Funds, crashes and fly-by-nighters

By MARY HOLM

Q: You have said that funds have much less chance of losing value the longer you hold them, but I have seen articles that scare me.

For example, one article predicts 7-10 years of poor returns coming. Another points out that after the 1929 crash it took 25 years to get back to even.

How do you feel when you read these sorts of articles?

Do you think fund managers always seem to be optimistic of future returns as they don't want people to withdraw funds and lower their commissions?

Have any managed funds gone broke with investors losing all their money?


A: Taking your last question first: I don't know of any funds that have gone broke, and nor do others I have asked.

If you are talking about share funds or balanced funds run by large institutions, it's hard to imagine one going broke. Most just buy assets.

Certainly the value of the assets will fall sometimes - but not to zero.

The other possibility is that the fund managers take your money and disappear. But that is highly unlikely in a reputable institution.

Now for the fund managers' forecasts. You don't hear fund managers, or others in the finance markets, predicting negative returns on shares. And yet markets do fall every third or fourth year, on average.

But don't read too much into that. Anyone who's investing must expect to get positive returns. Otherwise, why invest?

And, on average, returns are positive. While fund managers know they will sometimes have bad years in shares, they don't know which those years will be.

Having said that, fund managers' optimism may also be self-serving. I wouldn't take too much notice of their predictions.

You also asked how I feel about others' predictions, particularly the gloomy ones. Well, it depends.

I listen to the growing number of experts who say average returns on shares over the next few decades are likely to be lower than in recent decades.

Here is what hugely successful US investor Warren Buffett said in late 1999. What has happened since tends to support his statement.

"I think it's very hard to come up with a persuasive case that equities will, over the next 17 years, perform anything like - anything like - they've performed in the past 17," he said.

"If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate would earn in a world of constant interest rates, 2 per cent inflation, and those ever-hurtful frictional costs (brokerage, taxes etc), it would be 6 per cent.

"If you strip out the inflation component. that is 4 per cent in real terms. And if 4 per cent is wrong, I believe that the percentage is just as likely to be less as more."

One reason returns on shares are likely to be lower is that inflation is lower than in the past few decades.

Another is that, as Baby Boomers retire, many are expected to transfer savings from shares to fixed-interest investments. Lower demand for shares will hold prices down.

However, I don't pay much heed to more specific predictions, like the one you mention about seven to 10 years of poor returns.

I can remember being a bit unnerved when a highly qualified American guru said, a few years ago, that the US Dow Jones index was way overvalued at 7000, and a crash was almost inevitable.

If you got out of the US market on the strength of that, you missed out on one of the best bull runs in a long time. The article you quoted about the 1929 crash actually said, "If you bought into the US market in August 1929, it would have taken about 25 years before the capital value was back to square one."

The key words are "capital value." If you include dividends, you would have been back to square one by the late 1930s.

But, don't forget, that was the time of the Great Depression, the likes of which we are unlikely to see again - given what we now know about economics.

There have been other sluggish periods on the US market, but for the most part, it has risen pretty impressively. Events like the 1987 crash are mere downward blips.

What does all this amount to? There can be no guarantees on share returns.

If it really worries you, stay out of share funds.

But there's quite a chance you'll miss out on some pretty good returns - albeit probably in the single digits, on average.

Q: Can you advise if tax is due on any increase in value of shares in a US company, if such shares are unsold and the intention is to hold them long term - ie for future dividend income, not a share trading income?

If tax is due, then in the event of the company going belly up, I assume one would be entitled to a tax credit against other New Zealand income.

I presume the sole measure of value would be the quoted price on whatever exchange the company was listed on.

I would greatly appreciate any advice you can give me.


A: Relax. As long as you're a small shareholder, you probably won't have to pay any tax at this stage.

And it would seem - from what you say about buying for dividend income - that you also wouldn't be taxed on any capital gains when you finally sell the shares.

Basically, the same rules on capital gains apply, regardless of whether the shares are in New Zealand or foreign companies, says an Inland Revenue spokesman.

Your question probably arises from the fact that some shareholders are caught by the foreign investment fund rules.

The rules apply to people who own foreign shares worth $50,000 or more at any point in the year; who have at least a 10 per cent interest in a foreign company; or are in other circumstances that seem unlikely to be relevant to you, says the spokesman.

If you think the rules might apply to you, I suggest you see a tax adviser.

Q: We refer to a letter from one of your readers, in Money Matters on May 19, regarding the New Zealand tax treatment of their distribution from Westfield Trust in Australia.

While your advice was completely understandable in general terms, the specifics of Australian unit trusts (as opposed to companies) and the way in which such trusts are treated from a New Zealand income tax viewpoint can lead to some anomalous results.

Where these are material in amount, such income flows should certainly be approached with the utmost caution.

(The letter goes on to say that Westfield Trust receives mainly rental income, but also some dividends and interest. These different types of income are taxed differently.)

Australian taxes withheld from unit trust distributions to non-residents may comprise a mixture of non-resident withholding tax (NRWT) and Australian income tax, paid on account of a unit holder.

Generally, where the unit holder is an individual, this income tax is withheld at the maximum marginal tax rate for individuals, being 47 per cent.

Where amounts are material, it may even pay the unit holder to file an Australian income tax return and seek a refund of excess tax withheld.

Where the unit holder is a company, the income tax is withheld at the company rate (34 per cent, moving to 30 per cent from July 1).

Corporate unit holders will have different compliance obligations in New Zealand. These are best addressed outside your column.

In either case, NRWT is the only tax credit allowable against the New Zealand tax payable on the "dividend" income. Credits are not allowed for other tax paid in Australia. The net result to New Zealand investors may well be a rather severe element of double taxation.

Our review of the Westfield Trust distribution advice note for February 2001 has shown that only a small proportion of the amount described as "Australian withholding tax" constitutes NRWT.

The balance of the "withholding tax" is Australian income tax on the rental income portion of the distribution.

Therefore, New Zealand individual investors should return the net distribution received, plus a gross-up for the small amount of Australian NRWT actually deducted.

The investor would only be able to claim a tax credit for that small amount of NRWT.

Your reader must calculate the amount of interest and dividends contained in the distribution and calculate the NRWT deducted.

You may wish to state that for tax matters such as this, your readers should contact their tax advisers for specific advice.


A: I certainly may!

Readers won't be surprised to learn this letter came from an accountant, Kevin Pitfield of Staples Rodway. I appreciate his efforts to enlighten us all.

I also can't resist saying that if I were a unit holder in Westfield Trust, I would be tempted to get out.

Not only are you being heavily taxed, but you could well end up paying more for tax advice than the returns on your investment.

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