One Year Overall Returns
It has taken approximately 6 years for US Quantitative Easing (QE) to come to an end. Since the beginning of the Global Financial Crisis (GFC) many US mortgages have been re-financed, the clean out of defaulters has occurred and regulatory changes aimed at preventing poor lending practises while encouraging both private and Government Sponsored Enterprises (GSE), e.g. Freddie, investment have been implemented.
During this period there has been considerable commentary about the economic effects of QE in the form of currency wars and that cheap money has driven equity markets up. So what does the future hold? In the short term there will be a return to greater than normal price volatility particularly in debt capital markets, because QE has suppressed price volatility in these markets. The impacts of its end on other asset classes are now starting to be worked through the financial system. Equity markets are factoring in higher interest rates while currency markets notably the Australian dollar has significantly depreciated against the US dollar in recent days. These price corrections will continue as investors seek to price risk in a Federal Reserve intervention free world.
There may not be much agreement in Washington on most matters, but there is one item that the White House, Democrats, Republicans and regulators agree on – that in the future the US tax payers will never again bail out the mortgage industry. This is why the Tea Party and some sections of the Republican Party are trying to have Freddie and Fannie closed down, but what is more likely is that these organisations operating and risk frameworks will change. Initiatives such as Qualified Mortgages (QM) that defines the credit underwriting standards for a GSE securitisable mortgage and Qualified Residential Mortgage (QRM) that requires the originator and securitiser to carry first losses are being introduced. These compliance requirements are directed at preventing poor lending practices while establishing securitisable standards, so that investors understand and can have trust in the paper they are investing in while shifting the risk from the tax payer to private enterprise.
These “green shoots” appearing in the US secondary mortgage market reflect these regulatory initiatives and the forecast end of QE. This can be seen in the narrowing of the return expectation gap between the buy and sell side, because investors understand this asset class as it provides bond like returns without investing directly in bonds.
There has been a lot of media attention on Bitcoin recently. Many people want to know what it is as they are unclear as to whether it is a currency, a payment method, investment or Ponzi scheme?
About 20 years ago there was early runner of Bitcoin called Digicash. It was electronic “coins” that could be converted to cash, i.e. one Digicash was worth 0.10 cents. The bank promoting this electronic payment tool guaranteed the payment. This provided confidence and assurance in the system. It did not get off the ground for a range of reasons including it was too soon for the market. The major issues identified at that time were credit risk, value, fungibility and legal tender. These are the same issues facing Bitcoin.
So by way of background the Bitcoin concept is not new, but it is missing a number of key elements that make it sustainable. Namely, no bank will accept Bitcoin as payment. If you walked in to any bank today with a certificate for 1000 Bitcoins (even though you may have paid $1,000,000 for the Bitcoins) they would not give you one cent for it. Bitcoins outside the Bitcoin market are not fungible and have no value.
As is reported in the press each day their value fluctuates widely within the Bitcoin market and recently one of the key storage /processing units was hacked, so security is questionable. Until fungibility and value (that are supported by a financial system) are addressed Bitcoin has a limited future life. It just takes a few people to lose confidence in the system for it to collapse. The possible linking to gold, silver, oil, etc could potentially give it value because investors/users will look past the Bitcoin to the underlying physical asset where the value is.
Finally, it is noted that Bitcoin is used by people in the “silk road”, with some senior Bitcoin personnel recently being arrested in Australia and the USA on drug and money laundering charges. Credibility and integrity are paramount principles in business and particularly in the payments area.
With Bicoin - Buyer beware!!
The private or institutional US Secondary Mortgage Market is coming to life. It’s taken a long time, so it is important to look at what is happening.
Before doing so, a brief overview of the US mortgage market is necessary as there are many similarities, but also some very important differences to the Australian market. The main difference is that the Australian market is dominated by the 4 Majors and is highly vertically integrated where the 4 Majors banks control the origination, do their own servicing and fund on a 60% retail/40%wholesale basis 90% plus of all mortgages. Whereas, the US mortgage market is segmented with the origination, servicing and secondary markets each are highly competitive. The Australian Secondary Mortgage Market requires investment tranches of $200 million, while US mortgages can be securitised individually or in tranches according to the investors’ requirements. The US money centre banks do securitise large tranches in the same way as the Australian market.
These GSE’s have been implicitly guaranteed by the US government, thereby protecting the investor, not the borrower. It was the US mortgage and related markets where the Global Financial Crisis (GFC) had its genesis. As we all know at that time investors did not understand what they were buying. The paper may have been rated AAA when in fact it was junk. So investors left the market because of the loss of trust in the product. As it is well reported on investigation, the GSEs books were found to be full of non-performing loans. The US Federal Reserve through its Quantitative Easing (QE) has been buying back these mortgages which have allowed the GSEs and the banks to re-capitalise their balance sheets while simultaneously the historically low interest rates are to encourage investment. This cheap money has driven equity markets. This is a well understood story.
There may not be much agreement in Washington on many matters, but there is one item that the White House, Democrats, Republicans and regulators agree on – In the future the US tax payers will never again bail out the mortgage industry. This is why the Tea Party and some sections of the Republican Party are trying to have Freddie and Fannie closed down, but what is more likely is that these organisations operating and risk frameworks will change. Initiatives such as Qualified Mortgages (QM) that defines the credit underwriting standards for a GSE securitisable mortgage and Qualified Residential Mortgage (QRM) that requires the originator and securitiser to carry first losses, unless it’s a QM. These compliance requirements are directed at shifting the risk from the tax payer to private enterprise.
QE has artificially suppressed secondary market price volatility. With the proposed end of QE on mortgages in October it is likely that price volatility will return to this market, as investors seek to price risk in this new world. At the moment there is an investment return expectation gap between the buy and sell side which is keeping investors out of the market; however this gap is narrowing and QM and QRM initiatives should help reduce it further. There is some debate that QM will only provide an artificial comfort, only time will tell.
There is also a push to have a single fungible security and QM and QRM are components of that goal so as to remove the price distortions between Freddie and Fannie paper which should improve liquidity. The goal is to have the market trade on credit quality, not on the underlying collateral, however this will take time to implement, if it’s ever achievable.
It has taken 6 years but now that many mortgages have been re-financed, clean-out of defaulters has occurred and with regulatory changes aimed at preventing poor lending practises the private or non-GSE market is starting to come to life. QE is ending and hedge funds and institutional investors are showing a renewed interest in mortgages for a number of reasons, including that the long term consequences of QE on the bond market are unknown. Investors are seeking bond like returns without necessarily having direct exposure to the bond market, the “new” secondary mortgage market may be the asset class that meets that need.
How can you know what you need when you don’t even know it exists? Quite often people gloss over the need for a financial planner because they are unsure about what they need, what financial planners can actually offer and are sometimes afraid to show their lack of knowledge. Let’s be frank, the industry in recent times has not helped itself with organisations like Storm giving their clients very poor advice. Rather than helping the clients to protect their wealth, they embarked on strategies that meant their clients’ wealth was all but lost.
To be simplistic, Financial Planners are experts in the field of helping you plan your financial future and implementing strategies to protect your wealth. We’re not just talking budgets here, they will work out your current financial situation and devise solutions that will help you increase your future wealth without burdening your current cash flow. They can identify tax minimisation strategies, increase your wealth through investment (through property, shares or other types of investments) and ensure you and your family are looked after in case of unforeseen circumstances. They often have relationships with many other experts including tax advisers, accountants, mortgage brokers and share brokers.
Most people think of seeing a financial planner when they are approaching retirement age and require advice on boosting their superannuation and retirement planning. However, there are many benefits in using financial planners in all stages of your life. You do not need property or investments or lots of savings. In fact, the less you have the more benefit you’re likely to get as a financial planner can help you make the most out of your income and structure your investments to create wealth for your future and provide wealth protection strategies. We all know the longer you consistently invest in a range of assets, the more benefits you will gain.
Over the years financial planners have received a bad name. There are a couple of reasons for this:
1. Pushed Products - the majority of financial planners work directly or indirectly for one of the major banks or financial institutions in Australia. This generally means that they can only advise clients on a limited number of investment products, most of which are the bank products.
2. Poor Investment Returns - in part this was a symptom of the Global Financial Crisis, but the other part was the astronomical fees on many retail financial products.
3. Too much Leverage is a Risky Strategy – Many of the investment strategies were unnecessarily risky. Either the client was too leveraged (borrowing to invest), and as we know the greater the leverage the greater the return, but also the greater the potential loss.
4. Inappropriate Investments – some of the investment types, e.g. trees, emu farms and like type investments were never going to deliver the returns claimed. Furthermore, the structures around these were usually very complex.
5. Excessive commission levels - some commission levels were so high that financial planners focussed on selling certain types of products regardless of customer needs.
Today, current regulations have banned certain types of commissions. However, one major issue still exists and that is that the majority of financial planners are ‘tied’ to one of the major financial institutions. They are highly likely to push products onto a customer because of their affiliations and these products may not best suit your needs. WealthMaker Financial Services is not owned by a large major bank or a fund manager and all our planning advice is completely independent.
An example of a good financial planner is one who can develop a strategy to reach your financial goals and can provide a broad range of investment choices. They are experienced and knowledgeable and should be willing to help you no matter what stage of the financial lifecycle you are in. In addition, they should not be driven by product commissions, but rather “put their clients interest first”.
Financial planners simply cannot know everything and so they often focus on a particular area, e.g. superannuation and retirement, tax planning or investment advice. It’s important you have a general idea of what you hope to achieve by seeing a financial planner so you can find one that best meets your needs. One general observation is to avoid people limited to 'selling' one investment product or solution.
To help you make a decision during an initial consultation each financial planner must give you their Financial Service Guide (FSG). This is your time to ask lots of questions and read this document carefully. Look for the following, do they:
If the answer is yes to any of these questions there is a conflict of interest and conflicts increase the likelihood of poor advice. Another way to assist in determining the right financial planner is to see if they are a member of a recognised industry body such as the Australian Independent Financial Advisers (AIFA) and Independent Financial Advisers Association of Australia (IFAAA) who encourage and support independent financial planners. Their members genuinely strive to promote a ‘gold standard’ and help people when they need it most. This membership should be in addition to their qualification membership with either the Financial Planning Association of Australia (FPA) or Association of Financial Adviser (AFA).
The right financial planner can help you set and achieve financial goals well above the expectations you might already have. You can start a conversation with one of WealthMaker’s financial planners today. We are completely independent and knowledge in almost all areas of financial advice and wealth creation. Call us on 02 9233 1111
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