Jul 27 2018Add to Favorites
Instant gratification x the Marshmallow experiment x investing.
In a famous Stanford university experiment conducted in the 1960’s led by a professor and psychologist (Walter Mischel) on delayed gratification, children were given a choice between one marshmallow, or if they waited a short period, 15 mins, two marshmallows. The study followed these children into early adulthood and found that the children who had waited had higher SAT scores, lower body mass index and had more fulfilled and successful lives overall.
What does this have to do with investment? Well, like the Marshmallow experiment, patience in investing - delaying gratification, riding out market movements, and not focussing on short-term results – facilitates the marvel of compounded growth and provides the best chance of optimising long-term investment objectives.
In similar studies to the above Marshmallow experiment, age was found to have a bearing on decisions, with younger participants more likely to focus on the short term rather than long-term outcomes.
Intergenerational transfer of wealth - Baby Boomers vs Millennials.
There is a really interesting shift in the generational control of wealth which is on the horizon and will transform the investment landscape. This is essentially the shift in control of wealth from Baby Boomers to Millennials. As someone who is on the “cusp” of the two generations, and with the primary segment of our existing investor client- base being Baby Boomers who themselves are navigating this complex transition of the intergenerational wealth transfer, it is really interesting to note the differences between the two demographics. The most notable would probably be the expectation by the younger generation for instant gratification. This is predicated on technology and availability of cheap credit making almost everything available now.
The question this brings up in my mind is how does the investment landscape evolve to provide channels for a more Millennial-driven requirement for instant gratification, especially when investment by its nature requires patience and a view to the Long Game? In the opinion of MP Funds Management, the process will need to be more digitally oriented rather than relationship driven.
The rise of recent innovations such as “PayPal”, “Afterpay”, global online shopping, and the ready availability of credit, is fostering younger generational segments to behave as consumers as opposed to investors, so it would make sense that investment solutions will need to innovate to capture the ways that younger generations interact and behave.
The life of a Rockstar Athlete or a UPS worker?
A few years ago I watched an ESPN documentary on professional sportspeople (particularly American NFL Football and NBA Basketball professionals) which explored the unfortunate correlation between retirement and financial distress. The report found that approximately 60% of professional basketball players and 78% of professional football players end up in significant financial distress after retiring from lucrative careers. When you think about the fact that many of these professional athletes earn more in a year of their career than most of us will earn in our working jobs in a lifetime, yet end up with almost nothing, it’s a really interesting phenomenon.
In stark contrast to this is the story of the UPS worker who never earned more than $14,000 a year and invested consistently, amassing a fortune of $70 million over his lifetime, $36m of which he donated to education-based charities to support young people getting a quality education.
These both are examples of the Marshmallow experiment to its extreme outcome but also serves to illustrate that over time, your choice of investment can be less important than discipline in the face of market movements. Making sound, informed decisions (rather than simply following trends) and having a long-term investment plan will stand us in good stead and, with any luck like the UPS worker, enable a legacy to be handed to future generations. Like the children’s tale of the tortoise and the rabbit, slow and steady wins the race, the Long Game wins (most of the time).
It should be the primary objective of investment groups to ensure that investment fundamentals are promoted and accessible to every generation, including the UPS workers and Rockstar Athletes.
Why we need to be better investors now.
It’s never too late to become an investor, but doing it sooner rather than later maximises the potential to reach our investment goals, which will vary at each stage of our lives: from just starting out, to buying a house, to family building, to preserving lifestyle as we transition into our less productive years.
The sooner our objectives are identified and quantified, the more time we have to implement strategies to achieve them.
I am a firm believer in applying youthful energy to build momentum for adulthood, meaning the better stead we will be in when older. With any luck, patient and considered strategies implemented with consistency over time will build sustainable wealth and a legacy like the UPS worker giving the next generation of your family a financial “leg up”.
Getting high quality diversified real estate exposure via my SMSF
One of the most valuable and tax effective structures that each of us has available (currently) to build and grow personal wealth for the long term is our superannuation. In Australia the aggregate value of superannuation is $2.5 trillion, it’s one of our largest pools of investment capital. Of this, approximately $700 billion is self-managed.
Whilst many would argue that Self-Managed Superannuation Funds are expensive to set up, manage and audit, we believe that it’s less than the potential costs involved in letting others do it. I’d prefer to control my own destiny, and it’s a worthwhile investment of time and resource in my view.
According to the 29 July 2018 edition of the Australian Financial Review, the Top Performers List of externally managed and pooled superannuation funds was lead by Hostplus which was reported as delivering a 12.5% annualised return over the 12 months to 30 June 2018, an 11% 5-year return and 7.4% over the last 10 years. As part of a diversified portfolio, I have a portion of my superannuation in the Host Plus Managed Fund, and another portion which is self-managed. Because Superannuation contributions are capped I think it’s important to find other effective ways of investing outside of Superannuation. As an example, I allocate a portion of my portfolio to syndicated property investments such as the MP Funds Management real estate investments, such as 9 Hunter Street [read more here].
Banks have stopped lending to SMSF’s for real estate, what does this mean?
As a consequence of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, major banks are reviewing their lending practices and some (like Westpac) have stated that they will no longer lend to SMSF’s to buy property.
Whilst this could be seen as a setback, the way that I invest in real estate via my SMSF is via participation in syndicated, high-quality real estate investments either as debt or equity depending on the capital requirements of the investment. These arrangements generally have a minimum investment of c.$100,000 or $250,000 and the process is as simple as filling out an application form, transferring money into a designated investment bank account, and the investment is managed for me. Investing this way, there is no need to go to a bank and get a loan to get high-quality real estate exposure. I receive monthly rental distributions with the added benefit of a capital gain on the sale of the property.
Achieving a high-quality investment portfolio includes high-quality real estate exposure
The key outcome that we are committed to at MP Funds Management is achieving exposure to real estate assets that offer a commensurate return for the risk taken in the investment.
Case Study: During the period 2013-2017 one of our high net worth clients, who incidentally doesn’t have an Australian Superannuation Fund because has been domiciled offshore, gave us a pool of capital to invest. Rather than putting the pool of capital into one deal, we split it across about 20 transactions, some of which were equity participation in stabilised, income- producing assets, like A and B-grade tenanted office towers which had the benefit of rental annuity together with the potential for capital growth. Other investments included development financing loans for construction of residential apartment blocks, townhouses, and land subdivisions which were higher risk but benefitted from a rising market and a compelling return profile.
The final investment was realised in late 2017, and we are proud to confirm that we achieved an outstanding result for this investor, with the portfolio of investments producing a blended gross IRR of c. 21% and a gross ROI of c. 65%.
Commentators have identified that we are approaching a complicated investment cycle that is a result of the activities of central banks and their post GFC stimulus objectives. The low-interest rate environments have had the desired effects in generating economic stimulus, which can be seen in the run-up in asset prices, particularly housing, but also in the overall positive outlooks in major global economies, particularly the US. Growth is now coming through, which means interest rates around the world are starting to rise in response to inflation pressures.
The market is characterised by a combination of economic optimism and a heightened sensitivity to interest rates stemming from the run-up in household debt. This is creating a period of higher risk, and investors should be seeking diversification in their investment portfolios and moderating any overweight exposure to any one sector.
In real estate market, commercial and industrial property remains fully priced, retail is pulling back on sentiment driven by the “Amazon” or online influence, and the residential market contracting as a result of cooling demand and tighter credit conditions. Over the last 12 months, residential markets in Sydney have fallen around 6%, however, more than anything sentiment and commentary has become increasingly negative.
MP Funds Management remains optimistic on the long-term dynamics of the residential market based on Australia’s strong reliance on the need for in-flows of skilled working tax-paying migrants to fill the employment base as the aging population near retirement age.
Opportunities remain in pockets that demonstrate strong underlying real estate fundamentals where mainstream banks may not have an appetite at the present time. Read more here.
We are currently working on several senior and junior construction funding solutions for residential development projects, with debt requirements in $50 - $100m range. Each of these projects has outstanding real estate fundamentals and are of high quality and highly sought-after locations.
Ultimately whilst the life of a Rockstar Athlete looks like it would be fun for the time it lasts, we are focused on implementing the fundamental behaviors of the UPS worker for the Long Game. We are focused on sustainable results to build wealth that lasts and for generations to come.
We really love retail property at the moment at MP Funds Management because we see opportunity in the disruption. Australia’s population is growing, our living is getting denser and whilst the advent of online shopping is creating change in the sector, human behaviour causes us to gravitate towards food and entertainment. Whilst some of the retail tenants may be outmoded or a centre underperforming as a result of this evolution, it’s fair to say that well-located and underperforming CBD- located centres, which have a strong demographical catchment area can be turned around with some TLC and well thought out repositioning.
November analysis released by both UBS and Macquarie Bank highlight that potential buyers have become very cautious and expect prices to fall further. Both reports highlight that whilst borrowing capacity has declined, most borrowers don’t borrow at their maximum. The RBA recently showed that relatively few households would have been constrained by the tightening in lending standards over recent years.
Each of the primary property investment sectors, residential, commercial office, industrial warehouses, retail shopping centres has an investment cycle and a market cycle. Its useful to have the ability to move across sectors so that when one isn’t performing so well, others which are performing better can be capitalised on. Also, investing across sectors can build up diversification.
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