Mid Semester Exam

Question 1

what is financial planning?

Answer 1

Financial planning is a process whereby a client’s financial position is analysed and a set of strategies / recommendations put in place through a financial plan (Statement of Advice) with a reasonable basis that will assist the client in meeting their goals and objectives.
* Financial planning is very much a people-oriented business helping people achieve their financial goals.

Question 2

what are the four areas of financial planning?

Answer 2

1. investment
2. retirement
3. insurance
4. estate

Question 3

what are the past Australian recessions?

Answer 3

1. 1974-75
   the world price of oil had almost quadrupled causing high rates of inflation
2. 1982-83
   high inflation rates and drought conditions
3. 1991-92
   due to excess domestic demand, reduce speculative behaviour in commercial real estate market and lower inflation

Question 4

what are the indicators of the direction of the economy?

Answer 4

1. pro cyclical indicators
   - in direction of economy
   - eg GDP increases as economy improves
2. countercyclic
   - opposite direction
   - unemployment rate increases
3. leading
   - before economy changes
   - share market, cash rate, average weekly earnings

Question 5

What do financial planners need to know about the client?

Answer 5

Needs vs Wants
 Objectives
 Requirements
 Financial circumstances
 Family circumstances
 Motivational factors
 Perceptions of financial planning and financial planners

Question 6

what is the need for financial planning?

Answer 6

1. demographics and politics
   - ageing population
   - There is an increasing trend to shift the onus of retirement funding from the Government to the individual
   2.self- funded retirement
   - - Mandatory Superannuation Guarantee (SG) contributions (currently 11%; The SG percentage rate is scheduled to increase by 0.5% every year until it reaches 12% from 1 July 2025.)
   - Tax concessions for personal contributions
   - Lump sum withdrawals or pensions received from super after the age of 60 are tax free
2. complexity
   - legislation
   - choice of investment products

Question 7

what are the questions of time value for money?

Answer 7

1.What will an investment (or a series of investments) be worth after a period of time (i.e. future value)
2.How much has to be put away today (or as a series of investments) to provide some dollar amount in the future (i.e. present value)

Question 8

what are the regulatory bodies?

Answer 8

1. Australian Securities and Investment Commission (ASIC)
2. Australian Prudential Regulation Authority (APRA)
3. Australian Taxation Office (ATO)

Question 9

what is the financial planning association of Australia?

Answer 9

• This is the peak organisation for financial planners
• Works to enhance the professionalism of the industry and the image of planners in the eyes of the industry
• To protect the interests of clients, a number of codes have been established

Question 10

what is fiduciary duty?

Answer 10

• A fiduciary relationship between a professional and a client is recognised in common law and, if broken, has legal consequences for the professional involved
• One of the reforms introduced was a statutory fiduciary duty on financial advisors to act in the best interests of their clients; a ‘best interests duty’. The duty is a codification of the existing common law fiduciary duty that is owed by all advisors. Penalties for breaching this duty include banning and disqualification orders.

Question 11

what is the financial services guide?

Answer 11

– purpose is to ensure that clients are given sufficient information to enable them to decide whether to obtain financial services
– as a general rule, the FSG must be given to the client at the earliest practical opportunity before a financial service is provided and as soon as it becomes apparent that a financial service will be or is likely to be provided

Question 12

what is the statement of advice?

Answer 12

• The providing entity must provide a retail client with a SOA where the client is given personal advice (s946A).
• Must be provided to the client at the same time as, or as soon as practicable after, the advice is provided
  – This must be before the provider arranges for anything connected with the advice
• The SOA is a disclosure document that helps a retail client understand and decide whether to rely on personal advice

Question 13

when is financial advice provided?

Answer 13

An adviser will be providing financial product advice when either:

a recommendation
a statement of opinion
a report of a recommendation or statement of opinion

is provided with the intention to influence a person in making a decision in relation to a particular financial product or group of financial products, or in circumstances where some might reasonably expect the adviser had that intention.

Question 14

what is personal vs general advice?

Answer 14

personal
- The adviser has considered one or more of the objectives, financial situation and needs of the person
- A reasonable person might have expected the adviser to have considered any of those matters

general
- The adviser did not consider any of the objectives, financial situation and needs of the person
- A reasonable person did not expect the adviser to have considered any of those matters

Question 15

when is personal advise given?

Answer 15

• The adviser explicitly offered to provide advice
  (and for example provided an FSG)
• The adviser had an existing financial relationship
  with the client
• The client requested personal advice
• The adviser requested details about the client’s personal circumstances
• Personal circumstances are referenced in a recommendation
• The adviser had received or already possessed info about the client’s personal circumstances

Question 16

what is the financial planning process?

Answer 16

initial interview:
1. gather info
2. establish goals and objectives
3. analyse data issues
follow up interview
4.develop SOA
5. implement
6. review and revise

Question 17

what is first step of financial process - gather info?

Answer 17

-The data collection process assists you to understand your client’s needs and provides the opportunity to know your client.
 It can potentially justify and substantiate the reasons for a particular course of advice if that advice turns sour.
- Data is most commonly collected through a document
known as a Client questionnaire or “Fact finder”
- Eg: superannuation overlap with insurance, inefficient /excessive super contributions, cash flow problems

Question 18

what is the second step in the financial process - establish goals?

Answer 18

Some client goals are unachievable and should be reconsidered
 Goals will vary from client to client, but certain age groups are likely to have similar types of goals.

Question 19

what is the third step in the financial process -identify issues?

Answer 19

Analyse the financial circumstances of the client
 Prepare financial statements, ratios and projections  Analyse the risk profile of the client
 What degree of risk is the client willing to accept with their investments?
 Identify issues and problems with the client’s existing strategy
- Two main financial statements that should be drawn up to assist the planner to summarise information:
– Balance sheet (or Net worth statement)
– Cash flow statement

Question 20

what is the balance sheet - assets?

Answer 20

assets ( what is owned) is broken down:
1. monetary assets
- Liquid assets/Cash
2. Use or Lifestyle assets:
* Designed to provide to the client for use.
* House, car, holiday house etc.
3. investment assets
* Designed to generate a return
* Bonds, shares, managed funds, superannuation

Use current market values instead of historical cost to value assets.
Note: planners do not normally provide recommendations around personal “lifestyle” assets of the client

Question 21

what is the balance sheet - liabilities

Answer 21

• Liabilities: What is owed
  1. Short-term (current) liabilities

2. Long-term liabilities

Question 22

what are strategies to increase your net worth?

Answer 22

1. IncreaseAssets
2. Decrease Liabilities
3. or both

Question 23

how can the cash statement be analysed?

Answer 23

1.Sources of cash inflows (income):
*Salary, returns from investments, business income, pensions, gifts, asset sales
2. Sources of cash outflows (expenses)
*Living expenses, taxation, asset purchases, debt repayments
3. cash surplus or deficit
*A cash surplus(net gain) will indicate the client’s ability to invest, commence a savings scheme or repay debt
*A cash deficit (netloss) will indicate the need for budgeting, increased sources of income / reduced expenditure, increased borrowings

Question 24

what are useful financial ratios?

Answer 24

1. Net worth/Solvency ratio
   net worth/total assets x 100
2. Liquidity ratio
   - measures the speed which an asset can be converted to cash
   - shows the percentage of assets available to cover current debt
   - liquid assets / total current liabilities x 100
   - liquid assets / monthly expenses x 100
3. Savings ratio
   - surplus /disposable income x 100
4. Debt service ratio
   - total debt / disposable income x 100

Question 25

what is a budget?

Answer 25

A budget is a paper or electronic document used to record both planned and actual income and expenditures over a period of time.

Question 26

what are the steps of budgeting?

Answer 26

1. make and reconcile budget estimates
   - disposable income must equal or exceed planned expenditures for the budget to be balanced
2. revise budget to create a balanced one
3. before period: plan cash flows
   - Cash-Flow Calendar illustrates variations in income and spending throughout the year
   – Revolving savings fund is set up to hold funds from months when there are net gains to fund higher expenditures in months when there might be deficits
4. before period: control spending
   - track spending
   - budget for shopping trips
5. during period: control spending
   - justify exceptions
   - use a subordinate budget
6. after period: evaluate budget
7. after period: what to do with money left over

Question 27

what are financial records?

Answer 27

• Financial records are documents that evidence financial transactions, such as bills, receipts, credit card receipts and statements, bank records, tax returns, investment statements and pay slips.
• Good records enable you to review results of financial transactions and find them in an emergency.
• Some records should be kept in a safe- deposit box

Question 28

how to analyse clients risk profile?

Answer 28

A recommended investment portfolio for a client should be designed around their risk/return philosophy
 what amount of risk is a client prepared to accept in order to generate a certain rate of return
 is the client - conservative, balanced, aggressive

Factors likely to influence the degree of risk a client is
prepared to accept:
 term of investment, likely need for the funds in future, previous investment experience, investment knowledge, objectives, relative importance of investment portfolio in terms of client’s total wealth

Question 29

methods for clients risk profile

Answer 29

1. risk profile questionnaire
2. are you stock like or bond like
   - The risk you expose your financial capital to should consider the risks of your human capital
   Is your wage income (as an investment) flexible?
   Is your wage income (as an investment) sensitive?
3. risk - set point
   - Differentiate between needs and wants
   - Achieve $$ for needs and wants using different asset classes
   - Where safety zone ends & risky zone begins: Risk Set-Point

Question 30

how to develop a SOA?

Answer 30

• Content and presentation are important – not a “data dump” (ASIC shadow shopping)
  be based on clients’ current and projected financial position, preferences and risk profiles.
• be capable of explanation in plain language to the clients (and contain this explanation in summary form).
• outline the nature of strategy and products recommended and point out possible risks. Taxation issues should be clearly explained.
• have a definite initial timeframe in mind, and provide projections as to how the financial prospects of the clients might be expected to evolve over that period.
• contain a summary of how the plan is expected to achieve the client’s objectives.
• contain a declaration of any associations, commissions, etc. which any person associated with the provision of the plan might receive, which might influence the objectivity of the advice.

Question 31

what is a managed fund?

Answer 31

Investors pool money and get an interest in the scheme (unit holders have a right to distributions)

A managed fund is characterised by the:
– Asset type (categories), Style, Structure

Question 32

what is the link between risk and return?

Answer 32

• no guarantee higher risk will lead to higher returns
• the trade-off is that increasing potential for higher returns means growing risk to investors capital
• and increasing safety of principle means the growing risk of purchasing power.

Question 33

what are characteristics of managed funds?

Answer 33

Pooling allows:
– reduced investment costs, access to expertise, diversification…(more on this later)

The managed fund structure provides access to:
– One or all of the asset classes
– Sub-categories of asset classes
– A particular asset mix

Question 34

what are advantages of managed funds?

Answer 34

– Able to access investments with only a small amount of funds
– wide range of asset classes and investments
– Funds are managed by a professional fund manager
– Consolidation of reporting - master trusts/wrap accounts
– ‘Ready-made’ diversified portfolio

Question 35

what are the disadvantages of managed funds?

Answer 35

– Fees (types and ranges) - entry, exit, switching, management, investment, etc.
– Lack of control over investment- can’t time capital gains
– Lack of transparency?
– Which is the most appropriate fund? Too many choices

Question 36

what is the management expense ratio and indirect cost ratio?

Answer 36

– Management Expense Ratio (MER): ongoing fee to cover the cost of managing your investment. MER can vary substantially (0.5 to 4% pa).

– Indirect Cost Ratio (ICR) - are supposed to be the new standard rather than MER. ICR includes all indirect costs such as performance fees, investment-related legal, accounting and other operational and compliance costs.

• ICR & MER estimate how much of contributions are used toward the operating costs of the fund vs. invested

Question 37

what is entry fee

Answer 37

– Entry fee: between 1% and 5% and will reduce the amount of your initial investment.

Question 38

what is contribution fee?

Answer 38

– Contribution fee: similar to entry fee, charged on future contributions.

Question 39

what is withdrawal fee

Answer 39

– Withdrawal fee: fees charged by fund for each withdrawal.

Question 40

what is performance fee

Answer 40

– Performance fee: fee paid to fund manager if the investment return is better than the target return.

Question 41

what is termination fee

Answer 41

– Termination fee: fee charged for closing the account.

Question 41

what is switch fee

Answer 41

– Switch fee: fee charged when investor change their asset mix.

Question 42

what is adviser service fee

Answer 42

Adviser service fee: some funds managers pay financial planners ongoing fees for every year a client’s funds remain in their managed investment scheme.

Question 43

what is unlisted managed funds?

Answer 43

• Open ended funds which issue & buy back units from investors
• Unlisted funds do not pay tax in their own right if they distribute income to unit holders
• Unit price is a function of Net Asset Value (NAV)

NAV = FUNDS ASSETS - FUNDS LIABILITIES / NO OF UNITS ISSUEd

Question 44

What are listed managed funds?

Answer 44

*Investors buy or sell units or shares on the ASX

Main types are:
– Listed investment companies (close-ended: do not issue
new shares or units, or cancel shares or units.) (LICs)
– Listed investment trusts (units: close-ended) (LITs)
– Real estate investment trusts (units: close-ended) (AREITs)
– Exchange traded funds (units: open-ended) (ETFs)
* Track and duplicate the performance of a particular market index

Question 45

what are master trusts?

Answer 45

Pools money, access to range of different fund managers and investment options. Record keeping and administrative services.

Question 46

what are wrap accounts?

Answer 46

Investments held in name of investor and can be transferred between different providers without CGT (in specie transfers)

benefits
* Investor only deals with one organisation
* Managed funds can be accessed at cheaper wholesale MER’s * Consolidated reporting of performance, asset allocation and tax

Drawbacks:
Cost - Investors must pay for the product/service

Question 47

what is an active management style?

Answer 47

• Regular trading (Tactical, Fundamental, Technical, …. Top-down approach, Bottom-up approach, Absolute Returns, market timing)
• Value (focus on income generating potential), Growth (Focus on assets potential capital growth or gain)

High-frequency trading (HFT) involves ultra-fast fibre-optic data connections between trading systems and stock exchanges, giving a minuscule speed advantage over rival traders. This millisecond advantage, allows HF traders to see other buyers’ orders before they are executed.

Question 48

what is passive management style?

Answer 48

• Seek to replicate rather than attempt to outperform benchmark or index – limited changes
• Should be cheapest asset class exposure
• Performance determined by the asset class invested
• • Efficient markets hypothesis (EMH):
    – As new information arises, the news is incorporated into the price of securities.
    – The market is so efficient at incorporating all known information that no amount of analysis will give you an edge over the millions of other investors out there.

Question 49

does passive investing make markets more or less efficient? ( less efficient)

Answer 49

The paradox of the indexing process is, of course, that if everyone ignores valuations and buys portfolios that blindly match the market, asset prices become extremely inefficient, which only amplifies the opportunities for “active” managers who profit from these discrepancies to outperform.”

This is saying that the increase in passive investing will lead to less price discovery making markets LESS efficient.

Question 50

does passive investing make markets more or less efficient? (more efficient)

Answer 50

Unskilled investors do not have to incorporate their lack of skill into their investment decisions. They do not have to suffer from uninformed picks. With index funds, they get a superior return (superior for them).
The effect of unskilled investors taking up passive investments is that the average skill of the rest of the market increases, without these investors. Those active investors deal with less noise and less price inefficiency caused by unskilled investors. They are able to partake in price discovery with more accuracy, making markets more efficient.

Question 51

what is unsystematic risk?

Answer 51

Firm specific (or unsystematic) risk stems from the success of the specific investment chosen such as one company’s stock.
– Diversification, such as buying, many companies’ stocks reduces random risk

Question 52

what is systematic risk?

Answer 52

• Market (or Systematic) risk stems from movements in an entire class of investments such as the stock market as a whole.
• Diversification is not as likely to reduce market risk unless you diversify across class of investment such as in buying both stocks and bonds

Question 53

what are tracking errors?

Answer 53

not a performance measure but a summary statistic- standard deviation of the differences between the fund return and return on the benchmark
- Measure of how closely returns of managed fund follow benchmark

Question 54

what are the different ratios for assessing managed funds investment returns

Answer 54

• Sharpe ratio – reward for total risk
  – A measure of the risk adjusted performance of a fund (excess
  returns)
• Alpha/Treynor ratio - reward for systematic risk (compared to CAPM)
  – A measure of how sensitive portfolio returns are to market returns
• Information ratio - (excess return / tracking error)

Question 55

what is risk profiling method - stock like or bond like

Answer 55

1. Labour and wage income as investment
   - flexibility
   - sensitivity to general market conditions

Question 56

what is risk profiling method - risk set point

Answer 56

– Identify your goals/objectives

– Differentiate needs (place to live) vs wants (place in Monaco)
* Needs are not exposed to risky assets
* To meet Needs invest in Federal Govt Inflation Indexed
Bonds (or Term Deposits, Annuities)

– Needs achieved through non-risky assets

– Wants achieved through risky assets

– Where safety zone ends & risky zone begins: Risk Set-Point

Question 57

what is risk profiling method - risk profile questionnaire

Answer 57

example:
1. life stage - age, when to withdraw cash from investment portfolio
2. financial resources - expenses, income, savings
3. emotional risk tolerance - expectations, personality, goals,

Question 58

what are cons of profile questionnaires?

Answer 58

– Self-reporting on behaviour and self-evaluating on financial knowledge/literacy
* Biases may exist - overconfidence, optimism, anchoring etc
– Depth (anywhere from <10 to >45 questions) – Understandability - language, technical terms

Question 59

what are the classes of asset allocation?

Answer 59

1. Defensive: cash, fixed interest/bonds
2. growth: shares/equity, property
3. other: commodities, derivatives, currency, ethical, infrastructure , private equity

Question 60

what is the levels of asset allocation

Answer 60

1. index portfolio to a nominated bank
   - Invest in securities in this index so as to match the performance of the benchmark
2. strategic asset allocation
   - Investment in asset classes over long term (“generally” >10 years). In effect take higher weighting in asset class we believe will outperform
3. tactical asset allocation
   – Re-weighting portfolio over shorter period, eg. month, away from SAA. Believe performance in asset class different to that suggested by SAA
4. investing in particular sectors of that asset class
   A proportion of portfolio invested in particular asset class, eg. equity. Within
   equity identify resources & industrial sector as two broad sectors. Take shorter term bets of particular sector within asset class. “Sector Rotation”
5. asset selection
   Having decided SAA, TAA and Sector Rotation now what particular company, bond or equity are we going to buy. Which assets are more likely to outperform?

Question 61

what is socially responsible investing?

Answer 61

• the practice of incorporating social goals into the investment decision- making process.
• In traditional economic theory, the constraints of SRI investment suggest that a fully diversified portfolio is not possible.
• There are many arguments (and supporting evidence) that suggest these constraints could be either good or bad for potential investment return.

Question 62

what is the vice/barrier funds?

Answer 62

• The Vice Fund invests in companies within industries that have significant barriers to entry (tobacco, alcohol, gaming, and weapons/defence) :
  – Natural barriers to new competition
  – Steady demand regardless of economic condition
  – Global Marketplace - not limited to the U.S. economy
  – Potentially high profit margins
  – Ability to generate excess cash flow and pay and increase dividends

These industries tend to thrive regardless of the economy as a whole.

Question 63

what are the types of SRI screening?

Answer 63

1. negative screening
   - excludes companies based on their involvement in what are commonly known as SRI-prohibited industries. E.g.
   alcohol, tobacco, gambling and defence stocks.
2. positive screening
   - involves seeking out companies that enhance SRI practices, such as those with good labor relations or a good history of community involvement.
3. best of screening
   - is similar to negative screening; however, it does not take such an extreme position when rejecting companies. For example, a negative screen will completely exclude a company if any of their profits are derived from a SRI-prohibited industry, whereas a best-of screen will still consider companies that derive a small portion of their earnings from such industries.

Question 64

what is the difference between neo-classical finance and behavioural finance

Answer 64

neo-classical:
* investors maximise return whilst minimising risk
* are rational and unbiased in evaluating and acting on information
behavioural finance:
* uses psychology & economics to explain investor behaviour
* descriptively detailed model of investors

Question 65

What can affect investors’ decision making and preferences?

Answer 65

In an ideal world, humans are rational, can perform calculations/ forecasts accurately, have self control and are not ruled by their emotions. Thus their actions/ decisions allow them to achieve the best possible outcome.
In reality, biases, heuristics and emotions get in the way of optimal decision making.

Question 66

what are the two systems of the mind?

Answer 66

system 1:
System 1 – “operates automatically and quickly, with little or no effort and no sense of voluntary control” (p. 20)
– System 1 is operating when you do things automaticallyInnate skills

system 2
“allocates attention to effortful mental activities that demand it, including complex computations” (p.21)
– System 2 monitors thought & action proposed by system 1
- When system 2 kicks in, you tend to get better decisions (by burning more energy)

Question 67

What are some outcomes of people being affected by availability bias?

Answer 67

– decisions are based on incomplete or incorrect data
– generalise from small samples - law of small numbers
– cling to initial judgement despite new (perhaps contradictory) information

Question 68

Will shares in a high-profile, reputable company deliver strong returns in the future?

Answer 68

• Not necessarily because past performance is not a guarantee of future performance
• Not necessarily - maybe the company has levelled out and achieved maximum growth. The share price already reflects the quality of the company and thus future return prospects may be moderate.

Question 69

what is hofstede’s 6 dimensions of culture?

Answer 69

1. indulgence
   - relatively free gratification of basic and natural desires of enjoying life / having fun. NEGATIVE RELATIONSHIP
2. long-term orientation
   - Because people care about the future, more likely to invest in their financial literacy. POSITIVE RELATIONSHIP
3. power distance
   - How less powerful members of organisations/institutions (e.g. the family) accept and expect that power is distributed unequally. Negative relationship
4. individualism
   - Choose to invest in own financial future. POSITIVE RELATIONSHIP
5. masculinity
   - Focus on men as breadwinners / decision makers, lower female participation. NEGATIVE RELATIONSHIP
   - OR both men and women are more assertive/competitive. POSITIVE RELATIONSHIP
6. uncertainty avoidance
   - Establish rules (e.g. saving) to cope. POSITIVE RELATIONSHIP
   - OR Not comfortable with volatility so delegate to financial intermediary NEGATIVE RELATIONSHIP

Question 70

what are alternative assets and strategies?

Answer 70

Alternative assets provide exposure to securities whose performance is not highly correlated with traditional stocks and bonds.
* Eg. Commodities, global real estate, precious metals, derivatives

Alternative strategies provide exposure to managers who invest in stocks and bonds in non-traditional ways.
– E.g. absolute return strategies, gearing

Question 71

what are examples of alternative investments?

Answer 71

• Collectibles – cultural artefacts that have value due to their age, scarcity or popularity.
• Gold is a commonly desired precious metal.
• Silver, platinum palladium and rhodium also are of interest to speculative investors.
• Precious stones and gems.
• Speculate by trading in currencies.
• Alternative coins and cryptocurrencies
• Derivatives (or derivative securities).

Question 72

what are derivatives options ?

Answer 72

• Options allow you to buy or sell an asset at a predetermined price.
  – Share option
  – Expiration date – Striking price
• Options are created by an option writer
  (seller). Option premium is the price paid for the
  option. Option holder (buyer) is the owner of the option contract
• call options allow the holder to buy

Question 73

what is a futures contract?

Answer 73

• A futures contract is the obligation to make or take delivery of a commodity by a set date.
• Conservative economic needs create futures markets.
• Speculators may trade in futures markets.
• Futures (and options) are a zero-sum game

Question 74

what are the benefits of alternative assets?

Answer 74

• The theory of an allocation to alternatives is that it is uncorrelated with mainstream asset classes of shares and bonds
• So when shares and bonds are underperforming, alternatives will keep your portfolio on track, delivering returns through the bad times
• That is, they provide diversification benefits

Question 75

what are the excess returns of alternative assets?

Answer 75

• E.g. hedge funds, private equity, infrastructure and commodities
• What we observe
  – These are much longer-term investments
  – Relatedly, these are less liquid markets
  – These assets have been shown to have excess returns

Question 76

Is there an illiquidity premium?

Answer 76

Academic research shows general consensus =
Yes, but…
* It is difficult to isolate the illiquidity premium from
other risk premia
* Voluntary nature of hedge fund reporting (worst performers are not represented in the data?)
* The risk of illiquid assets is difficult to measure
– Return profiles of alternatives are not normally distributed. Thus, standard deviation is a poor measure of risk
*Who undertakes the valuation of assets

Question 77

what are the risks of alternative investments?

Answer 77

*Alternative strategies and assets reduce (diversifiable) risk but also expose investors to additional risks
– Operational, governance, liquidity, disclosure risks, valuation risk (which is important to understand…)
– Valuation risk: Infrastructure is valued externally by an independent valuer typically using the DCF method. Private equity is valued in-house using the multiple of earnings method

Question 78

what Is gearing as an alternative strategy

Answer 78

• Gearing describes the use of borrowed money to invest in assets (that will increase in capital value)
• Provides a means of diversification
• Suitable for people with:
  – aggressive risk profiles
  – strong, secure cash flows
  – higher incomes
  – Long term investment horizon - need to be able to survive short term volatility

Question 79

what is the process of gearing

Answer 79

• A margin loan is secured against the value of the shares being
  purchased.
  – Daily fluctuations in value of stocks/managed funds changes risk of loan
• Interest expense on a loan for the purpose of investing in income producing assets will be a deductible expense
• This will be the case whether the investment is positively or negatively geared

Question 80

how is a case negatively or positively geared?

Answer 80

• Positive
  – Rent received covers costs e.g. profitable
  – the excess income is taxed at the marginal tax rate
• Negative
  – Costs are greater than the rental received
  – The loss can be claimed as a tax deduction to offset your income tax payable

Question 81

what are the benefits of gearing?

Answer 81

– Expanded opportunities for portfolio exposure
* Diversified therefore volatility is reduced
– Tax benefits
* Interest payments and other expenses can be claimed as deductions against taxable income.
– Magnify gains
* As long as the net gains from your investments outweigh the costs of borrowing

Question 82

what are the risks of gearing?

Answer 82

– Assets prices drop and/or market moves unfavourably
– Ability to service the debt may be impacted by changes to income / interest rates
– Additional costs will be incurred (brokerage, lender fees and charges)
– May need to have full personal insurance
– Need to be fairly liquid just in case
– Involves frequent and careful monitoring

Question 83

what is the gearing ratio

Answer 83

• Gearing ratio measures the amount of debt in relation to investor’s contribution (net current market value of asset purchased with debt).
  Like a company’s D/E ratio

Question 84

what is loan to value ratio

Answer 84

• This value is set at the beginning of the loan and will change as market value of the portfolio changes
• amount of debt expressed as a percentage of the total asset value

Like a company’s D/A ratio

Question 85

what can go wrong with margin lending?

Answer 85

– Debt x Debt: taking out a margin loan and a home loan to invest in index funds
– Centralised control - no individual planning by advisers – One-size-fits all? Similar SOAs: not consistent with s945

Question 86

what to look out for with margin loans

Answer 86

• How to manage your LVR
  – Don’t borrow too much in the first place
  – Ensure your underlying assets are diversified
  – Make regular interest payments
  – Reinvest income from investments or use it to pay off interest rather than withdrawing
  – Monitor and review periodically

Question 87

what are the options to deal with a margin call?

Answer 87

• If you go over your LVR, you will receive a margin call. Options to deal with a margin call:
  1. Give the lender more security
  -e.g. buy more shares or add other shares
  2. Pay off the loan-with cash or by selling shares
  
  • Is it a good time to sell?

Question 88

are alternative assets actually uncommon/ unavailable to most investors?

Answer 88

Rainmaker research shows that in the alternatives space:
- Retail funds focus on hedge funds and commodities
- Industry funds focus on private equity and infrastructure
The difference is driven by liquidity demands due to membership profile

Question 89

what is a VC?

Answer 89

A VC is a financial intermediary (i.e., it takes the investors’ capital and invest it directly in portfolio companies).

Question 90

what are endowment funds

Answer 90

• University endowment funds are non-taxable vehicles established to contribute towards the future funding requirements of the university. Funds come from legacies, gifts and investment returns. They have a long term investment horizon.
• The average US Endowment Fund holds 54% in alternative assets.

Question 91

what are the keys to success for an endowment fund?

Answer 91

Keys to success:
- Resources/skill to monitor alternative asset fund managers - mechanisms to align
investors of managers with the fund’s (e.g. less AUM based fees and more
performance based fees.
- Avoid funds of funds - don’t know who the underlying investment manager is
- Focus on “equity like” asset classes (e.g. liquidity from illiquid assets)
- Bonds pay interest, real estate produces rents, private equity partnerships distribute proceeds from realizations.

Question 92

how is agribusiness an alternative strategy?

Answer 92

• Agribusiness is an alternative strategy (and asset) known as an “inflation alternative”
  – Hedge against inflation since food prices are linked to inflationary trends.
• Opportunities - grains, beef, dairy, trees, olives, almonds, wineries (Margaret River is big in this space!), water entitlements
• Tax benefits- R&D tax incentives
• Diversification (within the asset class too - geographic/commodity)
• Less impacted by economic slowdowns (food is relatively inelastic to income)
• Invest directly via agricultural assets (land, livestock, crops)
• Or indirectly via managed funds, futures etc.

Question 93

what are absolute return strategies?

Answer 93

• As opposed to traditional managed funds, absolute return strategy managed funds have a different return and risk profile than traditional funds that invest in stocks and bonds.
• Independent from traditional benchmark indexes, absolute return strategies have flexibility to seek to protect capital during bear markets.
• Focus on generating a positive risk-adjusted return stream over time, regardless of market conditions or direction.

Question 94

what are the benefits of absolute return strategies?

Answer 94

• Traditional benchmarks constrain the investment universe that a fund manager can work with
  – Without such restrictions, a fund manager can more effectively address bear market risk
• Consequently, an absolute return strategy can be added to a portfolio of traditional funds and improve overall diversification. In turn, this further diversification may allow for an overall reduction in risk at the portfolio level.

Question 95

what are examples of absolute return strategies?

Answer 95

1. long short equity strategies
   - involve long and short positions and are liquid
2. relative value strategies
   - exploit apparent pricing anomalies between particular securities
3. event driven securities
   - likelihood of events occurring. manager takes long Positions in securities in one company and short in the other.
4. global macro strategies
   - assessment in global economies and financial markets
5. managed future funds
   - algorithmic and technical models to focus on trends over liquid securities
6. multi-stategy funds
   - uses multiple strategies listed above
7. funds of hedge funds
   - invest in 30 to 70 underlying alternative strategies