Farming is a tough business. One that almost seems in perpetual crisis. Farmers face a constant stream of challenges ranging from lower commodity prices to their exposure to natural events, as seen recently in Australia with the droughts and fires. In New Zealand our agricultural sector represents the second most significant credit exposure of our banking sector, dairy debt, in particular, is high and concentrated. Technology can present an opportunity for farmers, but scale means the efficiencies and the benefits are typically skewed to the largest farms.
Farming is forever an unfortunate lesson about diversification. Nothing highlights the dangers of being undiversified more than a small family farm. Small farmers often have to concentrate their operations around one or two commodities or crops. In the case of the farm, there’s no criticism, their options are quite often limited. It leaves them extremely vulnerable to variances such as weather, government policy and consumer behaviour. One variance from expectation can quickly take a season from profit to loss.
If you asked a farmer, given the opportunity, would they add another 20 crops or stock varieties while using the same amount of resources to diversify their income, you could bet they’d take that option. Their risk is lower meaning the likelihood of a catastrophic loss would be much lower. Unfortunately, these are mostly luxuries of scale and determined by location.
For a small investor, it’s a different story. They have access to broad diversification options that can help lower the risk of any catastrophic loss while allowing them to capture market gains across the world’s capital markets. Unlike the farmer, for a small investor diversifying a portfolio isn’t capital and cost-intensive and their investments are liquid. A smaller investor can often globally diversify at a lower cost than in their domestic market.
Not that New Zealanders are overly keen on diversifying. NZX makes up 0.01% of the world’s share market capitalisation, but most New Zealand investor portfolios are overly weighted to the home market. In other words, a New Zealand investor with a strong home bias would have just a 7% allocation to technology, compared to approximately 16% in the global portfolios. It’s not that long ago that most Mum & Dad investors experience with a diversified portfolio was a handful of Telecom, Telstra shares and for some with longer memories GPG and Brierly.
Why might this be?
Lack of quality advice would be the obvious factor but don’t discount high dividends and imputation credits being a likely lure for such a significant home country bias. There’s no true diversification in those New Zealand focused portfolios.
The most common criticism of diversification you might hear is it’s for people who don’t know what they’re doing. This may be true. An investor might not be interested in EBITDA, ROI, P/E or cash flow of a company, but knowing about these things doesn’t automatically protect an investor from random events. Market forces can sneak up, while legislative and governance issues can strike without warning.
Just recently the Australian Transaction Reports and Analysis Centre ‘Austrac’ has taken Westpac to court, alleging the bank contravened anti-money laundering and terrorism rules on over 23 million occasions and failed to properly monitor and report transactions with a known child exploitation risk.
Dividend cut. Share price at a seven-year low. Aggrieved Westpac shareholders ready to pelt the board with International Roast and Tim-Tams at the annual general meeting.
Since Westpac’s Austrac scandal broke there has been over 150 articles or columns relating to it in The Australian newspaper and 14 articles in the NZ Herald. Online, when the comment section is open for these articles, it’s not hard to spot the Westpac shareholder, even if they don’t identify themselves as such.
There’s a reason you diversify and it’s nothing to do with how knowledgeable you are. Or maybe it does. The knowledge you can’t see the future. The small investor has an amazing luxury the small farmer can only dream of. Investors should never take diversification for granted or claim it’s only for those who don’t know what they’re doing.
It’s the best protection there is against the unexpected.
Nick Stewart is an Authorised Financial Advisers and CEO at Stewart Group, A Hawke’s Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
This article is prepared in association with Mancell Financial Group, Australia. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
