banking system was forced to contract by merger.

There will be a real danger of these cycles being repeated in the US and Europe if support programmes are withdrawn too quickly.

China’s 2009 fourth quarter growth rate, announced at 10.7% shows a clear trend, even if the figure itself, coming from a centrally planned system, is probably not entirely accurate. There is a danger in this growth; the Chinese government is encouraging domestic banks to lend to domestic companies apparently without much concern about logical capital allocation or the future strength of the loans. This encourages short term growth, but there will necessarily be a series of bad credit based crises in the future, meaning that investors’ Chinese exposure should be very carefully analysed and kept to conservative levels, with an expectation of boom and bust cycles. Such exposure should not be for the faint-hearted.

China’s demand for raw materials, especially iron and copper, remains strong. Rising per capita income, especially in China and India, raises demand for dental and healthcare (in particular), but also for cars, domestic appliances, meat consumption and travel. Demand has already risen and will continue to do so, with supply being expected to outstrip demand for some years to come.

Not all Asian countries are the same, either in terms of economics or politics. One thing is clear; the economies of China and India in particular are strong and growing; some other, smaller, regional countries such as Vietnam have nowhere near this level of economic strength and can be relied upon for some economic chaos in coming years. Investors should focus on those fund managers who have many years of experience and a successful track record in this very complex market.

In the USA, consumer spending still accounts for 65% of GNP. With declining levels of lending leading to (sometimes enforced) deleveraging, I expect the effect on US growth rates to be inevitable. At the same time, the USA has a history of issuing debt and then devaluing the dollar. Well over half of Chinese foreign currency reserves are in US Dollars, mainly treasury paper. The question is how long foreign investors will be willing to accept this structure without demanding higher yields and probably a more stable currency base such as an updated SDR – the existing IMF composite currency.

Despite expected high market volatility, I firmly believe in the slow growth of the global economy in the next 2-3 years. Industrial indicators, seen for instance in growing demand for copper, iron and other raw materials and  their resulting price increases, show that corporate de-stocking as a whole has now largely finished and that production is resuming. But the picture is not homogenous, some industries and countries are moving forward, others, such as in Eastern and South Eastern Europe are not.

There are three kinds of lies: lies, damned lies and statistics. Mark Twain, quoting British Prime Minister Benjamin Disraeli, 1804 – 1881.

The end of 2009 produced the inevitable flood of claims from public investment companies that their products were at the top of their peer groups over one, three, five or 10 years. These claims are all too often spurious. A fund that looked good over 5 years often had one or two excellent years and then a catastrophic recent history. Equally, a fund that looked good over the past 12 months, may just have had only a single year’s luck. In any event, raw statistics should never be believed without thorough investigation. A minimum three year successful track record under the same manager and a minimum 100 million Euros in volume will also not only show the manager’s skill, but at the same time ensure that the costs of managing the funds are not carried by too few investors.

The investment environment will be volatile for some years to come as governments and major companies restructure their policies and produce varied results. I strongly recommend saving on a regular basis, ideally monthly. A savings plan will take advantage of the cost averaging effect and will in the medium and longer term be effective in combating the damage done by volatile markets. A regular monthly savings plan, will often yield a higher end return over 5 years than the same overall amount of money invested in one amount.

An investment portfolio which reflects the dangers of 2010 should allocate money as broadly as possible, normally with a maximum of between 5 and 10% of the entire portfolio amount in one fund or strategy; this a reduction of my 2009 limits. It is important to be invested in the market at all times. A number of past studies have shown that there are on average between 20 and 22 profitable days in any one year; if these days were to be missed, a portfolio of funds would be unlikely to make much of a profit for the entire year.

Asset allocation is the key for a secure portfolio in a volatile market. Analysis will show which peer groups have a limited correlation with each other. Careful quantitative analysis will show the top funds in each suitable peer group. Qualitative analysis in turn will show which of the funds and fund managers have, or lack, credibility despite their peer group rankings. Thereafter it is up to experience to make a final selection of well managed and uncorrelated funds  Equities, especially blue chip companies, despite their inherent volatility, will be a useful to combat inflation. While it is important to be in these markets, the overall exposure to the equity sector in a portfolio should ideally be controlled to limit exposure to falling markets. On the other hand, with rising interest rates ahead, bond funds should be selected with a concentration on short durations.

Chinese and Indian equity funds and indeed South East Asian equity and short duration debt and currency funds which include China, should form a small but definite part of the portfolio; small because of the risks inherent in a new and volatile market, yet definite because of  the long term importance of these markets. Emerging markets are a source of potential profit and yet equally carry the potential of unacceptable losses. This sector is potentially important and the selection of skilled and experienced fund managers is therefore essential.

Raw materials and commodities will necessarily be important and potentially profitable in the year to come; but these sectors also have their extremes of volatility (which is why I have and will not recommend that my clients invest directly in Gold). However those funds that invest in companies that produce, transport, or process commodities and raw materials should have a great future.

Currency risk is to be avoided whenever possible; Euro based investors should avoid the US Dollar in particular, but also other non-Euro currencies. I have to assume that my clients do not normally wish to speculate in the currency markets with their money; it is therefore safer to avoid this particular risk.

The yield spread between Euro government bonds issued by Germany or France on one side and the weak or mismanaged economies of Greece, Spain or Ireland on the other is widening. It may well be that Greece could in time be excluded from the EU, the others requiring help from the European Central Bank. In the meantime the profitability of these investments will suffer. It is best to avoid them at least until stability has been restored.

Open ended property funds are also an excellent source of stability for an investment portfolio. There are 69 such funds on the German market, in truth some absolutely dreadful. The top funds and managers are however essential to a stable portfolio.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de