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This is the Sharenet company blog where we will bring you the latest news and events on the go at Sharenet, together with tips on using our site and our products.

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    Seed Weekly - Active Share - Are You Getting Value?

    Over the past few years there has been an increased focus within the investment industry, by government, and through the media, on costs involved in managing client assets. Naturally these are important questions that need to be addressed, but more important, in our opinion, is to focus on whether investors are getting value for money.

    As multi managers, we are acutely aware of the need to monitor manager portfolios and mitigate costs in order to deliver value to our clients. Part of this process is to ensure that any manager or mandate that we include in our Funds has a meaningful value proposition. In this regard we make use of lower cost smart beta products (that have the possibility of outperforming traditional indices) and higher cost active managers.

    Here it is important that all active managers have the ability to meaningfully outperform an appropriate benchmark over a full market cycle, after the impact of costs has been taken into account. In doing so, it is crucial that the manager has a completely benchmark agnostic process, that over time will result in his portfolio having meaningful differences from the benchmark/index against which he’s being measured (on top of having a great process).

    At Seed, we think that active share is the best measure of how active a fund is, and is superior to tracking error for the following reasons:
    • Tracking error is backward looking (whereas active share looks at the current portfolio)
    • There can be periods (particularly in broadly trending markets) where a fund can have a low tracking error, while still being completely different to the benchmark index (incorrect conclusions can be drawn from tracking error).
    Drawbacks of the active share measure are that it requires holding data that can be tricky to obtain, is much more time consuming to calculate, and can (and does) change over time, but is something that is monitored on all managers used by Seed (we feel a value add as a multi manager).

    When looking at local property unit trusts it is interesting to compare the active share across the various funds. For this sample we looked at the largest (non multi managed) funds comprising over 90% of the sector’s assets. While we know that property managers in South Africa are typically quite benchmark cognisant, we were shocked at just how close to the benchmark most of the funds currently are!

    Out of the 12 funds investigated, only 2 of them had an active share above 50% (what we’d consider the base level for a manager to be considered active) and have been highlighted in red below. One manager has a stated objective of managing close to the benchmark (yellow) and as a result has the lowest total expense ratio (TER) of those funds surveyed (although at 0.76% is a bit higher than pure tracker, Satrix Property Index at 0.57% - which isn’t cheap in its own right)!

    A major reason for the low active share is that 11 out of the 12 funds have Growthpoint (GRT) as their largest holding (with all of their GRT positions at least 5% higher than the second largest holding) and Redefine is in the top 3 holdings in 9 of the funds. The chart below shows the various managers (ranked by AUM), the TER of their fund (as per latest ASISA data), and their active share (as per latest Morningstar data). There are many managers that will tell you just why they don’t like Growthpoint and yet it’s still their largest holding and typically more than 15% of their fund (GRT is 23% of the SA Listed Property Index)!

    Active Share Across Funds

    When looking to include property mandates in Seed’s multi asset funds (Seed Flexible and Seed Absolute Return) we had 2 options – track the market as cheaply as possible, or pay a bit more, but get an active manager. We chose the latter and further looked to get the manager’s ‘best ideas’ in a concentrated building block, as property only makes up a portion of the Funds’ total assets. It is therefore obvious that the mandates in Seed’s funds have the greatest probability of generating a return that is different from the benchmark. As we have done extensive due diligences on the manager concerned, we feel that there is greater probability of outperformance and therefore wanted to maximise the impact of his skill set.

    We feel that paying active manager fees, where active share is above 50%, is justified (although we’d typically like this number in excess of 80%). Furthermore, charging active manager fees (in our view anything above 0.75%) on a portfolio that is less than 20% different from the index is excessive. Judged on these standards a large number of property managers need to have a good look in the mirror! While some managers have been able to outperform even with such low active share, we can only but wonder how much better they would have done had they used a blank slate when constructing their portfolios!

    Take care,

    Mike Browne

    021 914 4966

    Permalink2014-10-28, 09:46:46, by Mike Email , Leave a comment

    Seed weekly - Capitec – Growing Earnings and Clients

    Capitec Bank has taken the banking sector by storm since its listing in 2002, and is widely regarded as the most innovative player in the sector. Its mantra of Simplicity, Affordability, Accessibility and Personal Service has found favour with SA’s consumers, enabling Capitec to grow its client base rapidly. The bank now boasts nearly 6 million clients and 9,491 employees at 647 branches.


    Capitec has its roots intertwined with that of PSG Group, which entered the thriving microlending sector in 1997 by acquiring SmartFin and FinAid, two Gauteng based microfinancing businesses. PSG’s aim was to establish a dominant position in a very fragmented industry by consolidating some of the smaller players.

    The microlending business was spun out as a subsidiary of PSG Investment Bank, and sold into The Business Bank in order to use its existing banking license. Thus Capitec Bank was established in March 2001, and the holding company Capital Bank Holdings Ltd listed on the JSE in 2002.

    In 2003 PSG unbundled Capitec, and over time PSG’s ownership stake has reduced from around 56% to the current 28%.

    Financial Results

    The bank recently released its interim results for the six months ended 31 August 2014, and reported an impressive 21% increase in headline earnings per share. Further highlights included an increase in the interim dividend by 21% to 246 cents and a 16% increase in active clients over the past year.

    The graph below illustrates the growth in headline earning per share (cents) over time:

    Capitec’s number of active clients has grown exponentially since 2005, and now stands at 5.8 million including 2.9 million mobile clients. Primary bank clients, which Capitec defines as those making regular monthly deposits such as salaries, have increased to 2.4 million.

    Capitec has realised the importance of diversifying its revenue stream away from its microfinance roots. As a result, management has focused attention on increasing the revenue from transactional banking as opposed to interest and fees earned on loans granted. The increase in active clients has enabled Capitec to make some progress here, and transaction fee income now accounts for 22% of income from banking operations.

    The net transaction fee income (millions) over time is illustrated in the graph below. For the six months ended 31 August 2014, transactional income was 33% higher at R 1.2bn compared to the same period last year.

    On the liability side, the value of new loans advanced decreased by 2% to R 9.3bn, while the number of new loans reduced by 20% to 1.3 million for the period. The average loan amount is now R 7,059, up 22% from the previous period. This is a result of tighter affordability requirements and granting less low-value, short-term loans. Management took the opportunity to remind investors that they remain cautious in extending credit, and that comprehensive affordability assessments are done before granting any loan. The overall term of the outstanding loan book decreased from 45 to 44 months over the last 6 months.

    It is encouraging that Capitec continues to provide very prudently for bad loans: 8% are provided for loans that are up to date, 46% for those who are 1 instalment behind, 74% for two instalments behind and 87% for three instalments. After 90 days in arrears the loan is written off as a bad loan.

    Gross loan impairment expenses – that is debt written off and provisions for bad debts – rose by 6% compared to the previous period, with write-offs totalling R 2.1bn. Provisions made previously were more than sufficient to absorb the current period write-offs. Recoveries increased by 58% to R 259m.


    Capitec currently trades at a PE of 13 and a dividend yield of 2.4%, comparing favourably with the ALSI’s 16.3 and 3.1% respectively.

    The share has been included in the Seed Equity Fund in the recent past as a small portion of both the Momentum and Value building blocks, but is not held currently.

    Kind regards

    Cor van Deventer

    021 914 4966

    Permalink2014-10-21, 09:53:36, by Mike Email , Leave a comment

    Seed weekly - Retirement Reform

    With the end of the year looming we should all be starting to plan for the year 2015; a very highly anticipated event is the implementation of the much publicised Retirement Reform. The date Treasury has set for implementation of many of the new regulations is 1 March 2015.

    There has been much speculation among the general public regarding the new regulations that was extensively covered in the press. Although we don’t have a final draft on all the proposed changes, Treasury has been providing regular updates on some of the areas that they have finalised. Not all of these topics were always covered in the press and many members of the public are not entirely familiar with how these changes will impact them.

    There have also been some instances where members’ have cashed in their retirement funds as they fear that the Government will nationalise their pension/provident funds, there is absolutely no substance to these rumours and should be disregarded altogether.

    The retirement reforms that we will undergo in a few months are Government’s response to, among other things, South Africans’ low rate of saving. The new regulation attempts to encourage members to preserve their retirement benefits and also to make retirement products easier to understand. There are many differences between the pre- and post-retirement treatment of benefits from Pension & Provident funds and Retirement Annuities, the proposed reforms go some way to simplifying these vehicles.

    One of the most important changes is the amalgamation of contributions to all 3 different retirement vehicles. From 1 March 2015 a person can contribute 27.5% of their annual taxable income, capped at R 350 000 pa, to either a Pension fund, Provident fund, Retirement Annuity or a combination of the 3. This eases the planning surrounding your annual tax deductible contributions to retirement vehicles and also makes it more ‘fair’ to individuals who do not have access to Pension and Provident funds.

    There have been some misconceptions formed about the treatment of Provident Fund benefits after retirement. The new regulations state that only benefits accumulated after 1 March 2015 in Provident funds will be treated the same as benefits from Pension funds and Retirement Annuities, i.e. up to one third may be taken in cash while the balance needs to be transferred to a Living Annuity. Members of Provident funds will still be able to take the full benefit accumulated by 1 March 2015 in cash, and contributions made (with benefits accumulated) by members 55 years of age or older on 1 March 2015 will not be affected by the new regulations. Another important note is that for the members younger than 55 Treasury decided to include a ‘de minimis rule’ stating that if you contribute less than R 150 000 after 1 March 2015 to the day you retire the benefits will still be available fully in cash on retirement date.

    The above is a brief description of some of the changes to be implemented. Many changes haven’t been covered in this piece or finalised by Treasury. Our team of dedicated investment consultants is available to guide you through the process of aligning your investment portfolio in order to be prepared for the changes on the way.

    Kind regards,

    Stefan Keeve

    021 914 4966

    Permalink2014-10-14, 08:40:28, by Mike Email , Leave a comment

    Seed Weekly - Compounding at higher rates of return

    Why do some companies seem to consistently move up in price, even though at face value they appear to be expensive when measured on typical measures such as price to earnings ratios, while others businesses constantly appear cheap but the price struggles to move up.

    One answer is that these superior business are those that generate a high return on invested capital (ROIC) above that of the cost of capital and they also have the ability to reinvest a large portion of their profits at higher rates of return. By consistently doing this, these businesses generate above average compounding of their intrinsic value.

    An investor that allocates capital to such a business will over time typically participate in the compounding effect of the higher rate of return on the company’s intrinsic value. The compounding is the product of two main factors; firstly return on capital and secondly the reinvestment rate. If a business can achieve a return of 20% on its invested capital and it reinvests 2/3 of its earnings, then the intrinsic value of the business will compound by 13,3% per annum, (20% x 66,6%). The excess not reinvested, can be paid back to investors as a dividend or by way of a share buyback.

    Compare this to a business that only generates a return of 8% on its invested capital but has to reinvest 100% of its profits back into the business each year. It will only see the intrinsic value of the business compound at the 8% per annum.

    An article by Deloitte found that ROIC is an understated but powerful metric, for the following reasons:

    Persistence – Studies have shown that ROIC tends to persist over time in a given industry. One is likely to find that companies in sectors like utilities and construction have a relatively low ROIC while companies in, say, the pharmaceutical or beverage sectors have a relatively higher ROIC.

    Robustness – the metric is extremely robust as it assesses the underlying performance of operating assets before being complicated by a company’s financial structure or non-operating assets. ROIC measures the investing decision, which is independent from the financing decision.

    Comparability – It can readily be compared across industries, companies, early/late stage growth businesses or against an entity’s weighted average cost of capital (WACC).

    In the long run it has been demonstrated that share price movements are determined primarily by growth in earnings. This is well illustrated in the following chart, which compares the ALSI’s price with this index’s earnings. Although the market fluctuates widely around the earnings line, it is clearly heavily influenced by long-term growth in listed company earnings.

    Therefore companies that can compound their earnings at a higher rate because of a high return on capital and a higher reinvestment, should over time have a share price that moves up commensurately.

    Earnings and equity performance

    Therefore for an investor seeking a superior investment return, it is more than buying companies at low prices to current or one year forward earnings. More importantly it is about allocating capital to a business that has an ability to compound its earnings over time at a higher rate than others. Naturally if one can at the same time also buy such a business at a lower than market price, then this is a huge positive.
    Kind regards

    Ian de Lange

    021 914 4966

    Permalink2014-10-07, 10:41:10, by Mike Email , Leave a comment

    Seed weekly - Capital Protection

    One of the many pearls of wisdom dispensed by Warren Buffett is “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1”. Unfortunately this is easier said than done in the real world. Fund managers are acutely aware of investor aversion to losses.

    Losses on portfolios can be due to market movements in the price of the investments or when investments go under or default on their obligations. The latter is permanent capital loss, as there is no opportunity to recover the losses suffered. African Bank is an example of this. Investors may get some of their capital back, but will unlikely get a material portion of it back.

    When suffering losses, an investor requires a return higher than the loss to return to breakeven. The graph below shows the subsequent required return needed to breakeven for a particular levels of loss.

    From the above graph we can see that the breakeven return required grows exponentially as losses increase. When investors suffer a 10% loss, they only need 11% to get back where they were. At a 50% loss the investments needs to have subsequent return of 100% to breakeven.

    Fund managers have different ways in trying to minimise possible capital losses. If the fund manager is managing a multi asset class fund he/she will be able to underweight or avoid asset classes that are expensive (high in risk) and rather allocate capital to asset classes that are cheap (low in risk). An active fund manager can also try to reduce possible losses by individually picking the instruments he/she wants to include in their portfolio. They can select the companies that are undervalued and avoid ones that are expensive.

    No fund manager is exactly alike and each has a different way in classifying risk and varying levels of risk aversion. The more aggressive fund managers will tend to outperform a conservative manager at the end of strong bull market. In bull markets a conservative manager will typically start taking profits from the stocks that performed well and deploy the capital into asset classes where there are opportunities. The aggressive manager will tend to ride the run as far as possible and will experience a bigger drawdown when the markets correct. Managers that avoid deep drawdowns typically perform better over full market cycles.

    The graph below is a drawdown comparison between two funds (blue and green) and the category’s average fund (yellow). The blue line is a typical conservative manager and the green line a more aggressive manager. Both of these funds fall into the (ASISA) South African MA High Equity category.

    During the financial crisis of 2008 the blue fund manager was able to protect capital much better than the green fund. The maximum drawdown of the blue fund was 11.8% compared to the green’s 23.4% and the average manager’s 16.8%.

    This is one of the reasons one should take time to understand a fund manager’s philosophy and investment process. You might just be able to spare yourself some heartache by avoiding making an investment with an aggressive fund manager at the peak of a market cycle.

    At Seed we understand that risk needs to be taken to generate inflation beating returns, but seek to structure our solution Funds (Seed Flexible and Seed Absolute Return) in order to ensure that they don’t experience permanent capital destruction.

    Kind regards,

    Gerbrandt Kruger

    021 914 4966

    Permalink2014-10-01, 17:11:49, by Mike Email , Leave a comment