Shares in McMillan Shakespeare plumetted when the Rudd government announced it was axing the fringe benefits tax concession on cars.Is your portfolio too reliant on franking?
In Spread yourself out, but not too thinly, I said that diversification – spreading your investments across a variety of assets – means you’re not overly exposed to the vagaries of luck. In particular it helps avoid “cliff risk” – the chance your investments might fall over one.
If you want to know what cliff risk looks like, take a look at Chart 1, showing the share price movements of McMillan Shakespeare, one of the country’s leading salary packaging companies.
The moment when the Rudd government announced it was axing the fringe benefits tax concession on cars is pretty obvious isn’t it?
The company recovered when the current government scrapped the change but it shows how badly a company’s share price can collapse when affected by a change in law.
It’s not just individual companies, either. Law changes can have a large impact on entire classes of shares, or the sharemarket generally. For instance, consider the current financial system inquiry and the push by some to do away with dividend imputation, better known as franking.
I doubt we’re going to lose franking completely; it’s enshrined in our investing culture and the basic logic is sound. But it’s entirely possible we might see some tweaking of the rules.
It’s worth remembering when dividend imputation was introduced in 1987 we didn’t have refundable franking credits. Tax paid by companies reduced the tax bill on dividends (avoiding double taxation) but the shareholders couldn’t just rock up to the Tax Office and ask for the money back.
That changed in 2000, when franking credits were made refundable to individuals and super funds. Since then, any business operating in Australia has, on a net basis, been paying tax at its shareholders’ rate, not the company tax rate (unless foreign owned or paying tax overseas). To the extent it’s owned by pension mode (tax exempt) super funds, it’s effective tax bill on that part of the business is zero.
As super funds continue to grow, and Australians age, this isn’t sustainable. The risk is that the Government will decide that refunding franking credits to non-taxpayers wasn’t such a good idea and go back to the pre-2000 rules.
If it does, expect the share prices of those companies paying high, fully-franked dividends such as the banks and Telstra to fall over a cliff. Investments that specifically cater for franking credits – for instance, hybrids – would probably suffer an even worse fate. For a super fund in pension mode, they’d become a security paying an unattractive distribution and get sold en masse.
Other securities might benefit. Property trusts, for instance, wouldn’t be affected, so their unit prices might rise as investors scramble out of shares that have franking credits priced in. And investments without an excessive yield focus – like international share funds and small companies – would be relatively untouched.
If you’ve got a diversified portfolio you don’t have too much to fear from franking credit changes or one-off risks generally. But if you’re loaded up on financials, hybrids and Telstra, you might be at more risk than you expect of your portfolio value dropping off a cliff.
Richard Livingston is the managing director of Intelligent Investor Super Advisor, an online service providing advice on superannuation and investing. This article contains general investment advice only (under AFSL 282288).
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