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    Is it worth taking another look at global bonds?

    We mostly discuss equities, but most investors have an allocation to other assets in their portfolios including cash, bonds, hedge funds, property, private equity etc. While I generally have a bias against government bonds, one cannot discard permanently from a lower risk portfolio.

    Yesterday we met with the fund manager advising us on various offshore funds. I was initially surprised that the recommendation was to increase the weighting to the global bonds. But, setting aside my natural bias, I took a closer look at the fund and the asset class.

    Our local asset allocation has been very underweight local bonds and this decision has proved to be accurate so far as interest rates have moved up. Until we see interest rates and inflation peaking, we will remain very underweight.

    But globally bonds have performed better than expected, especially with an active management strategy.

    The chief investment strategist from Merrill Lynch this week stated that they are increasing the weight to bonds from 30% in a balanced portfolio to 45%, thereby overweighting their long term strategy. This is the first change to their asset allocation since May 2006.

    Their reasons for overweighting bonds include:

    o Global growth is now global slowdown
    o Inflation is not tomorrows but yesterday’s story
    o Current sentiment is extremely bearish towards bonds.

    A fund that our clients access offshore is the respected Franklin Templeton Global bond fund.

    This fund has produced an excellent result over a long period of time. For the periods ended Feb 2008: In US $

    o One year – 17,7%
    o 5 years – 11,82%
    o 10 years – 8.98%

    These are excellent long term US$ returns.

    The fund seeks out value bonds – only investment grade and sub investment grade sovereign debt.

    It then overlays a currency strategy, which is often at odds with the underlying asset allocations. E.g. at the end of April it allocated 32% to Asia Pacific bonds, with very low exposure to Japanese bonds. However its currency exposure across Asia Pacific was 55,5%, the bulk of this to the Japanese Yen.

    The annual Financial Mail South African Analysts rankings came out this week. The top technical analyst is JP Morgan’s Murray Morrison. He has also been favouring global bonds over global equities.

    So there are a few pointers that indicate that there is merit in including global bonds. We will continue to monitor.

    That’s all for today

    Have a great weekend



    Permalink2008-05-30, 17:46:32, by ian Email , Leave a comment

    Interest rates are moving up

    We have been discussing gearing on investments and specifically on property investments. Yesterday I discussed how over time property lends itself to making use of gearing, but that while this enhances the potential for greater profitability on equity, risk increases. Today the issue of risk was accentuated as the cost of debt is on the increase.

    Global inflation is on the increase.

    Locally it’s now running at 10,4% at the cpix level.

    Can the Reserve Bank governor contain it, by pushing up interest rates?. He has been using the slow and steady approach of 0,5% hikes – 9 of them in total.

    On Wednesday night he hinted at a 200 basis point hike. This left the market shaken on Thursday.

    It’s at times like this, that the risk of gearing becomes very apparent.

    As I discussed gearing or applying leverage to an investment is a financing decision, with its own set of risks. Without gearing property returns in general have not beaten the returns from equities.

    Property unit trust returns are total returns from listed commercial property. Indeed many investors would have received better returns on specific residential and commercial property, but as an asset class it has returned the following:

    Before tax to December 2007

    o Over 10 years 26,3%
    o Over 15 years 20,3%
    o Over 20 years 18,9%

    After tax the picture changes, because rental income is taxed at marginal rates of tax.

    o Over 10 years 21,1%
    o Over 15 years 15,0%
    o Over 20 years 13,7%

    Over the last 20 years, local equities have outperformed property, producing an after tax return of 19,9% per annum.

    Property returns benefited from falling yields as the long term interest rate cycle fell from the late 1990’s. That same cycle has been moving up steadily, which puts pressure on total property returns.

    Kind regards


    Permalink2008-05-29, 17:10:35, by ian Email , Leave a comment

    Using gearing

    Yesterday I discussed a property investment scenario and compared the capital return to various other investment assets. Although I pointed out that this assumed no gearing on the initial property investment, I received some questions from readers on the subject.

    Tomorrow I will look at the total returns from listed commercial property versus other asset classes.

    I believe that in general commercial property is a superior asset to residential property, BUT do understand that for certain “on the ground” investors, residential property development and rental properties can be just as, if not more lucrative than commercial.

    Let’s however discuss using gearing or leverage.

    Some readers noted that I was not comparing like with like because the property investor may only have put down say R4500 in equity, financing the balance. I.e. using borrowings to gear up his investment.

    Gearing or leverage is defined as the use of financial instruments or borrowed capital, to increase the potential return on an investment.

    Leverage works particularly well with property investments, BUT it is not confined only to this asset class.

    The important thing to remember though is that the actual return on the investment and the return on equity are two different things altogether – they must always be separated out. Using gearing or leverage is a separate FINANCING decision.

    The financing decision that the investor takes in order to enhance the return on the underlying investment, adds to the risk. Leverage magnifies gains and losses. It thus can add to or detract from the owner’s equity. Naturally in good times, when the investment generates a higher return than the cost of debt, the equity return is enhanced.

    A property investment is the type of investment that lends itself well to gearing, but investors must always understand the additional risk.

    Property has the following attributes, which make using gearing an attractive option.

    o The bulk of the return is returned to the investor as a running yield.
    o Especially for commercial property, longer term leases are agreed, which provide a greater certainty of income against which debt financing costs can be offset.
    o The cost of debt can be offset against the yield or rental income received for income tax purposes, helping to improve the after tax returns.

    Over the ensuing 3 years, the decision may not be that easy with lower yields and higher cost of debt. As I have always mentioned buying at the best yield possible helps put you on the front foot with regard to the potential return.



    Permalink2008-05-28, 17:18:15, by ian Email , Leave a comment

    A different look at investment returns

    A letter in today’s Finweek from a 67 year old property investor discussed some of the property transaction costs often forgotten about. He concluded by saying “I recently sold a house for R750 000 that I bought in 1980 for R22 500.” He then commented on the fact that at first glance it sounds “fantastic”, but then that it ignores inflation.

    In his example he equated the purchasing power of R22 500 in terms of the number of loaves of bread it could buy in 1980 versus how many loaves R750 000 could buy in 2008.

    Being a self styled property investor, I assumed he maximised his investment, but I do also know that property like local shares, was expensive in the early 1980’s. But over 28 years this should have smoothed out, especially given the exceptional recent property boom.

    So just how good an investment was it? Well without taking any impact of possible gearing used, let’s look at the numbers.

    The property investment
    The property investment produced a compounded annual growth rate of 13,3% over the 28 year period.

    I decide to look back and see what the official inflation was over this period. Well at official inflation numbers the buying power of R22 500 in 1980 is the equivalent of R334 000 today.

    Fixed deposit
    In 1981 shares on the market went backwards by 7,3%. In the high inflation period, interest rates were moving up again. In 1981 a fixed deposit would have given 9%. Had the investor left the funds in cash for the past 28 years, it would have grown to R531 000, before tax. An annual 12% per annum, but not much better than inflation.

    Had the investor placed the funds on the JSE in 1980, and assuming received the JSE All Share performance with dividends reinvested, the R22 500 would have grown to R3,1 million. The annual growth rate was 19,3%

    Compared to the investment in fixed deposits, an investment into equities produced negative and flat periods. By contrast in nominal terms the investment into cash only increased.

    This then is the dilemma. Accepting a lumpy return with periods of setback or a smooth return. Fortunately it’s not a case of one or the other, but a combination. And the best way to determine the combination is to continually assess the relative valuations.

    Hope that this gives some food for thought


    Ian de Lange

    Permalink2008-05-27, 16:51:41, by ian Email , Leave a comment

    What has the average investor received?

    A US company, Dalbar, releases a report titled the Quantitative Analysis of Investor Behaviour - QAIB. In the report they attempt to examine the result of investor behaviour compared to the actual market returns. The results are very interesting.

    It is based on US data derived from the Investment Company Institute, which tracks a variety of mutual fund data. Similar information is available in SA, concerning flows into and out from various mutual funds.

    Their key finding is this:

    They have been producing the report since 1984 and the results reflect to varying degrees that the average investor earned significantly less than the mutual fund performance data would indicate.

    I think the same analysis can be extended to the performance of individual shares. We know that at market peaks, new money is attracted in increasing quantum.

    They make this important point:

    Investment return is far more dependent on investor behaviour than on fund performance. Mutual fund investors who hold their investments are more successful than those who time the market.

    Over the 20 year to 2006 they found that

    o The S&P 500 produced an annual 11,8%
    o The average equity investor a return of just 4,3%

    Investor’s fear and greed instinct has and continues to detract enormously from potential returns available. Far too many, in fact the majority of investors tend to rush in when the market is moving up and rush out when the market is going down. This reduces investor’s returns to a fraction of what they should be.

    Investors are also drawn to the allure of new funds and funds that surge in popularity, again reducing returns.

    How is this overcome? Well it’s not easy to discipline highly charged emotions of fear and greed, but their report makes the following point:

    QAIB shows that investment returns increase when the natural characteristics of herding, mental accounting, narrow framing, loss aversion, media response etc, are replaced by disciplined investment behaviour. While many investors can overcome these hurdles, most need the support of a financial advisor to supply the required discipline.

    In our process we list behaviour risk as the third of three main risks that investors face. A detailed annual report such as Dalbar’s QAIB report quantifies this risk on an annual basis. Achieving less than half of the return is not acceptable.

    ALL investors should consider the potential opportunity cost of NOT having an ongoing disciplined approach to investing. It’s at times like this that investors must ensure they have a strategy. Looking at the list of equity funds for the 12 months to April – the average is 2%. The average of the value funds is a negative 3,5%. Throwing away a strategy at a market bottom has proven to drastically reduce returns.

    If you need to construct a strategy for the next 10 – 25 years, give me a call. 021 5511580

    Kind regards


    Permalink2008-05-26, 17:17:36, by ian Email , Leave a comment

    Are developed markets now more attractive?

    A strategy report that came out from Merrill Lynch this week was titled Déjà vu in Emerging Markets. One of their calls for 2008 is overweighting developed markets versus emerging markets. For investors in South Africa, typically with the bulk of their funds in an emerging market, it’s important to note some of the reasoning.

    Their call is not necessarily shared and is controversial, given the momentum in emerging markets and the fact that global investors in general still find them attractive.

    For the current year to date, developed and emerging markets have experienced their tightest race in 20 years.

    o S&P500 total return to 16 May is down 2,2%
    o FTSE100 was -1,7%
    o TOPIX (Japan) was up 3,6%
    o MSCI Emerging Market index up just 0,3%

    Emerging markets have experienced a positive relative performance for the past 7 years now from 2001.

    Prior to that the period 1994 - 2000 favoured developed markets.

    Their concern for possible slowdown in Emerging Markets is:

    o Overvalued equity markets
    o Slowing growth
    o Rising inflation

    So the global growth story has quickly turned into the global slowdown story and they therefore believe that investor’s expectations for growth in emerging markets are too optimistic.

    They note that in 2006 approximately 70% of the world’s economies were experiencing accelerating GDP. This has now slowed to 2 out of 35 countries. And so while portfolio managers still need to structure portfolios for a slowdown, this is not generally the case where portfolios are overweight cyclical sectors such as energy.

    They questions why investors should be surprised that inflation is popping up everywhere in emerging markets and then state that, “The history of emerging market investing is riddled with stories of poorly managed monetary policies leading to inflation. That seems to be the case today.”

    Plotting the relationship between rates of inflation and performance, they note that countries with higher rates of inflation have tended to underperform those with lower rates of inflation.

    A simple model of comparing a countries expected growth rate with price to sales (used because of differences in accounting for earnings from country to country), also reflects that developed markets are generally ranked higher than emerging markets. The one emerging market exception is Turkey, which they find attractive.

    Brazil remains the most attractive BRIC market, but India and China overvalued.

    Allocating capital to developed markets out of SA appears to be prudent. Out view is that we cannot predict a currency, but we can make some assessment of relative valuations of companies. After underperforming on a relative basis for many years, developed markets do appear attractive.

    Have a great weekend


    Ian de Lange

    Permalink2008-05-23, 17:13:04, by ian Email , Leave a comment

    A closer look at inflation calculations

    When the world’s largest global bond investor is concerned not just about inflation, but the extent to which it’s being understated in the US, then all investors need to sit up and take note. Inflation is a key number for all investments. Everyone understands that inflation is an ongoing depreciation of the purchasing power of money.

    While government’s calculation of the inflation rate should account for most investor’s inflation rate, we also understand that it probably understates each person’s actual inflation rate, given varied baskets of goods.

    As investors and consultants, it is imperative that an inflation number is calculated as accurately as possible.

    But global bond manager, Pimco is once again questioning the methodology of calculating US inflation and the authenticity of the published numbers.

    Quoting Abraham Lincoln’s famous quote,

    You can fool some of the people all of the time,
    and all of the people some of the time,
    but you cannot fool all of the people all of the time.

    Against a range of countries, which has been running at an average of 7% inflation over the last decade, he questions how the US has an average of 2,6% over the same period.

    There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. Wages, interest on debt, pensions etc, all benefit from low inflation numbers.

    So how has the US massaged its official inflation number down.

    Pimco’s Bill Gross says the US seems to differ from other countries in terms of how it calculates inflation rate, when it starting making changes some 25 years ago.

    Some of the changes to the computations of inflation include:

    1. modifying the cost of housing, by using substituting actual cost by what an owner would get if he had to rent the house out. He estimates that the average cost of houses has escalated 3 times the annual owner’s equivalent rent and so this has been at least an annual 1% under calculation of inflation.

    2. IN the 1990’s inflation calculations were adjusted downwards by product substitution on the presumption that more expensive goods and services would be used less and substituted with less costly alternatives.

    3. Then they also implemented quality adjustments for improvements in technology. i.e. as the price of computers was moving up slightly by “a hundred bucks or so”, it was actually going down for purposes of inflation calculations because it was considered more powerful. So called hedonic quality adjustments.

    Then there is the fact that government policy concerns itself with core inflation, as opposed to headline. Core excludes the impact of oil, and in the US was a concept initiated by Nixon a soil shot up to $12/barrel.

    Headline has moved up far ahead of core and is unlikely to come back in line again given price pressure.

    Locally Cpi-x excludes mortgage and fuel.

    Inflation concerns have wide reaching implications for asset allocations. Conservative, low volatility “assets” such as bonds and cash end up being riskier assets classes over medium and longer term as they cannot provide inflation proof returns.

    Portfolio construction is a critical area for all investors.


    Ian de Lange

    Permalink2008-05-22, 17:39:10, by ian Email , Leave a comment

    Long Term Investing

    We all know that investing should be for the long term, but human nature compels us to watch our investments like a hawk. We sit trawling the internet, and listen to TV and radio pundits, trying to eke out any bit of ‘information’ that will help us to make better decisions. Very often this leads to destruction of capital through excessive trading.

    A solid investment strategy involves purchasing a company (that has good prospects) when there is a margin of safety. Part of the investment process is in understanding that the company’s share price requires time to go from being undervalued to having the value realised. If you have done your research properly then you should know what the company’s true value is, and ideally there should be a large gap between the purchase price and true value.

    If your portfolio is composed as mentioned above, then all the news flow should do (if it has any effect at all) is slightly alter your idea of true value. An example is buying a company at R30, believing that true value is actually R50, and then waiting for true value to be reached (one can also often hang on for a bit longer and only sell above true value). News items along the way will affect the true value. If earnings are stronger than expected, or the dividend payout is larger than anticipated, then true value may rise to R60, with share price moving up to R45. Bad news may push true value back down to R55, while the price falls to R35. Prices often fluctuate more than value, and you need to be aware of this when investing.

    In this example the ‘investor’ who buys on the news flow (buying when good, and selling when bad) will buy at R45 and sell at R35, while the investor who has done their research, and buys on the back of solid fundamentals will have bought in at R30, and then held through the good and bad news. As long as the investor believes that true value is higher than actual price, and that the true value is attractive relative to other investment opportunities, then the share should be held.

    This is obviously a very simplistic look at investing, and it is never this easy, but by being patient (and waiting for good investments to come around) you will be able to make better investments that you can hold onto for longer.

    The benefits of holding onto an investment include:
    • Gains being classified as capital gains, as opposed to income gains, if the investment is held for more than 3 years.
    • A reduction in transaction costs (each transaction triggers fees that detract from performance. More transactions results in a larger performance drag).
    • Making fewer mistakes. Importantly by making fewer decisions you will be able to cut down on your mistakes. We are all human, and mistakes are inevitable, but if you wait until you have a high conviction in a share, you will be less likely to make a mistake than if you invest your capital at any fleeting opportunity.

    In a world where instant gratification is sought after, we need to remember that those who sit back and channel out the noise are the ones who will be successful over the long run. And long term satisfaction is far more rewarding than short term pleasure.

    While it can be tough on your character, investing for the long term has been proven to add value.

    Take care,

    Mike Browne

    Permalink2008-05-21, 16:39:53, by Mike Email , Leave a comment

    The dividend discount model

    I discussed Lewis’ results yesterday and noted the dividend yield. This prompted one reader to ask “Thanks ….. you spoke about the dividend yield, I have heard about the forward earnings yield and the dividend discount model, but don’t really understand. Perhaps you can elaborate.” I will look at the forward earnings yield another time, but briefly discuss the DDM.

    As a shareholder of a company, one is entitled to receive dividends as and when they are declared by the board of directors on an annual or semi annual basis.

    There is no guarantee that dividends will be received, and often when a company is in a growth phase or when in financial difficulty it will have no choice but to pass up on paying a dividend. Both scenarios are obviously problematic when it comes to using this model.

    But for most established companies, shareholders come to expect annual dividends. In more extreme cases when steady dividend paying companies pass up on paying a dividend, shareholders get more than annoyed. A recent example was the Mutual and Federal’s initial “decision” not to pay a dividend, which had shareholders extremely dissatisfied.

    So the basic theory behind the dividend discount model is that a share or company is worth the discounted value of the current and all future dividends that it will declare to its shareholders.

    In a way this model looks at a share as a type of perpetual bond. I.e. an asset that pays an annual coupon, being the dividend, into perpetuity.

    To value a cash flow into perpetuity, the formula is:

    o At zero growth -: price = dividend/discount rate

    E.g. a prospective company that is likely to pay a steady R750 000 dividend per year. You as a prospective buyer are satisfied with a 15% required annual return. What price will you pay for the company? Simply R750 000/15% = R5m.

    If however you a reasonable expectation that the annual dividend will grow by say 10% p.a., then naturally you would expect to pay a higher price for the business. In this case the formula is:

    o Price = dividends / (discount rate – expected growth)

    In this case a reasonable price is R750 000 / (15%-10%) = R15m.

    If the business were in a risky business sector, or the profits more volatile, then while a buyer may factor in an annual 10% escalation, he may want to increase the discount rate. The rule is higher risk = a higher discount rate. So perhaps a discount rate of 20% may be more acceptable.

    In such a case the value would decline to : R750 000/ (20%-10%) = R7.5m.

    So you can see that the fair value is very sensitive to the growth rate and discount rate used. The dividend discount model is just one of the metrics that should be used to value shares.


    Ian de Lange


    Permalink2008-05-20, 20:02:37, by ian Email , Leave a comment

    some comments on a value share

    I have completed a quarterly report and concluded that large scale optimism in the resources sector is leading to more expensive prices, while large scale pessimism in certain market sectors may just be revealing investment opportunities. A case in point was that while the resource heavy index moved up to a new high, Lewis, which has been under immense pressure gained over 3% on the day.

    Lewis Group announced its annual results today. The company has a March year end and in the tough 12 months, managed to increase revenue by 8,2% to R3,6 billion.

    Of this R1,88 billion was actual merchandise sales, up just 4,5% from 2007.

    The balance of the revenue account comprises finance charges of almost R800m, insurance premiums of R564m and ancillary services of R347m

    Operating profit by the same percentage of, i.e. 8,2% and so margins remains intact at 25,9%

    Earnings per share increased by 10,3%, with headline earnings up only 6,9% to 689c.

    Because these retailers sell mostly on credit, the quality of the debtor’s book is an important aspect for management. The provisions were actually decreased from 14,9% to 13,5%, which is surprising. But they do state that this was due to write off of older debt, which was fully provided for.

    Management note that due to centralised credit granting, but in store debt collection policies continues to ensure quality of the debtor’s book.

    The debtor’s book on the balance sheet gained 20% to R2,6 billion and so there does appear to be some slow down in collection period. On a gross basis the debtor’s book increased 7%.

    Lewis provides some indication of the debtor’s book and from this we can see that various levels of non performing and slow paying customers are up slightly from 2007 as the tougher interest rates start to bite.

    The company is turning down more credit applications – some of this increase is probably due to the implementation of the NCA, but also management not wanting to write bad business, just to boost turnover. The credit application decline rate increased from 20,1% to 22,5%.

    On this basis then the net asset value of the company is R30,58 up from R27,74. The return on average equity at 24,4% , similar to 2007.

    The environment has and continues to be challenging. The results are a reflection of this, with headline ESP up just 7% for the year, yet the share price jumped 3,3% on the day after the release of these numbers.

    It’s an indication of the extent to which this share, along with many other retailers was knocked down. At R35,60, the price is trading at 1,1 times book value and an historical PE of just over 5 times.

    The dividend paid was a total of 323c. This is slightly behind the consensus forecast of 343c. Still at R35, the price trades on a yield of over 9%.

    On a PE relative basis this is now less than 1/3 of the market. This provides a buffer and value investors are looking at this company very closely.

    I will be mailing out the Seed quarter report tomorrow. If you have not signed up on the Seed website for regular topical newsletter, please visit the site and sign up for the newsletter. Go to www.seedinvestments.co.za

    Kind regards


    Permalink2008-05-19, 17:23:59, by ian Email , Leave a comment

    Using futures to reduce volatility

    Greater market volatility and uncertainty is disconcerting to many investors who prefer to see a smooth steady gain in their asset value. The reality is however that returns from real assets are just not linearly distributed, which in English means “it’s a bumpy ride”.

    Today I want to chat about one method used by managers to try and smooth the price volatility and that is using derivatives.

    More and more fund managers are making use of futures in portfolios. They have been used extensively by hedge fund managers as a means to enhance returns and limit downside.

    Lets then take a brief look at how futures work.

    A typical “long only” portfolio manager with a fund of say R100m would buy into a range of shares with the view that these shares would rise in price over time. The manager would sell something that gets too expensive and buy into what he believes to be more attractive.

    The total fund would rise and fall with market volatility, i.e. there is typically a high level of correlation.

    This is what is know as the cash or spot market.

    The same portfolio manager can, instead of buying the physical shares, buy the futures market. A future represents an obligation to buy or sell an underlying asset and so instead of buying Anglo shares, the portfolio manager can buy the Anglo future, which is an obligation to buy the physical Anglo at a later date.

    In this case the portfolio manager would retain his R100m cash on call a/c earnings interest, but still have an exposure to Anglos share price. He would however forfeit the receipt of dividends from Anglo.

    o So buying the shares one receives full upside but foregoes interest (because funds are committed)

    o Buying the futures one receives full upside, plus the interest on cash, but foregoes dividends.

    The futures fair price can therefore be established as

    Index or price level + interest yield - dividend yield.

    Because the interest yield is typically higher than the dividend yield a futures price is generally higher than the current spot price.

    The advantage of futures is that they can sold just as easily as they can be bought.

    A hedge fund looking to reduce volatility by reducing exposure to the market may adopt the following strategy.

    o Commit the full R100m to value shares.
    o Sell futures by selling the JSE All Share index for R100m.

    In such a scenario the portfolio will result in:

    o Synthetic cash through the sale of the futures.
    o Plus or minus the performance of the basket of shares versus those in the index.

    This is a fairly simplistic approach and typically managers would vary the extent of shorting futures.

    Hedge funds are not regulated by the FSB, but are available to clients through life policies. These have typically displayed excellent longer term risk versus return characteristics. Don't hesitate to contact us for more information on this.

    Have a great weekend

    Kind regards

    Ian de Lange

    Permalink2008-05-16, 18:01:12, by ian Email , Leave a comment

    Investec reports results

    Investec Limited and plc reported annual results to the end of March today. A bank’s annual numbers are detailed and comprehensive and Investec’s are made more complex due to its 2 listings.

    On a combined basis operating profit before goodwill and tax came in at GBP537,6m up 15%.

    This was slightly behind consensus forecasts.

    The more important number is earnings attributable to shareholders. This came in at GBP391m up 15,1%

    Earnings rose 5,5% to 57,5pence, but headline earnings per share fell 5% to 49,7pence.

    Investec provides segment analysis geographically and across its main business divisions.

    Splitting up the GBP537m across the main business divisions is interesting.

    o Private banking GBP166,4m
    o Private clients GBP 27,3m
    o Stockbroking GBP115,7m
    o Investment banking GBP77,3m
    o Asset management GBP76,8m
    o Property activities GBP36,3m
    o Group services GBP37,7m

    So private banking, stockbroking, investment banking and asset management are the four main divisions.

    South Africa still remains the largest contributor to total earnings.

    Return on average shareholders equity decreased from 26,1% to 23,6%.. The target is anything greater than 20%.

    In total third party assets under management decreased slightly from GBP56,1 billion to GBP54,2 billion – these remain huge numbers.

    Expenses increased 19,9% to GBP831,8 billion.

    The big write down last year was due to the Kensington acquisition. Here Investec wrote down GBP59,9m. Against the SA Asset management business relating to businesses acquired in previous years, Investec wrote down GBP2,9 billion.

    On an historical basis the shares are trading on a multiple of around 7,6 times. This is not expensive. It does appear that analysts are looking for a greater slowdown next year.

    Nevertheless the price gained 1,8% to 5532c. It’s fallen from its peak and this should be closer to the bottom.

    Kind regards



    Permalink2008-05-15, 17:28:50, by ian Email , Leave a comment

    Two main approaches to portfolio construction

    I find reading and listening to various investment strategists key investment themes interesting. But the question is – does a macro theme approach provide an edge for investment managers. Two major approaches to portfolio construction and ongoing management are a top down and bottom up approach.

    A theme approach to understanding financial markets leads to a top down approach.

    But let’s look at some of the differences of each:

    o A reference to top down investing generally means using macro economic or global market factors as primary inputs to construct a portfolio.

    o Bottom-up investing on the other hand largely ignores what’s happening at a macro economic perspective, preferring to concentrate on micro issues affecting each firm.

    In analysing managers for inclusion into client portfolios, ascertaining the main investment approach is very important.

    Top Down

    An example of a global top down approach may be along the following lines. First analysing expected growth rates across the main geographic areas, include the impact of the interest rate cycle, and maybe also demographic data. Once overweighting a certain regions, say the US, then take a bird’s eye view of the main sectors, example exporters, retail consumer, manufacturing and banking, trying to identify particular industries that look attractive.

    So in the top down approach the idea is to start with broad macro measures and then shift down to regions, countries, industries and also currencies.

    The idea with top down is to make money by shifting funds to rising trends as opposed to evaluating the investment case for specific companies.

    The problem with the approach is that there are a myriad factors that cannot all be identified, making seeking out inefficiencies near impossible

    Bottom up approach

    In contrast a bottom up approach spends far less time on considering macro economic variables.

    Here portfolio managers spend the majority of their time on ranking the available universe of shares, filtering out ones that don’t meet specific criteria and then once they have a smaller list of available investments start to consider micro issues that affect profitability and hence valuations.

    Bottom up investors will need to consider macro drivers such as oil price, exchange rates, interest rates etc into their valuations models, but they tend not to take views on these because they are not easily determinable as we all know.

    As a general comment I would say that the majority of successful investors are bottom up investors. And then typically with a strong value bias.

    While many professional will also use a top down approach as an overlay to their bottom up analysis, many amateur investors will spend a greater percentage of their time on trying to understand the macro position.

    Have a great day



    Permalink2008-05-14, 16:56:46, by ian Email , Leave a comment

    Investment Product Proliferation

    This last week I took note when a senior high level strategic consultant to a large financial institution mentioned the difficulties she had in determining the best investment advice when she went on formal retirement – Despite excellent knowledge of the financial and investment industry, when it came to her own circumstances, she struggled to receive clarity of advice.

    A common problem area is product proliferation.

    No one can blame a financial institution, small or large from developing products which have specific features. A financial institution’s business is no different from say a motor dealer. They both create products that have certain qualities and features, spend money on marketing and then appoint salesmen.

    That’s business.

    Many investment products have valuable characteristics and may be attractive for a segment of your total portfolio.

    Investment products use various methods to essentially convert straightforward investments into something with a different payoff profile.

    This is done using a variety of tools including:

    o More and more sophisticated and readily available derivatives.
    o Utilising the tax arbitrage across individuals, trusts, companies, life companies etc,
    o Using the balance sheet of a financial institution.
    o Smoothing of returns
    o Lock up terms
    o Using leverage to enhance returns, etc

    Unfortunately while these products may serve niche requirements, assist in reducing risk to a total portfolio and genuinely have attractive qualities, they are too often sold to unsuspecting investors who in many instances don’t need the product.

    Some of the potential pitfalls to look out for

    o The packager of the product will always build in a profit element for themselves.
    o They will often package the product to appear very attractive – i.e. highlight the upside, use past performance and downplay the risks.
    o Implement time pressures

    Remember the one valuable “tool” that investors have is time. Never be forced or rushed into making a decision. Take your time to first understand all the pros and cons of any product and how it fits into your total strategy.

    As investment advisors to high net worth clients, we will always look at various products, but only where they can truly add value to our client’s portfolio in excess of their costs, would we consider. More often than not building a diversified portfolio provides the same expected payoff profile with lower costs.


    Ian de Lange

    Permalink2008-05-13, 16:57:59, by ian Email , Leave a comment

    What drives share prices

    Investors are fully entitled to ask the question – what exactly drives investment performance. “Is it a hit and miss affair, is there too much insider information, or is there perhaps some science to long term results.”. I looked back at longer term history to gain some perspective of the drivers of overall returns.

    The good news is that there is some science to the process, but it takes some patience.

    In the long run share prices are determined primarily by growth in earnings and dividends. Dividends are a function of earnings, and therefore long run earnings growth drive prices.

    o A steady up tick in earnings WILL result in a steady appreciation in prices
    o A collapse in earnings WILL result in a collapse in prices.

    If an investor knows that the long run growth in company earnings provides the foundation around which share prices move, then this must be the anchor around which valuations are determined.

    When plotting the annual earnings increase against the JSE All Share price graph, its very evident how closely the two track each other over longer periods of time.

    But the relationship is not perfect and for periods of time, prices run ahead, while the companies grow their earnings quicker. At other times price appreciation runs ahead of underlying company profits.

    In addition to the annual growth in earnings (or more accurately dividends), investors also receive the initial yield. I.e. the initial dividend.

    Investors can sometimes also benefit by paying a cheaper price (say 10 times) and selling at a more expensive price (say 12 times). But over time, in the aggregate this so called rating change has proven to be a relatively small percentage of total return. At times rating can be negative, i.e. detract from performance.

    So the 3 components of the total return from an investment into equities are:

    o The initial dividend yield.
    o The compounded annual growth of those dividends
    o A possible rating change

    The biggest component is the compounded growth in earnings. Then comes the initial yield and then rating change.

    Over the last 40 years to December 2007 an investment in the JSE All Share index would have returned 21,1% compounded, made up as follows:

    o Initial dividend of 4,9%
    o Annual growth in dividends of 13,2%
    o Positive rating change of 3,1%

    Over the last 10 years to December 2007 the total return was 21,8% made up as follows:

    o Initial dividend of 3,1%
    o Annual growth in dividends of 16,9%
    o Positive rating change of 1,8%

    Although the initial dividend yield is only the second largest component, the yield determines the subsequent annual growth. Buy on a higher yield and subsequent growth rates tend to be higher – buy on a initial low yield and the subsequent growth rate will tend to be lower.

    Sign up on www.seedinvestments.co.za for a once off copy of the Seed Investments Quarterly report.


    Ian de Lange


    Permalink2008-05-12, 15:31:22, by ian Email , Leave a comment

    Investment Strategy

    Earlier in the week I wrote about how active managers are able to outperform the market. While outperforming a benchmark is great, and getting good absolute returns is also sought after, it is no good to choose the best manager but then not have enough capital to invest with him. It is important to have sufficient capital invested in order to retire comfortably.

    After going through 5 years of excellent absolute real returns until October last year, where significant capital has been accumulated, we have hit a bumpy patch. Returns have been more volatile, and the rand has also been unstable (and trended down quite significantly). There are many ‘problems’ that should affect both local and global markets. News flow isn’t that great.

    It is in markets like these that the average investor will be more inclined to hold off on their investments, instead letting their disposable income sit in their bank or other interest bearing accounts, until there is more ‘clarity’ on the direction of the market. The rationale behind this kind of decision is that rather wait until an investment can be made that will yield attractive returns, than allocate capital to an underperforming asset.

    For this reason investors are understandably jittery about investing, but it is often when investors are most nervous that the largest opportunities are available. Many value managers have been delighting in the quality companies that they have been purchasing at low PE multiples, and high dividend yields. These qualities have historically led to superior performance over the longer term, but you need to be in the market when it takes a turn for the better, otherwise you will have missed out on a good opportunity.

    Investing isn’t a science, and no one has a crystal ball that can tell them where the market will be in 12 months time. In times like these the old axiom, “it isn’t about timing the market; it is about time in the market” is so true. While there is a place for moving a portion of your investments into and out of the market when values are at their extremes, the most important decision is getting the basic allocation correct that will ensure that you achieve your investment targets.

    Investors close to retirement will obviously have a shorter time horizon than those who are far away. For these older investors timing the market does become slightly more important, particularly if their asset allocation needs a major overall. While their time in the market won’t be as long as younger investors, with the advances in medicine one can expect to live for around 25 years in retirement, hardly the short term. For those investors who want to leave money for future generations their investment horizon begins to extend even beyond the 25 years, and will be influenced by when the beneficiaries will retire.

    Investing is all about assessing the available information, and making decisions accordingly. Understanding how the markets move, and the main reasons to be invested will dramatically increase your chances of being successful. If one simply says that markets tend to move up (in the long term) and that the main reason to investment in the market is to earn a high enough return on your assets to retire comfortably, then it makes sense that you need to have a significant portion of your capital invested in the market for a considerable portion of time in order to achieve your goals.

    I haven’t sought to provide a comprehensive list of how to be a successful investor, but rather provide some food for thought on the importance of having a strategy before making your investments. As with any activity, if you are able to sit down beforehand and think about what you’re going to do, and how you will react to certain situations based on what you want achieve from that activity, you will have a better chance to succeed than if you went in blindly.

    Enjoy your weekend, good luck to the Sharks and Stormers in their quest for a semi final!

    Mike Browne

    Permalink2008-05-09, 16:15:43, by Mike Email , 1 comment

    Long term real returns

    At the beginning of the week I started discussing historical inflation data. Today I looked back at the performance data, looking at the level of real returns generated. As inflation picked up sharply from the early 1970’s, the equity markets stumbled a bit. I am not inferring a direct relationship because there are always a multiple of factors, not least of which is prices coming off a high base.

    1975 and 1976 were very difficult years, where investors suffered back to back negative years of -12,3% and -3,3%.

    Then came four excellent years to 1980, where the JSE gave investors 29%, 36%, 91% and 41%.

    The last 5 years 2003 – 2007 have been consistent back to back winners with an average return of 29,4%. As mentioned inflation during this period was low, averaging just 4,4%. The real returns received have therefore been fantastic.

    Rolling 5 year returns

    Because an investment into equities should be done on a multi year basis, its good practice to monitor your investments on a 5 year rolling basis – often we are too short term focused.

    When stripping out inflation, the past 5 year rolling returns presents a picture of 24,4% - the highest its ever been since 1960. The last time it came close to this level was back in the late 1970’s to 1982.

    Remember the long term average real return on the equity market has been around 7,5% - 8% per annum.

    So by definition investors in history must have also suffered 5 year rolling periods of negative real returns. Looking back, 4 such periods occurred – with the last being 1994-1998. Over that time investors suffered an ANNUAL negative 3,4% (after inflation).

    Other times have also been difficult. In 2000 to 2004, investors received an annualised real of just 5,8% (i.e. less than the long term average).

    As we all know 5 years is a long time to watch with your money invested, while other asset classes are appreciating. Because performance from assets tends to go in cycles, so real returns achieved tend to move in cycles.

    This is important data to monitor in order to try and determine asset allocation.

    Have a great day


    Ian de Lange

    Permalink2008-05-08, 17:32:59, by ian Email , Leave a comment

    Active Management of Equity Funds

    As part of our investment process we are constantly sourcing information on the investment fund universe, be it information on new funds, funds that we invest our clients’ money into, or funds that have been around for a while that we want to keep updated on. The information comes through reading about them in the press and on their websites, analysing their holdings, attending their roadshows, or (mainly for the funds that we use) speaking directly with the fund managers.

    Through these interactions and through our own research we establish a short list of managers that we believe will outperform the market over the long term (3 – 5 years), and then direct client funds to them. We continually monitor the fund managers that we use to ensure that they continue to manage the fund as they should, keep an eye on new funds that pop up (often with experienced managers), and keep track of those funds where there is a change in manager/process, to keep our short list as relevant as possible.

    Among the decisions that we need to make is whether to make use of active or passive funds. In a nutshell passive funds seek to track a benchmark as closely as possible trying to keep costs as low as possible, while active managers attempt to beat the benchmark and don’t explicitly aim to minimise costs (although some of their strategies will result in low costs). With the active fund’s target of beating the benchmark it makes sense that the fund needs to be different from the benchmark (which will hopefully lead to outperformance). Being different from the benchmark generally means returns different from the benchmark, and while we understand what we’re getting ourselves into when entrusting capital with these active managers, there is often the urge to question their abilities when their returns are below the benchmark (even if only for a relatively short while).

    This week I spoke to one of the equity managers that we invest with, and attended a roadshow for a well respected management house whose funds we also invest into. Both have an excellent long term track record, and while one has struggled of late, the other is now enjoying a patch of good relative returns after going through a tough patch a while back. Both independently reminded me of an important fact in the investment business - in order to be better you need to be different. In being different there will be periods where you are wrong, but as long as you are right more often than you are wrong (and when you are wrong you don’t permanently lose capital) then you will be better off in the long run.

    The reality of underperforming at some stage frightens many investors away. When these managers do underperform many investors don’t have the stomach to hang in – too often switching at exactly the wrong time. This is a behavioural trait, and one that costs investors time and again. In order to reduce the chances of this happening you need to ensure that you have thoroughly researched the managers you intend on using, and be confident that they have the ability to outperform over the long term.

    If you don’t do the research, don’t want to appoint someone who will do the research for you, or if you have a serious aversion to being different from the crowd, then possibly a passive tracker fund or ETF is more suitable. Remember though that market return is not a risk free return. Also, index construction applies a higher weight to more expensive and therefore less attractive shares.

    While some statistics indicate that only 30% or so of active managers outperform the index, when one spends the time looking at the detail a couple of points emerge. Firstly, those that struggle to outperform are often no less than index huggers, i.e. managing a portfolio close to the index. Secondly, the style bias of those that outperform tends to be that of value managers.

    There clearly is an opportunity to beat the market; you just need to get the odds in your favour.

    Ian is in the process of finalising a detailed quarterly report which is normally only sent to our clients. We will, however, also be emailing this copy to those investors who sign up on the web page who insert their FULL name and e-mail address. Please go to www.seedinvestments.co.za and sign up for the mailing list. The report will be emailed out next week.

    Enjoy your day.

    Kind regards,

    Mike Browne

    Permalink2008-05-07, 17:25:22, by Mike Email , Leave a comment

    The cost of hedging

    The dangers of hedging were apparent with Anglogold’s announcement that it will be reducing its hedge book by way of a massive rights issue. This looked like the catalyst many for hoping for and the share price gained 9% to R287. Just how does this hedging work?

    Over many years the price of gold in USD was declining steadily. As a major gold producer it could not have been encouraging faced with each year’s mined production being sold at lower and lower prices.

    In such a scenario it makes sense to hedge. i.e. sell unmined ounces at today’s prices on the assumption that the price will continue to fall. Theories abound that some companies were encouraged to sell forward on the understanding that central banks would be selling and or leasing in order to put pressure on prices.

    In some respects selling gold forward by the major gold producers was a self fulfilling prophecy in that it created greater supply onto the market, leading to pressure on prices.

    A producer will enter into contracts selling gold forward at a fixed price. In this respect it defines and caps its income per ounce sold. This is naturally problematic as the spot price of gold starts to move above the hedged price.

    Anglogold started selling production forward in 1994. It worked in their favour for many years as the price fell from around $400/oz in 1994 to a multi year low of $253 in 1999. Thereafter the price started picking up steadily and this has a negative impact.

    In the last year as the price of gold moved up to $1000/oz it hurt Anglogold badly. To give an idea it indicated today that should it raise funds, procure early settlements on some forward contracts, then it anticipates that the price it will receive for the remainder of 2008 will be $475/oz against an assumed price of $900/oz.

    Over the years it has reduced its hedge position, but at the end of December 2007 it had total committed hedge position of 11,28million ounces.

    Now today Anglogold announces a 1 for 4 rights issue, looking to raise approximately R11,9 billion. This is a massive dilution for shareholders of a R75 billion company.

    They say that if the restructuring is executed as currently anticipated the overall impact will be to reduce the hedge book to an approximate 6,25m ounces. Still a big number, but heading in the right direction.

    In many respects its also an indication of where they see the longer term trend of the gold price. They have suffered the price moving to US$1000/oz, now that its fallen back, they perhaps see this as the right time to buy back sold ounces.

    Gold gained 3,2% to $880/oz.

    The gold index gained 5,2%.

    I am in the process of finalising a detailed quarterly report, which is normally only mailed to our clients. We will however also be mailing this copy to you if you sign up on the www.seedinvestments.co.za website and insert FULL name and e-mail address. The report will be mailed next week.

    Kind regards

    Ian de Lange

    Permalink2008-05-06, 17:40:44, by ian Email , Leave a comment

    A quick look at inflation over 48 years

    JP Morgan produce a detailed report on the annual returns from the different asset classes. The data goes back to 1960 and so gives an investor a longer term perspective. Investment performance is naturally a key objective for all investors. Accurately measuring return and comparing to both benchmarks and risk is an important and ongoing task.

    The historical performance data across multiple asset classes is a crucial element in determining an appropriate asset allocation strategy. Because it’s historical in nature, it’s not the only element, but a good start.

    The report makes the following comment about diversification, “Given the varying returns, the different risk profiles and the lack of certainty that historical performance will be repeated in the future, “betting the farm” is rarely worth the risk.”

    Looking back at numbers over a 48 year period, its naturally easy is to justify a 100% weight to equities. However only when you start to look at the detail, is it evident that no single asset class outperforms each year. This is where the benefit of diversification comes into play.

    There are some interesting facts that emerge from the study and I will take a couple of reports to cover these. Firstly let’s look at the bare minimum hurdle rate for all investments, namely inflation.


    Throughout the 1960’s the official inflation rate was low. 1,6% in 1960, 1% in 1963, but slowly starting to pick up into the late 1960’s where it reached 4,8% in 1970.

    Then the oil shocks of the 1970’s kicked in and inflation started becoming a problem. 7,4% in 1972 and then 9,9% in 1973. In that year, neither equities, bonds nor fixed deposit returns could beat the almost 10% inflation.

    This was repeated in 1975 and 1976 when inflation touched 11,9% and equity returns came in at a negative 12,3%.

    Inflation continued heading up into the late 1970’s, recording 15,8% in 1980, as the price of gold made then record highs.

    Inflation persisted throughout the 1980’s as the rand depreciated, foreign corporates left the country, and government debt became a problem. In 1985 inflation ran at 18,4%, but in that year at least equities produced 41%.

    It was only into the early 1990’s with Chris Stals implementation of positive real interest rates, that the back of inflation was broken. Other factors came into pay such as an opening up of the economy, the China impact. And so double digit inflation came down to 2,2% in 1999 and 3,4% in 2004.

    On a 5 year rolling basis then inflation over the last 10 years inflation has been under control and reminiscent of the 1960’s. Average inflation came in at 5% for 2002 – 2006 and 4,4% for 2003 – 2007.

    The question now is have we seen the best years from an inflation perspective? If inflation is picking up, how did various asset classes perform in previous high inflationary periods?

    We will explore this in the week

    Kind regards

    Ian de Lange

    Permalink2008-05-05, 19:29:53, by ian Email , Leave a comment