Professional management reduces the risk

Friday 5th May 2000

PLAY MONEY: Syndicates based on racing horses need to be distinguished from those for horse breeding, which is no game for amateurs

Syndication gives groups an almost unlimited range of activities, not all of which come into generally accepted definitions of "investments."

While livestock of various kinds have been popular syndication vehicles in the past 20 years, sometimes with disastrous results, some aspects of that business are better considered as a hobby interest rather than an investment.

Bloodstock is an example, when the syndicates are based on racing thoroughbred (galloping) or standardbred (pacing and trotting) animals. Racing horses should be distinguished from the breeding aspect. The latter can involve amounts in the millions and is the province of well-heeled people who are running businesses and know what they are doing.

It is not a game for amateurs. Opinions differ about whether horsebreeding is an "investment" in the accepted sense of the term, particularly among those who argue there must be a regular return in cash before an activity can qualify as an investment.

It is obvious substantial risks are associated with horsebreeding and other form of livestock syndication, such as prime cattle, but no member of such a syndicate enters it without the expectation of receiving regular distributions from the cashflow generated from stud fees and/or sale of the offspring.

It is immaterial that some exercises turn out duds; that happens even in the sharemarket from time to time.

Not everyone can have the successes of, say, Sir Patrick Hogan of Cambridge Stud, people who have joined with him in syndicated multimillion dollar stallions or the other breeders who efforts have produced less spectacular but nonetheless profitable returns.

Horseracing syndicates are a totally different matter. Anyone who enters them with a get-rich-quick outlook should go and have a quiet liedown. The "glorious uncertainty" of racing is one of its main attractions for people who want to be part of the action and hope to see their colours first past the post, irrespective of how humble the particular race and racecourse may be.

Syndication can be for them, particularly as the rules about ownership have been amended over the years and individuals can now become involved for little cost. That form of syndication is definitely not an "investment." Those wanting to participate should be doing so with "play money," not their life savings.

More traditional syndication vehicles - apart from the fads that are promoted periodically - have particular risk elements, not least of which can be the lack of a secondary market. It is easy to sell a bundle of shares or fixed interest securities and - but not always - to liquidate a position in a managed fund, depending on its type.

Disposing of a position in a syndicate can be difficult, although the forestry industry has produced a form of secondary market through structuring operations as companies, giving investors in investment units the benefit of limited liability, relatively easy transfer of shares and taxation benefits.

A small syndicate can suffer most from the liquidity problem, particularly in property (see story on previous page). Syndicate members may have agreed on the project's costs and how long it will be before they get a return but that does not stop participants changing their minds further down the time track and wanting to get out, either because they have become disillusioned or want to free up funds.

It is a fair bet if someone has become disillusioned the prospect of another person taking up the investment with enthusiasm could be remote. People who enter syndicates based on long-term projects must realise they would be foolish to adopt a variation of the "borrowing short to lend long" phenomenon.

Long-term projects need stable long-term investment funds and cannot be entered into for a quick dollar or with the idea that capital withdrawal in the short term is simple.

People thinking of entering syndicates, particularly a group of friends, relations or colleagues have particular issues to sort out. A decision on whether the syndicate will engage professional management or operate on a do-it-yourself basis is fundamental.

The issue obviously does not arise where professional promoters have developed the syndicate and advertised for public participation, although in that case people should check out the competence of the promoters and their associates.

There are also issues related to the future state of the market. Reliance on today's situation as a guide to the future was the downfall of the 1980s syndicates that saw massive profit available in the kiwifruit, deer, goats and other livestock industries. They bought land, livestock and/or other assets at inflated prices as the industries took off and were left with those expensive assets when the markets for end-products tumbled and the return on assets was insufficient to support the capital bases.

The problem was compounded when a crash in output prices led to a similar crash in general asset values. Wipeout was the result. That applied to public companies as well as syndicates, but at least some of the former were able to trade their way out.

Questions have been raised recently about the future market for forests geared to come to harvest over the next 10 years. Some of those questions could be misplaced, because foresters have the capacity to refrain from harvesting wood, unless they are massive public companies who find it essential to get at least some cashflow at any particular time from their productive assets.

There is also the point that medium- to long-term projections in any industry are based on trendlines and absorb short-term fluctuations in supply and demand.

That has been seen in the forestry industry over the past three years, when the Asian economic crisis hit a relatively strong industry which then rebounded - albeit modestly so far - when those economies worked through their problems.

Conversely, such investment could be beneficial when the particular industry/product is at a low - the old counter-cyclical approach when assets drop in value and are likely to produce excellent returns in future, provided the syndicate - or other vehicle - can hold on to get the cyclical benefits.

Syndicates without professional management run the risk of letting personal matters interfere with business decisions, so people looking at non-professional management should assess carefully the intangible element of their personal relationships with potential members.

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