Question: I think that I can put up with some significant fluctuation in capital values of my bank stocks over the years in my pension fund. My sensitive points would be reduced dividends and bankruptcy. With those thoughts in mind, I tend to think that even a regional like BOQ is still a fair bet for the next few years. Do you agree?
Answer (By Peter Switzer): It’s exactly what I am doing for my super fund. Of course I do have 20 stocks in my fund and so I do limit my exposure to a bankruptcy.
On dividends, sure, you can see a fall in dividends, but looking at CBA’s returns, it only lasted a year and bounced back better than before.
We are all taking risks with shares over term deposits but that’s the price we pay for wanting better returns.
Have a look at Charlie Aitken [1]‘s story today.
Question 2: I am keen to buy exchange traded funds (ETFs) but am unsure how to determine when a price is a “buy”, when it is a “sell”, and also when it is overpriced. Is there some guideline to help me make these decisions and from where do I get this information?
Answer 2 (By Paul Rickard): Most ETFs are based off an ‘index’ (such as the S&P/ASX 200 or US S&P 500) and attempt to fully replicate the underlying components of the index. Accordingly, they have almost negligible tracking error.
Because they replicate in full and track the index so closely, the issuers of the ETF can appoint or arrange for “market makers” (brokers) to make an active two-way market on the stock exchange in the ETF. As the value of the underlying index changes during the day, the bid/offer prices on the ETF change. This process effectively becomes automated – so when you trade an ETF on the stock exchange, you are pretty well guaranteed that you are trading the ETF at a price that is within a fraction of a per cent of its underlying value.
The ASX tracks this (effectively, the spread between the bid and the offer price) and publishes it in its funds report (the most recent report, December 2013 is available here [2]).
So, it is not really a question about the price of the ETF – it is a question about whether it is the right time to invest in that market or not.
If, on the other hand, you are considering LICs (Listed Investment Companies), this becomes a valid question because the price that the LIC is trading at in the secondary market can be “overpriced” or “underpriced” relative to its underlying value. Known as the “premium” or “discount” to Net Asset Value, these amounts can be material in percentage terms – often as high as 15%. These premiums or discounts arise due to supply/demand pressures and the fact that that the LIC is effectively a close-ended structure with a finite number of shares on issue. While not always the case, discounts tend to occur more in “bear” markets, and premiums in “bull” markets.
LICs are required by the ASX to report and publish their NTA at the end of every month. The ASX report noted above also covers LICs, and reports on the premium/discount using end of month market prices.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Charlie Aitken: Bank on it! [1]
- Fundie’s favourite: Macquarie (MQG) – well placed to benefit [3]
- Roger Montgomery: REA Group offers some upside [4]
- Staff Reporter: Buy, Sell, Hold – what the brokers say [5]
- Penny Pryor: Short ‘n’ Sweet [6]
- Tony Negline: A new product that focuses on income [7]