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Extract from November 2010 newsletter

Government to Abolish Gift Duty

The New Zealand Government has announced that it will abolish gift duty from 1 October 2011.

How does this affect you?

“Government agencies will monitor the impact of the changes and a post-implementation review will ensure there are no unintended effects,” said Dunne.
Normal gifting procedures and gift duty rates will apply until 1 October 2011 so it is important to closely monitor your current gifting.
It will not be open slather with people attempting to hide assets in trusts to avoid creditors, tax or gain access to rest home subsidies and various benefits. Dunne believes there are adequate measures to safeguard creditors in the Insolvency Act 2006 and other legislation and officials had found that gift duty had been of little benefit in recovering the value for creditors. Likewise, the Ministry of Health is confident existing legislation is sufficient to prevent access to the residential care subsidy where people have deliberately deprived themselves of assets, before requiring care. WINZ has a review underway to ensure that personal asset stripping via trusts to obtain Working for Families benefits, tax credits or student loans will not be able to occur. Recent changes in the tax rates now make family trusts less advantageous from a tax minimisation perspective.
It is important to ensure that your family trust is correctly documented and operated and has been established for legitimate asset protection and estate planning purposes and not specifically to obtain access to lower tax rates, avoid creditors or increase the likelihood of benefit eligibility.

The "BRIC" Economies

Goodman Sachs first coined the term BRIC economies in 2001. BRIC is an acronym for the emerging economies of Brazil, Russia, India and China. Sometimes there is a “K” added for Korea.

"There is no longer any debate among investment experts of the vital importance of global emerging markets - and particularly the big rapidly industrialising countries of Brazil, Russia, India and China - to world economic growth, and their role as fundamental elements of any quality investment portfolio. The last decade saw the BRICs make their mark on the global economic landscape. They contributed over a third (36.3%) of world GDP growth and have grown from one-sixth of the world economy to almost a quarter. Goldman Sachs' latest projections (May 2010) envisage the BRICs, as an aggregate, overtaking the US by 2018, together contributing 49% of global GDP growth and accounting for a third of the world's economy." – Graham Rich, Portfolio Construction Forum.

GDP growth expectations in the BRIC economies for 2011 is expected to be around 8% versus western economies growth expectations of around 2%.

The “I” and “C” in BRIC
In August Richard attended the Portfolio Construction forum in Sydney where the principles around building ‘shock resistant ‘ portfolios and avoiding economic shocks and bubbles when constructing portfolios were discussed. The BRIC economies have been a frequent topic over the last couple of years.

"The contrast with China's practically flawless hosting of the Olympic games in 2008 could hardly be starker. Many people will draw the wrong lesson from this... Despite the headlines, India is doing rather well. it's economy is expected to expand by 8.5% this year... its growth rate could overtake China's by 2013, if not before... its private companies are strong... India's growth will start to outpace China's within three to five years. China will rumble along at 8% rather than double digits; India will rack up successive years of 9-10%. For the next 20-25 years, India will grow faster than any other large country..." The Economist 30 September 2010

India is the seventh largest country in the world and the second most populous. Economic reforms since 1991 have turned India's economy into one of the fastest growing. India was the 11th largest economy in the world in 2009, cautious banking policies and a relatively low dependence on exports for growth meant India escaped the brunt of the GFC and achieved the second highest GDP growth among major economies in 2009 (6.5%). It's on track to grow by 8.5% this year, and should outstrip China's growth by 2013 if not earlier. And unlike China, it is a free and democratic country with a long history of property rights, capitalism and private ownership. To quote The Economist, India is "a bumpier but freer road." "– Graham Rich, Portfolio Construction Forum.

The “B” in BRIC
In September we went to South America visiting in Chile the capital Santiago, Atacama Desert, and in Peru the capital Lima, Cusco the navel of the Inca empire, and then on to Machu Picchu, followed by a brief stay in the Amazon and then up to Lake Titicaca. In Argentina we visited Buenos Aires and Iguazu Falls from both the Argentinean and Brazilian sides.

Our trip was a trip of extremes of altitude and temperatures, from sea level in Lima flying to Cusco at 3,300 meters (11,000 ft sounds more impressive). One day we were in the Amazon at 35C and then flew to Lake Titicaca at 3,800m (12,500 ft) and 4C.Our bus trip back to Cusco passed through mountain pass and we stopped for photos at 4,300m (14,000 ft). It's amazing how quickly one is gasping for air at these altitudes.

The Atacama Desert was an interesting place for extremes of altitudes, temperatures and moisture. We stayed in the small village of San Pedro at an altitude of 2,400m (8,000 ft) and travelled one day to see some geysers leaving at 5:30 am. We drove up to 3,300m (11,000 ft) and the temperature was -10C. In winter the temperature will get down to -20C to -25C at this spot. The Atacama Desert has mountains on the west going up to 8,000m (27,000 ft). It is the driest place on earth. Well it does rain, maybe 3 days a year for 1 hour at a time. Some areas experience no rain. But life is present even in these extremes. There are several streams which come down from the Andes but never leave the desert.

Why you may ask did we leave at 5:30am? The reason is that once the sun comes up the temperature approaches 30C and the steam from the geysers is not visible.

On another day we paid a visit to the Atacama lakes. Well, can you imagine extreme dryness with salt crystals, but just centimetres below the surface there is water. There we observed three species of South American flamingos (birds not the dancers), brine shrimp and lizards.

Why are we mentioning Atacama in such detail? Interestingly around 65% of the world’s lithium production (used in glass, batteries, medicine) comes from this region, 40% of the copper production from Chile comes from Atacama. The deposit's are also rich in boric acid. Bolivia, however, has the world’s largest deposits of Lithium and when this comes on stream in a few years then Atacama’s contribution will drop to a still impressive 25% of the world’s production.

Alison has already identified some of the mountains around Atacama she wants to scale. Not technically challenging. The challenge is putting one foot forward and focusing on your breathing when walking at altitudes of 5,000m (17,000 ft). It maybe a fleeting thought, but I have found when she applies her mind and imagination to something there’s no stopping her.

Why is Brazil the B in BRIC and not some of the other South American economies? After all Argentina used to have a stronger economy than Brazil. So what happened?

Our observations were that Peru and Chile are very dry, but have very fertile soils. Essentially they only have two seasons, 6 months of rain and 6 months of summer. The reason the Incas were so successful was because of their skills in agriculture. It is believed they originally came from Lake Titicaca and moved through into Peru and Chile. Their empire lasted around 100 years but they achieved amazing results in this time spreading from Cusco throughout Chile and Peru.

One of the reasons for the Inca’s success, as we mentioned above, was their ability with agriculture. We visited a site at Moray (about two hours drive from Cusco) where the Incas, through selective genetic breeding, transformed three varieties of corn introduced from North America into more than 55 varieties. They took the local wild potato, which was poisonous, and bred this into more than 15 varieties.

Peru and Chile have good growing temperatures but mechanisation is very rare Peru. Over our two week visit we only saw 2 tractors and only once did I see any form of water spraying for irrigation that is very prevalent in the South Island in New Zealand. In many places fields are irrigated by redirecting water flows and families have specific times when it is available. One can’t help wondering if the dry fields could be transformed into growing several harvests each year with a bit of modernisation. Imagine fields still being ploughed with wooden ploughs pulled by cattle or oxen. The ploughs were not even metal tipped and several times we saw fields being tilled by hand using hoes.

Argentina is similar in a number of ways to New Zealand. The north is green and it has some arid areas in the South. The impression is that it is a giant collection of farms. It has a population of 40 million of which 15 million, 38% of the population, live in the capital Buenos Aires.

What’s holding Argentina back is it's politics and culture. For a country to develop there must be laws which are enforced protecting ‘property rights’ and free education for all. Argentina society appears to be very corrupt judging by the numerous conversations we had with educated locals. We discussed politics with a well educated Argentinean (PhD from Germany in genetic engineering) he said the education standards keep getting lowered so while there is free education it’s not working. In Brazil parents are given a Government grant if their child attends school for the whole month.

Brazil is the only Portuguese speaking country in South America so there are cultural differences from it's neighbours. Brazil produces 75% of the world’s orange juice. Soya bean has transformed the prosperity of farmers. China takes all of Brazil’s soy protein. As the living standards in China improve there is an increased demand for soy protein which is used in animal feed. The down side for Brazil is that its once strong shoe industry has been decimated by cheap Chinese imports. Nearly 40% of Brazil’s iron ore production is exported to China.

It would be fair to conclude Brazil’s future is closely linked to the Chinese economy, but the big future driver of the Brazilian economy will be oil production. Five years ago one of the largest oil fields in the world was discovered in Brazilian waters. Production is expected to come on stream in less than 3 years.

If you have any doubts about global warming then you will not after visiting South America. We heard numerous stories of how glaciers are retreating, and rivers are getting lower each year. The traditional practice of burning the stubble after the harvest is still practiced, as it still is in the UK. There was a massive natural forest fire in the Amazon when we were there which added to a very hazy, smoky atmosphere.

As an aside if you like waterfalls, we have seen Niagara Falls and Victoria Falls, but the best we believe are the Iguazu Falls. They are not the highest, nor do they have the greatest water volume, but they do have the highest number of cascades of around 275 and the widest at 2.7km. A really spectacular sight. The falls need to be viewed from both the Argentinean and Brazilian sides to be fully appreciated.

We were amazed that there seemed to be an acceptance of the Spanish as the Incas were also seen as conquerors and Spain brought the technology and culture. Of course this may be a highly biased view as there is so much intermingling. Approximately 85% of Latin America is Catholic. The early Catholic priests and Jesuits were able to blend some of the symbolism of the Incas and Christians which assisted the adoption of Catholism. Killing non believers would have also helped the conversion rate. For example often in churches there is a symbol high above the altar which is very similar to the Inca sun god. Christmas is close to the summer solstice of 21 December. The Southern Cross was particularly important to the Incas who had an 8 pointed cross and so it was easier to introduce the Christian cross. There is also symbolism between the Halo and the Inca symbol for the Moon.

How does all this apply to investing?
For the international equity sector of an investment portfolio it is important to have some exposure to the Asian and emerging market economies. This can be via a diversified international equity fund manager or through direct Asian or emerging market funds. Up to 25% exposure of the international allocation to the BRICK markets is appropriate, but it is important, for diversification and risk reasons, not to be over exposed to these economies. When constructing portfolios we also need to be aware that international fund managers are also tilting to these economies so you could inadvertently be over exposed to this sector.

There are some interesting funds we are using in creating more "shock resistant portfolios". These fund managers are picking up on the consumption story through US consumer brands, such as Coca Cola, Colgate Palmolive, Proctor & Gamble, but without the inherent country specific risk and potential corruption problems. While the demand for steel (iron ore) may be peaking the consumption demand has at least another 25-30 years to play out.

Why not save your tax break?

From the 1st October the new PAYE tax rates were introduced.

Taxable income	Income tax rate for every $1 of taxable income (excluding ACC earners' levy)	PAYE rate for every $1 of taxable income (including ACC earners' levy*)
up to $14,000	10.5 cents	12.54 cents
from $14,001 to $48,000	17.5 cents	19.54 cents
from $48,001 to $70,000	30 cents	32.04 cents
$70,001 and over	33 cents	35.04 cents
No notification**	45 cents	47.04 cents

Monthly tax savings:

Taxable income (annual)	Monthly Better Off By	Annually Better Off By
$50,000	$125.84	$1,510.08
$100,000	$309.18	$3,710.16
$150,000	$507.18	$6,086.16
$200,000	$715.52	$8,586.24
$250,000	$923.74	$11,084.88
$300,000	$1,132.17	$13,586.04

If you don't assign this extra income to extra savings or extra mortgage repayments you will find it will 'evaporate' and you will wonder where it went.

In addition to the new PAYE rates, new PIR ( Personal Investor Tax Rates) apply from 1st October 2010.