Mailbag: incl. Should the Australian government be ‘prepping’? November 26, 2023

26:29It's the beneficial ownership. So it might be almost always is held through a trust structure or a PCY, LTD kind of thing. And in many cases, several of them combined. So he's like, not only can I not see that director's name or the CEO's name, but I can't see any entity that owns the amount that has been said. It's because it's split across, you know, a bunch of different legal entities. So that's something worth digging into a little bit more as well. Again, companies will disclose exactly what the senior executives and directors and that own. But if ever you're trying to sort of match things up and you can't match it up, that's what's going on there.

27:09No, perfect. I agree it's nice to know when companies that I like also have a similar interest in the companies that I follow so I'm with you there in terms of the the benefit of knowing who's only what and potentially you know how they're thinking there can be a bit of a bit of bias there which maybe isn't super helpful in other words they won't always be right about those holdings either like anything my track record of the wallet feels pretty good but I've made some clangers don't don't choose one company I own and say well Scott owns it must be good Scott owns it, so he hopes it's good, but it doesn't make me necessarily right.

27:42So that's the only other thing I'd just add is if you've done your own research and it happens to be the same, well, that's probably nice. And it's a green flag, not a red or a yellow flag. Just be careful you don't assume like anything, gee, Buffett bought that boot business, it must be great, goes broke six months later. It's like, oh, maybe, you know, there's reasons to go with and not go with that sort of stuff. Just as always, be diversified and make sure you remember they can make mistakes as well. Well, and also too, you don't know, So you might know at the last disclosure what the position was.

28:11Yes, that's also true. But it's not reported minute by minute, right? Like things can change. Stanley Druckenmiller is an investor I really like. He's an incredible track record. But he's famous for changing his mind. Right. And so you catch an interview and he's like, oh, he's really bullish on XYZ. And then you think, oh, okay, that's really interesting. And the next time he's talking about it, oh, no, I sold that. I'm out of that. That was a disaster. No, I changed my mind completely that afternoon. And that's, I mean, I actually think that's a strength of a really great intellect, actually, the capacity and ability to change one's mind when the facts change or your interpretation of the facts change.

28:45And you can be led astray if you just assume that the reason they're holding that are for the same reasons that you hold that. And in fact, that they still hold that. Because by the time the next time it's updated, I don't think it's updated all that often. Yeah, things can change. So just beware. Mates, here's a great set of comments and questions from Andy, including his sign-off, which I will get to. So I'll wait for that one. He says, hi, Scott and Andrew. In the last podcast episode, which might have been a couple ago, you commented on the inflationary effects of infrastructure investment and population growth.

29:20I respectfully disagree, says Andy. And it would seem to me that we should be utilizing this as a way to grow our economy organically outside of artificially increasing house prices in the major cities. In Australia, we have house affordability, we just focus on the wrong area. I believe we should begin to accept that home ownership in the major cities is unattainable for the growing majority of people. Instead of having government tailor policies that, quote, address the housing affordability in Sydney, end quote, just let it go. There is more to Australia than the inner west of Sydney. I think he's talking to you, mate.

29:54If you can't afford to own a property in a major city, says Andy, so be it. It sounds harsh. There are people who have to live and work there. However, I believe the government should instead be focused on developing regional centres with the infrastructure they need to adequately house, support, and care for the people who cannot afford property in the major cities and therefore drive regional growth. I'm going to probably butcher this. I was born in, is it, you're born this way, mate. Is it Corindai? Q-U-I-R-I. Corindai, beautiful. There we go. I was born in Corindai, says Andy, a small town near Tamworth, and I currently live and work in Wagga Wagga.

30:28I also grew up in Maroubra in the eastern suburbs of Sydney. I know city living and I know regional living. If you invest in these regional areas, Bathurst, Orange, Broken Hill, Wagga, Tamworth, etc., the desirable aspects of the city will develop organically in these areas, such as cafes, shops, bars, culture, etc. Developing a strong and robust local healthcare system, sewage and race management, schooling and roads will take the heat out of the Sydney property market, but will be offset by infrastructure spending and growth for a new demographic of people. Tourism growth will help supplement the government investment as more people will be happy to visit Outback Australia.

31:02We've formed a strong national identity around Outback Australia and it's time we used it, says Andy. Want to see a kangaroo? Come and see hundreds in the wild, as well as sheep, cows, cotton, wheat, and the best sunsets you will ever see. I fully believe this will lead to an overall improvement in the healthcare system as well, due to the fact people actually want to go to these areas to live and work, the current issue being that people are sent to these smaller, under-resourced rural areas and don't want to stay. Why would you? These are some thoughts I have had recently. And it seems ironic you discussed it on the latest pod episode.

31:31Feel free to discuss. Andy. And he signs off by saying, as a description, lover of economic stability. At least I like the idea of it. I'm 28, so I wouldn't know. Which I really appreciate. Thank you, Andy. That's some really, really great thoughts there. But I'm just going to, I'm going to just throw it open and say, what do you reckon? I think I agree. Yeah. You're way too much focus on the cities. I mean, the Australian psyche is we love to sort of see ourselves with the Akuba and the Drysabone. It's like, what, 2 % of us have any, you know, direct recognition of that or experience of that.

32:11The rest of us are city dwellers. You know, I think Australia looks at, I mean, the world looks at Australia and thinks of Paul Hogan and Steve Irwin. and it's no we're all latte sipping inner city types that's what we the country's beautiful i i think yeah i i strong agree that there is i mean look at look at canberra we built that from nothing yes now it's one of the most desirable places to live with one of the highest average incomes great infrastructure now it's a bit different because like the government just basically moved all of its operations there. That really helps a lot when you've got that kind of funding available, that kind of spending that's sort of going there.

32:56But it can be done. So, yeah. So, I think I made the comment. I'm trying to remember what we said in response to infrastructure spending. But I think my point was it depends on what you spend it on. Infrastructure investment done well is deflationary. infrastructure spending done well is is a boost to economic growth and prosperity it's only dumb when it's sort of diverting resources very scarce and precious capital away from far more productive uses which is which i think is a fair charge to be made against a lot of the government sort of spending so when it's sort of dumb reckless vote buying infrastructure spending you know putting solar panels on a gun club that doesn't need it you know that that is That is just stupid.

33:44We should all be up in arms about that kind of stuff, regardless of which party you're sort of doing it. But, yeah, if it is going to alleviate all the things that Andy was sort of talking about, help foster development and entrepreneurship and business growth in these other areas, then, yeah, I'm all for it. Absolutely. I think, yeah, I think there's some really good points made, Andy. I agree with you entirely and Andy I agree with you almost entirely but I'm going to pick a couple of arguments to have with you just for the sake of adding to the conversation I don't have a problem with your solution or the suggestions I think I would I think if we decide to say hey let's not worry about house prices in Sydney or Melbourne or Brisbane that therefore it's going to be permanently unaffordable I think that would be an abrogation of policy responsibility by governments.

34:43I don't think that making our three largest or three of our largest cities unaffordable for whole swathes of people suggests we've got the policy settings right. I don't think that's a society we should be happy with or proud of or comfortable with. Which is not to say, again, your solutions or the upsides of what you're suggesting aren't right, but I don't think it's, well, I would like to think our policymakers, and I'd love to say politicians, but I'm being realistic here. Should want to say, actually, let's write the whole thing off. It's dead, it's gone. We can't possibly do anything about fixing it.

35:15I think we should fix those problems as well as do the things, some of the things you're talking about. So I think that's, you know, I don't think we should write off investing and living in the city. I don't live in a city now. I live in Barrow, which is not exactly rural, but it's regional. I moved out for reasons similar to your thoughts and I would have moved further had my beautiful lady wife decided she'd be happy with that. We went as far as I was allowed to. But yeah, so, you know, I don't think we should ignore house price affordability because it's underpinned by some real significant policy problems that we should fix, in my view.

35:47That said, I love Tamworth. I love Wagga. I love Bathurst. I haven't been to Orange in years. Broken Hill's beautiful. I'm one of those people who actually has done a decent amount of outback travel in my last few years. A young bloke, we kind of every winter tend to go to Bush in some direction, normally west or north or northwest, somewhere around that sort of range from where we are now. So I agree there are some beautiful places out there and more people should live there. I would happily live there, again, if I was allowed to. I also think your point about scale is true. We know that it's underinvestment in some of these places just because you can't, at least purely economically, and that shouldn't be the only decision we make, fund major medical infrastructure in, I don't know, pick a state, Bourke in New South Wales, right?

36:30We can't put major teaching hospitals in the Flinders Ranges in South Australia or in Kalgoorlie. These are not the people there and the resources there. And we could, we could choose to, just overinvest in those things and we could absolutely do it. But the volume of, you know, cases or use of any of these assets just won't be there to make it a reasonably, you know, decent ROI for returns on that. So you're absolutely right about the size of some of those places. I do worry a little bit about, and this kind of goes to your big Australia thing we talked about on Friday, Ram. I do worry a little bit about the ability of some of our inland cities to absorb sufficient numbers of people, particularly thinking about environmental concerns and water specifically.

37:09Water. I don't know how many more people you can put in Tamworth or Broken Hill. And at some point, the infrastructure… I just saw, we lived a bit out of town there. My folks moved for water considerations. Dad was just sick of not having any. Yeah, I can imagine. So, you know, that's a big one. I think we need to be a little bit careful of, you know, big continent, but not a lot of it's particularly arable or, you know, as efficient water. The only thing I'm going to add one thought to yours, ram on on infrastructure again just to be a little bit um add some hopefully some some value um not that i disagree with you or andy but there's there's a bit of a cargo culture and infrastructure which i don't love and it's just that idea that as you said mate this is the devil's in the detail done well you're 100 right done well infrastructure is deflationary done well infrastructure adds to productivity done well it adds to gdp done well it adds to people's standard of living those things are all 100 true by definition the problem is that uh let's say you want to see you've got a great road between i don't know sydney and tamworth somewhere and someone says you know what we should do we should make it a four-lane highway dual carriageway put bridges over some of the big rivers and then you say well there you go that's let's improve travel times by 10 minutes now if you've spent a couple of billion dollars on that I am still not convinced that the infrastructure investment has a positive ROI it might be nice people might like it they might be happy it's been done does it ever really pay for itself in an ROI perspective I don't know that it does so you know fixing the roads absolutely yes you can argue making them safer is just better for people better standard living I don't disagree with that either and if you want to measure ROI in more than economic terms then you can absolutely make that point i would suspect that a lot of regional infrastructure doesn't have a positive cash roi for the reason i just said you don't have that many people to use them you might want to do them people might like them it might be the right thing to do i'm not entirely sure the last one on infrastructure investment being inflationary um i think that it i think it's inescapably inflationary sorry let me be clear inescapably puts upward pressure on inflation at the point in time which the work is done.

39:21It's deflation over the long term, Ram, which was your point, which is you make things cheaper, easier, faster. That lowers the cost of getting goods to market, workers to work sites, all that stuff. It's all true. In the event though, the work being done right now on infrastructure, if it wasn't done, there'd be less demand in the economy. It would be less inflation to have it cancelled right now. It makes it be worthwhile getting over the hump of inflationary pressures to get that deflation eventually, but you've got to be a little bit careful because the timing of this stuff matters. The time to do these sorts of big things might actually be in 12 months' time when the economy needs a boost.

39:55If unemployment goes from 3.5 % to 4.5%, yeah. Whack a couple of infrastructure projects in, get that unemployment back down. So timing really, really matters when it comes to this stuff. So I think it is, I still disagree with you, Andy, I think it is inflationary now, particularly because the economy is so tight. There's so much what I call capacity constraints. Now is not the time to be adding more work. But there is a time and a place for that to happen. And as Ram says, there are definite long-term benefits of doing just that. Yep. Any other thoughts on what I said, mate? It's complicated.

40:26I mean, it's easy to get cynical because there's nothing like, as a poly, putting a hard hat and a high-vis vest on and standing in front of a big bit of equipment and saying, look how many jobs we're creating. I did this. Correct. Yeah, you know, and look how much it's going to boost future productivity and the rest of it. The trouble with it is that as beneficial as good investment is, malinvestment is equally damaging. You know, it's just on the other side of things. Like just phenomenally damaging. We've got to remember we live in a finite world and, you know, effort and energy and expense over here obviously can't be in two places at once.

41:11And if you all decide that we want to build a 100… Let's say Albanese decides in the middle of Australia, I'm going to build a 100-foot concrete statue of myself and I'm going to coat it in gold. Now, it's going to cost a huge amount of work. A lot of people will be employed. I've seen your true instruction. The big elbow. There's a big banana. There's the big merino. I've seen the big elbow. That could have legs. Someone's going to do that. You know that, don't you? All of those builders, all of that material is not being used to alleviate the housing problem or to build a new road or a hospital.

41:44I mean, it's just so wasteful, does it create jobs? Think of a tourism. I know. There's some benefit to it, I know. But, yeah, I think that was the thrust of the criticism that was leveled recently is the government is going hell for leather in these areas while the private sector is scrambling for reasons. We've seen construction costs blow out massively. we've seen a lot of failures in construction companies that's on the rise too which is fascinating given you would think that this should be a great time uh for you guys but but isn't um so there's yeah there's there's all of that um what was the other point i did have another point that's escaped me uh yeah i just i feel as though to the and this isn't i've got to be careful how you say this because you get into the realm of ideology pretty quickly but i don't know if the government is always the most efficient allocator of capital.

42:42My personal view, and this is just a personal view, and it gets pretty polarizing pretty quickly, but my view is the government really needs to step in when there is market failure, or there are situations where the market can't handle it itself. I don't think the Australian government has any business in getting into a buy now, pay later product. Why would you do that for? I don't think you've got any business in having publicly produced t-shirts like why private sector can do that much better it's very easy opm it's very easy to spend other people's money right right name me a government project where you haven't seen insane cost blowouts and and and delays right yeah because look at the ndis like it's been rorted like a hundred different ways you know it's just it's sort of it's I say all of this while at the same time saying that yeah there is a time in a place like you for government to make these big nation building projects you know the snowy hydro schemes always held up as the the big success story then look how much value that thing created that's an example of when it's done right but when it's done wrong it can be really really really damaging and often unfortunately this is why I say it's easy to get cynical they're being made by people who have a very short time frame and whose benefit is measured in terms of how it directly impacts their re-election chances.

44:06And it's being done with money that's not theirs. So it's easy for things to go wrong. And more often than not, things do tend to go wrong. So we need to demand a very high bar, I think, from decision makers when they're spending our money. And it is our money that's absolutely true i think we have a fetish about building stuff i think yes let's like local manufacturing we should build things here so well actually i'm not sure because our services economy is doing very nicely thank you very much now wages are higher than if we're a largely manufacturing country and so if you really want people to work for less so you can say we built a thing um then you kind of have that view if you want or do you want to pay more for it here's an australian made car oh fantastic oh it's it's it's really crap like it's terrible compared to what you can get from Japan.

44:53And it costs more. And it costs five times as much. But it's made in Australia. Like, can I just get the Toyota? I'm happy. Like, we should support the Australian industry where we can. I'm a big fan of, we've talked before about buying stuff that lasts. I'll happily buy a pair of William's boots for two or three times all I can pay for, you know, something else. Any day. But there's an ROI on that which has to make sense. And I think just making stuff and doing stuff, it's the same thing with, yeah, I think it's worth thinking about what we want to make, what we want to do, building a bridge, it's cool because there's a bridge there, but it's not a good ROI on the investment, as you said, Ram.

45:31By the way, we also are spending infrastructure to offset other mistakes we're making. And it's kind of one of those, paying more for the Band-Aid rather than actually solving the problem in the first place is also worth talking about. So how much of that stuff do we need or should we need or would we need? Speaking of water, a bit of simple water recycling, for example, I do in Israel and other places around the world, rather than, you know, a brand new dam or a pumped hydrocephalus. And there's reasons for energy and stuff. I don't want to get into it necessarily now. But I would just say there are some of the infrastructure, maybe even a lot of the infrastructure is in place because of inefficiencies in the way we live.

46:05And that's also worth thinking about because there are cheaper ways of skinning the same cat, which actually have a much, much, much better outcome than maybe spending billions on infrastructure. One quick point before we move on is the one caveat I would add to the view of, you know, we don't need to make stuff here if we can get it better and cheaper overseas. There is a security dimension to it, which I acknowledge. Yes, 100%. So, you know, if ever we got into a nasty war, I would be pretty… Like, you don't know what… You don't miss what you don't have until you really need it, right? It's like, oh, well, we need to make some…

46:41I don't know. I was going to say tanks, but that's just really old thinking. We need to make some more drones. It's like, oh, we got all our drones from Korea. It's like, oh, can we get any more? No. Okay, well, what do we need? You know, like, there are times when it's like it really pays to have some of this stuff here. And so… I 100 % agree, actually. That's security, absolutely. And some degree of redundancy as well is important for some of this planning stuff. We assume everything's going to be perfectly fine until it's not, and there's no plan B, and that's always a horrible mistake. By the way, did you see, just we had a break before we were chatting, and I got off, I looked at my messages, someone's friend sent me through saying, oh, another respiratory virus out of China.

47:15I was like, oh, my God. So, this is breaking news. It might all be nothing by the time this goes to air. But my immediate response was, well, at least we've learned from our mistakes and we've got lots of stuff prepared because we just had the experience of 2020, et cetera, et cetera. And I think, oh, my God. We almost deserve another pandemic, don't we? Because it's just like… We don't know, do we? If there's a higher being up there, it's like, guys, I don't know. I gave you a chance. I gave you a chance to prepare for this. You know, my favorite is the… We sold off all the quarantine stations for a bit of real estate profit.

47:49Oh, my God. Then we kind of went, shit, we need some, excuse my language. We need some quarantine facilities. Let's build those. So we did. By the time the end of the quotes pandemic, the official pandemic, Queensland government went, oh, I don't need that anymore. Let's sell that off. Like, what is wrong with you people? You didn't have it. Then you finally thought maybe some building in some redundancy might be useful. They're selling it off because you don't need it anymore. It's like, of course you don't need it. That's the point. It's there for you. You do need it. That's why we have those things.

48:14Is there somewhere, is it Norway where they have the global seed bank? Yeah, somewhere like that. Which is the best idea humanity has ever had. It's perfect. So it's up there in the permafrost. We've taken seeds from every species of plant around, you know, commercial crops, importantly, but also all other kinds of things that may have future benefits we don't know about yet with medicine, et cetera. And this thing does nothing but cost huge amounts of money. Yes. There is no, to date, zero ROI. No, that's not true. Negative ROI on that. Yes, exactly. That's right. And I, as someone who hasn't had to pay a single cent for it, am very much in favor of that kind of thing existing.

48:55I tell you what, I would be pretty happy if the government came out tomorrow and said, hey, listen, we're going to dig a giant hole under Uluru. Okay, maybe that's a bad idea. We're going to dig a giant hole in the middle of Australia and we're just going to put a bunch of capital equipment there. We're going to have a whole bunch of books in case the internet goes, We're just getting like, you know, just a whole bunch of just-in-case kind of stuff. And if the government turns around… You want the government department of preparedness, don't you? You want this record to be prepped just a little bit, just a little bit.

49:24I'm just saying you don't need it until you need it. And then you'll be like, oh, goodness. Thank great. You know, we've got this. I think that's a really smart thing to do. That's why we save some of our money, right? That's why we don't spend everything. Because if something goes wrong, we want to replace the car or fix the washing machine or whatever else needs to be done. It's the very nature of what we do as a quid is putting something aside for the future in case we do it or for when we want it. So it's there for us. That's the point. I think you're absolutely right. I mean, I'm kidding about the prepper stuff.

49:48But I mean, you're not miles wrong, mate. That idea of having stuff, PPE, maybe just as a strange idea. How about we have enough stuff for medical professionals if there is another virus? That would work. It's not that hard. Or a few barrels of oil stuck somewhere just in case they have problems with shipping or, you know, just, yeah. The analogy here is to bring it back to more tangible personal finance kind of stuff. Other prepping. Before we go way too of the deep end. But imagine if – we all know someone like this, right, who's on a really good income but has zero savings and lives the life of Riley.

50:23And it's just dumb because it's fine until it's not. Yes, correct. And you lose your job and now you've got the payment on the Beamer and this and your mortgage. Everything unwinds incredibly quickly for just the general – You know, I was whinging to you off air before that, you know, we had an oil leak in our car and I've had to take it into the shop and it's cost whatever many thousands of dollars. You know, it sucks, right? But I'm fortunate in the sense that I've got some savings that I can dip into that. We know statistically, I forget what it is, but some depressingly high percentage of people are paycheck to paycheck.

51:00And a lot of people in that situation are not because they're reckless, by the way. They're there because they're not paid very well and in cost of living and et cetera, et cetera, et cetera. but but it's it's the same point i guess that we're trying to make just at the nation state sort of level it's it's the exact same kind of principle of preparing for the rainy day and i know the bean counters can look at it and go well it says where's the roi on this there is no roi well there's not until there is and that's i guess that's the point million percent mate the fact we have not learned about redundancy from the the covid pandemic it just drives me bananas we should have had we should have stockpiles of things that are stockpileable yeah that's the you know what supply chains shut down because we ran, as you said, on Friday, just in time supply chains until we didn't, right?

51:43Where's that stuff? Oh, it's over there. Can we get it? No, we can't. It might have been nice to have some more here then. That's why toilet paper got nuts. And, you know, the toilet paper thing was stupid. But by the same token, wouldn't it make sense to have like a couple of packs of toilet paper at home just in case you needed it at some point without having to go to the shops? Like, you know, we're so used to being able to, you and I are old, right? That helps. There was a time when shops went open on Sunday and only opened half a day on Saturday. before Christmas or the day before East Good Friday the shops are busy not buying eggs people going oh my god the shops are going to be closed tomorrow what do I do now I better go and stock up you know again speaking about grandparents they did on Friday our grandparents would be like you'd have stuff in the cupboard you'd have stuff in the garage you'd have stuff in the house because you just don't want to everyone went to the bank on Friday right yes exactly to get cash out exactly for the weekend for the ATM yep it just it makes sense to have that there in case you need if you don't need it you'll use it eventually you know have an extra couple of cans of baked beans or tomato paste in the cupboard because if you want to make something and you don't have it, you do that and you replace it next time rather than, if I have a problem, what am I going to do?

52:43I've got no food in the house and the shops are closed. Now what do I do? Yeah, I completely agree. It's madness. It's madness economically. It's madness. It's madness economically. That's the point I was just going to make too. So again, I spoke to a CEO recently with Strawman. They have what you could call a lazy balance sheet. It's too much cash there not doing anything. You know, it's just getting, you know, whatever interest rate they managed to get from their bank, which is nothing. And they always have done it this way. And you know what? Like any company, there are times when you, you know, the cycle turns and business isn't great.

53:22But the point was, was that actually for them it is. Not because they enjoy the lower volumes and the lower sales, but all of their competitors who have got no resilience there. Correct. to the wall, get in trouble. Yes, yes. Right? They get to buy up their competitors for cents on the dollar. Yep. They get to endure. They don't have to fire their best talent, right? Like we spent 20 years training this person up and they're an incredible resource. And I'm going to give them a pay rise and make sure they're looked after. All this stuff that makes no sense in the moment until it does. And then when, you know, the proverbial hits the fan, And it's just sort of like, oh, this is long-term.

54:05This is wonderful for us. This is really, really, really wonderful. And it's hard, I think, for the market to see this. The other point that they made as well is that, and this is, I've made this a few times, but it bears repeating this point, which is that companies that have a big jump in revenue and sales and profitability, generally speaking, that hasn't come from nowhere. They didn't just arrive one day on the door. It happened because in years previous, they invested in greater capacity. They invested in brand and marketing. They invested in resources so that they could deliver when the demand sort of came.

54:43There's an interesting – I don't know what to think of this yet. I'm still trying to work it out. But there's a company called Pointero. It's a fascinating story. I could go on about it for ages. But they had a shocker year. They went from, you know, they went from$0.04 to$0.90 back to like$0.04 or$0.05, whatever they are now. and what happened was they had all this, what they thought was all this massive amount of work about to come through and these big US-based utilities just all delayed all their work. They had contracts with Amazon to do stuff with their warehouses. So nah, we've just gone through a redundancy.

55:15We're not going to do it now. So they bulked up all of their costs. They did everything that you would want them to kind of do under that expectation. Now again, I don't want to be too favorable here because maybe this is all just the CEO making the right noises. So you've got to be careful of being told what you want to hear. But devil's advocate, there is something to be said with that view. And like I speak to some investors and they are just ruthlessly critical. They did this and they're hopeless and they should go and they screwed us all over. It's like, well, did they? Maybe they did. Maybe in the fullness of time we'll be having a conversation.

55:54Yeah, it turned out they were full of hot air. That was never there. it was never going to happen and everyone's lost all their money. So please don't at me on Twitter. Please. Please don't. That's sage underscore seminar. You already see it. There's a lot of emotions when it comes to point terror. But my point is, benefit of the doubt here, that is an entirely plausible story. And there is a parallel universe out there where all of that work came through and they didn't invest in the resources to deliver when that was there. And in which case, the market is screaming at them saying, you idiots.

56:28Now your competitors are taking all of this market share. Why didn't you bulk up when you had the chance? Why didn't you put in the resources to deliver on these contracts? So anyway, the only point here being is that we live in a wild, wacky, unpredictable universe. And it pays to have a little bit of buffer around the systems that we build. Anything times zero is zero. Yes. It makes no sense to risk that zero rolling up. Yeah. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener. Hey, let's go to a question from Chris. Hi, Scott and Andrew. Thank you for all the great advice you both give out each week.

57:14Following your share advisor guidance, Scott, I've achieved a 6 % return over the ASX 200 over the last six months. Looking forward to many years of continued success going forward. but Chris, thank you. I would say - I thought he was going to say 6 % return. I'm like, hmm. Hey, hey, hey. I will say six months is not necessarily indicative in either direction. I hope it continues to do well. If the Tusk might have been terrible or wonderful, I would say the same things, which is it's a long-term that counts, mate. So we'll keep doing our best, but don't judge me either way over the last six months.

57:47Also, by the way, if you're doing well so far, don't assume it's always going to be this good because things come in waves. So just be careful of that. I'm just starting to build a small cap portfolio, says Chris, following Andrew's advice slash suggestions, and I'm confident this will further grow my portfolio. I'm very comfortable with the philosophy and investment strategy for stocks, but I cannot say the same for bonds. I understand the technicalities of fixed interest or bond investing and their role in a balanced portfolio. The fact that it can be an offensive hedge or a compliment to your stock portfolio, I agree.

58:20I feel that I should and will use bonds. If not now, then at some stage in the future. But I have no confidence in picking some to invest in. With your help and guidance, I can now look at a company's financials and see from the consistent revenue or profit growth, the gross margin, return on equity, cash flows, etc., whether this is a good investment or not. With fixed interest, I cannot do the same. Many bond providers have very large minimums, and the return on bond ETFs are abysmal over the last three years. I have much of my spare cash sitting in term deposits, getting 4.85%. He says, for only three months, so almost at call.

58:56So why get into bonds for the same or less? I am prepared to invest time and effort to learn the nuances of fixed interest investing as I feel will have its place going forward. So I was listening to some podcasts and reading online. Can you provide any advice or guidance on how I overcome this challenge? We will have many more foolish times together, me thinks. Regards, Chris. Wow. What's your advice, mate, for someone looking for fixed interest bond investing. Yeah. Yeah. I don't. I think. I'm not sure I can spell that. How do I spell Nya? Is that N-Y-A-H or something Nya? It's a big thing more in the U.S.

59:32You know, the 60-40 idea of a portfolio. 60 % equities, 40 % fixed interest. One zigs, one of the other zags. I think it just guarantees yourself mediocrity over the long term, frankly. You know, a very nice listener once sent us some T-shirts that said I'd rather stay in growth and live with the volatility. Yes, yes. You know, which is true. So it's like there's all this stuff you can do which will smooth things out, but the cost there is lower returns. And I also think it depends on who's issuing the bonds. A bond is just an IOU, right? So it's not complicated. It's so super easy. But it's also diabolically hard.

1:00:14It's super easy in the sense that it's an IOU with some coupon payments along the way. But it's super complicated because it's only as good as the person who's making the promise. So you've got junk bonds. So maybe you can go buy some bonds from Argentina if you want. They've got a new president. Bitcoiner, actually. So there you go. But you can do that. I wouldn't. Interest rate will be super high. That seems attractive. Why am I investing in an Australian government bond when I get an Argentinian bond that's paying 40 %? So the counterparty matters, and it matters a lot. And just for our listeners, the implication Andrew is making is that you get a higher rate of return from Argentina, but they're likely or possibly going to default on that bond and not give you money back at all.

1:00:56So I know you implied that. I just wanted for listeners who maybe aren't following a higher yield bond, a junk bond, they have higher yields because they're much, much, much riskier. And you should be mindful of that. You need, if Argentina, this isn't a go at anyone in the country or anyone from Argentinian background, just the decades of corrupt leadership that they have suffered under. And a pretty creaky economy as a result. Yeah. Did you ever know 100 years ago, Argentina was the richest country in the world? Yes. There is a saying, it's an older one from probably our parents' generation, but as rich as an Argentinian.

1:01:31Really? Yeah. I never heard that before. No, I heard it recently and looked it up. Because in the day, it made a lot of sense because anyone from Argentina was really, really, really rich. Lots of natural resources. They had just less corruption and better institutions. And that all got taken away. That's a whole other story in and of itself. But I'll make this point. They won't default. They can't default. It's their own money. You can't default on it. If I create my own money, I can't default on it. So the default happens because of inflation. So you'll get your nominal value back. It's just that the purchasing power of that money will be worthless, right?

1:02:11So that's why they will default. And if they're paying you in pesos, Argentinian pesos, and the exchange rate moves because of that, even if you get those pesos in Australia, the value of those pesos per Australian dollar will possibly be meaningfully less. Or even if you're in the country. It's sort of like, well, okay, I've still got the notional amount of pesos that I expected. It's just that I can't, you know, what used to cost, you know, I don't know, this is all over the place, but 10 pesos for a loaf of bread is now 200 pesos. So I was like, okay. So I really, that's what matters, right, is the purchasing power.

1:02:46So there's that. But where it gets hard is, and it's not something you have to worry too much about. Let's say it is the Australian government. And let's say that we can trust them to pay it back and for inflation not to be a major problem. Some people have an issue at that, but let's just go with that for the moment.

1:03:06what if interest rates change radically? Well, again, if I'm holding it to maturity, it doesn't really matter. But this is how we had this huge, we had the second biggest banking failure in the US earlier on this year. It's kind of just got swept under the rug. Something's brewing there, but that's a whole other conversation. But what happened to all those banks? Why did the Fed and Treasury have to step in with all these emergency measures? They had to step in because all of these banks had excess deposits. they bought bonds, 30-year bonds and 10-year bonds, and the interest rates went up. Now, when interest rates go up, bond values go down.

1:03:43It's just the way that the maths works. Why am I going on the secondary markets? And not the issuing body here, but the person who already holds. I'm going to start again. You've issued a bond. It pays a 5 % rate of interest. It's a$100 bond, and you pay me$5 every year. It's nice and easy. All of a sudden, interest rates that I can get at the Fed or elsewhere jumped to 10%. So I was like, and now I want to sell my bond. Now, who's going to buy that bond off me at par? Who's going to buy that bond at$100? Like, well, I'm only going to get$5, i.e. a 5 % return. I can just go and invest in this new issue over here and get 10%.

1:04:18So to account for that difference, I need to sell it at 50 bucks. So in other words… So the buyer gets a 10 % return. That's right. They're still getting the five… The coupon is set in stone. It's contractual, right? Say coupon, the interest payment effectively. So for me to get 10%, I need to pay a much lower price. And then the carrying value of these loans, well, that's another story, but the real value of what they were holding dropped substantially in price. Again, these are called risk-free assets. These were U.S. treasuries, right? Risk-free as so-called. Well, they're not. Not in this instance, not when dealing with very long-dated bonds when there are very fast rates of interest rate changes.

1:04:58And that's why I say they're both super, super, super easy and yet diabolically hard. Because if you are going to be any fixed rate, any kind of fixed rate investor, and you are going to have any kind of reasonable timeframe there, you're not just buying very, very short dated bits of paper. You are at the whim of the random global changes in interest rates. And that can have a massive, massive, massive impact. As a lot of big, supposedly smart, sophisticated investors are now finding out. So it's not risk-free. I'll make that point. And I agree. Why on God's green earth am I going to buy some of these IOUs when I can stick it in a term deposit for effectively the same kind of risk for a better return?

1:05:46I suspect, the whole other conversation, but part of my reason that I think interest rates will be higher for longer is because the U.S. is increasingly having to offer higher. that for the US to fund its very substantial deficit, it was able to do so for ages very cheaply because it was a global reserve and is the global reserve currency. As the, now the US is not going to default, but inflation is still a bit of a problem there and potentially could last there. The market, the free market is saying, I don't want to buy those bonds at that rate. In which case to meet, to clear those, to clear the inventory, the issuer, Treasury, has to actually say, okay, well, we'll give you a higher interest, a lower price and therefore a higher interest rate.

1:06:34That's going to be something to watch over the next decade or two, I feel. I know I would be very nervous lending a government that is structurally and significantly in deficit money for 30 years, like with no hope of getting back to any kind of fiscal responsibility. I'd be extraordinarily nervous in doing that. and the kind of people who play in these global bond markets aren't that dumb and I feel as though at a point they'll just go well I will lend you the money right but you need to pony up more dough there's a lot in that mate there's a lot there's a lot in that sorry I'm going to I'm going to just quickly I think you've you know I'm just going to cover the risk free bit because I think I'm going to disagree with you but also agree with you and explain thinking that hopefully you help our listeners understand a bit better so first thing I'll say is I agree with you completely I wouldn't buy bonds I see no value in doing it other than for volatility protection.

1:07:26And that's real if that's what you want, right? So, you know, you made the point about the T-shirt. If you don't want volatility, then bonds make sense as part of our portfolio because it reduces the volatility of the average portfolio. You'll pay for that with lower total returns. So, careful what you wish for. But for some people, they might be like, I just can't do 40 % falls every five years. And I just can't do that. So, I need to protect myself from that. And if that's bonds, then fine. By the way, it could be cash in the bank or anything else, but if it's bonds, then fine. So I get why people might want to think about that.

1:07:59In terms of the risk-free thing, I'm going to disagree with you but then come around to agree with you. So give me a bit of rope here. Okay. In my mind, the bond is entirely risk-free because you don't have to sell it on the secondary market. Yep. So if you want to sell it, you might lose half your capital in your example, great example. Well, jeez, I mean, if I lose half my capital, that sounds pretty crap. Except if you hold it to maturity, you get all of your capital back plus you get the coupon or the interest payments during the period. and let's leave default out of it. It's not risk-free because there is a chance of default, but as you say, if you're issuing your own currency, it's right.

1:08:30So it's risk-free in that sense that you will get your money back. You will get your interest payments. It'll be completely fine. So I disagree that it's not risk-free, except where I agree with you, and this is why I want to bring it full circle, is there's two elements of risk that still are involved in that process. The first is, to Ram's point, if they print money, then the real value of the bond falls, even if the nominal value, You get your$100 back, but in a year's time or 10 years' time, $100 is worth$25 because they've printed so much money and inflation's been so high. It's the Argentinian problem.

1:09:00The capital's been eroded. Right, exactly. So in nominal terms, it's risk-free. In absolute terms, you are always going to fight against inflation. The other reason why it's not risk-free, and this is a little bit more detail but not much, is why – when Andrew was talking, you might have thought, well, hang on, if you had to sell it for$50, why would you just not keep it for$100? Well, firstly, you might need the money. So you take a duration risk anytime. If you need to sell that, the great thing, you can't sell a term deposit. You can redeem it. You can get most of your money back, maybe with a penalty, maybe without.

1:09:30Bond, you can sell it generally as long as it's a willing buyer. You've got to agree to the price, but as long as it's a willing buyer, you can sell it. So it's a nice instrument to be able to sell a bit like shares when you want to, generally, and you can close out the trade in a couple of days to get the money pretty quickly. So that kind of works. The risk bit here is twofold. The first is, if you need to sell it, as I said, that duration risk. The other thing is there's an opportunity cost, which is a form of risk. If you can get 10 % elsewhere, but you're stuck with your 5 % bond because you've chosen to invest in a 10-year bond at 5%, you're getting your 5%, maybe that's okay, maybe you're happy with that, but a little bit like owning bonds in the first place for volatility protection, you can secure that capital at$100 in 10 years' time, but in the meantime, you could be yourself investing at 10 % returns if you had a different asset.

1:10:17But by holding a fixed-term asset at a lower interest rate, you're costing yourself the ability to invest at higher rates of return if interest rates do move. Now, is that risk? On one level, no, because you're not losing your capital. But the ability or the cost of not being able to chase a higher return is a very real financial impediment. And you may, halfway through the story, feel that things are going to get worse. Yes, that's the other thing. So it's sort of like, okay, I've lost, like, I only lose if I sell, but I'm not going to sell. Actually, I think interest rates are going to go even further, which means my bonds will go down even lower.

1:10:54So it's not – there's a sunk cost deal. There's already sort of a loss there, but it may be that you expect the loss to get worse. So it's – yeah, it's tricky. I mean, I cannot believe that governments, big major Western governments were issuing 30-year, I think, was it the Eurozone that had a 100-year bond or something? Sounds likely, yeah. About at 0%. I think even Apple did 30-year bonds at like 1 % or something ridiculous. Bravo. Bravo. You found a counterparty? I just, you know, I just get on my knees and I bow to you. That is brilliant. I would. By the way, anyone listening out there wants to let me money for 100 years at 2%, I will take it.

1:11:50Let's talk, right? I will very happily sort of take that. And you kind of think, who's dumb enough to do that? I don't know. Just pension funds and massive sovereign wealth funds and huge, like big, smart money. This is how crazy the world got there for a time. So it kind of blows my mind a little bit. And they did, by the way, because they wanted to have that security or certainty of capital in a volatile world where shares seem as a riskier asset because the price can fall. I mean, the reality is we prefer shares because they're more upside. The reality is there is also downside risk, right?

1:12:26So, you know, the bond, you'll get your 100 bucks back. And even after inflation, that might suck because it might be worth 50 or 30 or something. If the company you buy, the shares go nowhere or fall, and then inflation does it, you could still be worse off owning shares, the wrong shares, or even just shares in general if the market falls. So we don't want to portray bonds as a risky asset where shares are really safe and reasonable. Oh, yes. What we're saying is the upside potential for well-chosen shares, we think makes a much, much better risk-reward proposition than bonds. But we also, we don't want to pretend that only bonds can lose money in that scenario.

1:12:58Oh, that's a very good point. Shares can too. So we often sing the praises of Howard Marks. He's a really great investor. I sign up to Oaktree, The memos that he does, they're free, they're brilliant, they're all great, well worth reading. He's a bond market investor. He invests a lot in junk bonds and the rest of it. Distress bonds, right. Yeah, companies that are teetering. Yeah, yeah, yeah. But it's not – they're buying it because they've got a view, a macro view essentially on these things and what's going on. So it's – on one hand, it sounds really vanilla and boring. On the other hand, they've delivered incredible returns for their shareholders by sort of predicting which ways the economic macro winds are going to blow and realizing that markets are offering, you know, dollars for pennies kind of thing.

1:13:41So yeah, it's an excellent point you make. And there's always exceptions to it, but I'll put a bow on it. I think for the average quote unquote retail investor, there's not much. Don't feel as though you should because diversification or because volatility or something like that you know it's like we often have fun with the idea that oh you should have exposure to gold and retail and should you why who said who said that i need exposure to these kinds of things right and i feel there's too much stuff that's just pure just indoctrination really it's like you should because you should because that's the way it's always been done people say you should so i guess it makes and it's it's more insidious than that mate actually because it's a really easy um i don't think people are necessarily doing it deliberately but diversification is good right yes so more diversification must be better than yes so then if i buy bonds i'm more diversified i yes so therefore i should buy bonds then yes so hang on no that that that that series of statements it seems to follow it doesn't mean you should buy beanie babies and yo-yos and baseball trading cards because well we bought what about i don't know wine i don't know any art maybe i should own some art because i should be diversified maybe i should own you know at some point there is diversification and there is just silliness and i think i'm not saying bond buys silly necessarily what i am saying is don't don't follow that logic all the way through otherwise you never stop you know unless you're one of everything in the world you're not truly diversified you could always be more diversified couldn't i well i'll do that then um it seems to make sense it was born out of i think mate some reasonableness around volatility i think most old-school financial advisors were of the view that that 60 40 portfolio or the bond should be was it 100 minus your age or something should be a bond allocation yeah that's right yeah And it makes some, if you've got nervous clients who are going to freak out.

1:15:33My mom has said to me years ago now, but my super went down. It's not supposed to go down, is it? And it was a really, really innocent question where it was like, well, I thought super was supposed to go up over time. And now I've lost money over the last 12 months. What the hell's going on? Not her words, mine. Paraphrasing. But, you know, it's not an unreasonable question. There are people out there who need to be given lower volatility products or solutions because they just don't have the temperament to deal with volatility. Completely appropriate. Yeah. But that's what it's for, not for maximizing your returns.

1:16:00But there's a compromise. There's no free lunch. Any benefit that you get from a certain financial product comes at the expense of something else. 100%. Yeah. Oh, man. It's really, I mean, the other type of bond we, oh, gosh, we're well over time, but I'll just finish this because it's fascinating bonds.

1:16:24There's sovereign bonds, but there's corporate bonds as well. So the CBA… Hence the Apple ones we talked about. Yeah, that's right. They can be very interesting too. The other, and before someone writes in and complains, we didn't mention this, is that if a company gets into trouble, bondholders rank ahead of equity holders. Correct. Although that's pretty, you know, you want to hope that there's a hell of a lot of net assets there to sort of make it good because generally speaking, no one's going to get much of anything. It's going to be a bad experience for all. But as a common shareholder, you're the last person in the queue for whatever is left over after the administrators have come in and tried to fix everything up.

1:17:04You're probably not going to get much at all. Bondholders will rank ahead of you. So let me just quickly put some detail on that, mate, very quickly. When an administrator or a liquidator is called in and take over a bankrupt company, there are rules that apply to how they distribute whatever assets are left over. So the liquidator says, right, I've taken over Phillips Enterprises. It's gone broke. It's insolvent, so it can't keep trading. But it's got some land. It's got a couple of buildings. It's got some inventory. It's got a little bit of cash in the bank. Either I'll try and sell the business to someone else and get some money back and distribute that money or sell a whole asset, shut the whole thing down and return the money to the stakeholders.

1:17:43Yes. And in that context, there is an order. Generally speaking, employee entitlements. At least legislative ones come first. After that, what they're called secured debt holders. So secured is like, a mortgage is security over your house. So it's tied to an asset, generally speaking, or to the assets of a company. Then unsecured creditors, so think about a personal loan where you haven't pledged the car as collateral. That's an unsecured loan. After that are the owners of the company. So when all the company's debts have been paid, almost never are, by the way. There's almost certainly nothing left.

1:18:14But the debt holders get first go, and then the equity holders, the shareholders gets what's left. That's why share investing is considered more risky than bonds, generally speaking, from that perspective, because you're lower on the credit totem pole. Before you rush out and fill your boots with commercial bonds, though, again, there's a compromise here. And the compromise is this. Let's say I buy some corporate bonds from a company. And let's say that company happens to be the next Apple. And between now and 2033, its profit just goes to the moon. Well, guess what you get as a bondholder? You get exactly what you signed up for on day one.

1:18:52There is no upside beyond what was contracted for. That's right. So, oh, it's safer and there's less downside and if anything gets into trouble, I'll get more money back than shit. Well, A, you're still going to not be in a good place. And B, just remember, it comes at a cost and the cost is you don't get any of the upside either. Correct, correct. I think we've done that well and truly to death. The three people who are still listening to find out more about bonds have been totally sated in their desires to understand more about the murky world of fixed interest investing. Everyone else left a very, very long time ago.

1:19:25Mate, thank you for sharing your knowledge today. Really, we've seen a whole lot of different topics. I really love the great questions. Everything from Outback Australia through the bond investing and everything in between. So thank you very much for all those who asked those questions. We are going to, in the next little while, start recording some Christmas episodes. We are going to our level best to deliver to you episodes right through Christmas and New Year as we try and do every year. I've said before, we've only ever missed one episode. that was when I was in hospital crook. Weak. Unplanned.

1:19:53Yeah, I know, exactly. To be fair, I had a bloody respirator in my head. It was going to be hard to use a microphone, but that's my problem. I'm saying some people, you know, when they are called upon, stand and deliver. Others take the easy time. Hide behind excuses. Exactly. But we always do try and get through Christmas, so we will try and pre-record them. What that means is we need questions. So if you have questions for the mailbag, by the way, another one, another quick thought. If you have ideas, suggestions about topics we can cover, in our regular episodes. We normally kind of make Fridays a bit newsy or at least news kind of generated.

1:20:24We kind of tend to rant and discuss other stuff, but it tends to come from the events of the week. If there are things you want us to talk about, which maybe aren't direct questions, but topic ideas for those pre-recorded episodes, particularly the Friday ones, please let us know as well. Info, I-N-F-O at fool.com.au. By the way, if you gave up not listening to The Bond Answer, you missed this bit, so you don't get a chance. So the benefit of listening, of hanging around till the very, very end is you get to find out what's happening. Info at fool.com.au. Hit me up on Twitter at TMFScottP. That's also my Instagram handle.

1:20:56You can get Ram at Sage underscore Simeon and at StrawmanInvest. And you can follow me on Facebook, facebook.com forward slash Scott Phillips Money. As always, be careful of imitators and spammers and scammers because they will try and do that. So make sure you look up the actual addresses, the actual handles. I'll just say it right now. We'll never sell you anything on those platforms. Correct. And we're not DMing random people. We're not rich yet to say hello. Exactly. If you hear from me, if I slide into your DMs, as the cool kids say, and I'm offering you my trading course or something like that, like run a mile.

1:21:33Yeah. I had someone try and sell me something they made 100 % in a month the other day. I was like, you don't know who I am, do you? It's a pretty funny one. Anyway, all that said, thank you for listening. Thanks for sending some time with us. Have a great Sunday. And until Friday afternoon. Full on. See you later. The Motley Fool and people appearing in this program may have positions in the companies mentioned. General advice only. Please speak to your financial professional to understand how it may pertain to your situation. Subscribe to the free newsletter at fool.com.au forward slash listener.

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