Daily Equity Report

It is always interesting to note the returns of the different asset classes at the end of the month. The graph below illustrates the cumulative returns of the last 12 months of the Bond, All Share Equity, Listed Property and Cash indices. It was a surprise to the market how the listed property market has performed, especially over the last quarter.

The graph below illustrates the cumulative returns of the Global Bond, World Equity, Emerging Equity Markets and the Listed Real Estate indices in US dollars. It was no surprise that the emerging market outperformed the developed market over this period. Structurally the emerging economies are supported by stronger fundamentals.

During the recent six months we noted again the flight to “safety assets” (driven mostly by the US bonds). This resulted in a strong positive return by the Global Bond Index over this period.

The graph below illustrates the cumulative returns of some of the equity managers we track.

There has been quite a variation in the returns by the managers. This can be mostly attributed to their allocation resources, financials, and industrials and also to large, mid, and small companies. The graph below illustrates the relative performances of the three main sectors.

Naturally it is important to understand where you came from but more important where you are going to. This is true not only in life but also in investing.

Kind regards,

Vincent Heys
vincent@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

The local market traded sideways for most of the day today, but then raced up by about 1.3% from 15:00 to close up 0.4% for the day. This leaves the market down 3.6% for the month and it is now relatively flat year to date (down 0.05%). The rand has weakened slightly during the month (by around 0.66% to the US dollar) most likely as a result of the rolling strike actions by the various unions, most notably the public servants’ strike. Year to date we find the rand flat against the US dollar.

Performance this year has been driven by the bond and property market on the back of foreign portfolio flows into South Africa and an inflation rate that has continued to surprise on the down side. The All Bond Index is up over 13% in 2010 while the SA Listed Property Index is up over 21% in the same period! Offshore assets have continued to disappoint, but continue to show better value than their local counterparts (with the exception of global – particularly developed market – debt).

Gold has been a solid performer – the New Gold ETF is up over 9% as investor demand for this ‘safe haven’ commodity drives up the price.

While benchmarking performance of asset classes and managers is an important part of the investment process, investors must be aware of how they interpret this data. It should be used as a process to show where you made good and bad decisions, rather than a process of where you should be making changes to your strategy. Investing is a long term game, and monthly benchmarking does provide its anomalies as explained below:

Anomaly: For equity unit trust investors who compare their funds’ returns to the market on a monthly basis, a movement this large after 3pm (when most unit trusts are priced) can have quite an impact on a manager’s monthly relative performance. This month the market rally in the last 2 hours of trading will provide a headwind for August returns, but investors must remember that it will also be an initial tail wind in September as the performance in the last two hours of today gets incorporated into tomorrow’s price.

Seed supports Eagle’s Nest Primary School, which is a school in Wallacedene (an informal settlement near Cape Town). Eric Simons and Gary Kirsten, two notable South Africans who have achieved success both as cricketers and as coaches, will be attending a Business Breakfast in support of Eagle’s Nest at Newlands Cricket Ground on 17 September. They will be sharing some of their experiences in the world of sport and how the lessons they have learned can be related to business. For more information on how you can join the Seed team at this event click on their invitation:
http://eagles-nest.org.za/business%20breakfast.pdf
or Facebook event:
http://www.facebook.com/event.php?eid=138874406147640&index=1

To access a range of fresh investment reports join Seed’s Facebook page by clicking here, or click here to follow us on Twitter.

It is apparently the first day of Spring tomorrow, being the 1st of September, but it seems as if Cape Town as usual will be joining the rest of the country a little later in the year.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

We often find ourselves quoting and reproducing GMO’s work, and for good measure. GMO is a privately held investment management firm founded in 1977, headquartered in Boston, USA, with offices worldwide. Several key factors in GMO’s success are: discipline, value orientation, investment research, and constant innovation. These are factors that we at Seed identify with, and it is therefore natural that we find value in much of their work.

As the company’s co-founder and chief strategist, Jeremy Grantham’s views are most often dissected, but James Montier, who forms part of the asset allocation team, is also an astute analyst. We find his views most thought provoking and he writes without fear or favour. His recent white paper on the importance of dividends is a case of point. I’ll take a few interesting pieces out of the report.

Initial dividend yield and the growth in dividends accounts for nearly 80% of total return over five year periods (based on US data since 1871). The remaining 20% or so comes from a change in valuation (i.e. re-rating or de-rating of the PE multiple). Conversely over a one year period nearly 80% of total return is determined by the change in valuation and the remaining amount is explained by starting dividend yield and dividend growth.

From the above chart it would logically flow that most investors would be concerned about dividends when making their investments. Unfortunately (or fortunately for those who follow this approach) many ‘investors’ are myopic in their focus on the next earnings figure for a company. As a result these ‘investors’ attempt to consistently profit from the change in valuation. This is an extremely difficult method to successfully follow as only those who can accurately predict next quarter/half earnings on a repeated basis AND who materially differ from the consensus number will profit from this method. The chart below show how the average holding period has dwindled dramatically over the last 50 odd years on the NYSE as investors take a shorter and shorter perspective.

James Montier goes on to point out that, in the derivatives market, European dividends are currently priced for a depression, which means that they are cheap if the region doesn’t experience a depression over the next ten years or so. Investors taking a longer term view are able to look through the current noise.

A further arrow in the ‘dividend quiver’ is that as companies are generally able to increase their prices in line with inflation, dividends are typically a good inflation hedge over a five year period. As inflation is probably the biggest enemy to a retirement portfolio, this characteristic is particularly attractive. The chart below shows how dividends and inflation move in line with one another.

Ultimately investors who truly have a long time horizon need to make sure that their portfolio contains companies that are priced attractively (good initial dividend yield), and will show good longer term growth (good dividend growth). This can either be achieved through selecting the shares yourself or using a portfolio manager who follows these principles.

Click here to access our Facebook page and let us know if you take dividend yield and growth into account when selecting your shares/portfolio manager.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

It was around this time, two years ago, that pretty much everyone who attempted to forecast inflation came up with a number that understated the actual inflation rate. Oil prices had just peaked and the price of food had just been going one way. Consumers were on their knees as the felt the pain of high inflation.

We now find ourselves in a position where inflation has fallen into the SARB’s target range of 3% - 6%, transport and food inflation are muted, electricity has been pushing inflation up and while the current wage negotiations won’t impact the current figures, any real wage increases will push inflation up in months to come. In these relatively benign conditions we find that those professionals forecasting inflation are generally overstating the actual numbers.

While the quantum has been quite surprising, the fact that the forecasters are trailing the actual numbers is nothing new. Many studies have been conducted over the years that show that forecasters generally lag whatever variable that are attempting to forecast, be they company earnings, share price, inflation, etc. Unfortunately we don’t have the data for local inflation to display.

Stats SA today announced that inflation for the twelve months to 31 July 2010 came in at 3.7%, a full 0.3% below analyst expectations. A main contributor to the surprise was an acute fall in the restaurants and hotel index as a result in a fall in hotel prices post the 2010 FIFA World Cup.

Below is a chart with the long term inflation rate, it has averaged 10.4% over this period, but over the last decade has averaged a more ‘normal’ 6.3%. Inflation only consistently fell below 10% in the early 1990’s when then Reserve Bank Governor, Chris Stals, broke the back of inflation.

Low inflation is typically accompanied by low interest rates, which tends to be good for the economy. You will therefore see that countries around the world target an inflation rate between around 2% and 5%. At the moment there is a problem globally in that interest rates and inflation are nearly at 0%, but the economies aren’t responding. While low interest rates are conducive to economic growth, consistently negative inflation (that hasn’t been generated as a product of improved efficiencies) has exactly the opposite effect. This is why governments around the world are trying to stimulate their economies (and by extension inflation rates) by engaging in extremely loose monetary policy.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

Last week I went to the Sanlam Benchmark Symposium presentation. It is an annual presentation where Sanlam communicates their research findings to the pension fund industry in South Africa. They conduct a broad research every year across many stand alone pension/provident funds as well umbrella pension/provident funds.

According to their research the average member contributes 11.3% of his/her salary towards retirement, 1.9% towards death benefits, and 1.3% towards disability cover.

One of the most shocking statistics that was thrown around was that 60% of today’s 20 year olds in South Africa will not live beyond the age of 60. We as a community have lots to do in this regard.

Then, also interestingly, 65% of members belonging to a pension or provident fund invest in the default option. One should be concerned about this because it shows that many people in SA are either not informed about investments or not interested. Investing is one of those things that you just need to understand whether you like it or not. After all, you do spend most of your time accumulating some sort of nest egg.

Let’s look at some of the questions you should be asking yourself when you are far from retirement, close to retirement, at retirement, and in retirement.

I trust that these questions will provide a starting point for you when taking a closer look at your current investments and investment strategy.

I always enjoy the quote by Richard Cushing:
“It wasn't raining when Noah built the Ark.”

Have you started building your ark?

Kind regards,

Vincent Heys
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

The smoke seen and reported towards the end of July turned out to be more than just smoke, and today there was an announcement that HSBC has made a proposal to Old Mutual to gain a controlling stake in Nedbank. There are always rumours in the market of potential suitors for various companies, and Nedbank is no exception. Many rumours in the past have come to nought, but Old Mutual today announced that it had given HSBC a period of exclusivity to perform a due diligence.

Characteristics of Nedbank that are conducive to takeover bids include the following:
• Controlling shareholder has a majority stake: When negotiating to make a purchase of a stake in a listed company it is generally easier to negotiate with one party with one agenda, than having to negotiate with a multitude of smaller shareholders who all have their own agendas.
• Controlling shareholder realigning business direction/requiring a capital injection: When the majority shareholder is keen to hang onto an asset it can be nearly impossible to make a successful bid, but where the major shareholder is open to offers it can make it easier to negotiate a reasonable price for the deal. A shareholder looking to exit will generally be happy to sell at fair value or a slight premium, while one looking to hang onto the asset will typically demand an excessive premium, if they decide to put the asset on the market.
• Well understood business with a simple/streamlined product offering: Nedbank’s business model is fairly straight forward. It is a bank with an emerging market footprint. Businesses with a focused strategy are often preferred to assets with a diverse income stream unless the acquirer is in the business of spinning off the various business units at a profit.
• Exposure to emerging markets: The growth of banking companies is highly dependent on growth and business activity in the economy in which it participates. Developed markets are expected to face slow economic growth with low activity over the coming years, while emerging markets provide banks with high growth high activity markets, with potentially larger margins as competition isn’t as fierce as it is in developed markets.

Possible pitfalls in the bid by HSBC for Nedbank:
• There could be regulatory resistance: The Reserve Bank and Finance Ministry could protest against the sale of a key South African asset particularly considering ABSA’s sale of a majority stake to UK listed Barclays and Standard Banks sale of 20% to the Industrial and Commercial Bank of China. This could be overcome if Nedbank’s acquirer agreed to certain conditions relating to the management of the company.
• A rival bid: Rival bids are common in the merger and acquisition business. In the case of the Nedbank deal there were rumours that Standard Charter was interested in making an offer. HSBC does have a period of exclusivity to perform its due diligence, but this doesn’t preclude another competitor from making an offer in the interim.

This deal won’t be sealed overnight, but as HSBC gets further down its due diligence you can be sure that the share price will move to reflect the increasing or decreasing certainty that a deal will be done. Nedbank and Old Mutual reacted positively to the news today. They were up 6% and 3.9% respectively. Nedbank has been a poor performer over the past 10 years, and can now be found in the portfolios of several astute value managers as it is trading at attractive valuation metrics.

Tell us what you think of this development by clicking through to our Facebook page.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

It is a bit of an anomaly that in a country where unemployment is so high, workers go on extended strikes demanding wage hikes way in excess of inflation even though there hasn’t been a marked increase in productivity. Other parts of the world faced with weak economic growth and stretched government finances have seen workers taking reduced packages and shorter hours.

It was interesting to hear that Jacob Zuma today threatened to fire striking workers. He mentioned that he was within the law in this regard. Obviously workers that haven’t been striking peacefully have brought about this type of statement.

Hopefully we are nearing the end of the striking season, as it not only slows down economic growth, but also affects the image of the country. The car industry is a case in point. Vehicle exporters have agreements to export a set number of vehicles on a monthly/annual basis. Extended strikes jeopardise the companies’ ability to meet their agreements, which can put them in breach of contract, which in the worst case scenario will result in them losing future contracts. Contracts lost equals jobs lost, and workers therefore need to be careful that their striking doesn’t jeopardise their employment. Getting your desired pay raise is of little consequence if you lose your job at the end of the year.

Over in the US, the jobless claims hit a new nine month high of 500 000 claims. There has been much talk over whether the US will experience a double dip recession or not. Increased unemployment in a country that is highly reliant on its consumers doesn’t bode well for economic growth going forward.

Obama is currently trying his level best to pass legislation that will make it easier for small business owners to get loans. Small businesses are the life blood of the economy in that they generate two out of every three jobs. In the absence of any stimulus to the economy the central bank has begun its stimulus spending again, increasing money supply by buying Treasury debt which should also keep interest rates low.

Enjoy your weekend. Good luck to the Springboks tomorrow!

Take care,

Mike Browne
www.facebook.com/SeedInvestmentConsultants
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

Company results continue to flow thick and fast at the moment, as many of the JSE listed companies with December and June year ends get their interim and final results out. Listed companies have 3 months to report their financials after half year and year end, and most do so within 2 months.

Briefly looking at two of the companies to release their results today:

Truworths – Final Results

Truworths is a fairly recognisable brand in South Africa, as it is one of the larger clothing retailers. Other brands that form part of the Truworths Group are Daniel Hechter, YDE, Identity, and UZZI. Some of the highlights in their results include:
• Turnover up 11%
• Operating margin at 34% (unchanged from 2009 – 33.8%)
• Final dividend up 18%
• Bad debts down to 9.8% from 11.9%
• Cash on balance sheet: R1.32bn

The Group turnover was up 11%, but this can be mainly attributed to trading space growth of 6% and product inflation of 4%, which means that on a like for like basis there wasn’t much real growth in turnover. With the operating margin only slightly up, the group was able to increase their trading profit by 20% by controlling costs.

Truworths’ outlook for the 2011 financial year is positive as inflation and interest rates are at low levels, while wage growth has been generally been well in excess of inflation, leading to real income growth.

The share was down 0.4% on the day.

Grindrod – Interim Results

Over the past decade or so Africa’s biggest shipping group, Grindrod, has raised its public profile in this country. Grindrod is one of the few listed companies with their head office in Durban and, other than its shipping business, has interests in logistics and financial services. Some of the highlights in their results include:
• Revenue up 20% (Financial Services up 78% off a low base)
• Attributable income down 10%
• Interim dividend down 10% (from 30c to 27c)
• Cash on balance sheet: R700mn

Operating in the shipping industry over the last few years hasn’t been an easy task. Shipping is a highly cyclical industry and a global recession followed by generally muted recovery isn’t conducive to good results. Grindrod faced further headwinds over this period as the rand strengthened against most major currencies. The interim dividend was cut in line with the results, but the company did have over R700mn on its balance sheet at year end. With a debt to equity ratio of 18.7% the company isn’t overleveraged, which is important in a cyclical company when times are tough.

The share was up 0.1% on the day.

To generate an investment decision an investor needs to take both the financial health of the company and its share price into consideration before deciding to buy or sell. Just because a company is struggling doesn’t mean that it isn’t a good investment and vice versa.

Click here to let us know on our Facebook page what characteristics are important for you when investing.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

It is often the case that laymen and professional investors alike, when discussing the performance of the stock market, refer to the performance of the All Share Index (ALSI), which is a return based on the market cap weighted performance of the local bourse’s constituents, as a proxy for the return of all shares/sectors. While this is often the case – typically in trending markets – there are occasions when this assumption can turn out to be way off the mark.

As a little exercise we had a look back at the returns of a variety of indices going back three years. For the purposes of this report the returns of the ALSI, Financial Index, and Resource Index were used as they illustrate the point most clearly. The table below shows the annualised returns from each of these indices over this period:

31 July 07 - 31 July 10
All Share Index 2.5%
Financial Index 0.3%
Resource Index -1.4%

One can be forgiven for thinking that the performance of these different indices tracked one another over this period. The truth can’t be further from the truth. The Financial Index peaked in October 2007, and then started to fall as the consequences of the global financial and credit crises started to become apparent. While this happened the Resource Index continued to race up as demand for commodities appeared as if it would never end, which pushed commodity prices to record highs. This divergence was so marked that from 31 July 2007 to 30 June 2008 the Financial Index was down 28% and the Resource Index was up 38%!

By mid 2008 most of the bad news had been priced into the financial shares, but not in the resource shares. With the crises taking hold in mid 2008, the prospect of a rapidly slowing global economy saw the price of many commodities falling by over 50%. Resources fell nearly 50% in just four months, while the financials’ held their own! From this point (November 2008) the indices have followed a similar path, and as shown in the table above have ended the three year period in line with each other.

In the chart below we look at the performance of the three indices. In addition to this we plot the returns of two investors: both invest in the ALSI until 30 June 2008, the one then switches into the Financial Index (that has performed poorly) and the other into the robustly performing Resource Index.

It is clear that we have the benefit of hindsight and that very few, if any, investors would be able to get the timing spot on, but the performance of underlying sectors can dramatically alter the performance of your portfolio. There are some pointers that we can take from this analysis:

• If you have made an investment based on solid research (i.e. invested into financials in early 2008) don’t change strategy (switch to resources) purely because you have underperformed for a period. Investors who had the courage of conviction to stay the course in their financial shares end up with similar performance over the investment period displayed.
• Making bold (large) calls on your portfolio can dramatically alter the outcome of your performance (good or bad). Have solid reasons for making any changes backed by fundamental research. Switching into an asset class/sector/any investment “Because it has done well” is not a good reason to make the change.
• Diversifying your portfolio can reduce the likelihood that you will make a really bad decision based on emotion.

Click here to let us know on our Facebook page if sector rotation is part of your investment strategy.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

South Africa is currently in the middle of the annual strike season. Every year employees, lead by their unions, attempt to ‘negotiate’ better wages with their employers. Strikes occur when a deal can’t get agreed upon. This isn’t something that’s new, and in my opinion this year’s striking hasn’t been materially better or worse than previous years. South Africans should also be aware that striking (and the associated violence) isn’t unique to our land. While the associated violence is to be strongly condemned, the act of striking under a ‘no work, no pay’ principle is part of any employee’s rights.

Striking is also typically associated with developing (or third world) countries, and while this is true in general as a result of lower standards of living, poorer education, and higher poverty levels in these countries, highly developed first world countries, with socialist leanings, also experience their share of strikes. Paris, for instance, was full of strikers (particularly in the public transport sector) right as the Rugby World Cup was coming to a conclusion, making it really difficult for spectators to get to their matches. Greece has also seen its fair share of strikes (and riots) this year.

In years where the economy and company profits are growing strongly, there is perhaps less resistance to workers’ demands with companies and government able to pay up to keep up productivity. When these institutions are under strain and workers are demanding significantly above inflation wage increases (without improved productivity) the workers can expect tougher negotiations.

Locally, the latest public sector ‘negotiations’ have been grabbing the headlines recently. The union demands are for a wage hike that’s more than double current inflation, as well as a doubling of their housing allowance. At the moment the government are offering a 7% wage increase and a 40% increase in their housing allowance. Time will tell where the parties eventually agree.

There are undoubtedly pro’s and con’s of the striking process. Taking advantage of an uneducated labour force can’t be condoned, but at the same time unrealistic demands and expectations (fuelled by the unions) isn’t right either. In a country with a massive unemployment problem there is also the question of whether we should be targeting higher employment levels at a lower wage per employee, or lower employment at a higher wage per employee? It is unrealistic, especially in tough economic times, to expect employment and wage levels to grow strongly at the same time.

What are your views on striking? Click here to have your say and vote on our Facebook poll.

Enjoy your weekend.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966