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ASX All Ordinaries Movement FY 2021/22. Click to expand.

The Market

In terms of the financial markets, the 2021/2022 financial year has drawn to a close in a spectacular fashion. The ASX All Ordinaries Index has decreased by 11.1% over the full year, as a result of a 13.4% decrease in the last quarter. This is in a stark contrast to the astonishing growth that occurred in 2020/2021 when the index increased by 26.4%. The US equity market recorded its worst first half period in 60 years (calendar year to date), shifting the market into bear territory and, unfortunately, the Fed has signalled more rate hikes are to come, noting the difficulty of bringing down inflation without triggering a recession. This is a similar problem facing central banks globally, with the Eurozone under even greater pressure due to the ongoing Russia-Ukraine conflict.

Given the current macro climate, it will be interesting to see what is written about the financial year 2021/2022 in five or ten years’ time: is this the beginning of an inflation-driven global recession or is this a dint due to interest-rate speculation that normalises and rebounds?

EOFY 2022 Wrap Up

“In the real world things fluctuate between pretty good and not so hot. But in the markets they go from flawless to hopeless” – Howard Marks

Given the last two to three years this quote seems as true as ever and taking a long-term approach allows us to see the turbulence as a normal part of the market. This cycle through periods of excesses and then corrections can be seen in the movements of the ASX All Ordinaries Index, which is down 11.1% this year and over the past 24 years has returned an average of 3.8%. However, the annual return in any one year has never been within 10% of the average, instead, we have five years where the losses are greater than 10% (the lowest being negative 26% in FY2009) and nine years where the gains are greater than 10% (highest being 26.4% in FY2021), the remainder fall somewhere in between, but nowhere near the average. If you’re wondering, the FSI portfolio has generated annual returns of 11.8%, with only two years of losses of more than 10% (lowest was negative 24.1% in FY2008) and 14 years of gains greater than 10% (highest was 40.7% in FY2021).

Quarter by Quarter

In the first quarter of the financial year, the outlook was positive. Monetary policy was favourable, corporate earnings were strong, consumer spending was buoyant and labour markets were resilient despite numerous COVID-related restrictions. The only red on the score card appeared from concerns in China’s property market.

In the second quarter despite a rollout of vaccines, the new COVID strain caused some concern. Supply chains were still constrained and persistent inflation raised concerns over central bank policy settings. “Transitory inflation” was the term used frequently, allowing central banks to hold interest rates and remain upbeat in their forecasts.

In the third quarter, Russia invaded Ukraine. The West was quick to issue sanctions and multinationals started closing down any operations linked to Russia. However, the war amplified energy and food price issues straining an already constrained supply-side environment and pushing inflation higher. Central banks began raising rates and forecasting future increases. Particularly for growth-orientated stocks, the rising interest rate environment drove declines in equity valuations across the board.

By the fourth quarter, the high inflation readings were a major detractor for all sectors of the financial markets. Despite numerous interest rate increases during the quarter, with low unemployment continuing, retail sales remained resilient. In addition, there has been little done to improve supply-side inflationary factors such that the current environment is likely to continue in the near term.

Over the Long Term

“Time is the friend of the wonderful business, the enemy of the mediocre.” Warren Buffett – Letter to Shareholders 1989

While market uncertainty continues, it is more important than ever that one has a strict investment process. It is vital not to get caught up in the hype and noise of the daily market movements, and instead invest with a long-term approach. A sound investment philosophy sets out a number of ‘rules’ or ‘procedures’ to fall back on when the market noise gets too loud. Companies that have a sustainable competitive advantage will always be well-placed to withstand short-term headwinds, regardless of market conditions, maintain market share and ultimately find new ways to grow.

It can be challenging to recognise the potential in companies, particularly those that are in the growth stage of their life cycle. It can also be difficult to evaluate the ‘narratives’ that some companies are telling about themselves. To invest in a company in the growth stage of its life cycle it is important to balance the company’s narrative alongside its numbers.

By drilling down into a company’s financials and growth plans in a careful, considered and committed way, it is possible to identify the quality growth stocks that will prosper over the long term. Their ability to be flexible, to move quickly to take advantage of opportunities as they arise, and to capitalise on market trends and demand, will continue to support the ongoing success of such businesses, and provide significant long-term opportunities for their investors.

An age-old question since the imputation credit system came into being in the 1980s in Australia – “Are franked or unfranked dividends better?”. This is an all too common question received by accountants, tax specialists and financial advisers alike during elections, as well as annually during tax time.

A popular topic with politicians and investors, with arguments for and against its implementation, franking credits and franked dividends. For a detailed insight into the world of “Franking Credits” and “Franked Dividends”, visit our new and updated Ultimate Franking Dividend Guide.

With two years until the next election, the Australian share market on the rise, and the economy out of a recession as 2020 comes to a close, reviewing your portfolio and shareholdings to determine whether unfranked dividend stocks are the right investment choice is potentially something a savvy investor should consider.

To understand the questions around what dividend is “better”, we have to consider the basics behind dividends and the impact franking credits may have on an individual’s (or SMSFs) taxable income.

Dividends are transfers of something of value to a shareholder by a business. Certain distributions are exempt for tax purposes from being dividends.

Generally speaking, dividends obtained from company profits are beneficial to Australian citizen recipients, who may also be entitled to the Australian income tax franking credits charged by the corporation to receive those profits.

The Advantages of Unfranked Dividends

A franked dividend is when a business distributes to shareholders a percentage of its profits and adds a tax credit from 0 to 100% of the tax value for any amount of tax paid on that amount.

The method of imputation taxation is quite unique to Australia and New Zealand, which has made it an easy target for governments trying to raise government revenue and decrease Australia’s debt dependency, but to the disdain of shareholders.

An interesting thing to note is that a majority of the dividend-paying companies on the ASX are international companies, domiciled outside of Australia. An oversimplified way to conceptualise this is, that given these companies are incorporated overseas, they rarely pay tax in Australia and as such, they don’t have the option to pay out franking credits.

The Advantages of Franked Dividends

Fully franked dividends mean the company has already paid tax on the money at the company tax rate of 30%. So that the money isn’t being taxed by the ATO twice, you’ll receive a franking credit for the tax already paid on the dividend by the company. This means while you do need to include the dividend in your total taxable income, you’ll receive a discount credit which will reduce your taxable income by the amount already paid by the company.

Because dividend payments are a form of income, you do need to include these in your total taxable income when you file your tax return. However and as mentioned above, thanks to the franking credits system in Australia, you often won’t need to pay much tax on your dividends (or any at all).

What Is Dividend Yield?

The dividend yield is calculated as a percentage and represents the total dividends received in relation to the cost paid for the shares. The dividend yield is determined by deciding which proportion of the share price is returned as income to the investor. The dividend yield lets investors evaluate similar businesses, as it helps determine which company shares will generate better yield.

Why do some companies not pay franked dividends?

Not all benefit from franking credits in the same way. For example, the everyday investor may receive a reduction or refund on their tax return whereas self-funded pensioners are positioned more favourably in the current imputation system as they are able to claim the maximum tax benefit. As such one may question that when given the option, why don’t companies just frank their dividends to 100%?

Although not the norm, one example might be for corporations that make up a significant portion of their revenue from non-taxable income, such as tax-exempt sales of fixed assets (i.e. real estate investment trusts or REITs) or have substantial offshore earnings. In this case, the attachment of franking credits may not be possible, since these are allocated by the company from tax paid in Australia.

Something which you may notice is that the overwhelming majority of the constituents of the S&P/ASX 200 index will pay fully-franked dividends to mitigate the tax consequences for their shareholders.

Simple corporate finance is the other major factor affecting franking credits, being what is ideal for the actual and planned makeup of shareholders of a company.

Instead of paying a dividend to shareholders, a lot of smaller, emerging businesses will reinvest any profits made back into the business to help it develop. Many investors are okay with this because if the business is growing, the value of their shares will also increase.

It is also necessary to remember that there is never a guarantee of dividends. Each corporation decides what the amount of the dividend will be and if, yearly, there will even be a dividend payment at all. So just because a business pays a good dividend in one year, that doesn’t mean that a repeat will occur the following year.

So, what is better? Franked or Unfranked Dividends?

In short – there is no definitive answer.

While your tax situation can benefit from franking credits, it is wise to always seek qualified tax and financial planning advice. As everyone’s situation is different, it would be difficult to conclude that one strategy would be better than another in the longer term.

In Australia, 49% of adults own shares and other listed securities on the Australian Securities Exchange (ASX) according to the 2020 Australian Investor Study.

  • In the wake of COVID-19 and its worldwide effects on humanity as a whole, the Australian share market was not spared its own trials and tribulations as a result of the global pandemic.
  • At the time of writing, Australia has been tracking well in its economic recovery compared to most other developed economies.
  • In the June 2020 quarter, Australia saw a 7% decline in GDP, followed by a partial recovery in the September quarter, with economic activity rising 3.3% (in seasonally adjusted chain volume terms).

Despite this, the Australian economy and its share market are not out of the weeds quite yet. The lasting effects are yet to be seen as we commence our recovery, and investor sentiment has started to shift, with investors directing their focus more strongly on the future sustainability of dividends, fully franked dividend income and “defensive” investing during these uncertain times.

Many investors may however, not completely grasp the concept of dividend-paying shares and their benefits, nor do they understand the concept of fully franked dividends and unfranked dividends, franking credits and imputation credits, as well as the interaction they have in relation to personal tax obligations.

This comprehensive introductory guide will be the first guide in our multi-part series of smart investing in dividend-generating investments for individuals and Self-Managed Super Funds (SMSFs).

Before we dive into the world of franking, it is important to first understand how dividends work to build wealth for investors.

What Are Dividends?

When you purchase shares in a listed company, such as one listed on the ASX, you become a part-owner of the business. Dividends are your portion of the profits.

Dividends reflect a payout to shareholders from the earnings of an organisation as a way of rewarding their investment in the business.

Payment of a dividend is fully up to the discretion of the board and if they choose to do so, more often than not, dividends are paid twice a year.

Assuming you purchase shares at $1.00/share and a dividend of 10 cents per share is payable each year, you’ll realise a return of 10%.

Although dividend-paying shares are seen by many Australian investors as an attractive investment in providing a steady stream of passive income to live off, others will seize the opportunity to reinvest the profits to further boost their assets.

Types Of Dividends

There are three major types of dividends:

Interim Dividend
This is a dividend which is distributed before annual profits have been determined by the organisation. Typically, it will be issued at the same time as the interim financial statements of the company, usually six months into the financial year.

Final Dividend
When a company reports its earnings for the entire financial year, this dividend payment is issued. Some businesses will only pay a final dividend.

Special Dividend
These are bonus dividends which are usually higher than the regular distributions a company earns in the form of dividends. When it generates increased revenues over a certain financial period, a company may pay a special dividend to its shareholders.

Not all businesses will pay all types to their shareholders and some may not pay any dividends at all.

What Is Dividend Yield?

The dividend yield is calculated as a percentage and represents the total dividends received in relation to the cost paid for the shares. The dividend yield is determined by deciding which proportion of the share price is returned as income to the investor. The dividend yield lets investors evaluate similar businesses, as it helps determine which company shares will generate better yield.

Dividend Reinvestment Plan

Rather than accepting the dividend payment in your bank account as cash, some companies offer what is called a Dividend Reinvestment Plan (DRP for short), which allows you to opt-in to the use of dividend distributions, used to purchase additional shares.

There are many benefits to doing this but the main one is that you can use the revenue to purchase additional shares without paying any brokerage. It’s also a good passive investment opportunity for steadily increasing your shareholdings in a business with minimal input required. It’s a strong investment strategy for set-and-forget – when you opt-in, the DRP process quietly takes place in the background.

One drawback to opting into a DRP is that you are unable to acquire the cash for other day-to-day expenses. You are unable to set the share price which will apply to the DRP and on the day of the dividend payout, the shares are automatically acquired on your behalf at market price.

The Relationship Between Dividends, Franking & Tax

There is another feature of dividends that makes them much more appealing than other passive investment options like savings accounts and term deposits: tax advantages.

In Australia, businesses may attach to their dividends what are known as ‘franking credits,’ which represent the amount of tax already paid by the company.

Dividends are not “double taxed” in Australia unlike in many other countries worldwide. Companies that distribute franked dividends pay their tax on their profit at a corporate tax rate and then allocate the balance to shareholders.

In order to satisfy their individual tax obligations, the shareholder gets the deduction for the tax already paid by the corporation.

To avoid double taxation, the Hawke-Keating Labor Government formulated the concept of franked dividends in Australia and adopted the dividend imputation system in 1987. Before this, Australian companies would pay corporation tax on earnings, and then if they paid a dividend to shareholders, this was taxed as part of the income of the individual.

Under this scheme, Australian businesses continue to pay company tax and post-tax dividends to shareholders but may determine how much tax they pay to be “imputed” for the dividend they paid.

Dividends are paid on revenue subject to Australian income tax, which is 30% at present. This ensures that shareholders earn a refund on earnings distributed as dividends for this 30% in tax already paid by the company.

Such dividends are referred to as being ‘franked’. Franked dividends have a franking credit attached to them which reflects the amount of tax already paid by the corporation. Franking credits are also known as imputation credits.

For any tax the company has paid, you are entitled to earn a refund. The Australian Tax Office (ATO) will refund you the difference if your top marginal tax rate is less than the company’s tax rate.

What Is The Difference Between Franked & Unfranked Dividends?

There are two main kinds of dividends that you can obtain from businesses which you have invested in – franked and unfranked dividends (a third if you count “partially franked dividends”).

You earn an imputation credit when collecting a franked dividend. An imputation credit is a tax credit already paid by the corporation. This stops the taxation of your money twice.

A business that pays a 30% tax on all its income will pass on to its shareholders the full 30% of the tax already charged. If a corporation made $100 and paid $30 in corporate tax for example, It will distribute $70 in dividends and $30 in credits for franking. This would be an example of a fully franked dividend.

Unfranked dividends are where a company remits a dividend to its shareholders without a franking credit attached to it.

Why Do Some Companies Pay Unfranked Dividends?

If a business does not pay the full Australian company tax rate of 30% on all its earnings, it can only produce sufficient franking credits to pay a partially franked dividend.

Unfranked dividends are not uncommon when you invest in businesses that do not pay company tax in Australia. Although they may have generated revenue which may be made available to pay their investors, they may not pay tax in Australia (due to being domiciled overseas for tax purposes).

A company is not eligible to give you a tax credit if it does not pay tax in Australia – this results in an unfranked dividend, should they decide to distribute profits to their shareholders.

You receive an unfranked dividend if a company is unable to give you any imputation credits on the income earned from the dividend – indicating the business has not paid tax in Australia on the income which has been distributed to you.

What Are Franking Credits?

Franked dividends have a franking credit linked to them that reflects the amount of tax already paid by the company. As such, franking credits, also called imputation credits, are an investor tax break. They are credits given to Australian investors collecting dividends from companies who pay tax in Australia.

Franking credits are also known as credits of imputation. They are passed on to shareholders where dividends are paid, and where the tax has already been paid for by a corporation. Franking helps avoid taxes from being paid twice by a shareholder. They’re known as credits because they’re received and applied as a tax offset.

For any tax paid by the company, you are entitled to earn credit. The Australian Tax Office (ATO) will reimburse you the difference if your top tax rate is less than the tax rate of the business.

A completely franked dividend indicates that the corporation has paid tax on the whole dividend, so all the tax paid on the dividend is earned as a franking credit by the shareholder.

Franking credits are refundable to persons whose cumulative franking credits are in excess of their yearly assessable income tax liability. This will raise the income of persons with fully franked shareholdings owned through retirement funds that do not pay tax (such as SMSFs) and other individuals earning under the marginal tax rates threshold in comparison to the 30% corporate tax rate.

Personal Income Tax

Share dividends are deemed as income and as such, are treated accordingly with other earnings. Where dividends have been franked, the credit’s one applied as a tax offset to reduce tax payable on taxable income.

The 45-Day Rule

To be eligible to claim franking credits in personal tax returns, the 45-day rule (occasionally referred to as dividend stripping) requires shareholders to hold the stock “at-risk” for at least 45 days (inclusive of the purchase date and selling day).

Individuals will not receive the franking credits on the dividends earned if they have kept your share for less than 45 days. The rule is intended to avoid the claim of franking credits by shareholders who keep shares for a limited period and then sell them as soon as they qualify for a dividend. Both individual taxpayers, companies and SMSFs are covered by the law.

Exemption To The 45-Day Rule

For certain private shareholders, the 45-day rule is not strictly applied. By implementing the small shareholder exemption, the ATO has allowed small shareholders to be excluded from this stringent regulation.

The Small Shareholder Exemption allows shareholders with a cumulative franking credit of less than $5,000 to claim their franking credits in their tax returns for the financial year, even though they may not have kept their shares at risk for a maximum of 45 days.

How Do You Calculate Franking Credits?

In practice, franking credits can boost your return on investment.

In 2000, the Australian government made franking credits fully-refundable, meaning shareholders could reduce their tax liability past zero and receive cash refunds.

Here’s how it works in practice:

  • You hold 1,000 XYZ Limited shares. XYZ makes a $100 pre-tax profit and pays $30 in corporation tax – the corporate tax rate of 30%. With $70 in after-tax benefit left with XYZ.
  • The Australian Taxation Office receives $30 in tax from XYZ Limited. The ATO also incurs a $30 franking credit obligation – basically an “IOU” to XYZ Limited’s shareholders.
  • You are now earning $70 in dividends and a $30 tax credit from the ATO as a shareholder in XYZ Limited. Your taxable income, therefore, is $100. 45 per cent is the maximum marginal tax rate. You, therefore, incur a $45 tax obligation, 45% of $100. Your tax liability, however, is reduced by $30 in the value of the franking allowance. Your final tax liability is reduced to $15 if you trade in your franking credit.
    It is essential to mention that for shareholders who pay no income tax, excess franking credits also apply. Meaning, if your marginal tax rate is for example 0%, you’re retired or otherwise not in paid employment, this would enable you to claim the full $30 cash credit.

In 2007, when the Australian government made benefits paid from taxable sources such as superannuation benefits tax-free for those over 60, the franking strategy for older investors gained momentum. Many untaxed retirees will now collect dividend imputation payments, a cash reimbursement, from the government in accordance with the 2000 amendments.

This was restricted in 2017 by the government of Malcolm Turnbull, which limited the super tax-free status to accounts of less than $1.6 million.

Franking Credits & SMSFs

SMSF (Self Managed Superannuation Fund) trustees may potentially lower the tax liability owed by their fund by choosing to invest in completely franked Australian securities.

The company tax rate for businesses under the $50mil gross turnover threshold will be 25% from the 1st of July 2021 (30% is the typical company tax rate in Australian, as mentioned above), while the maximum amount of tax paid by an SMSF is just 15%. This makes it an enticing tax break for SMSFs buying fully franked stocks with high yielding dividends. If a large portion of the investment portfolio of the fund consists of entirely franked securities, their net tax bill can be greatly reduced.

The franking credit will offset the tax payable on the dividend if an SMSF earns fully franked dividend income in the accumulation process. Franking credits can also be used to minimise or reduce taxes due on all other SMSF profits, including the tax on capital gains, rental income and tax on concessional contributions. In the absence of any other taxable income from the SMSF, the ATO shall provide the SMSF with a cash refund for the company tax charged.

When the SMSF tax rate is lowered to 0% through the pension process, franking credits become much more valuable since the full value of the franking credit is returned to the SMSF.

For high-income earners trying to reduce the amount of tax levied on concessional super contributions, franking credits may be especially beneficial. The tax on concessional super contributions is expected to rise from 15% to 30% for individuals earning over $300,000. Individuals may look at raising the investment of their SMSF in fully franked Australian shares, rather than investing additional funds in super.

Proposed Franking Credit Reforms & Why They’re Controversial
The Labor government has repeatedly claimed that a backdoor for rich investors is the franking credit scheme. The opposing view is that many retirees aren’t affluent and rely on franking credits as a main source of income. Nevertheless, economists estimate that the government loses around $5 billion a year for franking credit deductions.

While most governments offer some form of tax relief on dividends, the Australian scheme is unique because it facilitates the conversion of imputation credits into cash. New Zealand, by comparison, provides imputation credits but the tax bill of a shareholder can only ever be reduced to zero.

Labor has suggested that Australia return to its pre-2001 scheme (which resembles New Zealand’s) where franking credit refunds outside of superannuation will be scrapped. In March 2019, opposition leader at the time Bill Shorten revealed Labor’s intention to restore the dividend imputation scheme to the original 1987 format by scraping excess franking credit cash refunds.

The problem is especially troubling for the SMSF industry since SMSF funds will not be eligible for refunds under this scheme, while standard super funds will be.

So What Is Better – Franked Or Unfranked Dividends?
While franking credits can be advantageous for an individual’s particular tax situation, it is always best to seek input from professional accounting or tax specialists and financial planning advice to determine what investments are right for you.

More information about investing in securities listed on the ASX which show both solid growth performance in terms of capital return and dividends for investors, contact the experts at Flagship Investments Limited (ASX Code: FSI) on 1800 FLAGSHIP (1800 352 474).

About Flagship Investments Limited

FSI is an investment company providing its shareholders with access to an expertly crafted portfolio of quality, growing Australian companies. For more information, call FSI today or contact@flagshipinvestments.com.au and we will endeavour to connect with you as soon as possible to discuss your franked dividend goals.

We welcome the Company Chairman talking to Flagship Investment’s shareholders through this interview.

Further information about Dominic and other FSI Directors can be found here.
Find the full transcript below:

Q: About yourself and your background?

My name is Dominic McGann and I’m the chair of the board of Flagship Investments or FSI but my background, my day job is as a partner of Michael Robertson Lawyers, which is a large commercial law firm in Queensland, New South Wales, Victoria and the Australian Capital Territory. I’m often what is referred to as a front-end lawyer and work to obtain agreements for infrastructure renewables and resources projects whether from traditional owners, landholders or relevant state and local governments. So I’m a front-end lawyer that does a lot of negotiating.

Q: When did you first become aware of FSI?

I have a long association with Flagship’s (FSI), having originally worked with Manny [Pohl] on the float of what was then the Wilson Investment terrain fund limited back in 1998 and happily, I’ve been associated with the entity ever since and actually recently went back to look at one of the very early annual reports and I can report that if nothing else many hasn’t aged a day. As is often said nothing’s ever certain but if you look back over the performance of FSI over the years I think it’s fair to say it has a sustained above-market performance and that’s, I think, principally drew to two things the particular methodology around management and real discipline in applying that methodology.

Q: What attracted you to the Company?

So I was always attracted to the approach that Manny and the team have. It’s principle based and it’s also very disciplined. Why I’m attracted to it is because it is one of the key elements of our broader economy but it is also it’s very complex and it is it really rewards a strong methodology with discipline but also patience. One of the things that particularly interests me about the industry is the tension between a methodology on the one hand and sentiment on the other and really having the discipline to stay attached to the methodology and not falling with sentiment. So it’s a complex industry but it’s one that certainly interests me and I gain an appreciation of every day my discussions with Manny and the balance of the board.

Q: What do you aim to bring to the board as Chairman?

Well the board of FSI is three it’s Manny as the Managing Director, Sophie Mitchell and myself. In addition, we have a very talented Company Secretary Scott Barrett and an Alternate Director and Angela Obree. So there’s a lot of talent around the board table at any time and the approach in that the situation as the chair is really to simply allow the talent to realize itself and to adopt a very collaborative approach at the board. it doesn’t take a lot of effort but I should say because each of Manny, Sophie, Scott and now Angela have a very collaborative approach so it’s really about ensuring the environment encourages and allows collaboration and for the talent to be fully realized.

Q: A little about yourself outside of the work environment?

Putting aside the fact that some people accuse me of regarding work as a pastime when I’m not at work there are probably two things I do more than anything. One is reading. I read very broadly and the other is I like to exercise regularly and just at the moment in terms of the book I’m reading it’s a particular book called the Evolution of Beauty by a professor from Yale University, Richard Prum and what it explores is the distinction between what’s called adaptive evolution as opposed to aesthetic evolution. And aesthetic evolution gives rise to beauty. Adaptive evolution gives rise to the survival of the species and in a sense, there’s a resonance with FSI because one of the things that FSI does, is not to simply stay on a well-trodden path it’s always willing to look at new stocks provided as I’ve said before it always meets a particular methodology and performs over time.

Dr Manny Pohl AM, Chairman of EC Pohl & Co, together with the Conservation department of the Art Gallery of NSW, hosted a cocktail party to celebrate the completion of the conservation of the important painting The Five Senses by Carlo Cignani and to acknowledge that Sophie Mitchell has retired as Director of Flagship Investments.

A delightful night was had by all as the NSW Art Gallery shared the completion of the conservation of Carlo Cignani’s (now) spectacular painting The Five Senses.

We really are very grateful for the support provided by the Pohl Foundation, which has allowed the conservation team to play a vital role in the Art Gallery’s core mission to ‘acquire, study, conserve and present’ significant works of art in order to connect people to creativity, knowledge and ideas. As well as be enjoyed by future generations.

During the event, we took the opportunity to acknowledge Mrs Sophie Mitchell for her work with Flagship Investments as she retired from her position late last year. Sophie has served as a Director since 2008 and Chair of the Audit and Risk Committee and has played a significant part in steering the successful strategy of the Company. We wish Sophie all the best in her future endeavours.

In an August article first published on this website the performance and correlation of the Flagship Investments (FSI) portfolio was compared to other Listed Investment Companies (LICs) that primarily invest in Large Cap Australian shares. One of the things shown in this research was that many of these LICs have a very high correlation to one another. The performance of many is similar and that was a result of the bulk of the investments within their portfolio being much the same.

Flagship was shown to have a lower correlation and for those building a portfolio of LICs its differentiation (and strong performance) validated its place in portfolios. Six months on we revisit current performance data to identify if there have been any noteworthy changes or whether FSI continues to remain a worthy inclusion and offers differentiation from other LICs.

Strong Performance

Table 1 – LICs returns over a period of time.

In table 1 we can see that while the FSI portfolio has had a relatively flat 12 months – where we would like to think that potential value in the portfolio has been building – we can see over 3 and 5 years it is the stand out performer demonstrating the competent and superior stock selection skills of the investment management team.

FSI for Diversification

Chart 2. 5 Year monthly NTA correlation between Large Cap Australian Equity LICs – names removed.

Research by Hayden Nicolson, Bell Potter Securities LIC/ ETF specialist, offers a rarely-seen insight into the correlation between various Australian Equities LICs and these are shown in Chart 3.

Chart 2 is provided as a prelude to Chart 3 to help readers new to Correlation Matrixes better understand what data is being shown. [If you understand matrixes you can skip a few paragraphs ahead.]

Essentially the Degree of Association between variables is measured by a correlation coefficient. The correlation coefficient is measured on a scale that varies from + 1 through 0 to – 1. Complete correlation between two variables is expressed by either + 1 or -1. When one variable increases as the other increases the correlation is positive; when one decreases as the other increases it is negative. The complete absence of correlation is represented by 0.

Figure 2 gives some graphical representations of the correlation between the performances of various investment products. If we look at cell B2 we can see that LIC A has a perfect correlation of 1.00 to itself. If we look down a row into cell B3 we see the number 0.98. That means that (in this example) LIC A has a 0.98 correlation to LIC B. If we glance over to cell B9 we can see LIC A has a 0.97 correlation to L IC H. You will see a lot of grey in matrixes and that is just for simplicity to remove what would be duplication of numbers to help with ready reading. By this, if you look at Column D you will see there are grey squares in cells D2 and D3. The data that would fit in those cells is also found in cells B4 and the data in cell C4 would also go into cell D3. By looking up and down and across rows and columns you can observe the correlations between all variables to one another- which in this case is the 5 Year monthly NTA correlation between 12 Large Cap Australian Equity LICs.

Looking into this table you can see that the movement in the monthly performance of LIC B is very closely matched by that of the other LICs, with the exception of LIC F (0.87), LIC I (0.86) and LIC L (0.85). The most differentiated LICs are LIC F, LIC I and LIC L. The correlations between LICs A, B, C, D, E, H, J & K are so high an investor who held 2 or more might do well to consider if they are just duplicating their investment at additional cost?

So, where does Flagship fit in this table?

Chart 3. 5 Year monthly NTA correlation between Large Cap Australian Equity LICs.

The big reveal

It may be of little surprise to many FSI shareholders that it was LIC #12, in row 13 at the foot of the table. The reason it would be unsurprising is that they are aware that FSI has a unique and differentiated portfolio and – unlike so many other LICs – is not merely a replication of the ASX top 20.

(It should be noted that the other lower correlation LICs in this table in CIN (row 7) and PIC (row 9) are specialist LICs: PIC has nearly ¼ invested overseas and in cash and CIN holds 43% of its portfolio in just the 1 stock – Event Hospitality and Entertainment Ltd.)

One can instantly see that FSI has a lower correlation to these other LICs. Further, other LICs recognised as being the traditional “big-guns” of the LIC space can be seen to have a higher correlation to one another. An argument can be made that they are almost indistinguishable. Investing in more than one of these may not provide much diversification, risk protection, or opportunity to generate excess performance.

As was noted in the August article this would be even further amplified if you already held many large-cap stocks directly and then invested in these high-correlation LICs. You could be “tripling up” and incurring unnecessary direct cost and opportunity costs. Also, don’t forget that your super fund probably has a large allocation to these same stocks too. FSI on the other hand has a lower correlation to all the other Australian Equity large-cap LICS and is clearly differentiated, offering potential investment diversification.

Summary

FSI remains distinguishable from other large-cap Australian Equity LICs by its long-term outperformance and its differentiated investment holdings on both an NTA and Share Price return basis where it is a table-topping LIC. While many Large Cap Australian Equity LICs remain are barely distinguishable to one another FSI presents itself for consideration of portfolio inclusion due to both its performance and also it is a differentiated portfolio to other LICs, the index and those household name stocks many investors may already hold. FSI performance has not come by luck but through superior stock selection. It is no surprise that for over 20 years FSI has been recognised for being a leading investor and identifier of what often become the “stocks of tomorrow” and market darlings.

Disclaimer and important note
This article is provided for information purposes only to stimulate the reader to undertake their own research into various investment companies and products. Investors should not rely on this article which does not take into account any person’s particular investment objectives, financial resources or other relevant circumstances, and the opinions and recommendations in this article are not intended to represent recommendations of particular investments to particular persons. All securities transactions involve risks, which include (among others) the risk of adverse or unanticipated market, financial or political developments. Past performance is no guarantee of or predictor of future performance.

The Flagship Investments Limited’s (FSI) portfolio closes out Calendar Year 2021 as it began- performing strongly, topping tables and delivering positive returns for shareholders. It achieves this through a disciplined investment process that produces a high conviction portfolio of quality-growth oriented companies.

The manager, EC Pohl & Co commenced 2021 managing $68.0 million in the portfolio and closed the year out managing nearly $93.5 million. This increase comes through a rise in the value of investments held and funds received through the issue of the Convertible Notes which trade on the ASX under the code FSIGA.

Table 1: Source Flagship Investments Ltd

Flagship for diversification

An article recently published on the FSI website explored the diversification benefit of investing in FSI as the underlying holdings were differentiated from other LICs, this article can be read here.

It also shows how many LIC’s hold similar sector weightings to one another, while FSI weightings are unique, demonstrating that the outperformance was generated by superior stock selection. The table below is from the 2021 FSI Annual report which lists all of the holdings in the portfolio as at 30 June 2021.

Table 2: Source Bell Potter

Beating the competitors

Our final table is produced by Bell Potter LIC research and is dated 10 December.

Flagship Investments Ltd performance closes out 2021 as the best amongst peer Large & Medium Cap investing LICs for 3 years pa, 5 years pa and 10 years pa. This is for both its NTA performance and Share price performance.

While we cannot predict how 2022 will fare and we must always acknowledge that past performance is no guarantee of future success, it is clear that the disciplined investment process of the manager identifies and constructs a portfolio of quality growth companies.

We thank our shareholders for their continued support in 2021 and look forward to continuing to grow shareholder wealth through 2022.

We would like to welcome our new Non Executive Director, Angela Obree talking to Flagship Investment’s shareholders through this interview.

Further information about Angela and other FSI Directors can be found here.

Full transcript:

My name is Angela Obree and I’m a non-executive director of Flagship Investments also known as FSI. I spent the last 25 years or so in management consulting predominantly in the financial services industry based in London in the UK. My focus whether working with the executive teams or the boards has been on strategy risk and compliance.

Q: How did you first became aware of Flagship Investments?

I became aware of Flagship Investments right at the ice age, I’ve been lucky enough to know Dr Manny Pohl for many many years. I heard about Flagship right when it started back in the early part of 1998 and I’ve been following its progress and successes ever since.

Q: What interested you in Flagship (Investments) over that time?

I’m sure like everybody else and the other shareholders it’s been the decided performance both in terms of capital and dividends to shareholders but more than that and for me, it was also I really like the professional and disciplined manner in which the portfolio is managed.

Q: What do you hope to bring to the board of Flagship Investments?

I was honoured to and to be asked to consider the role and mostly because I resonate very much with the values of the company both in terms of their investment principles and also um because of the calibre and integrity of the management team. It certainly makes my job as a board member much easier.

Q: Tell us about your experience working with boards of investment companies?

I’ve been really fortunate in my career that in the last 25 years I’ve got to work with various boards around the world, you know in London in South Africa and Germany in the US. My role has been on the other side actually of the war table which has been to work with boards to develop a strategy to mitigate any risks and manage compliance and so forth.

Sitting on a board you get to see the business from all aspects and get to make that kind of you know high-level decisions that genuinely drive where the business is going and you don’t always get that on the other side as the executive, you get told what to do. So I quite like that element of it but in this business, it is so well managed by you know EC Pohl we would take a lot of you know guidance [obviously from] I mean we obviously you know around the strategy and so forth but in terms of decisions and investment decisions happy that’s left to the executive team to Manny and so forth.

Q: What are your thoughts on the journey ahead?

Now that the convertible notes has been successfully taken up I feel very likely to be part of this exciting journey as we watch Flagship Investments move into the next stage.

Q: Can you tell us something about yourself?

Outside of work I really really enjoy being outdoors whether it’s on the beach or on a mountain bike and I’ve taken part in a couple of triathlons. I’m not a good athlete whatsoever,
but what gets me to the end is just high energy levels and high levels of enthusiasm.

On 30 August 2021, the FSI Board announced the proposed issue of Convertible Notes. The Directors believed that the issue of FSI Notes would provide the ability to increase the overall size of the investment portfolio without diluting existing FSI Shareholders. The additional capital would be deployed in accordance with FSI’s existing investment mandate and investment process.

The Issue of the Notes was extremely successful. Brokers, Financial Advisors, Family Offices, and investors as well as many FSI shareholders and all its Directors applied for Notes. Supported by Joint Lead Managers Morgans Financial and Taylor Collison the entirety of the $20m issue was subscribed for within days of the Notes becoming available.

Issued at $2.70 per note under the ASX Code “FSIGA” the Flagship Investments Convertible Notes closed on the first day of trading at $2.87 providing Noteholders with an immediate 6.3% uplift on the value of their Notes.

On the 5th of October FSI released its September NTA at $2.81 per share.

The Board of FSI welcomes all 282 Noteholders to its share register and looks forward to welcoming new Shareholders to the register as the notes are converted at any time from the second anniversary of the issue date of the Convertible Notes until 17 September 2026.

Purpose of the Offer
  • Grow the size of the company
  • Increase the visibility, recognition and relevance to stockbrokers and financial planners
  • Expand the coverage by research houses
  • Reduce the MER and ICR ratios by spreading the limited fixed costs of operating the Company across a larger asset base
  • Expose the company to a new and a wider pool of investors
Benefits to Investors
  • Reduced share investment risk through a quality investment portfolio
  • Top quartile investment performance since inception
  • No historical gearing on the balance sheet
  • Professional, disciplined management of an investment portfolio by EC Pohl & Co’s highly rated and experienced team
  • Anticipated continued growth in fully franked dividend income
  • No fixed management fees: – the Manager is only remunerated on a performance basis
  • 1:1 Conversion ratio of notes to shares
A ‘Thank You’ Note

We would like to thank our shareholders who took interest in Flagship Investment’s convertible notes. We look forward to the investment returns in the long-term flowing to both Noteholders and Shareholders alike.

Flagship Investments Limited (FSI) invites you to participate in the FSI Convertible Note Offer. The listed, redeemable, unsecured convertible notes (FSI Notes) are an invitation for new investors to take an interest in the business and to provide existing Shareholders with a further avenue to benefit from their ownership in the Company. The Offer is subject to Shareholder Approval which will be sought at the Annual General Meeting of the Company.

This Prospectus contains further details of the Offer, the terms of the FSI Notes and a description of the risks associated with an investment in the FSI Notes and FSI. It is important that potential investors read the entire Prospectus carefully and consider the risks before deciding whether to participate in the Offer.

Overview of the FSI Note Terms:

The proceeds from the FSI Notes will be fully incorporated into the FSI Investment Portfolio and deployed in accordance with the investment mandate and investment process. To date, the Company has enjoyed enviable success, culminating in an investment performance which establishes it as a leading performer in active management.

FSI looks forward to extending the long-term benefits of ownership to existing Shareholders and welcoming new Investors to the Company. If you have any questions in relation to the Offer or how to apply, please email the Share Registry at enquiries@boardroom.com.au or call the FSI Notes Offer Information Line on 1800 352 474 (within Australia) or on +61 7 5644 4406 (International) Monday to Friday 8:30am to 5:30pm, Brisbane time.

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