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    Wishing you a blessed Christmas. The daily report will be back next week.

    Permalink2007-12-27, 21:06:21, by ian Email , Leave a comment

    Relative Valuation – Is the PE the only way to go?

    The best know measure of relative valuation is the PE ratio, or earnings multiplier. It is extensively quoted and seen as an indicator of how cheap or expensive a stock is at a particular time. In addition it is widely (and often erroneously) utilised in business as a valuation methodology by capitalising the earnings per share (EPS) of a business at an “appropriate” PE.

    The PE multiple has stood the test of time as a measure of relative valuation and statistical tests have consistently shown that PE’s are significantly related to long run returns. Company PE’s are often compared to:

        • The multiple on the broader market or a specific index
        • The multiples of peer companies
        • The historical multiple of the share itself
        • The “justified” multiple of the business

    The justified PE of a company is derived through a manipulation of the dividend discount model which requires forecasts of earnings, dividend payout ratios, required rates of return and sustainable growth rates. This “fundamental” PE can then be compared against an observed PE to see if a company is over or undervalued.

    PE’s can be manipulated in other ways, such as by dividing an observed PE by the sustainable growth rate of a company to obtain a PEG (PE to growth) ratio. The PEG ratio gives an indication of the extent to which each unit of future growth has already been priced into a valuation.

    It is probably safe to say that any self respecting investor and/or market watcher knows exactly what the PE ratio is all about, but what about its lesser known cousins in the relative valuation family? The Price/Book Value (P/BV) ratio; the Price/Sales (P/S) ratio and the Price/Cash Flow (P/CF) ratio for example are not nearly as widely utilised by the financial press or the investing public.

    A quick look at the three measures introduced above provides a quick solution to this relative valuation mystery. Earnings, as measured by EPS, are the primary determinant of investment value and the PE thus has an inherent advantage over the P/BV, P/S and P/CF ratio’s.

    Despite this, statistical tests show that all three of these measures are also significantly related to long-run returns. The serious investor should therefore consider whether there is additional space for them in his or her valuation “arsenal”.

    The P/BV ratio for example is a good measure of value when comparing firms with consistent accounting practices (e.g. in the same industry), in fact in this context the P/BV has an advantage over the PE ratio in that it can be used to compare firms that have negative earnings or cash flows (in which case the PE ratio is meaningless), it is also a good measure of value for distressed firms.

    The P/BV ratio is also a useful indicator of value for firms that have a large proportion of liquid assets on their balance sheet (e.g. banks, insurance companies). For these types of companies book value is often closely related to market value.

    This advantage is also a significant disadvantage for firms that do not have liquid assets on their balance sheets, in this scenario the book value is a poor indicator of the investment that has been made in a firm by its shareholders. Inflation and changes in technology can often create a huge disparity between the book value of a firm and its true value.

    The PE ratio also suffers from another significant fault in that it is highly susceptible to accounting manipulation. In this regard sales and cash flows are more “pure” in that there is less opportunity for management to use their “discretion” when presenting these numbers. P/S and P/CF ratios are therefore useful in situations where earnings are suspect and the financial statements do not provide enough information to make the necessary adjustments.

    A drawback to the P/S ratio is that is that it does not take into consideration the cost structures in a business so a company that appears undervalued using the P/S ratio may be so for a good reason (e.g. because it pays its staff more than it can afford).

    The P/CF ratio has perhaps the least drawbacks of any of the additional measures of relative valuation, its uses market prices in the numerator and the denominator is more stable and less easy to manipulate than earnings. A drawback that does exist however is that, unlike EPS, there are numerous different measures of cash flow and it is unclear which is the most appropriate. An investor should look to utilise CFO, Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE) in order to determine which is the most informative.

    As with the PE multiple; P/BV, P/S and P/CF are all relative valuation tools and should be compared with historical multiples; multiples for the industry and justified multiples. A comprehensive analysis will involve utilising these multiples as checks on the PE, as well as intrinsic valuation, methods and as leading indicators of inconsistencies and warning signs (e.g. when earnings are increasing smoothly each year but CFO is staying flat there is a good chance that management are manipulating the reported numbers in which case the P/CF ratio is a far better indicator of how over or undervalued a company is).

    Whatever your investment strategy, these are all useful tools that can be utilised when making investment decisions. (adapted from an article that appeared in Marketviews)

    Have a wonderful Christmas!

    Regards, Sharenet

    Permalink2007-12-24, 11:39:24, by Marika Email , Leave a comment

    Buy and Hold or buy and fold

    I received a mail from a reader who made the statement that there is a lot worse when it comes to investing into the stockmarket than buying and never selling, i.e. the simple buy and hold strategy. How many investors have regretted selling a share, only to watch in dismay as the price moved up and up and up in the months and years thereafter.

    It’s a very fair point and one made by many investors. Why concern myself with trying to buy and sell, when it’s far easier to buy and hold?

    The argument either way is not easy, but let’s touch on a few points.

    The Warren Buffett approach of buying and holding definitely has lots of merit. His approach over 40 years with the investment company, Berkshire Hathaway, has been to buy into companies, listed or unlisted and hold. Very seldom has he sold and he takes the view that the ideal holding period is forever. (he has however agreed that there were times when he should have sold)

    His approach though is to firstly make sure of what he is buying, secondly buy a very meaningful stake, or ideally buy 100% of the company. In this respect the Berkshire approach is more akin to a businessman as opposed to a passive investor.

    For passive investors who look back on their sales with regret, its will always be on those shares that have continued to move up steadily and strongly. No one would have regretted selling out of Didata at say R40, before it moved up to R50, R60 and R70…. and then down.

    Naturally there are many shares of companies that one can hold for long periods of time – years, or perhaps decades as both the company and its shares price produce the returns required.

    But more often than not, while the company may be a winner, the share price tends to slowly move further out of kilter with the underlying fundamentals at the one extreme getting too optimistic and at other extreme getting too pessimistic. It’s at these times that astute investors, not emotionally attached the company itself look to take advantage, selling the more expensive and buying the cheaper out of favour.

    I can think of a few examples, made that much easier with the benefit of hindsight.

    1. One that I always like to quote is Bidvest. An excellent company with excellent management, but into the late 1990’s the share price just got too expensive. At the time when the price was on multiples of 30 times and more, investors, even long term investors who loved the company would have done well to have sold out of the share and looked for better value.

    Those that held would have waited over 5 years, just for the price to start to move up from their buying price.

    2. Standard bank and Investec that along with the hype of the financial sector in 1998 also just got too expensive. Again excellent businesses, but at times, investors need to try and identify when prices have just overshot the fundamentals.

    3. Didata is a classic example of a company whose shares price just got too expensive. Perhaps not the best example, but again once which many investors thought that they could buy and hold.

    Then there are many shares that have not got to the point where their share prices went to extreme levels. Yes for periods of time perhaps the price ran ahead, but not massively so. I think of Remgro as a possible example. In the mid 1990’s it was cheap as it fell out of favour, but can’t think when its price got too exuberant.

    So yes in the main, long term investing does mean buy and hold, but the smarter investor will always be on the look out for extremes in price. Perhaps some of the construction shares are starting to be fully priced taking into account good profits over the next few years.

    Have a great weekend ahead of Christmas


    Ian de Lange

    Permalink2007-12-21, 20:05:51, by ian Email , Leave a comment

    A brief history in time at Citigroup

    Yesterday Goldman Sachs predicted that Citigroup may have to write off $15 billion in its next 2 quarters. Dr Henry Kauffman wrote in his book, On Money and Markets, “Of all the post war developments that transformed the markets, the most far-reaching was the conversion of non-marketable securities into marketable securities, or the process of securitization.”

    He should know - Kauffman was an economist with the Fed before moving in 1962 to the well known aggressive US investment banking firm Salomon Brothers (which itself was taken over by the forerunner of Citigroup). He rose to become a senior partner and member of the executive committee.

    Salomons became very prominent in the 1980’s when it was noted for its innovation in the US bond market and fixed income markets. According to Wikipedia it created the first mortgage backed securities.

    It was a controversial firm with proprietary traders taking big positions and risks. The firm was the subject of a book by Michael Lewis, a bond salesman at Salomon, called Liars Poker.

    In 1991, the firm was caught submitting false bids to the US Treasury in an attempt to purchase more treasury bonds than permitted by one buyer. It was fined USD290m - which eventually led to its demise as a separate company, taken over by Travellers, the forerunner of Citigroup.

    At that stage Buffett , who had a large stake in the company, became involved, taking over as interim chairman from legendary trader John Gutfreund for a while. Along with the resignation of Gutfreund was that of John Meriwether, who went on to become the founder of the most famous hedge fund, Long Term Capital Management, which collapsed in 1998.

    At the time of the collapse of LTCM because of its size and the potential for a chain reaction was bailed out by the Federal Reserve Bank of New York – it arranged contributions totalling $3,625 billion from various banks.

    One of the points made in Kauffman’s book is that success breeds amnesia and in the rush to innovate and create profit most Wall Streeters have forgotten the consequences of previous irresponsible behaviour.

    The forerunner to Citigroup was full of irresponsible behaviour – now Citigroup’s share price is down more than 40% this year, with billion dollar write offs, because of its exposure to subprime mortgages through collateralised debt obligations.

    It’s the same type of mess all over again, just on a bigger scale. Perhaps Buffett will step in again as he looks for cheap assets, but I don’t think that he did well from his investment into Salomon’s and this look a potentially even bigger mistake for the balance sheets of these companies.

    That’s all for today

    Kind regards

    Ian de Lange

    Permalink2007-12-20, 17:06:23, by ian Email , Leave a comment

    Are investors losing confidence?

    The JSE All Share index fell a further 1,45% or 413 points to 28112. The US market opened firmer and European markets were slightly up, but the JSE fell across the board- 19 shares traded at new 12 month lows.

    Investing has to do with a large dose of confidence. I read one comment today that is true – while there is a lot of value in certain retail shares, this does not necessarily immediately convert into share prices going up.

    One vital factor for long term investing is confidence. Where the balance between optimism and pessimism starts to shift to the pessimism then true investors start to get excited. I.e. prospects of quality assets at cheaper prices. But in the shorter period as prices decline, so those already invested start to get nervous.

    Some of the facts that have started to shake the confidence levels include:

    1. Change in political power. This past extended weekend saw the beginning of changes in the politics of the country. What fascinates me was that both the run up to the weekend with the correct speculation and then the election itself of Zuma as president of the ANC did not have any noticeable impact on the rand. Sure it has depreciated slightly, but at this point, unlike in the past, global investors seem to have ignored the news, or taken that there will be little impact.

    This could change in the weeks and months ahead.

    2. CPIX inflation data jumps to 7,9% in November. The rate hikes have not yet started to stop the inflation data and ongoing price gains, especially in the food sector may lead to a further rate hike in the first quarter of 2008. This may be one reason why the rand remains firm relative to the US dollar.

    3. The ongoing global credit crisis. More losses, more bank write downs, more liquidity infusions, and more foreclosures. At this stage there appears to be little impact for SA investors, but just as the creation of liquidity boosted asset prices around the globe, so the contraction of liquidity is likely to have the adverse impact on global asset prices.

    Remember that all asset prices are made at the margin. With greater balance coming into the market between pessimists and optimists, prices have and will likely to move sideways for a period of time.

    Investors are not enamoured with the retailers as they continue to come under pressure – Truworths fell 3,4% to 2550c, Mr Price down a further 2,5% to 2097c, JD Group down 2,45% and Absa down 2,4% to 10832c.

    The rand was flat at R6,90/USD and slightly firmer against the pound and Euro.

    Brent crude is pushing above $91/barrel and this is concerning again.

    So nothing to give the markets a boost before just yet – in fact just the opposite. So far the JSE All Share index is down a massive 2196 points or 7,2% for the month of December.

    If this persists, it will take some of the shine off the year.

    Kind regards

    Ian de Lange

    Permalink2007-12-19, 17:48:06, by ian Email , Leave a comment

    Plenty of announcements even as investors go on holiday

    While the holiday season kicks in for many this week, it’s interesting to see how much activity there still is for many of the listed companies. I often find that investors underestimate the extent to which they need to keep abreast of corporate developments.

    Today just till 5:00pm there were no less than 51 sens announcements. Granted most of these were “superfluous” information, but all investors need to have the time to filter through all the news, and pick out what is relevant and potentially of importance for an existing investment.

    Looking at some of the more important announcements:

    BHP Billiton announced the appointment of a new non executive director, and an update of its shares purchased in terms of its share buyback program.

    Naspers announced the details of its offer for Tradus plc. Naspers has offered to acquire all the shares in Tradus for GBP18 per share. This is for a total of GBP946 or approx R13,2 billion – it’s a bog transaction for Naspers.

    Tradus is listed on the London Stock exchange and provides online consumer trading platforms and related internet services into 12 European countries, connecting buyers and sellers. The company reported results for March 2007 – a profit of GBP15m on turnover of GBP 46m. It has assets of GBP60. The purchase price is thus at a premium and represented a premium to the market price of 19% to last traded price before the announcement.

    Naspers has generally done well from its operations in the internet, especially its Tencent business in China. It views this as a long term trend.

    The market thinks that the company is overpaying and the price fell 10,2% to 16250c.

    SAB Miller issued an update to its offer for Koninklijke Grolsch NV. The shares gained 2,69%

    Old Mutual announced further acquisition of its shares.

    Tourvest renewed its previous cautionary announcement

    Mutual and Federal announced the results of its special capitalisation.

    Standard Bank announced that its scheme of arrangement that will see the Industrial and Commercial Bank of China take a 20% stake in the bank, was sanctioned by the High Court of SA.

    Tongaat Hulett announced that it has received approval for its Umhlanga Ridgeside development. This announcement has implications for some other companies. Included in the proposed development is a 10 000m2 Mr Price concept store. This Umhlanga property node north of Durban, is one of the fastest developing areas in the country.

    Remember that Tongaat has owned this land for over 100 years, originally all sugarcane farmland.

    Tongaat shares gained 80c.

    Didata issued an update on executive director share dealings.

    Then there were the other typical director dealings.

    The volume of announcements is likely to slow towards the end of the week, but it was a full day today.

    Kind regards

    Ian de Lange

    Permalink2007-12-18, 17:54:12, by ian Email , Leave a comment

    December is proving to be tough

    December is proving to be difficult for the local equity market. Late afternoon the JSE All Share index was down over 600 points or 2,2%. Shares trading down were 3 times the number of shares trading up in price. All main markets were in the red. Gold fell below $800 and the rand weakened slightly to R6,84/dollar.

    The number of shares trading at new 12 month lows has started to pick up. While many are nervous, some of the fund managers are seeing this as buying opportunities. I chatted to one manager last week and he was saying next year has potential given the extent to which some prices have dropped.

    I looked over some of the shares that had dropped to 12 month lows and the list included:

    Absa. This made a high at almost R150 – 14993. Now it’s at R110,82 - a decline of 26%.

    Investec dropped a further 2,6% in late trading. It made a high at 10836, now at 6572, a decline of 39%.

    Foschini declined from 7795 to 4650, a drop of 40%.

    Imperial is down from 17338 to 10115c, a decline of 42%.

    Woolies down 35% from its high of 2510c.

    While never easy to buy into share prices which are falling, the opportunities are going to be there for investors that have the available cash and patience to wait for the right time.

    The JSE All Share index price to earnings ratio has fallen back to 14,4 times, which does not look expensive. The concern however is that earnings growth may slow next year from the high base now established.

    That’s all for today.

    Have a great long weekend.


    Ian de Lange

    Permalink2007-12-14, 16:59:26, by ian Email , Leave a comment

    Local JSE hit hard

    The JSE closed off a massive 3.03% to 29389 with value traded at R 9.21 billion on global nervousness. Declines led advances 337 to 104 with 70 shares unchanged out of 511 active. Mining closed down 3.96% at 37675, while Industrials were off 2.18% at 24945 and financials ended the day off 2.63% at 23308.

    The best performing sectors of the day were Diamonds Mining up 10.9% at 457, Leisure Goods Index up 1.3% at 1410 and Development Capital up 0.7% at 1131.

    The Platinum Mining index fell 4.7% at 96.

    Of the major stocks Sasol lost 3.4% at 32798, Anglo shed 4.17% at 43700, Billiton down 4.3% at 21725, MTN was off 1.82% at 12901, and Richemont off 3.49% at 4513.

    Best performers of the day were Itltile up 12.11% at 500, Trnshex up 10.95% at 1115, while the major losers were Amecor down 10.34% at 130 and Vukile off 7.33% at 1126

    The Dow was down 0.4% at 13417.24 and the S&P 500 down 0.7% at 1475.99 a few moments ago.

    Gold was down 1.6% at $ 801.00/oz

    The rand was last trading at R 6.75 to the dollar, R 13.76 to the pound and R 9.89 to the Euro.



    Permalink2007-12-13, 17:19:43, by ian Email , Leave a comment

    Liquidity crisis in the US calls for more action

    As was expected the US federal reserve lowered their key Fed Funds rate – but the market was looking for more than the 0,25%. Investors were very disappointed, leading to a sell off. Today saw some reprieve as central banks announced further measures to increase much needed liquidity.

    Bernanke, the US Federal Reserve chairman, is facing the difficult task of having to prop up the slowing economy whcih is deflating as asset prices decline, but at the same time unable to lower interest rates to rapidly or far because of increasing inflationary pressures. It’s a classic stagflation problem.

    Past Fed chairman, Alan Greenspan wrote a piece for Wall Street journal, titled, “The roots of the mortgage crisis”. His view was that it has been caused by a confluence of factors including:

    . risk being increasingly under priced over the last 5 years.

    . over the last decade market capitalism replacing government central planning.

    . large parts of the erstwhile third world, especially China, joining the developed world, leading to a surge in competitive low priced products

    . a pronounced fall in global interest rates since early 1990’s leading to equity premiums and real estate capitalisation rates moving lower – i.e. prices of equities and prices of property moving higher.

    He also conceded that the Fed lowering their interest rates to 1% for a short period of time in mid 2003 to counter the potential for deflation may have contributed to rises of US house prices given the increased use of adjustable rate mortgages.

    As they started to increase the Fed funds rates, they expected long term interest rates to start moving up, but this did not happen and Greenspan found this a conundrum. He says in retrospect global economic forces which have been building for decades appear to have gained control of the pricing of longer term maturities (i.e. longer dated bonds). He then makes the statement that “Asset prices more generally are gradually being decoupled from short-term interest rates.”

    Because the value of long term securities is now so large, estimated as approaching $100 trillion, these swamp the resource of central banks and he makes the point that central banks appear to have lost control of longer term interest rates.

    He concludes his piece by saying that while large losses will be taken as a consequence of the crisis (which has already been the case), after a period of protracted adjustment the US and global economy will be able to get back to business.

    Yesterday the US markets closed down sharply. Today after some further announcements from the US monetary authorities, the main US equity indices are up firmly again as money comes in looking for those cheaper prices.

    This helped the local equity market recover some of its earlier losses.

    Bloomberg announced that the US Fed, the European central bank and three other central banks have moved in concert to provide more needed liquidity to the banking system. The Fed will provide US$24 billion to ECB and Swiss National Bank and it will also hold 4 auctions that will add a further estimated $40 billion to increase liquidity.

    The local equity market came off just 0,5% to 30307. Gold came back 2,4%. The rand firmed to R6,69 to the US dollar and R13,69/pound.

    The US S&P500 is up 1,77%.

    This action should ease the markets into a steadier close for the year.


    Ian de Lange

    Permalink2007-12-12, 17:38:38, by ian Email , Leave a comment

    130-30 Funds

    On Friday Ian mentioned the growing talk about Short Extension Strategies or so called 130-30 / 120-20 funds that are particularly popular in developed markets. I will have a closer look at what these funds are, how they are managed, why they should improve your risk/return characteristics, and possible pitfalls. There is quite a bit of jargon, but I will try and keep the explanations understandable.

    “What is a 130-30 fund?”
    This is a fund where the manager seeks to improve returns through both long and short positions, in a way not too dissimilar to what hedge funds do. Essentially for every R 100 invested the manager will purchase R 130 worth of ‘cheap’ shares, and sell R 30 worth of ‘expensive’ shares, thereby maintaining a net position of R 100 for every R 100 invested. The shorting (or selling) element of the portfolio makes this strategy different from your regular equity unit trust in that the manager is able to sell shares that he doesn’t like, as opposed to equity unit trusts which are only able to avoid expensive shares.

    As the fund retains a 100% net market exposure the 130-30 fund should return beta (market related returns) plus (positive/negative) alpha (the managers out/underperformance), and is therefore different from market neutral hedge funds which will have 0% net exposure (i.e. sell R 100 for every R 100 bought), which only return (positive/negative) alpha.

    I hope that I haven’t lost you :)

    “How are these funds managed?”
    As the mandate is still fairly restrictive (when compared to most hedge funds) investors can be certain that the managers won’t be taking on excessive risk. 130-30 funds give individual investors access to funds that employ a fair degree of leverage, but at the same time not exposing them to undue risks. These funds also allow for a more transparent investment as the strategy is simple.

    “Why should these funds improve my risk/return profile?”
    These funds will improve your risk/return payoff as long as the manager exhibits some form of skill. If the manager makes poor selections (on either the long or short side) then under performance will be magnified. As the mandate is relaxed (when compared to your regular equity unit trust) manager skill will become more apparent.

    “Are there any potential pitfalls?”
    Most unit trust managers in South Africa have only been involved in the long side. Their skill lies in finding undervalued shares. These managers might not have the skill to successfully pick shares that will underperform their selection, as short selling is a different skill to buying shares. If the manager doesn’t have the requisite skill, then they may expose their portfolio to undue risks, it there isn’t some element of pairing in their long and shot positions.

    There is probably still a fair way to go before 130-30 funds become main stream in South Africa, and I am pretty sure you will eventually be able to invest in 130-30 unit trusts, but until then they will remain in the domain of the sophisticated investor.

    This is probably my last report for the year, so I would like to take this opportunity to wish you all well over Christmas and New Years, and may you come back refreshed and ready for 2008!

    Kind regards,

    Mike Browne

    Permalink2007-12-11, 17:28:13, by Mike Email , Leave a comment

    My word is my bond

    My word is my bond has since 1801 been the motto of the London Stock Exchange (in Latin "dictum meum pactum") where transactions were made with no exchange of documents and no written pledges given. It was and should remain the basis of all business dealings.

    The JSE commenced on 8 Nov 1887 by way of a similar open outcry method. This closed on 7 June 1996 when the trading floor closed after 108 year history and moved into the electronic age.

    For stockbrokers trust was a very important element. Firstly the orders were received from clients telephonically, then these orders were relayed again telephonically to the stockbroker agent on the floor, who in turn relayed orders to the runners who gave to the floor traders.

    These floor traders stood on the large JSE floor and bought and sold shares as the orders were received. They did this by shouting (hence open outcry) your buy order, e.g. “Barlows, Barlows”, without saying at first whether they were buying or selling. Two brokers would then conclude a verbal agreement and each record the transaction on paper (i.e. number, share code, price and counterparty). Although this process was surprisingly fast and mostly efficient, it could never have dealt with the volumes now traded.

    Throughout the process however it relied on – my word is my bond.

    There are few real world economic transactions that do not involve an element of trust, yet this is an area that is not prominently discussed today. But it’s an extremely important element in all business dealings.

    Where trust breaks down, then economic activity slows and at the extreme will grind to a halt.

    Nowadays, a lot of trust that should be in place has in many instances been eroded through various actions.

    Examples in the investment world include:

    - creators of funds disappearing with clients funds
    - pension fund advisors bulking funds in order to generate higher fees for themselves
    - so called independent stockbrokers putting out buy recommendations on shares where their firm is acting in banking or consulting capacity.
    - Independent not necessarily ending up being independent.
    - Sub prime issues where in words of Bill Gross, quoting Gilbert and Sullivan, “skim milk masquerades as cream”.

    While in no way saying that all investment and business dealings should not be reduced to writing in order to ensure full understanding by all parties involved, having a large degree of reliance in the word of the party that you are dealing with is paramount.

    While the mechanics of investing directly on the JSE make all trades trackable into a central order book with no need for human intervention, I still believe that the dictum should be retained uppermost in mind.

    Kind regards

    Ian de Lange

    Permalink2007-12-10, 17:43:59, by ian Email , Leave a comment

    Local Hedge Funds

    I attended the SA Hedge fund awards last night. It’s really an industry get together for some patting on colleagues backs, but it has the spin off of slowly starting to raise the profile of this category of investment manager. Globally this is now estimated at a $3 trillion dollar industry and locally assets under management are around R26 billion.

    This is according to the recent industry survey from Novare. The asset growth from just R1,38 billion in June 2002 has therefore been spectacular. Clearly the 5 year bull market has played a big part in attracting new participants. There are now more than 130 funds in South Africa and last night a figure of over 170 was mentioned.

    As with traditional managers, many of the new start up managers will not be around long enough if they cannot attract a certain minimum asset size. But looking at the survey most of the new hedge fund managers (as a percentage of new funds) were started up within a large asset management house. I.e. These are already established asset management businesses, now also creating hedge funds within their businesses.

    There is still a high concentration in the local industry with the 10 largest hedge funds managing 40% of all assets. There are only 7 hedge fund managers that manage in excess of R1billion across their single strategy funds. At the other extreme 37% of all the funds are only managing 3% of the total assets.

    While hedge funds adopt many different styles and strategies, although not nearly as many as offshore, the 2 biggest strategies by far are the equity long short and the equity market neutral at 42% and 23% of all funds.

    A long short is a fund that has the ability to be long certain shares and short certain shares at the same time, through a scrip borrowing arrangement. Through the use of shorting, the funds can use leverage (i.e. invest the funds received from their short positions to make further long investments). They can also use the leverage inherent in futures or CFD’s – contracts for differences. These funds have typically adopted a long bias (i.e. their long exposure has been greater than their short exposure), which naturally makes money in a bull market.

    Market neutral is similar but a more conservative fund in that they typically remain closer to market neutral compared to the equity long short funds.

    The ability to leverage in a fund is both a positive and a risk. When it works it works well, but it needs to be managed properly. This is why funds should keep within certain leverage limits. We have found that most local managers have not been particularly aggressive when it comes to leverage and the survey found that the equity long short funds are mostly leveraged between 1x and 1,5x the fund capital.

    Hedge funds pay a lot of attention to the risk that they take in achieving their returns. The returns are therefore compared to the Sharpe ratio which is the excess return above a risk free return for the additional volatility endured for holding that riskier asset.

    It’s not perfect because the ratio uses standard deviation as a measurement of risk, which has its flaws. Managers and investors will therefore not look at this measurement metric in isolation to make a decision on a fund or fund manager.

    Locally there is also more and more talk about the 130/30 funds, which are growing in popularity locally. These are not strictly hedge funds but really an extension of long only funds. I will be discussing these funds in future articles.

    Thus far hedge funds are not regulated by the FSB in this country although all managers are registered with the FSB (or should be) and indeed the FSB has now recently introduced a new category specifically for hedge fund managers. So the FSB definitely has a good understanding and has been in ongoing dialogue with the industry for many years now. The difficulty comes in trying to put the disparate funds into a box.

    Clearly this is an industry that is growing. In an increasingly competitive and efficient environment, managers become more and more innovative. There is a lot of merit in using short positions in a portfolio to reduce market risk and more and more traditional managers are using these techniques to lower risk in a portfolio.

    All investors need to be aware of what is available and need to know how they can possibly benefit from their use.

    Any comments or questions, don't hesitate to contact me.

    Have a great weekend.

    Kind regards

    Ian de Lange

    Permalink2007-12-07, 17:47:56, by ian Email , Leave a comment

    Short term and long term interest rates

    Perhaps your portfolio has been too highly skewed to so called safe haven bonds. Many investors may have been introduced to bonds by their so called investment advisor – read salesmen – as a safe haven option, only to find that they may not really understand how these things work.

    Most of the financial press quote the yield on the R153 and the R157 government bonds – but what exactly does this mean. Today, prior to the announcement from the Reserve Bank, the R153 was trading at 9,37% and the R157 at 8,38%.

    The R153 is the bond code denoting a government bond issue which matures on 31 Aug 2010. The R157 is the bond code for the government issue which matures 15 Sept 2015. In other words the shorter dated bond is trading at an additional 1% yield. In other words, longer term lenders to the RSA government as denoted by the R157 are demanding a 1% lower yield.

    The R157 issue was R55,9 billion and the R153 R98,7 billion.

    This is known as an inverted yield curve – a traditional yield curve should be positively sloping – i.e. money market rates at lower rates and longer term loans at higher rates.

    An inverted yield curve indicates a general slowdown. As the Reserve Bank has been increasing the short term interest rates in order to try and ward off inflation, so bondholders are looking for lower future inflation and thus prepared to accept lower rates on the longer end of the duration. I looked back at the yield of the R153 and R157 at the beginning of the year. These came in at 8,07% and 7,76% respectively. They have both weakened, which resulted in a loss for “investors” in these instruments.

    An investor in a basket of government and corporate bonds would have achieved a return similar to the All bond index – not fantastic at all at 3,32% for the 11 months to November. For the last 12 months the All bond index returned just 4,88%. The higher yield was therefore halved by the increase in interest rates generally.

    Over 2 years the All bond return has been 5,4% and over 3 years 7,6% per annum – not very exciting at all. This is a far cry from the 5 year average return of 23,6% to the end of 2003 for bonds – where equities had only achieved an average annual growth rate of 12,3% over the same period.

    The biggest risk to a holder of a bond is inflation. This is because the holder receives a fixed and agreed rate, which does not fluctuate with inflation (except for inflation linked bonds, which are priced differently). Should inflation pick up higher than originally anticipated, the holder essentially receives a lower real rate of return and vice versa.

    The UK’s Bank of England cut its key rate by 0,25% to 5,5% today. The concerns include a declining consumer confidence and the boom in housing coming off, as well as the very firm currency.

    Locally as expected after the inflation shock, interest rates have been raised by an additional 0,5% with the repo going to 11% and prime up to 14,5%.

    So despite the prospect of higher short term interest rates starting to possibly tame inflation, longer term yields are still not attractive. This is important for those investors looking to retire at the end of this year or into the beginning of next year.

    Shorter term rates however have been made more attractive with this rate hike.

    Kind regards

    Ian de Lange

    Permalink2007-12-06, 16:03:22, by ian Email , Leave a comment

    Market returns to the end of November 2007

    With less than one month to go for 2007, let’s have a look at the performance of various asset classes for the year to date. Again coming into 2007, many investors were sceptical of massive gains. But the year got off to a good start and at the end of May, the JSE All Share index was up 16,2%. The last 6 months have however seen a large slowdown with the return for the JSE All Share index coming in at just 7,2%.

    November was negative 3,19% resulting in just 7,2% for the last 6 months. The return for the year to date of 24,6% therefore looks far more attractive than reality for those investors that entered into the market half way through the year.

    Come March 2008, the strong bull market in local equities will be 5 years old. Over the last 5 years, the JSE All Share index has returned 29,7% per annum. But this rate of return has started to slow in the last 6 months.

    Over the last 10 year period, which includes the tougher 2001 and 2002 period, the annual compounded return from the local market was a more normalised 20,3% per annum.

    Listed Property gave a return of 28,8% for the year to date, but also slowing over the last 6 months returning only 7,2%.

    In US dollar terms the relative return has slowed dramatically and if this continues, foreign investors will make adjustments to their portfolio. A USD return of 9,7% for the last 6 months for the MSCI South African index looks rather pedestrian compared to the 34,2% for the Russian index, 38,9% for the MSCI India and 30,9% for the Brazilian Bovespa index. Not to even mention the MSCI China index gaining 59,6% in USD terms for the last 6 months.

    I have spoken about the possible risks of foreign money looking to take returns on the JSE and move somewhere else. A relative slowdown of the JSE performance adds to this possibility.

    The construction sector has raced up 69,7% for the year to end of November. With the JSE All Share index up 24,6% one can see the massive out performance of this sector. Mobile Telecoms – read MTN – has not been far behind at 61,9% for the 11 months.

    Tomorrow the Reserve Bank will announce on local interest rates. This comes as the UK MAY see a rate reduction. The Bank of England will also deliver its decision on Thursday with most analysts expecting it to remain on hold at 5,75%. This helped boost the UK equity market.

    The US Federal Reserve is expected to lower their main interest rate next week and possibly also their discount rate (which is the rate it charges to banks). They will remain aggressive in providing the necessary liquidity to the banking system.

    Locally a further rate hike must be close to the top of the cycle.

    Kind regards

    Ian de Lange

    Permalink2007-12-05, 20:46:23, by ian Email , Leave a comment

    Spending some time before the year end

    December is here with the traditional extended Christmas holidays almost upon most of us. It’s a great time of the year with plenty of enthusiasm. My suggestion is to take one day out of your diary before the year ends and spend it on aggregating and assessing your total investment position.

    Why do I say that? Well for a few years now, the strong financial markets have papered over many cracks, but there is a sense that this may slowly start to change and get a bit more difficult.

    So while the global and local markets have slowed from their more rampant upward move over the last 6 months, the last 12 months still remained strong. This is seen in the JSE All Share index which is up 26% for the last 12 months. It’s also seen in the total market capitalisation of all companies recorded at R5949 billion at the end of November which is up 21,5% in 12 months.

    But we are all starting to see many consumer related pressures building up, including:

    • Inflation pressures across the board;
    • A definite slowdown in asset price growth;
    • A potentially weaker currency; and
    • Higher interest rates with a strong possibility of a further rate hike this week.

    For these reasons the timing is even more important that each component of your total investment asset base is optimised. What do I mean by this you may ask? I think for many investors it first comes down to knowing exactly what they have. Far too often we meet with investors and when we start to work through what they have in place, we find:

    • A “mixed bag” if investments, annuities, insurance type products
    • No real knowledge of the actual underlying investments within the various products.
    • No real sense that someone is actually managing or looking after their funds on a consistent basis.
    • A low level of conviction as to the total investment capital required versus the retirement income needed now or at a later date.

    Having a very clear indication of where you are currently positioned is an excellent starting point. That’s why I am recommending taking at least one day out – before the end of the year and before you kick back for the annual holiday. For many it’s the very last thing that they want to do, but you will be able to start the beginning of 2008 with a far clearer outlook.

    Think about it


    Ian de Lange

    Permalink2007-12-04, 17:52:46, by ian Email , Leave a comment

    The currency factor

    A factor for all investors in their asset allocation model is determining how much they should invest offshore. This is not an easy determination and far too often in the past emotion has played too big a role. Investors headed for the exit in 2001, but for many years now, having been burned and don’t want to risk moving too much out.

    The allocation to offshore is a major decision and so worth exploring in a bit more detail. If we take a cursory look at some of the factors we can identify some positive and some negatives that could drive the currency over the next 12 months.

    Some positive influencing factors:

    • Stronger growth from many of the local industrial and resource companies. Many South African companies are operating at maximum capacity with resulting very high operating margins and returns on equity. While this continues, foreign investors will find these companies attractive.
    • Higher interest rates relative to lower global interest rates make the rand attractive as currency to hold. Foreigners can sell one currency such as the yen and invest into the rand earning higher rates of interest.
    • Ongoing support for emerging markets in general by investors.

    Some negative influencing factors:

    1. Impending political change.
    2. A large and increasing current account deficit.
    3. A large pullback in their investment into emerging markets by investors.
    4. Money supply remains.

    Because currencies relative to one another can move for extended periods of time in a certain direction, defying all underlying economic logic, they are EXTREMELY difficult to call.

    I think George Soros explained it well when he expounded on this at length in a theory that he developed called the theory of reflexivity. He starts by saying that he does not agree that financial markets tend to equilibrium on the basis of discounting the future correctly.

    His theory says that they cannot discount the future correctly because they do not merely discount it, but help to shape it. He sees in financial markets a two way feedback mechanism in which reality helps to shape participants thinking and the participants thinking helps to shape reality in an unending process.

    It possibly has greater relevance to exchange rates, because currencies are defined relative to one another, and not as against an underlying intrinsic asset that can be independently valued, such as a company. On a relative basis then they can move for long periods of time away from a so called mean.

    The US dollar is a case in point. For various economic reasons it has been negative against a basket of currencies. This then in itself promotes investors to agree with the negative bias, which reinforces the ongoing negative bias.

    Bloomberg reports that top equity and bond investors, Warren Buffett and Bill Gross both believe that the US dollar will continue to weaken.

    There are some investment strategists however that are looking for a rebound in the US dollar in 2008 after a long period of weakness, where the dollar fell to its lowest level ever against the Euro. This can only happen when there are more buyers of US dollars that combined sellers.

    Again this is very difficult to predict when that will occur. Sure there will always been some volatility along the way, but the big money is made in getting the major direction right.

    Locally the rand has been firm ever since falling to a low in December 2001. The strength slowly developed momentum, until the general trend itself, reinforces investor’s decisions and views. The trend for 20 years to that date had been negative, culminating in a large sell off.

    That’s all for today


    Ian de Lange

    Permalink2007-12-03, 18:06:20, by ian Email , Leave a comment