Insights

Is it better to invest directly into listed securities or into unlisted managed funds? There is no correct answer as it depends on your personal investment needs and objectives and, importantly, which strategy you are comfortable with.

The benefits of investing in shares

Why are shares so popular?

• Shares have historically outperformed all other assets classes over the long term.
• Shares can provide long-term capital growth.
• Shares can provide a strong and growing income stream.
• Tax benefits might be available via franked dividends.

What can change?

Change has been a major component across investment markets over the last 50-odd years. From the 'Black Monday' crash in 1987, to 18% interest rates in the late 80’s and early 90’s, through to the 1997 Asian crisis, the tech and internet stock boom and bust in 2000, and of course who could forget the GFC in 2008.

More recently, of course, investors are experiencing the impact of Coronavirus. In this respect, COVID-19 has had an impact on life in general, not just investment markets, which makes its disruption extraordinary.

Key points to remember

The market has never failed to rise above its previous high following a major correction. Shares are often considered risky due to potential short-term performance volatility. Over the long term, however, shares have provided consistent investment returns.

Shares are often considered risky due to potential short-term performance volatility. Over the long term however, shares have provided consistent investment returns.

Chart 1: Australian Shares (ASX200) vs Cash (90 day BB) : June 2000 to Feb 2021

Dividend yield & imputation credits

Many dividends paid to shareholders include 'imputation credits'. The imputation credit and resulting tax benefit available from the dividends means the actual return from a stock needs to be "grossed up" to reflect its true value.

A common mistake investors make is to compare bank rates with dividend yields. The cash rate is fully assessable whereas the dividend yield includes the imputation credits, so this tax concession should be taken into account. A 5% dividend yield would provide a similar return to a 7% bank rate.

Other tax issues

In addition to tax benefits arising from franked dividends, investors must also consider capital gains and/or losses and the tax implications as a result of investment decisions.

By investing directly into listed securities, it is the investor who controls the tax consequences of that investment.

That is, investments are bought and sold at the investor's discretion rather than at the discretion of a fund manager. Capital gains and losses can be managed to suit the investor's tax position.

In contrast, fund managers will usually turn over stocks within their investment portfolios (particularly Australian Equity funds) on a regular basis.

Distributions from managed funds include realised and unrealised capital gains or losses as a result of the higher level of trading, and is displayed as 'total return' . The investor has no control over the tax management of these distributions.

The resultant outcome generally means the investor has an unwanted or inconvenient tax consequence at the end of the financial year, which could have an impact on their overall tax position.

This lack of control is an influential factor that pushes investors to favour direct share investing over managed funds.

Access

One of the key advantages of investing in direct shares is the flexibility and liquidity it provides.

The ASX provides an environment for Australian investors to easily purchase or sell shares, or rebalance portfolios, in a timely and cost-effective manner.

The benefits of investing in managed funds

A managed investment combines an individual investor's money with the money of thousands of other investors to form an investment fund. Specialist investment managers then invest the pooled money on investors' behalf.

Benefits of managed funds

• Trained investment specialists: Constantly research and monitor investment markets to determine the best possible investment opportunities.
• Convenient and efficient: Paperwork and administration, regular information on the fund’s performance, annual tax statements and tax guides.
• Diversification: A truly diversified portfolio can be difficult for a direct investor to achieve. Managed investments make diversification easier.

Structure

Most managed funds are structured as unit trusts. When invested into the fund the investor's money buys units in that fund.

The unit price reflects the value of the fund's investments. If the value of the fund's investments rise, the unit price also rises. Conversely, if the value of the fund's investments falls, the unit price also falls.

Access

Managed funds provide access to investments in assets normally not available to individual investors (e.g. international emerging markets). Investing internationally via managed funds can provide greater diversification and investment opportunities compared to investing only in the Australian sharemarket.

The redemption process for managed funds is not as timely as it is with selling listed shares.

Fund managers must value all their assets at the prevailing market price. Depending on the unit price at the time of redemption an investor may be forced to sell a higher number of units to achieve a specific dollar value.

This means the portfolio's overall investment value is affected as there are less units remaining in the fund.

Dollar cost averaging via regular savings and compound growth

Investing in managed funds allows an investor to effectively reduce their investment cost (or capital) by dollar cost averaging.

Dollar cost averaging is simply purchasing investment units at differing prices on a regular basis (usually via a regular savings plan), which then reduces, or averages, the overall cost base of the investment unit.

This can help minimise potential capital gains tax when the units are eventually sold. Re-investing fund distributions into additional units provides a 'compound interest multiplier' effect.

That is, your investment capital benefits from the effects of compound growth as the distributions from your investment earn interest.

Diversification

Diversification of an investment portfolio across all asset classes allows an investor to 'hedge their bets'. By spreading the exposure and investing in different assets an investor can create a portfolio that can minimise to some degree the losses that may occur in one asset sector with gains in another.

The overall effect is that volatility is moderated, and investment returns can smooth out over time.

Investing in managed funds allows the investor to diversify funds over a basket of assets that may otherwise not be accessible. This is a key strength of funds as investors can spread their investments across a range of asset classes rather than having exposure to just one class.

The 'fee' factor

Having a team of specialist investment managers comes at a cost, as does the benefit of having an effective administration and reporting system. Fund managers can charge entry, exit, ongoing management and even performance fees.

Index fund managers traditionally charge lower fees than active fund managers as they have lower portfolio management costs. Retail funds are more expensive than wholesale funds, typically charging between 1-1.50% pa more.

An investor can access the cheaper wholesale funds, however, they must either have a larger initial investment (generally, from $20,000 up to $500,000), or they can invest via a platform (wrap) structure, which then charges its own administration fee.

It is this level of cost and complexity of fees that turn many investors away from investing in managed funds. Additionally, the level of fees charged by a fund manager can have a significant impact on the overall return of the investment, particularly over the long term.

So that like-for-like performance comparisons can reasonably be made between different funds, fund managers are required to display performance data as after-tax returns or 'net of fees'.

In conclusion

Regardless of preference, the winner here is the investor who can choose to invest in a manner that best suits his or her needs.

Whether direct investing is the preference or indirectly via a managed fund, the investor can decide based on their investment goals. A combination of both may be preferable so that the investor can fully appreciate the benefits of each strategy.

Understanding what you are investing in and why is the most important factor of all for any investor, regardless of how.

In the realm of financial analysis, Zip Co (ASX:Z1P) has recently disclosed its 1H21 financial results, stirring interest among investors and analysts. While the reported NPAT loss of approximately A$453 million reflects various one-off items, including a net revaluation of Quadpay (-A$306m) and performance shares issued due to met hurdles (~-A$64m), a deeper dive reveals an underlying loss of ~A$114 million, surpassing previous estimates due to increased expenses (-A$30m).

Strong Momentum in the US Market

Despite these financial intricacies, Zip Co's strategic investments to foster growth have exceeded expectations. Notably, the company is gaining significant traction in the United States market, indicating a promising trajectory.

Key Highlights and Achievements

Positive Developments

• Revenue Growth: Revenue stood at A$160 million (+131%), driven by robust year-over-year (yoy) Total Transaction Value (TTV) growth of 141% to ~A$2.3 billion.
• Effective Risk Management: Net bad debts were well-contained at 1.93%, down from 2.24% in the prior corresponding period (pcp).
• Operational Milestones: Australia remains cash Earnings Before Interest, Taxes, Depreciation, and Amortization (EBTDA) positive, achieving Cash EBTDA breakeven.
• Expansion Initiatives: Zip Co's entry into the UK market, accompanied by collaborations with prominent brands, signals a promising market entry strategy.

Quadpay Performance

• ‍Rapid Growth: Quadpay witnessed rapid growth in 1H21, with TTV reaching A$973 million and customer base expanding to 3.2 million, both reflecting over 200% growth compared to the pcp.‍
• Capital Efficiency: The net transaction margin for Quadpay remains above 2%, contributing to enhanced group capital efficiency and improved revenue yield.

Australian Market Dominance

• ‍Market Leadership: Zip Co's BNPL app emerged as Australia's most downloaded app in December 2020 and January 2021, underscoring its dominance in the domestic market.‍
• Robust Growth Metrics: Key performance metrics such as revenue and customer base witnessed substantial growth, ranging between 40% to 60% for the half-year period.

Areas of Concern

• ‍Increased Marketing Costs: Marketing expenses surged over fourfold (~A$26m compared to A$6m in the pcp), attributed to Quadpay integration, product launches (e.g., Tap and Zip), and heightened brand activities.‍
• Leverage Compression: Zip Co's high growth phase may lead to near-term compression in its cash EBITDA performance, evident in the 1H21 figure of A$0.2 million.

Revised Forecasts and Investment Strategy

Considering the evolving landscape, adjustments to forecasts are imperative. The FY21F/FY22F EPS is revised downwards by over 50% to account for current-year one-offs and increased investment across forecasted periods. Furthermore, a transition from a Discounted Cash Flow (DCF) valuation to a blended DCF/Price-to-Sales (PS) methodology has been made, resulting in a revised price target.

Navigating Towards Global Payments Leadership

Despite the challenges and adjustments, Zip Co maintains a significant PS discount compared to Afterpay (APT), indicating substantial growth potential. As the company continues to execute its strategy towards becoming a global payments leader, investors remain optimistic about its future prospects. With a strong foothold in the Australian market and promising growth trajectories in the US and UK markets, Zip Co stands poised for further expansion and market dominance in the evolving landscape of Buy Now Pay Later (BNPL) services.

Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.

Raising children is one of the biggest expenses parents will incur and although in most cases the emotional rewards offset the costs, it is still a smart move to put money aside for when the bills roll in, to pay for the children’s education or simply to give them a good start later in life.

However, investing for children can be costly for the adult if he or she is not aware of how the investment is treated in relation to tax. Investing in a child's name can attract a tax liability of up to 66%.

In this update we discuss the more common issues surrounding investing for minors. (Note, we are not tax advisers and recommend specific tax advice is sought from a qualified accountant or tax agent before entering into any arrangement.)

Watch now

Children and tax rates

There are very few options to invest directly in a child’s name without being hit with a punishing tax bill. Child tax rates are designed to deter parents from sheltering income in their child’s name in order to reduce their own marginal tax rate.

Excepted persons and income

Not all children are subject to the punitive tax rates. There are several categories of minors who are referred to as excepted persons and are taxed at ordinary rates.

These include people:

• Who are working full-time, or who have worked for more than three months and are intending to work full-time;
• Entitled to a disability support pension or rehabilitation allowance; or someone entitled to a carers allowance to care for them;
• Permanently blind or disabled;
• Entitled to a double orphan pension;
• Unable to work full time because of a mental or physical disability.

Certain sources of income are also considered excepted and are taxed at ordinary rates, ie, as an adult would be taxed, or not taxed, whatever the case may be. This includes:

• Employment income;
• Compensation, superannuation or pension benefits;
• Income from a deceased estate;
• Lottery winnings;
• Income from a business or partnership;
• Income from a property transferred to the minor as a result of the death of another person, family breakdown or to satisfy a claim for damages for an injury they suffered.

Tip

A common strategy is to establish a testamentary trust to hold assets and distribute income to minor children who have inherited monies from a deceased estate.

The primary reason being that income distributed from a testamentary trust is taxed at adult marginal tax rates, rather than the penalty rates applicable to minors.

Consider, however, that income derived from the direct investment of capital proceeds received via a deceased estate also receives the same taxation treatment, i.e. taxed at adult marginal tax rates.

This may be a simpler and cheaper alternative to establishing a testamentary trust as the tax outcome is the same.

Ownership of the investment

In most instances, it is generally more effective for the investment to be in the name of the person putting the money forward, such as a parent or grandparent (as trustee for that child).

This is due to the fact minors are generally prohibited from entering into legally binding contracts and ownership arrangements.

As a result, where money is deposited into a bank account or other investment for a child, it is not unusual for an adult parent/guardian to act as a trustee on the child’s behalf.

For example, the parent of Tommy Smith is Bill Smith. The investment may appear in this name: Mr Bill Smith <Tommy Smith a/c>. It is important to note that this is not a formal legal structure. Bill Smith is the legal owner of the asset.

This type of informal trustee arrangement does not generally involve the establishment of a formal trust deed or other legal document.

A formal trust can be established for the child (or a larger family group) but this involves significant establishment and ongoing legal and financial costs.

These can be warranted when the assets are of reasonable value and income from them may take a child into the highest marginal tax rate.

Advice and assistance on the establishment of any trust structure should be sought from a solicitor or accountant qualified in this area.

Tax File Number

If a Tax File Number (TFN) is not provided at the time of investing, tax at the top marginal tax rate (47%) can be withheld from investment earnings (excluding franked dividends). The question is, whose TFN should be quoted?

If the investment is established in the child's name then it is the child's TFN that is quoted to the financial institution or share registry (a child can get a TFN at any age).

If the investment is in the name of an adult as trustee for the child (as an informal trust arrangement) then the adult will quote their TFN.

If the investment is via a formal trust for the child, then it is the trust's TFN that is quoted (e.g. if held in a testamentary trust).

Ownership and tax issues

If it is established the adult ultimately owns the investment then instead of attracting minor penalty rates, earnings on the investment will be included in the adult's assessable income and taxed at his or her marginal tax rate.

If the adult is a grandparent, this may affect their eligibility for concessions such as the Senior Australians Tax Offset or the Low-income Tax Offset. It may also affect their Medicare levy payable.

If the grandparent is receiving Centrelink benefits there may be adverse implications as the investment could be asset tested and deemed.

Later on when the asset is to be transferred into the child’s name there may be gifting and capital gains tax issues, depending on the ownership situation. To help clarify ownership issues, the Australian Taxation Office (ATO) has provided some specific guidance on this issue on the ATO website.

The advice in the ATO's fact sheet "Children's share investments" rests mostly on the consideration of who rightfully owns and controls the investment (in this case, shares) and who benefits from any income generated from them.

The ATO offers this caution: "If there are large amounts of money or a regular turnover, you might need to examine the ownership of the shares further. You might need more information to work out who should declare the dividends."

A final word on the issue of tax and ownership issues, if there is a condition placed on the investment – that is, the child will only benefit from the investment if they meet a specified condition e.g. passing senior, attending university, buying a car – then ownership could rest with the adult for tax purposes.

This is because if the condition is not met by the child, then it is assumed the adult will retain ownership of the investment.

Strategies for adults considering investing for minors

Consider whether it is likely that the child's investment will generate income above the tax-free limit consistently over the life of the investment.

If the answer is no, then you should consider treating the income as belonging to the child. However, be careful to ensure all income generated from the investments is used only for the benefit of the child and the easiest way to show this is to reinvest it.

If you do withdraw it and use it for the child’s needs (education or otherwise) keep very good records to account for this use.

If the answer is yes, you should consider using a trustee with a low tax rate or use an investment vehicle like a trust or insurance/education bond or warrant.

The value of dollar-cost averaging

It is common for parents or their relatives to offer gifts to children in the form of an investment. This could be by way of a lump sum investment on behalf of the child or a regular savings facility, which can be drawn from at any given point in the future.

A regular savings facility includes the benefit of dollar-cost averaging – that is, the benefit of purchasing investment units at differing prices. The regular investment purchases less units when prices are high and more units when prices are low.

By averaging the unit price paid, the investment cost is reduced. Speak to your adviser for more information on regular savings facilities.

If you need more guidance on where to start when investing in your children's future, talk to your Morgans adviser or contact your nearest Morgans office.

• Heading into February results, we examine key strategic themes across earnings trends, the cyclicals rotation, yield security, rising AUD impacts and resources.
• In our Reporting Season Playbook (accessible by Morgans clients) our analysts preview the results for 184 stocks under coverage that report this February, calling out potential surprise and disappoint candidates.
• Key tactical trades into results include Sonic Healthcare, NextDC, Origin, Zip Co, Eagers Automotive, and Virtus.

Dampened expectations leave room for upside surprise

Investors have a lot to feel optimistic about as the economy continues to defy expectations (our chief economist Michael Knox is calling for a sharp V-shaped recovery) but analysts’ earnings and dividend forecasts are yet to capitalise the recent good form.

We think there is a risk of surprise in company results that have significant leverage to the recovery.

Domestic cyclicals outperforming overly fearful market expectations was a dominant theme in August and analyst previews of the 184 stocks under Morgans coverage suggest this trend will continue in February.

Our analysts expect that 28% of stocks covered have reason to respond positively to February results.

Various moving parts requires careful portfolio positioning

Investors need to position tactically into February results. Overall, we expect outlook commentary to be better than what was provided in August and we think the outlook for dividends has improved markedly.

But while the recent good form in the economy will benefit segments of the market (retailers, banks, resources), elevated valuations and currency headwinds will temper the performance of others (healthcare, offshore industrials/fintech).

We discuss key strategic questions:

1. Can cyclicals deliver expected EPS upside surprise?
2. Where’s the best source of secure yield?
3. Will currency moves complicate the FY21 earnings picture?
4. Do recovery expectations match reality?
5. Does the resources rally have further to run?

Commodities/resources upside

An overweight exposure to resources shapes as one of the strongest sector allocation ideas for 2021.

Commodities tailwinds include improving post-COVID GDP growth, ongoing central bank stimulus, tight supply, and the weaker US dollar.

The best opportunities in the sector are in lagging energy and gold sectors.

Best tactical calls heading into results

In our Reporting Season Playbook, our research team previews expectations for 184 stocks reporting in February, including 52 where we expect positive price reactions, and 11 where we expect negative reactions.

We also profile the best looking tactical buys and notable stocks to avoid/trim. In this list we prefer larger stocks and those that overlap with the Morgans Best Ideas and the Morgans Equity Model Portfolios.

Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.

Every day, you’ll read stories about people who’ve struck it rich (or simply got lucky) by taking a punt on the latest hot opportunity. It might be a stock that’s tripled in value, or the latest digital currency that’s being heavily promoted online.

It doesn’t matter which; all you know is that somewhere, somebody’s making a stack of money, and it’s not you.

You might even think you’re missing out, particularly if your investments are still recovering from the downturn last year.

You could be tempted to throw caution to the wind, and have a dabble in something hot.

Let’s just pause for a moment, and consider the difference between speculating and investing. One way to describe speculating is taking big risks, hoping you’ll get a big payoff.

That’s not what investing is about. Investing is about managing risks, not embracing them.

Manage the risk

One of the best ways of reducing investment risk is to spread your portfolio across a number of different investments, and types of investments.

It's the old 'don’t put all your eggs in one basket' theory, and it’s stood the test of time as an important way of smoothing investment returns and reducing risk.

The main investment classes – cash, fixed interest, property and shares – all carry different levels of risk, and all have provided different returns over time.

Historically, shares have been the best performer. But those returns have varied from a 30% gain in a good year, to a 50% loss in a bad year.

And nobody can predict which types of investments will perform best in the future.

At the other end of the spectrum, cash is safe (and there’s a government guarantee on bank deposits of up to $250,000).

But the return? In most accounts, it’s close to zero. If you take into account inflation, your bank return can actually be negative. If you hedge your bets, and spread your portfolio across cash, fixed interest, shares and property, there’s the potential for losses in one class of investment to be offset by gains in another.

You won’t get the peak returns of the share market in a boom year, but neither will you experience large losses.

Overall, your risk is lower, and your returns will be more consistent.

What is strategic asset allocation?

Strategic asset allocation is the process of choosing the mix of investment types that will meet your investment objectives, while minimising risk. And the best asset mix for you will depend on your investment timeframe, and how comfortable you are with risk.

There’s no one fixed asset allocation – it will vary between individuals.

A younger investor hoping to build wealth for the future might be comfortable with a high exposure to shares.

Somebody approaching retirement might be more cautious and balance their exposure to shares with higher levels of cash and fixed interest.

Setting a target asset allocation adds some discipline to your investment strategy.

It means sticking to a process that will optimise your returns, rather than chasing the hot opportunities that could make you rich (or broke).

Rebalance your portfolio annually

Just as there's no thing as a 'set and forget' investment, your asset allocation needs some attention from time to time.

At least annually, you should consider 'rebalancing' your portfolio. In any year, some of your investments will perform better than others.

Let’s suppose your original allocation to shares was 40% and the market has a good year. You might find shares now make up 50% of your portfolio. Rebalancing involves reducing your exposure to shares back to 40%.

In other words, you’re taking profits from assets that have performed well, and topping up your other investments.

Is your current asset allocation right for you?

If you’re not sure whether your current asset allocation is right for you, or you think it might need rebalancing, talk to your Morgans adviser or contact nearest Morgans office.

​The Australian Government has completed a review of the retirement income system to assess how it will perform in the future as Australians live longer and the population ages.

The review, which was commissioned following a recommendation by the Productivity Commission, was not asked to make recommendations or propose changes to policy settings. However, it did uncover evidence that many aspects of the system need improved understanding.

Key observations and overview

The need to improve understanding of the system

• Dealing with complexity. Complexity and uncertainty, a lack of financial advice and guidance, and low levels of financial literacy are impeding people from understanding the system. As a result, some people fail to adequately plan for retirement and make poor decisions about how to use their savings in retirement.
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• The nature of retirement income. Most people die with the bulk of the wealth they had at retirement intact. It appears they see superannuation as mainly about accumulating capital and living off the return on this capital, rather than as an asset they can draw down to support their standard of living in retirement. The family home is an underutilised source to support living standards in retirement.
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• The nature of retirement. The nature of retirement has changed. For many, the transition from full time work to permanent retirement is gradual rather than abrupt. Some people retire more than once, others are involuntarily retired. There is no mandatory retirement age for most workers.
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• The objective of the system. The retirement income system lacks an agreed objective. Differing views on the appropriate level of the Superannuation Guarantee (SG) rate stem from different views about the system's objective.
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• Role of the pillars. The ‘pillars’ of the retirement income system are commonly seen as being the Age Pension, compulsory superannuation, and voluntary saving (including housing). Some see housing as a separate pillar.
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• Dealing with diversity. The retirement income system covers people in very different circumstances: different incomes, time in the workforce, employment situation, capacity to save, home ownership status, risk preferences, financial literacy, partnership status and life events. While the system may provide adequate retirement incomes for many Australians, there is uncertainty about if and how it can compensate for those who may fall short, such as women, lower income renters, individuals not covered by the SG, involuntary retirees, Aboriginal and Torres Strait Islander people and those with disability.

Source: The Australian Government – The Treasury.

What does this mean for you?

This review has identified the need for greater financial advice for consumers, particularly when it comes to retirement planning, to help people understand the complex laws and regulations that are already in place.

Without this financial advice from qualified financial planners, you might be missing out on maximising your retirement potential.

Speak to one of our qualified Morgans advisers today to define your own retirement journey.