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    first quarter for 2008

    The last day of the first quarter for 2008 ended on a down note. The JSE All Share index fell 1,25%. But in spite of the massive volatility over the last 3 months, the JSE All share total return came in at 2,9%.

    The detail gives more insight into where the gains have been made. As we have been saying for a while, the resources have seen all the recent positive price action. This continued into the first quarter of 2008 with the resource 20 index gaining 17,5%.

    The financial and industrial sectors have been the sectors struggling. For the first quarter they fell a further 7,1%.

    There were some bigger movers today.

    Telkom fell 10% after it came out with a company announcement saying that any disposal of any subsidiary or joint venture will not be considered without compelling strategic rationale. The expression of interest by Oger Telecoms was dismissed.

    The price closed off its low at 13120c.

    Uranium One has been under pressure - it reported results to December. The company has a primary listing in Canada and secondary listing on the JSE. Its problem child has been production at its Dominion mine. The operation is still at various stages of feasibilities and commissioning at various operations and not operating at any level of full production.

    The price is down to R27, giving it a market cap of R12,8 billion.

    Ian Cockerill resigned as ceo of Gold Fields. This is one of the pre-eminent gold companies in South Africa with a market cap of R75 billion. The share price fell 2,8% to R115.

    Gold shares have underperformed for a long time now, essentially flat for 5 years.

    Anglogold has a similar market cap at R75,5 billion.

    The gold price has moved up strongly in dollar and rand term, but large scale mines have not necessarily benefited. The mines are battling with cost pressure increases. Still a number of funds continue to hold GFI. In the 4th quarter many however sold down their exposure.


    The rand was mixed, slightly down against a stronger US dollar at R8,13/US dollar.

    The US markets are trading up.

    That’s all for now. Feel free to contact us to discuss your investment planning.

    Kind regards

    Ian
    ian@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-31, 18:56:29, by ian Email , Leave a comment

    Portfolio construction

    No less than 191 unit trust funds own Billiton. Another 169 funds own Anglos. On a combined basis these 2 shares with a market cap of R528billion and R647 billion respectively represent an approximate 30% weighting in the JSE All Share index.

    The typical client segregated portfolio also tends to own the top 40 shares, and would in most instances also include the “big name” shares, Anglos and Billiton.

    At times when the JSE All Share index has been moving up strongly because of their strong performance from resources and especially the heavyweight Anglos and Billiton, fund managers find it difficult to outperform the index.

    For this reason, most managers find that they “need to” have a stake in these 2 companies, just to be in the race. They are typically underweight relative to the index, because of the index weighting. In the general equity funds, the highest weight to Anglos is around 13% and for Billiton at approximately 14%.

    Therefore when one manager – Allan Gray - announces (some time back) that they don’t own either Anglos or Billiton, it’s a big bet against the general index.

    Their view is simply that the shares are fully valued and they find better value elsewhere. Merely being the biggest component in the benchmark or the fact that virtually all competitors own it, should not dictate its inclusion in a portfolio.

    Index hugging or an obsessive fascination with competitor portfolios can be dangerous, especially at the key turning points. This may be the case for commodities, and especially resource shares, which could be facing a cyclical downturn. Whether we are there or not is a moot point.

    But this week Merrill Lynch in a strategy report this week said, “It appears as though speculators have been squeezing into, what might be, the last great beta trade of this cycle: short US dollar / long commodities."

    We are on the alert for a possible downturn in resource shares and therefore monitor exposure across combinations of fund managers for our client portfolios. If you have a portfolios manager or investment advisor, you need to ascertain if they even know the details of your aggregated portfolio, let alone monitoring changes on an ongoing basis.

    Have a great weekend

    Kind regards

    Ian de Lange
    ian@seedinvestments.co.za

    Permalink2008-03-28, 17:53:55, by ian Email , Leave a comment

    Peregrine expands offshore - should you?

    Many South African companies have attempted expansion offshore. While some have failed many offshore expansions have worked well. All private investors must look at their offshore exposure. The rand may have slightly overrun in the shorter term and it’s always difficult to call this with any certainty, but from a purely risk reduction aspect, offshore exposure is a must.

    Peregrine is a listed financial services company that owns Citadel, the private wealth management company. It also manages hedge funds and has recently announced a deal to acquire major shareholding in offshore based Stenham a wealth management business. It looks like a smart move because clearly all South African’s MUST have a good portion of their wealth offshore.

    Peregrine announced today that despite the market turbulence, headline earnings per share for the full year to end of March are likely to be up between 25% and 35% from last years 166,3c.

    The trading update assessment is made on the results for the 11 months to end of February and assumes no significant setback for March. Shareholders will approve the acquisition of a controlling interest in Stenham next week. The rand has weakened by almost 20% since negotiations commenced for the acquisition of Stenham, but the company structured and fixed the foreign currency payable, so that the rand consideration will not differ by more than 2% of original.

    The expected growth in earnings over the last 12 month period, that was extremely tough in financial markets, was in some respects due to Peregrine’s stake in hedge funds. Now it’s looking to expand offshore.

    This earnings update puts the share on an historical PE of around 6,5 times. It trades on a dividend yield of 3,1%. Looking through the unit trust funds, the biggest holder at the end of December was niche fund Katzgold Flexible. Peregrine was its largest holding at 7,5% of the fund. They acquired substantially in the 4th quarter.

    Other companies listed in this investment banks index include:

    Cadiz which trades on a PE of 5,6 times and a dividend yield of 1%. It has long held some capital offshore, which until recently depressed earnings as the rand held strong. It has R65m in US dollars, euro and sterling.

    Sasfin on a PE of 8 times and a dividend yield of 4,85%

    BJM, the stockbroker, on a PE of 6,2 times and a dividend yield of 6,7%.

    Brait, the private equity business, on a PE of 6,3 times and a dividend of 6,34%.

    Many of the share prices of these smaller niche financial services players have fallen sharply. They appear cheap hence some value biased managers starting to nibble at these attractive prices.

    If you are a high net worth private investor, with an under exposure to offshore, don’t hesitate to contact me to discuss planning.

    Kind Regards

    Ian de Lange
    ian@seedinvestments.co.za

    Permalink2008-03-27, 18:39:29, by ian Email , Leave a comment

    Inflation, Inflation, Inflation!

    The release of inflation data today by the Reserve Bank wasn’t pretty. While in line with analyst forecasts, the headline CPI annual inflation rate came in at 9.80%. CPI-X (CPI less interest on mortgage bonds) – the measure that the SARB attempts to keep between 3% and 6% – came in at 9.40% for the year to February 2008.

    An inflation rate of 9.80% means that if you bought the same goods and services today that you did one year ago, you will pay 9.80% more on average. Those individuals whose income level hasn’t changed in this period will have to either ‘find’ some more money to maintain their standard of living (extending your credit line is an example), or cut back on certain expenses until such time that their income increases again.

    While 9.80% is the average rate, each individual will have their ‘own rate’ depending on their particular basket of goods. Food price and transport inflation of 14.10% each for the year particularly affect the lower income earners who have to spend proportionately more of their income on food and travel. It is for this reason that low incomers earners are currently facing a higher inflation rate than quoted, and why the unions have been demanding wage increases that are ‘higher than inflation’ (being the general inflation rate).

    With the SARB mandated to keep CPI-X in the three to six percent range, there is the possibility that interest rates will go up again when they sit down for their 9 and 10 April meeting. Tito Mboweni would typically raise interest rates when inflation increases to curb spending on items which aren’t necessities, and whose prices are set locally. This in turn reduces the demand on these goods, and inflation dissipates. The problem with food and fuel costs driving inflation (as is currently the case) is that demand for these products is relatively price inelastic (demand isn’t that dependant on the price) and the result is that inflation doesn’t recede, so a rate hike isn’t a forgone conclusion.

    On the investment side inflation eats at real returns. It becomes even more important that you are invested into growth assets that produce a real return on your assets. In times of rising inflation equities have historically fared poorly which makes those inflation linked hurdles, which were once extremely easy to achieve, that bit harder to realise. Despite the going being tougher in equities at the moment it is essential to have a strategic allocation to them (the weight will depend on your individual circumstances), as even though money market yields look attractive on a nominal basis, on a real after tax level you are actually losing purchasing power. Putting your money under your mattress will only result in an erosion of wealth.

    Hopefully the SARB don’t see this increased inflation as a sign to hike rates in two weeks time. By pausing it will give all of us with debt a little bit of breathing space for a while.

    Kind regards,

    Mike Browne
    mike@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-26, 15:07:29, by Mike Email , Leave a comment

    Investing for tomorrow’s story, not today’s headline.

    Investing is made that much more difficult because leading participants often have strong but opposing views, which are invariably backed up with sound facts and reasons. Take inflation for instance.

    Leading local investment managers have been announcing how this is a looming problems for investors. Remember inflation is the minimum hurdle for any investment. So called guaranteed investment products that guarantee your investment capital after five years, forget that with inflation running at close to 10% the minimum guarantee should be 160% of your initial capital just to break even.

    Running close to 10%, it’s starting to get far more difficult for all investments compared to the 3 and 4% level a few years back.

    Inflation numbers for February will be released tomorrow with producer price inflation on Thursday. The Monetary Policy Committee of the SARB meet on the on 9 and10 April and the debate is now on whether rates will be hiked again, given the escalating numbers.

    Globally the investment strategists at Merrill Lynch note that inflation is a lagging indicator, while credit is a leading indicator. Many inflation orientated investment themes have also been exploited, and so they see less value in many of these. Traditional areas include gold, commodities, commodity related shares, and commodity related countries such as Brazil and Russia.

    Because credit conditions are tightening around the world, most notably in the US, causing or in some cases because of asset price deflation, this may be a more important indicator to monitor that inflation. Therefore watch the credit cycle closely and be cautious of an over reliance on inflation continuing to boost certain asset classes such as commodity prices.

    Other reports indicate that there is perhaps an overconfidence that China will continue to maintain its high growth levels in the face of the slowdown across the US and Europe, which supports the commodity outlook. As always overenthusiastic investors tend to overpay for investments – often setting themselves up for poor subsequent returns.

    We believe that there is a lot of merit in this view. If this is also your view, you should look to accordingly position your investment portfolio. Perhaps a lower allocation to emerging markets and to the global commodity markets, with higher allocations to larger cap more stable or defensive companies.

    Kind regards

    Ian de Lange
    ian@seedinvestments.co.za

    Permalink2008-03-25, 17:33:39, by ian Email , Leave a comment

    Commodity declines play havoc with share prices

    Some evidence of the gearing effect on commodity shares was reflected today. Prices of commodities have been under pressure yesterday and again today. This led to big declines in most resource shares and hence the JSE, which is seen as a commodity play by foreign investors.

    Gold came back to around $925/oz from over $1000/oz

    Platinum, palladium, copper etc were all down

    The price of oil fell back to around $100/barrelBrent crude.

    US markets opened up in firmer territory on Thursday.

    Locally the JSE suffered a big decline with the All Share falling 3,7%. Gold fell 4,45%. Resources 20 declined 6%.

    The big movers here were Anglo down 7,38%, Implats down 9,5% and ARCMittal down 8,7%.

    Kumba down 9,25%.

    Futures close out resulted in big volumes. Almost R20 billion was traded on the day. 170 shares ended up against 320 shares down in price - not a good day.

    In the top 40 index only a handful of shares traded up in price. Investec was one gaining 2,2% to 5335c.

    So banks outperformed resources today. We are watching the relative plays very closely.

    Have a blessed Easter

    Kind regards

    Ian de Lange
    ian@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-20, 17:53:38, by ian Email , Leave a comment

    MTN’s Results

    The JSE’s Sens announcements, while being necessary, often prove to be quite distracting with most announcements being along the lines of, “Anglo American Plc – Purchases of ordinary shares in the company”.

    Today one of the more interesting announcements that came to my eye was MTN announcing their final audited results for the year ended 31 December 2007. MTN is the sixth largest company on the JSE, by market cap, and as with any large company their results command quite a bit of attention from investors.

    It is indeed a fascinating read going through the results and presentation found on their website www.mtn.com. Some of the less technical information that jumped out at me included:

    MTN’s growth from a local South African player between 1994 and 1997 to now being a dominant emerging markets giant. MTN has grown from being a local operator to having 21 operations throughout Africa and the Middle East. In the past 10 years their market cap has grown from R2.7bn to R238bn (growth in market cap of 56.5% per annum compounded over 10 years)!

    Nigeria, with a total of 16 511 000, has more MTN subscribers than any other country. South Africa is second on this list with 14 799 000 subscribers, resulting in its local market share remaining constant at 36%. What is exciting about the Nigerian market is the low penetration rate (percentage of population with a cellphone). While in South Africa it is up at 86% (with not much more room to grow) in Nigeria penetration levels are only at 27%, and with a market share of 44% you can see that this region has outstanding growth prospects.

    While Nigeria and South Africa are the focus countries in the West & Central Africa, and South & East Africa regions, the major focus in the Middle East & North Africa is Iran. Subscribers levels were up 3 800% for the year (off a low base). The group is present in regions such as Syria, Sudan, Yemen, Afghanistan, and Cyprus. While these countries may not be the safest or most desirable locations, they do lend themselves to high profit margins. MTN must just ensure that risks are proportionate to potential returns.

    On a group level the number of subscribers over the past year grew by 53%, and MTN expects to grow its subscribers by 36% in 2008. While these growth rates are impressive one must realise that as more and more of the population gets connected the average revenue per unit (ARPU) decreases, which makes sense as the lower LSMs are targeted. MTN are currently focussing on getting penetration and market share as high as possible, and can then focus on trying to maximising revenue per client.

    Looking through the results reinforces the point that many companies listed on the JSE aren’t purely South African plays. An analysis of this company not only requires a thorough analysis of local drivers (where the company derives around a third of its revenue), but drivers related to each of the countries in which it operates.

    Clearly the market liked what they saw in the numbers as the share price was up 4.34% for the day, when compared to the ALSI, down 1.78% and the Industrial 25 Index, down 0.48% for the day.

    Kind regards,

    Mike Browne
    mike@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-19, 17:24:31, by Mike Email , Leave a comment

    The US Fed slashes the cost of debt

    With financial institutions under immense pressure in the US and therefore globally, the general consensus is that they currently make very poor investments. But is this the necessarily the case locally?

    As an astute global property investor said t me today, “I don’t just buy property for the sake of investing property, I make money by buying property at the right price.”

    Successful investors understand the difference between the investment story and the investment’s value. They understand that the large component of the investment return is due to buying at the right price. By right price I mean the cheapest possible price relative to the range of intrinsic values.

    With global financial institutions now seen as the poor cousin, investors have been right to shun them as investments. But perhaps, just perhaps, there is now sufficient value in some of these.

    Some pointers from a report yesterday from Merrill Lynch:

    Most assets are performing as they should in an increasingly volatile environment. High quality assets are outperforming low quality. Treasuries (i.e. bonds) are outperforming stocks, developed markets are outperforming emerging markets, large caps are outperforming small caps and fixed income spreads are widening (i.e. a flight to quality).

    Panicked investors will provide excellent buying opportunities for patient and longer term investors.

    The one year forward yield on local banks is as follows:

    Absa 6,87%
    Nedbank 7,81%
    Firstrand 6,67%
    Standard 5,65%
    ABIL 12,6%

    These are attractive yields for any investor, when the average for the JSE is around 3%.

    The outlook for banks themselves does not look too attractive. I.e. slowing advances, an increase in bad debts, highly indebted consumers, etc, but the share prices are saying that so much of this poor outlook is already priced in. i.e. shareholders are being compensated for these risks.

    All eyes will be on the ability of the US to stabilise the global banking situation. Today they cut their Fed Funds rate by 0,75% to 2,25%. This is a 2% cut this year together with other forms of injections into the banking system.

    The US will do everything in their power to avoid a protracted Japanese banking crisis. We will be watching developments closely for signs of stabilisation. This will help us with asset allocation.

    Kind regards

    Ian de Lange
    ian@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-18, 20:31:50, by ian Email , Leave a comment

    Inflation, money and real assets

    Credit lines are extremely tight as banks cannot meet massive margin calls. In order to counter this the US goes through the roof as the Fed continues to print in an attempt to provide liquidity to illiquid and highly leveraged US banks. At the same time inflation heads higher and higher and this is reflected in the prices of real assets.

    The US banks have paper assets on their balance sheet, which they cannot sell. There is no market and no buyers. This is why the US Fed has stepped in as buyer of last resort.

    Investment bank, Bear Sterns is a big casualty. They could not meet margins calls. They should have gone into bankruptcy. But according to global investor, Jim Rogers, the Fed did not allow this because of the millions in bonuses paid in January. So they facilitate a buyout, providing the financing and helping another player benefit.

    The US central bank is really there to try and protect the banking system. With no real asset backing to the paper that is printed, the true or intrinsic value decreases. The various auction facilities that its putting in place to buy junk paper from investment banks in reality is nothing more than more printing.

    They dropped the rate to commercial banks by 0,25% and tomorrow announce on Fed funds rate.

    The US total GDP is around $13 trillion. Total private and public debt is around $48 trillion. This debt expanded by almost $4 trillion in the last year.

    It’s an economy that has ballooned on debt creation.

    There is a strong argument that instead of trying to perpetuate the credit bubble, perhaps the Fed should be trying to curtail the past binge, and try to normalise the inevitable downward cycle.

    But they created the problem, and will try and work their way out. It may work, but in the meantime they run the real risk of decimating the currency. Other currencies may appear relatively attractive, but ultimately paper will be destroyed relative to real assets whenever central banks have the ability to put more in circulation that the increase in real production.

    Remember money is not wealth – it’s a medium of exchange. Where the purchasing power of currency is largely protected, investors can hold their wealth in money for periods of times. But where that purchasing power is continually stripped away through ongoing and massive printing, then NO-ONE wants to and should hold the paper.

    Just ask the Zimbabweans up north.

    Kind regards

    Ian
    ian@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-17, 20:09:36, by ian Email , Leave a comment

    The Yale Endowment Fund

    Ian has spoken before of the high regard that the Yale Endowment Fund is held in. Their performance over the long term has been outstanding. They are pioneers in identifying and implementing cutting edge investments that have helped them to produce these outstanding returns.

    I have had a look at their 2007 report, and it certainly is an impressive outfit. As at 30 June 2007 the fund was $ 22.5bn in size having returned 28% for the year (in USD). The previous three years saw the fund return 22.9% (2006), 22.3% (2005), and 19.4% (2004) growing almost $ 10bn in this time!

    In Yale’s case the Endowment is now so large that last year they were able to spend $ 684 million (which was 33% of the university’s budgeted revenue). They have got to this stage as a result of the fund’s superb performance. The superb performance is down to both their excellent asset allocation decisions and also due to the fact that they have been able to outperform each of their asset class’ benchmarks over time.

    Below is a list of the assets and their weighting in the portfolio. You will notice that there is a fairly even spread across the asset classes, and there is a relatively low correlation between these assets. Importantly there is only a 5.9% exposure to assets that can be deemed as ‘non growth’ assets, bonds and cash. The rest of the funds are invested into growth assets.

    Absolute Return (23.3%) – Yale’s endowment looks to invest in event and value driven strategies which looks to generate a real return of 6% per annum with standard deviation half to three quarters of the stock market, but importantly with no correlation. The lack of correlation is important in that it reduces the volatility of the total portfolio by smoothing returns. This is done without reducing the return profile of the overall fund.

    Domestic Equity (11.0%) – You will notice that there is an extremely low allocation to local equity markets. Preference is given to other less researched assets.

    Fixed Income (4.00%) – They have a very small allocation to an asset class that has low return expectations, and only serves to reduce volatility.

    Foreign Equity (14.1%) – This amount is split between developed and developing economies. Expected returns from these assets are higher than the average, but they understand that there will be more volatility.

    Private Equity (18.7%) – The fund has used private equity as an asset class for a long time, and it has performed handsomely, returning 31.4% per annum since inception. This is down to the approach that is made with private equity firms whereby a partnership is created to enhance the fundamental value of the firm. Financial engineering (which is what a lot of private equity companies only do) is of only secondary importance.

    Real Assets (27.1%) – This includes investments into a wide variety of real assets including real estate, oil, timber, and other commodities. Real assets typically protect a portfolio against inflation, and provide stability in times of market turmoil. The assets are typically of an illiquid nature, but have returned 17.8% pa since inception of this investment in 1978 (turning $ 100 into $ 11 567).

    Cash (1.90%) – Residual cash holding.

    The importance of asset allocation to an investment strategy cannot be underestimated with over 90% of investment returns generated from this decision. It is important to have a formal strategy (like Yale) that invests into uncorrelated assets, and sets limits for each asset class.

    Ian has updated Seed’s 2 page monthly market summary, which looks at valuations of local and global markets and asset classes. This normally only goes out to our clients, but if you would like a copy, please sign up on our newsletter list and we will send it out early next week. Visit www.seedinvestments.co.za and sign up for the newsletter.

    Have a good weekend,

    Mike Browne
    mike@seedinvestment.co.za
    www.seedinvestments.co.za

    Permalink2008-03-14, 16:51:57, by Mike Email , 4 comments

    Not worth a Continental

    The US dollar continued its slide against a basket of currencies, most notably long time trading partner Japan's yen. The dollar fell to below 100 yen for the first time sine 1995. It’s not only other currencies, but global assets that are priced in US dollars that move up as there is more and more pressure on the US dollar. Is it going to be a case of the US currency not worth a continental?

    You have heard the phrase – not worth a continental. Well a Continental currency was a paper currency issued by several American Colonies, as well as by the Continental Congress, after the Revolutionary War began in 1775. The currency was denominated in both pounds, shillings and pence, and dollars. With no solid backing and being easily counterfeited, the continentals quickly lost their value, giving voice to the phrase "not worth a continental". 1

    Is this now the exact same thing happening with the so called mighty US dollar? Greenspan and Benanke’s printing presses of the US dollar, is akin to a type of counterfeiting. Over the last 8 years the US Federal Reserve has continued to provide liquidity essentially increasing the money supply. One of their biggest fears is a Japanese type deflation, low growth environment, and they will continue to do all in their power to avoid this.

    The US dollar index is the relative value of the US dollar against a basket of trading partner currencies. In 2001 this index traded at around 120. No 7 years later it has fallen 38% to trade around 75.

    One of the beneficiaries of a declining US Dollar has been gold. Bullion is a precious metal that has a negative correlation to the US dollar. It is essentially a monetary asset, that has over centuries retained is purchasing power.

    It has a negative carry trade in that it does not earn interest or dividends, but investors incur a holding cost. But as the US Federal Reserve has been lowering interest rates, so the attraction of gold is elevated. i.e. the negative carry trade or opportunity cost decreases.

    Gold prices reached $1000/ oz. Bloomberg reckon that the inflation adjusted price of the $850/oz level reached in early 1980 is now $2224. The prices of gold surged on the back of double digit inflation and oil moving up sharply due to Middle East instability – sounds familiar.

    So far local gold companies have not benefited from the rising price of gold bullion. They have had cost and production pressures which have negated the higher selling price of the yellow metal that they mine. Now however this may change given these high prices and the weaker rand. We are looking closely at manager’s inclusion of gold shares in their portfolios.

    I have updated Seed’s 2 pager monthly market summary, which looks at valuations of local and global markets. This normally only goes out to our clients. If you would like a copy, please sign up on our newsletter list and we will send out early next week. Visit www.seedinvestments.co.za and sign up for the newsletter.

    Sincerely

    Ian
    ian@seedinvestments.co.za
    www.seedinvestments.co.za

    1 source Wikipedia

    Permalink2008-03-13, 18:04:54, by ian Email , Leave a comment

    Sovereign Wealth Funds

    We have recently been hearing more and more about Sovereign Wealth Funds (SWFs) in the press, but what exactly are they and why are they created in the first place?

    A SWF is basically a state controlled fund that invests into various financial assets, and a basic difference between a SWF and a country’s foreign exchange reserves is that forex reserves look at ensuring currency stabilization, while Sovereign Wealth Funds seek to maximise long term returns.

    The increasing popularity of SWFs has come about mainly as commodity exporting countries have accumulated massive budget and trade surpluses, as a result of the revenues generated from the sale of the various resources. As an example, Russia started a SWF in 2004 on the back of rising oil prices. When oil prices started to rise, Putin aggressively paid off all the foreign government debt, and when it was all paid off all the debt the SWF was set up.

    This forward looking country realised that the risk of being dependent predominantly on commodity (oil) prices and output is high, and so don’t spend all the ‘commodity’ revenue, but diversify into other areas. The capital invested into SWFs can be used to supplement government expenditure in times when commodity prices and output aren’t as profitable, which will help to balance the budget. As of April 2007 the Russian SWF has been split into two funds: one will be invested in low risk assets, and will be used when oil and gas incomes fall; while the other fund will invest in riskier, higher return assets. The funds are now valued at approximately US$ 158bn.

    A lot of the noise about Sovereign Wealth Funds has recently come from the US. Understandably the US government is concerned about the use of SWFs of ‘non-ally’ countries, particularly China. The US is worried that the intention of the other governments isn’t purely an investment one, but also includes political intentions. A hypothetical example, which the government would undoubtedly have considered, would be if China were to try and take strategic, controlling stakes in US arms/defence/oil companies. Now, while the US has historically been all about free trade, these kinds of industries could be considered important in terms of national security, and I am sure that there would be some form of protection to ensure that they don’t ‘fall in the arms of the enemy’.

    Noise not only comes from countries like the US, where SWFs are investing, but also from within the countries that manage the SWFs. For instance Norway runs the second largest SWF (at US$ 350bn) and there is debate as to how much of this investment should be spent on current needs, versus how much should be invested for the longer term. There is debate over the asset allocation of the fund, with some arguing that it’s too conservative, and others that it is overly aggressive. There are also concerns about whether the investments in the fund are ethical or not.

    The most recent beneficiaries of SWF money have been the beleaguered banks that have been hit by the subprime and credit crises. An example of this is the Abu Dhabi Investment Authority (ADIA) (the largest SWF at approximately US$ 875bn) that struck a deal at the end of last year with Citigroup to invest US$ 7.5bn, and take a 4.9% stake in the company (resulting in it being the largest shareholder). Here the SWF has been viewed as the white knight coming into save a failing company!

    Two things that are certain is that Sovereign Wealth Funds are here to stay, with Morgan Stanley MD Stephen Jed reckoning that they could increase from current levels of around US$ 2.8tn (a difficult amount to work out – an estimate at best) to US$ 12tn by 2015, and there will be continuing controversy as to how they are managed – how much should future generations benefit from current generation’s toil?

    Hopefully next time your friends are discussing SWFs around the braai you’ll be able to follow the conversation!

    Kind regards,

    Mike Browne
    mike@seedinvestments.co.za
    www.seedinvestments.co.za

    Source: Wikipedia

    Permalink2008-03-12, 16:21:09, by Mike Email , Leave a comment

    Investing the Keynesian way.

    An investor’s job is made that much more difficult when one considers that its not only a matter of deciding which is the best investment story, but determining how much have other investors priced in. Price in too little optimism into a good story and an investor may be left wanting. Price in too much exuberance and it will turn a fantastic story into a poor investment. Perhaps many investors are managing funds at the moment using the Keynesian Beauty contest methodology, which I think can be dangerous over the longer term.

    It was economist, John Maynard Keynes that pointed out that behaviour in investment markets was largely based not on what the investor thought the fundamental value to be, but based on what they think every one else thinks their value to be or what everyone else predicts what the value will be at some future date.

    His thinking was introduced in his masterwork General Theory of Employment Interest and Money. It’s a concept known as a Keynesian beauty contest.

    Keynes described the action of rational agents in a market using an analogy based on a contest that was run by a London newspaper where entrants were asked to choose a set of six faces from 100 photographs of women that were the "most beautiful". Everyone who picked the most popular face was entered into a raffle for a prize.

    A naïve strategy would be to choose the six faces that, in the opinion of the entrant, are the most beautiful. A more sophisticated contest entrant, wishing to maximize his chances of winning a prize, would think about what the majority perception of beauty is, and then make a selection based on some inference from his knowledge of public perceptions. This can be carried one step further to take into account the fact that other entrants would also be making their decision based on knowledge of public perceptions. Thus the strategy can be extended to the next order, and the next, and so on, at each level attempting to predict the eventual outcome of the process based on the reasoning of other rational agents.

    “It is not a case of choosing those [faces] which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.” (Keynes, General Theory of Employment Interest and Money, 1936).

    Keynes believed that similar behavior was at work within the stock market. This would have people pricing shares not based on what they thought their fundamental value was, but rather based on what they think everyone else thinks their value was, or what everybody else would predict the average assessment of value was.

    There is perhaps an element of Keynesian beauty contest thinking creeping into some of the valuations of many resource shares. Some value biased investors will agree that they are perhaps expensive, but will continue to buy, knowing competitors are buying.

    This was the game played by fund managers in 1998, not wanting to be left behind when technology shares were flying. It’s a “look over your shoulder” approach to investing and has and can cost investors. Now again with certain sectors valued above long term values, its important to consider.

    Sincerely

    Ian
    Ian@seedinvestments.co.za
    www.seedinvestments.co.za

    Source : Wikipedia, Keynesian Beauty Contest

    Permalink2008-03-11, 17:28:08, by ian Email , Leave a comment

    Warren Buffett's long term investment returns

    Warren Buffett’s wealth has slowly crept up over the years as he compounded the book value of Berkshire Hathaway “his” insurance and investment company at 21,1% for 43 years. It’s that wealth generation for him and his fellow shareholders that now puts him at the top of the list of wealthiest people in the world, surpassing his friend Bill Gates for the first time.

    Comparing the annual returns of Berkshire’s per share book value with the annual percentage change in the US’s S&P500 index, including dividends makes for some interesting observations.

    Over the 43 years, the book value per share grew from $19 to $78008, a compounded 21,1%. The pre tax annual compounded return for the S&P500 over the same period was 10,3%. The annual compounded 10,8% alpha that Buffett added is summed in one word – MASSIVE.

    It turns a starting value of $1000 into $3,76 million, while an investor in the market would be worth $67 000.

    It is worth noting that the comparison is not of Berkshire’s share price against the market, but the book value of the company’s assets. The book value of an investment company generally tends to be less volatile than share prices, which can often move far ahead and below intrinsic value based not only on underlying value, but driven by positive and negative sentiment.

    This was very apparent in 1999 when technology drove prices far ahead of intrinsic values. At this time Buffett refused to participate in buying expensive technology shares that were running away. In that year his book value gained just 0,5%, but the market gained 21%. His relative under performance was a massive 20,5%

    But he more than made it up in the next 3 years, gaining alpha of 15,6%, 5,7% and 32,1%.

    He did concede some years back that given the very high prices running up to 2000, that he should have sold some of share portfolio holdings, such as Coke that got to expensive levels.

    Then Buffett also managed to avoid large losses and this greatly contributed to the more alpha generated. In the 1969 decline he managed to avoid losses. The S&P 500 gave up 8,4%, but Berkshire gained 16,2% in its net book value.

    By not participating in companies whose prices are just too expensive, he has always tried to put himself in a position where he does not permanently lose capital. I don’t think that it’s his intention to annually beat the S&P500, but he knows that if he does what he does on a consistent basis, then over time, the results will come through.

    He also knows that returns can and will be lumpy, but rather more volatile earnings, with a greater probability of out performance after many years, than steadier returns with lower long run results.

    Active managers that follow a value driven investment strategy aim to produce similar results. We look out for managers that constrain their potential returns by sticking too close to the benchmark.

    Don’t hesitate to contact me if you would like to discuss your long term investment and retirement planning requirements.

    Sincerely

    Ian de Lange
    Ian@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-10, 17:25:36, by ian Email , Leave a comment

    Forbes List

    On Wednesday, Forbes released their latest list of US Dollar billionaires*. It makes for interesting reading. The list is now populated by a massive 1 125 billionaires, 226 of which are new comers to the list. I have had a look at some of the list, and it does make for fascinating reading seeing how these people got to where they are.

    On top of the list is Warren Buffett, who displaced his friend Bill Gates off the top mantle for the first time in 13 years! Buffett is often considered the world’s greatest investor, and is the CEO of Berkshire Hathaway. He has gone a long way since purchasing his first shares before he turned 11. He bought 3 shares in Cities Service Preferred for $38 each. His fortune now amounts to $62bn, up $10bn since last year.

    Mexican Carlos Slim Helu is in second spot, at $60bn, and Bill Gates is third with a fortune of $58bn. Slim is a self made telecoms mogul, and his fortune has swelled on the back of excellent performance of the Mexican stock market.

    Roman Abramovich, the owner of Chelsea Football Club is 15th on the list. His wealth has grown considerably on the back of strong commodities prices (and more specifically oil prices).

    It is interesting that all the above mentioned billionaires are self made. The list includes 50 billionaires under the age of forty, and it is interesting to note that 68% of them are self made, with the youngest being 23 year old Mark Zuckerberg who is now worth $1.5bn. Zuckerberg is the CEO and founder of social networking website Facebook.

    Among the top 10 are 4 Indians, which represents a massive shift from days gone by when US citizens dominated. You can be sure that more and more Indians and Chinese will populate these lists in years to come.

    The wealthiest female on the list is, 85 year old French citizen, Liliane Bettencourt. Bettencourt is the daughter of Eugene Schueller – founder of cosmetics giant L ‘Oreal. She comes in 17th on the list. The only author on the list is JK Rowling, of Harry Potter fame, her net worth is $1bn, coming in at 1 062 on the list.

    Not to be outdone, South Africa has 4 billionaires on Forbes’ list. They are Nicky Oppenheimer and family (173rd richest, net worth $5,7bn), Johann Rupert and family (284th, $3.8bn), and Patrice Motsepe (503rd, $2.4bn). Donald Gordon (a South African citizen residing in London) comes in 605th with a net worth of $2bn. Donald founded Liberty Life.

    The Oppenheimer’s derive their wealth from the De Beers diamond empire, and also Anglo American (founded in 1917 by Nicky’s grandfather Ernest). Johann Rupert is well known for being instrumental in getting Schalk Burger’s ban at the Rugby World Cup reduced, but is better known as the head of luxury goods company Richemont.

    Patrice Motsepe, along with Nigeria’s Aliko Dangote, is the first black African billionaire. Patrice, born in Soweto 46 years ago, is an entrepreneur of note and has built African Rainbow Minerals into a company worth R45bn, of which he currently owns 42%. He is now the company’s Executive Chairman.

    It is intriguing going through some of the billionaires, and finding out what they are all about. While there are those on the list that have inherited their wealth, there are many who are self made, and who have worked extremely hard to get where they are.

    Have a good weekend.

    Kind regards,

    Mike Browne
    mike@seedinvestments.co.za
    www.seedinvestments.co.za

    * 1 billion is defined as 1 thousand million, i.e. 1 000 000 000.

    Source: http://www.forbes.com/home/lists/2008/03/05/richest-people-billionaires-billionaires08-cx_lk_0305billie_land.html

    Permalink2008-03-07, 15:44:06, by Mike Email , Leave a comment

    Is it value only or value plus better growth prospects?

    Value investors and fund managers are having a tough time at present, given the runaway success of certain sectors, with others lagging. It’s in times such as this that their true mettle is tested. While banks, financials and credit retailers are considered value, each value manager has a distinct approach and this should be considered.

    Study upon study indicates that the value investment approach beats the so called growth approach. But there are degrees of how this value is defined. Because value and growth are joined at the hip, the dilemma for value investors is:

    • A cheap share on a price and net asset value basis may have a low growth outlook.

    • A slightly more expensive share on a price and net asset value basis may have a better earnings growth outlook.

    Some fund managers favour the first strict value approach. They typically don’t want to pay up too much for future growth prospects. While considering other valuations metrics such as EPS growth and return on equity versus cost of capital, they would down weight these, in favour of attractive price to current earnings and price to book etc.

    The thinking is simply that at attractive values, a share offers a buffer or margin of safety. If the eventual earnings growth is poor, well the share price won’t suffer much because it was in the price already. But if earnings growth is more positive, the price has the opportunity to re-rate because shareholders were originally too pessimistic.

    Other value managers look at this, but not wanting to get caught in possible value traps, they will equal weight growth prospects as well as current valuations. The thinking is that for long stretches of time investors are excited about growth prospects of certain sectors and pessimistic about others. Therefore its not just excellent valuation metrics, but also a positive earnings outlook that is important.

    These investors are therefore willing to pay a slightly higher premium for certainty of the earnings outlook over the next 12 – 36 months for example.

    With the bigger and bigger disparity in valuations across the sectors, the managers that get this aspect correct now, will produce superior returns over say a 3 year view. We for one will be looking at this very closely.

    Kind regards

    Ian de Lange
    Ian@seedinvestments.co.za
    www.seedinvestments.co.za



    Permalink2008-03-06, 17:24:18, by ian Email , Leave a comment

    Using asset allocation to produce inflation beating returns

    We have discussed the importance of asset allocation in driving investment performance. With the widening disparity in valuations across the various asset classes, superior performance over the next few years is going to come from the correct calls now made on asset allocation.

    We attended a fund manager presentation this morning. When asked what was their number one concern in managing investments this year, 2 out 3 fund managers said “inflation risk”.

    It’s no secret that inflation has been on the increase for some time. Even inflation on the steadier services element is picking up. Food, fuel and now also imported inflation on a weaker rand is going to make it difficult for the inflation to trend back to the 6% upper limit of the Reserve Bank inflation threshold.

    Dave Foord from Foord Asset Management asked the question this morning – “What is inflation?”

    Is it a persistent increase in consumer prices OR a persistent decline in the purchasing power of money.

    The latter definition is very apt for investors, and especially those retired investors that require an ongoing drawdown of their investment in the form of a monthly pension.

    Through an ongoing increase in the supply of currency beyond the increase in productive capacity, inflation causes an ongoing erosion of purchasing power. A few percentage points from say 5% to 8,8% may not appear much of a problem, but compound this difference over time, and it turns nasty.

    Foord went on to say that in times of higher inflation all asset classes face headwinds, but certain asset classes have a greater ability to beat this minimum target. Traditionally investors have allocated to the following assets:

    • Cash (money market)

    • Local and offshore equities

    • Property

    • Bonds

    The research that Foord produced looked at each asset class’s ability to produce a return of inflation plus 4%.

    Bonds have produced such a positive return in recent years and especially on a rolling basis since 1998 when bond yields went to 20% following the emerging market debt crisis. But going back in time, when inflation was running high, bonds have not managed to produce an inflation plus 4% return.

    Likewise cash has produced a positive real return as inflation came under control, but really struggles to deliver in times of higher inflation.

    Listed property, being a hybrid of bonds and equity, has a greater ability to produce a real return. But again not that easy when inflation was running hard.

    Returns from listed equities are more volatile, but it’s the asset class with the best ability to deliver real returns. Periodically on a rolling 5 years basis it has failed to produce inflation plus 4%. Foord also looked at offshore and noted this as a de-correlated, return enhancing asset class.

    Up until recently all asset classes performed well in the low trending down inflation environment. It’s changing very quickly - portfolios need to keep ahead of this curve.

    Kind regards

    Ian de Lange
    Ian@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-05, 17:16:10, by ian Email , Leave a comment

    How do you choose your fund managers?

    It is apparent after doing due diligences at various fund managers, and also through researching their portfolios, that you get many different types of managers.

    Layman investors often perceive fund management as a purely quantitative science, but it can often rely on more qualitative factors. An important part of the investment process is ensuring that you understand how your money will be managed, and to ensure that you are comfortable with that method.

    There are funds available where the method of composing the portfolio will be an exact procedure, including ETFs and tracker funds. Each investor will know exactly when shares will be bought and sold, and the rationale for their inclusion/exclusion. The mandates of the funds are clearly stated, and all the fund manager does is implement the mandate as accurately as possible. Most funds, however, include an amount of art in their process. It is here where one needs to be more aware of how the manager will construct the portfolio.

    When analysing equity funds composition, and how they are managed one can see that most managers are aware of their benchmark in the assessment of their portfolio, and many of them are influenced by the benchmark when constructing their portfolios. These managers will often create their portfolio with a relatively low tracking error (variation from the benchmark), by up-weighting shares which they like, and down-weighting shares that aren’t as attractive.
    Having a portfolio that isn’t too different from the market goes a long way to ensuring that you aren’t singled out and embarrassed. Any poor absolute performance will generally be mirrored by the market, and the manager will be able to show that ‘everyone’ has lost money. These managers have procedures in place to minimise their business risk (i.e. the risk that they underperform their peers, and subsequently are subjected to clients withdrawing their investments), with the result that they rarely shoot the lights out, but also don’t have their portfolio imploding in relation to most managers.

    On the other side are those managers who have the conviction to construct their portfolios without looking either at their peers, or at the market. They construct their portfolios from a clean slate, and only include those shares that they find attractive, and don’t have a problem leaving out a company that forms 10% of the index (provided that they feel that it is over valued). These are the managers who stick their necks out and as such take a big knock if they are wrong, but who also are able to produce outstanding outperformance when their stock selections are correct. As an investor into these kinds of funds it is great when your manager is producing exceptional alpha, but painful if/when returns are significantly below the market and average manager.
    While managers who display the skill and fortitude to stray from the pack have been able to produce alpha over the long term, they aren’t everyone’s cup of tea. The few skilled managers do produce superior returns, but often the investors into these funds don’t get the same returns, and even end up with returns far below the average manager...

    Behavioural aspects form a crucial part in deciding on which manager is best for you. If you know yourself well enough, then you should be able to decide which type of manager to use. For those investors who can’t stomach being different from the crowd, then it is probably best for you to stick to those managers that don’t deviate too much. By being different from the crowd we have seen clean slate managers produce returns that are different from the crowd (unsurprisingly), and when the difference is negative we have all to often seen investors panic, and sell out, or switch to the latest ‘hot’ ‘clean slate’ manager, only to experience the same effect. Alpha doesn’t come in straight lines, and investors seeking alpha need to ensure that their manager is skilled enough to produce alpha, and then they need to have the patience and endurance to sit through the tough times, and reap the rewards in times of plenty.

    Emotions play a role in all investments, and often detract from performance. It is for this reason that we often see that the better managers and investors are the ones who are emotionally detached from their portfolios.

    What type of investor are you?

    Kind regards,

    Mike Browne
    mike@seedinvestments.co.za
    www.seedinvestments.co.za

    Permalink2008-03-04, 16:44:29, by Mike Email , Leave a comment

    The great story does not necessarily mean a great investment

    March 2008 is the 5 year anniversary of the most recent 5 year bull run. January’s decline was all but forgotten in February as the JSE All Share index galloped up 12,4% in February leaving the market up 6,1% for the year to date. Just how does this price volatility play out into deciding what is a longer term investment strategy.

    January saw the JSE All Share index falling 5,5%. This in itself was a strong recovery from a decline from 28957 to a low on the 22nd Jan of 24005 – a drop of 21%. From this intra day low it gained a massive 26% to just over 30 000 on the 28th.

    The Resources 20 index gained over 41% from its January intra day low on the 22nd January to its close last week. This strong out performance can be seen in the strong performance of the resource index against the overall JSE All share index.

    So even with all the 2008 volatility, the last 5 years have been very good. The JSE All Share index gained on average 33,3% - an exceptional performance when considering that inflation was running at just 5,2%.

    While 5 years is a long period of time, the biggest contribution to these strong performance numbers was the depressed starting valuations. Remember the return equation is calculated as:

    Period end value / period starting value

    The depressed valuations of local assets in March 2003, resulted in the following subsequent strong compounded returns:

    • Resources 34,8%
    • Financials 27,6%
    • Industrials 34,4%

    Just to highlight the importance of the starting value, Allan Gray noted some numbers in its recent report. In the year that SA financial markets succumbed to global currency crisis – 1998 – financial shares were booming. At the same time investors and fund managers alike did not want to own resources, spurning them for the much loved IT and financial shares.

    But did this love affair pay off in terms of results:

    The 5 year compounded returns from the various sectors from 1 Jan 1988.

    • Resources 35,2%
    • Financials 1%
    • Industrials 11,7%

    I.e. the depressed story at the time surrounding resources, did not translate into poor returns. Exactly the opposite – resources were the clear winner, with financials suffering a long term de-rating to a more normalised level.

    We have a sense that the depressed story across many consumer, industrial and banking businesses now will not necessarily translate into depressed returns. Conversely investors need to be careful about higher rated and much loved resource shares, where the story is fantastic, but again may not translate into a superior investment return.


    Is your investment advisor tracking your asset allocation across ALL your investment funds on a monthly basis. If not, feel free to contact us – www.seedinvestments.co.za.


    Regards


    Ian de Lange
    ian@seedinvestments.co.za

    Permalink2008-03-03, 17:35:47, by ian Email , Leave a comment