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    Half way through 2008

    Half way through 2008. A lot has happened. I decided to look back over some past issues of Financial Mail to get a sense of the mood that the investors were in just 12 months back. In June 2007 the FM carried a cover story titled, “Absa / Barclays Happy couple”

    Two years prior to this Barclays had bought into Absa. It was a huge transaction and a major coup not only for the bank but for South Africa in attracting back a global banking player.

    Barclays bought into Absa in July 2005, now 3 years back. They bought a majority stake when the price of Absa traded at R82,40. The subsequent period was an excellent time for bank shares around the world and while Absa did not outperform its peers, the price rose to very close to R150 in April 2007.

    Then came the credit crunch and banks around the world fell sharply. Now Barclays 55% acquisition of Absa, does not look that fantastic. Yes they have taken dividends out, but the rand has depreciated and the share price is back where it started 3 years ago – closing today at R82,01, down 44,5% from its peak.

    Standard Bank peaked in November 2007 at around 118, falling to its current R76, a decline of 35%.

    This also marked the peak as China’s biggest bank, ICBC came in buying 20% of Standard for $5,6 billion. It was a complex deal with Standard issuing some shares at R104,58 a share and ICBC buying shares from shareholders at R136 a share.

    At the time many shareholders did not want to have to sell a portion of their Standard Bank shares at R136, but now the price is down 60% from this peak and clearly sellers were extremely satisfied with this deal.

    Large declines do not necessary indicate value. The price peaks may have been very expensive levels.

    RMBH has declined from around R37 to R21, a drop of 43%

    Nedcor down from around R155 to R91, a decline of 41%.

    On the other side of the spectrum, commodities have down exceptionally well, with the CRB index gaining 29%, the biggest gain since 1973 according to Bloomberg. The rise has now been parabolic and this in itself brings some risks.

    Commodities index

    The debate now is how long this will last.

    The first half of the year has been volatile, this looks set to continue into the remaining second half of 2008


    Ian de Lange

    Permalink2008-06-30, 21:04:58, by ian Email , Leave a comment

    Yields on Preference shares

    I touched on longer dated bond yields versus shorter dated money market interest rates yesterday. Another asset class that many investors have been disappointed in has been preference shares. These were introduced a few years back as excellent options for investors seeking good after tax yields.

    Expectations were that as interest rates rose, because these instruments paid out coupons based on a percentage of prime, as prime rose, so the capital value of these preference shares would at least remain intact.

    That was the expectation, but reality has fallen far short. As interest rates rose, so the capital value has fallen sharply – more than the rise in prime rates, so that now the payouts have grown in some cases to above 80% of prime from between 70% - 75%.

    A basket of preference shares can now provide a yield of 13,2%, while prime is at 15,5% - giving investors 85%.

    At a 40% tax, assuming one has utilised their tax free interest exemption, the differential between the after tax yield on preference shares and money market rates is as follows:

    o Money market after tax 7,2%
    o Preference shares after tax 13,2%

    The yield on preference shares is starting to look attractive.

    Until now, we have not been a fan of preference shares for a number of reasons and this has been a correct view has the total return has declined.

    But as capital values have declined and yields increased, so they have become more attractive. At 13% after tax they appear more favourable than the after tax return on money market, however with inflation at 10,9% officially and heading for 12%, this still leaves very little real rate of return.

    The extent to which real rates are being squeezed despite the Reserve Bank raising rates can also be seen from this graph, where CPI-x has the clear probability of breaching the repo rate level in coming months.

    As indicated we will closely monitor all available options in a rising interest and inflation environment.

    Have a super weekend



    Permalink2008-06-27, 17:36:15, by ian Email , Leave a comment

    Bond yields versus NCD

    Inflation spiking outside of the inflation band, led the Reserve Bank to hike interest rates. Higher interest rates have amongst other factors hurt the economy, but the question often asked by investors is how best to access these higher interest rates?

    Today there are numerous interest yielding instruments and each has their own nuances.

    Some of the options available for investors include:

    o Conventional money market funds
    o 3, 6, 9 and 12 month NCD paper
    o Government bonds
    o Corporate bonds
    o Corporate floating rate bonds
    o Listed property
    o Inflation linked bonds
    o Preference shares
    o Derivative notes

    Clearly higher interest rates have made some of these options now very attractive, but at the same time there has been risk and an element of capital loss across most longer dated instruments.

    For example if you were an investor who 6 months – 18 months backed started chasing the high returns that bonds and property had offered, you have unfortunately suffered capital loss.

    Bonds have traditionally been seen as a so called risk reducing asset class in a traditional prudential balanced fund. There is an element of historical significance when government prescribed certain minimums into bonds.

    And while total returns from bonds have provided a slighter better return than cash or MM over time, they can have longer periods of negative returns. Its important therefore to have a strategic weighting but to always ascertain on a tactical basis if there is value or not and adjust the portfolio accordingly.

    Remember holders of bonds suffer capital loss as interest rates start to move up. Buyers of these instruments demand higher yields in the new environment and because bonds have maturities extending from 12 months to 30 years, the longer dated values have to adjust to the new interest rate environment.

    Bond yields reached ridiculously low levels of just over 7% at the beginning of 2006. I.e. investors were satisfied to receive a 7,5% total return to maturity, in the expectation that inflation would be lower.

    Now buyers of that same bond are demanding 10,64% and in 3 months time it may be 11,5%! It could touch over 13%.

    When the interest rate cycle peaks however, investors want to have some flexibility and so lock in some of the higher rates. i.e. at that stage buy some longer dated paper and hold for a period of time.

    The trick is getting the timing right. From the data you can see how shorter dated paper, NCD has provided better yields at far lower risk. There still appears better value in shorter dated paper and this has been the case for a while.

    source Coronation

    We watch these movements and while never getting it 100% correct, have had very low exposure to government bonds in portfolios. There will come a time again when these are attractive.

    Kind regards


    Permalink2008-06-26, 20:00:01, by ian Email , Leave a comment

    May Inflation Surprise

    May’s inflation numbers were released today, and once again they surprised on the upside. CPI came in at 11.7% up from 11.1% to the end of April, and 6.9% a year ago. Consensus was 11.4%. CPI-X, which the South African Reserve Bank tries to keep in the 3% - 6% range, surged to 10.9% with consensus for this measure at 10.8%.

    CPI-X, owing to it being the targeted measure, is more widely reported in the press. We must not forget that this measure excludes the effects of mortgage bonds and as such, for those of us with outstanding mortgages, CPI is the more appropriate measure.

    Once again the main culprits are fuel and food inflation. Food prices were up 2.08% for the month, and food inflation is now running at 17% for the 12 months to the end of May. This is in stark contrast to an annualised rate of only 1.4% just 3 years ago. As you will notice the annual price increase 3 years ago is less than the increased prices experienced just last month! Over the 12 months ended 31 May 2008 the petrol price is up 31.7%, resulting in transport inflation coming in at 16.7% year on year. The year on year petrol price increase will soar to 54.5% for the period ended 31 July 2008 if the petrol price increases by 74c, as expected, next week! These factors are clearly pushing inflation up and up.

    Inflation has now been above the target band for 14 months, and is expected to worsen in the short term. Factors not included in the calculation of inflation to the end of May are the 27.5% increase in electricity granted to Eskom as well as the 5.4% increase in petrol price for June, and probable 7.4% petrol price increase in July as mentioned above. These factors, among others, are likely to push CPI-X above 12% in the near term, more than double the 6% upper target.

    Inflation rates do vary from region to region, and between different age and income groups. The area that experienced the highest annual inflation was Pietermaritzburg at 13.8%, with the Free State Goldfields area having the lowest inflation of 10.2%.

    Even when there is inflation in the economy there are often groups of the economy that experience deflation. With inflation as rampant as it is at the moment it comes as no surprise that none of the 14 groups experienced deflation over the last month or year.

    When there’s an inflation surprise on the upside it isn’t good news with respect to the repo rate. The May inflation figure has increased the likelihood that Tito Mboweni will raise interest rates again at the next MPC meeting at the beginning of August.

    CPI weightings are to be adjusted soon; details will be released to this effect on Stats SA’s website on 1 July.

    Have a good evening.

    Take care,

    Mike Browne

    Permalink2008-06-25, 17:09:54, by Mike Email , Leave a comment

    Negative terms of trade and real interest rates

    Tomorrow the US Federal Reserve announces any possible change to the US interest rates. They are concerned about rising inflation and the weak US dollar, which fanned some expectation for a possible hike in US interest rates, but Bloomberg reports that US economists believe interest rates will be left alone at 2%.

    The Federal Open Market Committee meets today and tomorrow, whereafter they announce on their decision for interest rates.

    Clearly monetary authorities across the globe are caught between the proverbial rock and a hard place. Inflation is on the rise – the typical antidote is a higher price for money, but at the same time economies are under extreme pressure, where the typical antidote is lower cost of money.

    The Fed acted aggressively to lower the cost of money, now it remains to be seen what their actions are, given higher and higher inflationary pressures. The challenge is not dissimilar to that of the local Reserve Bank governor.

    I turned to Paul McCulley from Pimco to see what his latest thoughts on the matter are:

    Writing from a US perspective, he points out that the soaring price of oil and food in recent months is an unambiguous negative real terms of trade shock. i.e. having to give up so much more to pay for the higher cost of imports.

    One way of looking at the terms of trade is to equate number of man hours needed to work to buy one barrel of oil. This equates a real variable with another real variable and the decline in purchasing power of wages in the US, let alone in the rest of the world is massive.

    In 1999 it required around 0,5 hours or labour to buy a barrel of oil. To buy that same barrel that same worker must put in around 6,5 hours.

    He goes on to say that a negative terms of trade is a real shock - it must translate into lower real wages and profits.

    Also it must translate into lower, even negative real short-term interest rates.

    This is exactly what the US and across the globe is experiencing. I.e. negative rates of return on shorter term interest rates.

    We always say that over any period of time, unless you have a Saambou disaster the return on cash will never be negative (i.e. in NOMINAL terms). Unlike returns on an equity portfolio it will always move up, but very seldom over the years will it move up in REAL terms.

    He then goes on to discuss that because we have global negative terms of trade AND asset price deflation, this is a prescription for a nasty recession.

    In the absence of any major second and third round inflation effects he makes the following point,

    “……it would be an absolute folly for the Fed – or any central bank in similar circumstances – to hike interest rates in an attempt to make the negative terms of trade shock go away. By definition, it can’t. And if it tries, it will create an even bigger mess.”

    The conclusion:

    Providers of labour to the market are receiving a massive hit to their real earning ability.

    Providers of capital, i.e. holders of cash are receiving a negative real short term interest rate.

    This is likely to persist and while cash may be a good move tactically, it is typically not ideal to have too high a cash holding on a strategic level. i.e. for very long extended periods of time.

    Don't hesitate to contact me to discuss any aspect to your investment planning.



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

    Index funds are not risk free

    I received a mail from a reader today on his unhappiness about the investment in the Satrix Dividend Plus exchange traded fund. He invested in the Satrix dividend plus during the IPO in September 2007 where the price was at R1,27. It rose to a high of around R1,40, but has dropped considerably and is now at R1,04 today. Clearly an investment into this ETF came with an element of risk possibly not that well understood.

    Naturally an investor feels aggrieved for some of the following reasons:
    o He is investing into an index which he understands to be typically low risk
    o The presentation that he attended displayed excellent historical data

    But since the IPO, the price has done nothing but go down.

    Let’s look at some of the issues, because many investors will find themselves in similar positions.

    Rob Rusconi has produced an excellent analysis on the merits of the Satrix 40 ETF with its relatively low costs. In addition to the Satrix 40, the other ETF managed by Satrix include Satrix Findi, Satrix Indi, Satrix Resi, Satrix Swix top 40 and the Satrix Divi.

    Essentially the Satrix funds are index tracking listed shares (actually funds). They do nothing more than tracking as close as possible the various indices created by the JSE and FTSE. In this way they allow investors to invest directly into the index.

    The detailed report compiled by Rob Rusconi on the Satrix 40 concludes that it’s an efficient tracking vehicle with low costs. There is no argument there.

    However the plea from my reader which I think resonates with many similar investors is this, “While I take a long term view with investments, I feel that there is something fundamentally wrong with this share. There was much hype and excellent historical data about the dividend plus index prior to listing.”

    The Satrix divi as with their others is a basket of shares. Its performance is no more and no less than the summation of the performance of the constituents.

    The incorrect assumption is made by too many investors that investing into an index is low risk, yet placing funds into the market or with a portfolio manager is high risk.

    The fund is advertised along the following lines:

    The Satrix Dividend Plus index selects 30 shares weighted to those with high dividend yields. The Satrix Divi provides a higher than average dividend yield (currently around 4,5% per annum) and holds the promise of out performance, as the companies that pay the highest dividends could be re-rated relative to the rest of the market, because of their strong cash flows and high earnings/dividend yield

    The Satrix listed on the 20 August 2007, closing at 132c, but trading as high as 180c.
    It’s down 20% to 106c on Friday close.

    The Satrix 40 closed at 2530 on that date and is now up 13% over the same period.

    We know that the Satrix 40 index is heavily weighted to resource shares such as Sasol, Billiton and Anglos, but let’s look at some of the components of the Satrix Dividend Plus.

    o Arcelor Mittal 9,77%
    o African Bank 6,33%
    o Angloplat 5,07%
    o Northam Platinum 7,54%
    o Telkom 4,81%
    o Implats 4,18%

    But then it owns the major banks – a total exposure of 14,4% and these have fallen sharply in price. E.g. Absa is down from R145 to R82 and Standard is down from R115 to R75

    Also fashion consumer businesses such as Foschini, Truworths etc. Woolies with an exposure of 3,21% has helped pull down the performance dropping from R24 to R10.

    Imperial has dropped from over R160 to R50.

    Clearly buying the Satrix Dividend plus index shielded the investor from such disasters, but not entirely from risk of capital loss over the short term. An investment into a basket of shares reduces the risk of investing into equities dramatically, but not entirely. Just because an ETF is touted as low cost, does not mean its low risk.

    For an investor to reduce risk further its important to consider other asset classes, example offshore equities, property exposure, hedge fund exposure etc. i.e. a total investment strategy, which defines the risk and potential returns.



    Permalink2008-06-23, 16:19:57, by ian Email , Leave a comment

    2007 new listings

    Across the world, the availability of capital is now far scarcer than a year back. New listings, which a year ago were doing extremely well, are a major causality of the dearth of capital. A year back the USD20 billion private equity firm Blackstone listed on the NYSE.

    I read today the ongoing concerns of investors with their investment into Blackstone Group LP, the US listed private equity firm that listed at the start of the US credit crisis. The company listed one year ago on the 2 June amidst a frenzy for the shares.

    A fantastic business, but within 6 weeks of it listing, the credit crunch kicked in and the price tumbled from a high of $38 dollars on the first day to $18,40.

    The winners were the owners of the company at the time of listing. The 2 co-founders reportedly received $2,6 billion from the IPO.

    Locally certain share listings marked the peak in valuations of various sectors. I was discussing the listing of ARB today. This was one of the companies that marked the tail end of the listings boom that had been building up some momentum.

    It’s no secret and I have said it many times before – when prices in certain sectors get expensive, owners of those assets become motivated to sell.

    This happened in the US, it happened across Europe and it happened in South Africa.

    No less than 62 companies listed across the main and Altx boards in 2007. 47 of these listed in the second half of the year. The momentum had been picking up for a few years.

    Bloomberg reports that none of the 9 analysts that follow the Blackstone share, expect it to recover in the next 12 months to its starting price. There is no surprise there.

    Likewise there are many local prices that are down sharply from their listing price, which are unlikely to recover in the next 12 months.

    In the froth of a good listings boom, investors can do very well as they buy into momentum. This demand in turn drives the owners of other similar assets to also consider selling, which in turn, helps create the momentum.

    This is why the sheer numbers of new listings increase, but quality tends to get poorer and poorer.

    In July Hulamin and Mondi were listed from Tongaat and Anglo unbundlings respectively.

    But then Kwikspace Modular listed on 8 Nov, traded at R12 and now down to R7.

    Mazor group listed on the Alt x on 21 Nov at around 450c, now at 300c.

    Vunani listed on 28th Nov at around 120c, now at 62c.

    Shorter term hype – be in the form of new listings or be in the form of “new economy”, “this time is different”, or “never go down” sectors – always runs of out steam.

    The mistake many investors make is that when they do find themselves at the right place at the right time, that they believe that the good times will continue into perpetuity.

    Most of the managers that we would use for clients portfolios avoid new listings – some will cherry pick, understanding the risks involved but looking for a bit of spice to the portfolio. Longer term they understand that buying at a full price, is a losing strategy. These managers are willing to undergo a shorter period of relative underperformance to avoid permanent loss of capital.

    A 50% loss of capital requires a 100% subsequent gain just to break even. Capital protection through booming and sideways markets is so important. If you are about to retire and need to consider planning, then feel free to contact us to have an intial discussion.

    That’s all for today

    Have a great weekend and enjoy the rugby.



    Permalink2008-06-20, 17:00:11, by ian Email , Leave a comment

    Remgro Annual Results

    The close of business yesterday saw the release of Remgro results for the year ended 31 March 2008. Remgro is one of South Africa’s larger listed company’s and is the spin off of the old Rembrandt empire created by Dr Anton Rupert in the 1940’s. Remgro is essentially an investment holding company, and holds investments in financial, industrial, and resource companies.

    The company holds investments across the board, with their main contribution coming from their effective 10.6% ownership in BAT Plc (British American Tobacco), which accounted for 44.6% of 2008 group earnings. Other industrial interests accounted for 24.1%, financial services accounted for 26.4%, mining 3.3%, and corporate accounted for 1.6% of 2008 earnings.

    Other than the holding in BAT some other well known companies that Remgro has a stake in include Firstrand and RMB, Medi-Clinic, Distell, Unilever, Rainbow Chicken, Nampak, and Implats.

    While the intrinsic value of their financial holdings (RMB and Firstrand) was down 31.2% for the year, headline earnings from this sector were up 35.2% to R 2.1bn. Industrials were more of a mixed bag with some increasing their NAV while others declined, and some increased earnings with others lower than in 2007. Mining contributions were up strongly mainly on the back of an R 8.4bn holding in Implats. Earnings from BAT were up 20.7% in sterling, with another 7.5% contribution from a decline in the rand.

    As is the case with most diversified companies, Remgro’s share price trades at a discount to NAV. This discount can in part be attributed to the difference between the directors’ valuations of unlisted operations and the general public’s valuation, but unlisted companies only account for around 10% of the company. The main reason that diversified companies trade at a discount is that investors generally prefer a company to focus its investments. This is typically a reason for unbundling companies, where management indicate that they’re going to ‘unlock value’. Despite trading at a discount there is no doubt that astute management can add value over time, and Remgro is a case in point. Anyhow, a new investor typically buys in at a discount, so continuing to trade at a discount shouldn’t have too much of an impact on the return achieved.

    The discount to NAV is currently 14.1%, having been 18.1% on 31 March 2007 and 22.8% at the end of March 2008. From September 2000 Remgro’s share price has outperformed the ALSI by 26.3% and the FINDI by 127.4%. Ordinary dividends have grown at 15.5% compounded per annum over the past 5 years. This is clearly a successful business.

    With all investment cases one needs to determine whether the company is successful as well as whether it is cheap or expensive, and with 40 unit trusts having at least 5% of their portfolios invested into Remgro, local fund managers are clearly showing that they believe it shows some value. It is one of Allan Gray’s larger holdings, and they like it as it has a large defensive earnings stream (BAT) that should protect earnings during a global slow down. As the 2008 annual report isn’t out yet I have been unable to ascertain just how large Allan Gray’s stake is in Remgro, but you can be sure that it is a sizable position.

    With the possible unbundling of the BAT position this is definitely a share to watch.

    Have a good day.

    Kind regards,

    Mike Browne

    Permalink2008-06-19, 16:24:32, by Mike Email , Leave a comment

    Inflation – A Dirty Word

    Inflation has, especially over the past 18 months or so, become a very dirty word in South Africa. When braai-side conversation turns away from Springboks and over to inflation and interest rates you know that the average South African is feeling the pain.

    After moving as low as 3.1% in February 2005, annual CPI-X (which the Reserve Bank is mandated to keep between 3% and 6%) has steadily risen, without slowing down after braking through the top of the target range in April 2007. As at April 2008 annual CPI-X stands at 10.4%!

    I clearly remember at the time that inflation looked like breaking through the target band that many economists were forecasting it to come back into the target band fairly quickly. Quite clearly the opposite has happened, and this can be blamed on external ‘shocks’ such as soaring energy and food prices. As these goods are priced globally it should come as no surprise that many other countries are also battling with inflation.

    Just yesterday I read on FT.com that the Eurozone’s inflation rate has hit a 16 year high of 3.7% driven primarily through oil and food prices, and that this number is expected to climb closer to 4% over the next few months. Now, while the absolute level is way lower than in South Africa, inflation still is a problem for the region with the ECB likely to raise interest rates in July. In the USA and Asia inflation is also on the up.

    Raising interest rates does generally have the effect of pushing inflation down, but also contributes to the slow down of growth. Governments around the world need to balance moderating inflation whilst not killing off growth.

    A typical inflation/interest rate cycle involves: inflation rates falling resulting in the Reserve Bank dropping interest rates to stimulate the economy and improve growth. When capacity usage increases above the long term trend prices start increasing at a quicker rate as new capacity is required. Bottlenecks in the economy result in inflation which causes the Reserve Bank to raise rates to cool the economy, as the economy cools inflation falls, and rates are dropped again.

    The problem arises in the above scenario when inflation doesn’t fall even as the economy starts cooling (as has happened in SA owing to cost push inflation). In these situations the Reserve Bank is in a tough spot. While raising rates will most probably not have the desired effect, the consequences of hoping that inflation falls naturally can be dire. In this situation the growth/inflation target trade-off becomes a very real issue.

    I was at a fund manager’s presentation this morning and the general consensus was that unfortunately inflation is here to stay for a while. This view is confirmed with NERSA’s ruling today that electricity prices will be going up another 13.3% after a 14.2% increase was approved earlier this year. Tariff increases are expected to be between 20% and 25% per annum over the next three years, putting more pressure on the local inflation rate.

    Whilst giving a brief overview of some of the variables affecting inflation, this report is by no means a conclusive review. As with most economic issues there is no definitive answer on how to solve the problem as there are many inter-relations between the various variables that react differently to each other depending on the specific circumstances. Globally the various interest rate setting bodies need to do their best to get things back in line.

    Take care,

    Mike Browne

    Permalink2008-06-18, 16:44:47, by Mike Email , Leave a comment

    retirement fund survey

    For so many retirees, their single biggest investable asset is the funds accumulated in their pension fund. On an annual basis Old Mutual produce a Retirement Funds Survey by interviewing various interested parties. I had a relatively brief review of the survey today.

    The retirement funding environment is complex, with many parties involved.

    We understand that most companies have attempted to cap their pension fund liability by moving employees from defined benefit funds to defined contribution funds.

    The other trend is the significant growth in the use of Umbrella funds and this growth is expected to continue. There are also a number of larger companies now also participating in Umbrella funds. An Umbrella fund comes in, where instead of a company establishing its own pension fund with increasingly onerous regulation, administration, and regulation, it opts to reduce this burden by aggregating with other funds.

    I was interested in a few elements of the survey, and where you are a member of a fund, it may be interesting to hear your view:

    o 71% of funds have a formal communication policy in place and 93% of funds indicate a responsibility to encourage existing members to preserve their retirement funds benefits. However only 50% actually provide advice and counselling to members who exit other than for retirement.
    o 76% of all funds provide members with pre-retirement counselling or financial advice, but 50% offering just one year before retirement.
    o 91% of funds interviewed consider the counselling to be effective.
    o 45% of all funds believe that it is

    Some of these numbers look high to me, such as 76% of all funds providing pre retirement counselling.

    All the defined contribution funds offer member choice. Some more than others.

    However despite this choice, it is estimated that approximately 80% of members use the default investment option.

    As far as the criteria for selection of asset managers to their pension assets, the numbers indicated:

    o Track record the most important – 55%
    o Performance (presumably recent history) – 48%
    o Reputation – 40%
    o Financial stability – 28%

    Relegated further down, were important criteria such as

    o Investment philosophy-26%
    o Management team- 9%

    These are just some of the points raised. Its clear from this survey and from ongoing discussions with employees or retirees that what is lacking is comprehensive investment planning and management across an investors total asset base, i.e. pension fund and discretionary assets.



    Permalink2008-06-17, 17:03:39, by ian Email , Leave a comment

    Bringing it all together

    Our business is fascinating because we spend a lot of time working with private clients, assessing their longer term requirements and developing strategies. As managers to the client’s portfolios we then also spend a lot of time with various funds and portfolio managers in order to assess their approach, investment style, philosophy, macro and micro views etc, to determine whether our clients should invest or not.

    In most instances these 2 main functions are separated out. Investment consultants have tended to provide the advice element, in varying and sometimes questionable degrees of quality, while asset managers have tended to only focus on the money management, with little or no concern for the objectives and requirements of the client invested.

    I have always believed that having a process to combines both roles, excellent investment strategy planning, but continuing to spend a lot of time on investment component of the business will ultimately benefit clients.

    Despite spending a lot of time with various portfolio managers and on research, arriving at specific investments to match the investment strategy is not easy, especially with so many conflicting views.

    Today we have what Merrill Lynch have called a “Great Divide” among investors. They introduced, saying.

    “Investors are at one end of the spectrum or the other. Should they invest for inflation or deflation? Has global economies decoupled, or is the US leading the world into an economic slowdown? Are commodities the “new in thing” or should investors be buying bonds? Both sides make cogent arguments but the debate may not do enough to help investors minimise their risks and maximise their returns.”

    There is no doubt, the issues are not, nor have they ever been easy to grapple with:

    Today we spent over an hour with a European portfolio manager. While not a fund in our client’s portfolio we are always on the lookout for investment funds to be included on a watch list.

    The views and portfolio from this specific European fund manager was strongly concentrated to the following major long term themes:

    o Growth in Asia
    o Death of cheap oil
    o European / global infrastructure

    From that they develop medium term views as sub sectors to the main them, so that the specific investment sectors include:

    Growth in Asia
    o Increasing food requirements
    o Mining
    o Maritime

    Death of cheap oil
    o Alternative energy
    o Oil services
    o Exploration companies

    European / global infrastructure

    o Security of power
    o infrastructure
    o Water

    These are widely held views, but approaching sub sectors from within a European fund and from different angles was very refreshing to see.

    That’s all for now

    Have a great long weekend



    Permalink2008-06-13, 17:44:38, by ian Email , Leave a comment

    The currency decision

    SA’s highly indebted consumers breathe a sigh of relief. Markets reacted positively. Why? Did interest rates stay flat? Did they come down? No, they went up by 0,5% today, on the back of 9 previous similar hikes since the same time 2 years back. That’s the power of painting a gloomier picture and then coming in with a slightly more positive outcome.

    The 0,5% rate hike had an immediate impact on the rand. It was expecting 1%, got 0,5% and so fell 1% to R8,0879 in late afternoon trade.

    South Africans, more than many understand the importance of the currency. Many times in the past, it has been alarming sitting at the tip of Africa, watching our rand depreciate sharply.

    In a world of floating currencies, every single investment decision carries a secondary decision, which is the currency decision.

    For local investments, that decision is automatic, unless the rand is hedged out.

    Globally the issue is very different and a good fund manager will split out the investments into geographic regions (which is less and less of an issue with multinationals) and the currency overlay, which is the separate decision.

    For example, shares in the US may begin to appear more and more attractive, but if the currency is expensive relative to a global basket, this can be sold down and the portfolio overweighted to euros.

    Unlike companies, where the reversion back to intrinsic value occurs with a higher degree of probability, a currency can stay under or overvalued relative to another currency for a very long period of time.

    There are many interwoven factors driving currencies and because they are only prices relative to one another, a consistent allocation to the winning currency has proven difficult even for the best managers.

    As with the price of shares under and over shooting relative to intrinsic value, currencies have also tended to under and overshoot one another.

    This coming weekend, the G8 (group of 8) finance ministers meet in Japan and news item indicate that despite the absence of central bankers, discussion will revolve around currencies and especially the US dollar.

    The US dollar has weakened for some time now to a trade weighted 20 year low and this is really starting to concern exporting nations, including Japan and Europe.

    Not only that but commodity prices, especially oil, being denominated in US dollars, has moved higher and higher. Reuters reported that a report from the Dallas Federal Reserve said that around 1/3 of the US$60 price increase in oil from 2003 – 2007 is due to dollar weakness.

    The low interest rate policy of the US Federal Reserve is seen as being a major factor in driving the value of the greenback lower and lower, and this is really starting to irk global central banks.

    Last weeks about turn on commentary on US interest rates from the Fed and their now increasing concern for inflation, started to rev up the US dollar against the euro and other major currencies.

    Merrill Lynch has done some work on the US dollar relative to other currencies. In addition to the Economists well known Big Mac index, which is a purchasing power parity model, they have a proprietary foreign exchange valuation model.

    Their conclusions are that the dollar remains overvalued against emerging market (EM) currencies, but undervalued against G10 currencies.

    While SA falls into the EM definition, they talk about the fact that EM are running surplus on trade accounts, which is not the case with SA.

    They don’t think that the dollar will strengthen aggressively, but against some currencies, such as the euro, it has reached “extreme misalignments.”

    That’s it for today


    Ian de Lange

    Permalink2008-06-12, 17:32:04, by ian Email , Leave a comment

    State of Affairs

    Despite all the doom and gloom that is presently quite invasive, there is evidence that the world isn’t coming to an end!

    I have mentioned in previous articles how it is the nature of media to hype things up both on the upside and downside, as it is in their interest to sell newspapers, and news sells!

    South Africa, and most of the world for that matter, has from the beginning of 2003 until sometime during 2007 experienced a massive boom. Equity markets surged, and many people and institutions took advantage of this rosy period by leveraging up their investments. Not only were the markets surging in general, but most sectors were firing on all cylinders.

    As is the case with most things in life, there’s no such thing as a free lunch, and market downturns result in your leveraged assets losing value in double quick time. This has been aggravated by the global ‘subprime crisis’ and ‘credit crunch’ which has caused the financial and property sectors in particular to splutter and spurt. In trying to assist these struggling sectors Ben Bernanke, the US Federal Reserve Chairman, dropped rates which helped spur commodities prices on.

    While there isn’t much subprime in local banks, the global sell off has hit our banking shares hard. Sure, defaults on loans will be up as a result of rising inflation and interest rates, but the local industry doesn’t securitize its assets to the extent of their US counterparts. They have also been more conservative in their lending standards, although clearly not conservative enough.

    The party ended well past midnight, and while some investors might still have some legs, most investors are beginning to nurse a hangover, and hangovers are generally directly related to how excessive you partied the previous night.

    It is precisely those who overindulge who end up missing out at the start of the next party, and sometimes miss out completely. There clearly are a lot of investors who didn’t have all of their money on the table because when I had a look at some of today’s SENS announcements, the majority of the director dealings involved directors buying their company shares compared those selling. They could be attempting to prop up their share price, but it can quite as easily be a vote of confidence that they expect things to improve.

    What is your state of mind? For those investors who stayed level headed there are some clear opportunities arising. As Ian mentioned yesterday there still is risk that markets (and certain sectors) haven’t quite hit the bottom, but some risk has been removed from the table.

    Hopefully you exercised some restraint when the market ran, and that the whack on the head that Tito’s expected to deliver won’t be as sore as everyone is fearing.

    Take care,

    Mike Browne

    Permalink2008-06-11, 17:13:21, by Mike Email , Leave a comment

    A look at a company that has dropped sharply in price

    You may have heard many times that a large part of the performance from a portfolio is from the overall market direction, as opposed to the performance from the specific shares. When sentiment is positive, the broad indices and market depth all look good, but when it turns negative, share prices can drop sharply below intrinsic values.

    Just when the risk of investing into an asset “feels” high, it tends to be much lower.

    The time to be concerned about investing, is when it “feels” right.

    A share that keeps appearing on the new low list is Woolies. I decided to have a closer look at how the share price has moved relative to the underlying performance of the company to demonstrate the point made above.

    The share price moved up steadily from R2,90 in 2000 to R5,70 in 2003 to R10,5 and then R13. It then exploded up to a high of around R25 in 2007 as investors became exceptionally enamoured with the company and were willing to push the valuation up fairly steeply.

    This was short lived and the price has been falling ever since as investors have been disinvesting.

    Now the company itself may have plenty of challenges ahead, especially in this economy, but at a price of R10 and with consensus earnings for the June year end around 140c, the price drops to around 7 times June 2008 earnings.

    Its dividends will be under pressure, but even if at the same level as last year – 76c. The tax free dividend yield is at 7,6%. The consensus has the yield at 8,2%, picking up to 11% in 2009.

    The question that a potential investor must ask is:

    “Has the risk of investing now increased or decreased into a company such as Woolies?”

    The 10 year compounded growth rate in earnings per share was 23,4%. The return on equity moved up steadily to over 30%. This is likely to drop to mid 20’s, but still very attractive.

    Can the price fall further? There is no doubt, but the key point is that the risk of investing in this and many other local shares is now much lower than 6 and 12 months back.

    Kind regards


    Permalink2008-06-10, 17:36:42, by ian Email , Leave a comment

    More on Sasol Inzalo

    Last week I discussed the Sasol Inzalo black economic empowerment scheme. As mentioned the BEE share allocation of a total of 3% of Sasol’s issued share capital has been split between what they term as a cash option and a funded option.

    Last week I spoke about the cash option, which to summarise, is the offer of unlisted Sasol BEE ordinary shares at R366/share.

    I had a question from someone saying should they sell the Sasol shares that they currently own to buy the Sasol BEE ordinary shares. The answer depends on the investment horizon. If such an investor plans to hold his existing Sasol shares for at least 10 years, then it makes sense to make an application and buy Sasol BEE ordinary unlisted shares at a 23% discount.

    The idea would be to buy so many more Sasol shares because of the discount. If you current own say 500 ordinary shares, then for the current value you could own 650 BEE shares, with the same economic value, just less liquidity. Compound owning 500 or 650 shares and the value after 10 years at 15% annual growth is either R976 000 or R1,25m.

    The more attractive option that Sasol is promoting is the so called funded invitation, whereby participants are funded with the bulk of the cost of buying Sasol shares. Sasol issued Sasol preferred ordinary shares, and has secured funding.

    Here the minimum is 25 Sasol Inzalo shares at a total price of R457,50 i.e. R18,30 for Sasol Inzalo shares. Thereafter the price per share goes up to R36,60.

    The preference share and funding mechanism is quite complex, but essentially provides tremendous leverage on the price of Sasol. The minimum period before restricted trading is allowed is years. After 10 years, the Sasol preferred ordinary shares will automatically be Sasol Ordinary shares and will be listed. There may still be loan debt outstanding and so some Sasol ordinary shares may have to be sold to redeem the outstanding debt and pay any costs.

    The net shares will be distributed to the Sasol Inzalo shareholders in proportion to shareholding at the end of the empowerment period.

    Estimates indicate the 100 Sasol Inzalo shares may translate into between 50 and 60 Sasol ordinary shares at the end of 10 years, depending on the balance of debt still outstanding.

    Information from Robert Cowen and Citi Investment Research indicates that 100 Sasol Inzalo shares bought now at R1830 could translate into a possible 66 ordinary shares after 10 years. Assuming a price at R1400/share – only an 11,4% compounded growth rate in Sasol’s share price, the value could be R92 400!

    This is 50 times the initial outlay - or 48% compounded annual growth.

    Assuming a possible 70 Sasol shares after 10 years and a price of R1800/share, the value for R1830 could be R126 000, or 69 times the initial capital.

    As I mentioned last week someone is paying for the upside. It comes off Sasol’s income statement and through equity dilution. Just the estimated cost of the deal for legal, advisory, structuring etc is R175m.

    All the Black executive and non executive directors are taking up either the cash or funded option.

    The scheme is aimed at BEE. They are also favouring lower income and Black women. It does appear to be an excellent mechanism to assist your loyal Black domestic staff in their pension. I for one will be doing so.



    Permalink2008-06-09, 17:46:56, by ian Email , 1 comment

    Sasol Inzalo

    The big money is made when a business is started from the nothing, well managed to a point of producing strong and growing cash flows and then listed on the JSE at an excellent multiple of earnings. When a large dose of BEE status together with favourable and limited licences is added to that mix, the outcome is mind blowing.

    Grand Parade Investments is one such entity - it listed on the JSE today and traded as high as 550c but on average around 450c. The company was started just over 10 years ago where the founding BEE shareholders paid 70c for their shares, which have now split 4 times. Not even taking into account that the bulk of their cost has been returned by way of dividends, the effective 18c per share today trades at 450c – an incredible 25 times payback.

    I have received a number of queries on this deal, and so today I took a closer look at the 154 page Sasol Inzalo funded and cash offer and wonder if the same type of returns are possible for selected categories of investors.

    I will look at some of the specifics on the shares next week, but let’s first take a look at the bigger issues.

    The Inzalo deal has 4 main beneficiaries. Let’s look at the deal offered to the Black public. Here there are 2 options.

    o The first is the funded option. This is an incredible deal for anyone that can take it up, whereby 2,6% of total Sasol share in issue will be issued. I will discuss this next week.

    o The second is the cash option. Here Sasol BEE ordinary shares will be issued (a total of 0,4% of Sasol) at a price of R366 with a minimum take up of R10 such shares.

    Let’s just look at the cash option. For the first 2 years, there is no trading on the shares. Then for the remaining 8 year period trading is restricted to other BEE investors. But all dividends will be received during the 10 year period, and thereafter the BEE shares will be converted to ordinary Sasol shares.

    When an asset is being offered at a 24% discount (R366 per share) versus the fully tradable ordinary shares at R481 late today, prospective shareholders must take advantage.

    Active investors looking for valuations gaps will take advantage where a single asset can be accessed in 2 ways (typically a pyramid structure) by buying the cheaper asset and selling the more expensive asset and waiting for the gap to close. Here is a perfect case, but it is limited to BEE shareholders. By only giving up on some liquidity constraints a BEE investor with a longer term view can take advantage by buying Sasol BEE shares at R366 and selling the ordinary shares at R481, a guaranteed 24% gap.

    Naturally there is a cost to this value transfer – someone has to pay, but payment of the massive value transfer is reserved for shareholders and details are tucked away in the fine print. On page 43 and 44, Sasol gives some indication.

    “The total share-based payment charge (IFRS 2 charge) for the transaction amounts to R8523 million for the Empowerment period. On a proforma basis the share issue at the large discount for the 6 months to December at the headline EPS level is 47,9%.”

    If you are the owner of Sasol shares, options etc, feel free to contact us to discuss how best to plan your total asset base into retirement year.

    Have a great weekend



    Permalink2008-06-06, 17:00:43, by ian Email , Leave a comment

    Wesco is looking to sell remaining stake in Toyota SA

    A company that has not been widely followed or owned by professional and private investors is Wesco. It is the vehicle (excuse the pun) that the Wessels family control, which used to control one time listed Toyota SA. For the past 6 years or so, their stake in Toyota SA was reduced to 25%, now they are looking at selling the remaining interest to the Japanese.

    The company released its annual results on Wednesday but had announced already that it has entered into discussions with Toyota Motor Corp of Japan regarding its remaining 25% stake in Toyota South Africa.

    Toyota SA was founded by Albert Wessels in 1963, with management passing on to son Bert Wessels, while his sister Elizabeth Bradeley looked after Wesco, which currently owns 25% of Toyota and held other interests. On his death she became non executive chairman of Toyota SA.

    In 2002, control in the form of 75% of Toyota SA was sold to Toyota Motor corp of Japan and the remaining 25% continued to be held by Wesco. Wesco remains controlled by the Wessels family, with their 59,1% held through six trusts / companies.

    Toyota has held a top position in motor sales for many years with percentage of market share consistently around the 20% level.

    In 2006 year this was 21,2%

    Into 2007 even as total vehicle sales dropped 5,4%, to a total of 676 097 units, Toyota still managed to increase their domestic unit sales by 2,8% to 155 244, with a market share climbing to 23%.

    However, despite improved unit sales and better market share, which led to improved sales at Toyota SA level, profits slipped massively from R435m to R61m.

    At Wesco level, its share of profits in Toyota (remember it owns 25%), fell from R108m to R15,4m.

    Finweek reported that there is some speculation that the 25% stake in Toyota could be worth some R3bn, which would translate into a price of around R350/share. It’s currently trading at R276.

    Wesco’s potential sale of the remaining Toyota SA stake to the Japanese has been on the cards for a long time. One now wonders if they had not left it one to two years to late. 18 months back car sales were flying, now slowing sharply, its going to have an impact on the agreed price.

    It’s debatable whether it has been a good business in South Africa. An operation that has to continually spend large amounts on capex for relatively shorter production runs, is unlikely to be able to compete with an increasingly competitive environment from the East.

    Still the cars are excellent, but perhaps I am biased.

    Kind regards


    Permalink2008-06-05, 17:41:41, by ian Email , Leave a comment

    fund managers need a process

    In just 3 days on the JSE there are no less than 332 news items and this before the market closes and many more are released up to 6:00pm. For a portfolio manager this is a lot of information to digest even if it does not have to happen all at once. For the part time investor, really getting to grips with the detail is tough task

    While many news releases are no more than perfunctory, these also need to be waded through.

    For example news flows on directors dealings. This is always important information for a potential buyer of a share.

    Even within asset management and stockbroker research firms, groups of analysts working on specific sectors and companies, cannot cover all companies.

    In order to cope with greater volume of data flow, we like to see portfolio management firms using IT to assist in analysing the raw data. The typical process will be along the following lines:

    o The firm defines their investment beliefs and style (i.e. deep value, value, growth or some combination).
    o Then defines the main selection criteria, e.g. price to net asset value, earnings growth above market average, low price to equity, high return on equity, strong cash flows to reported earnings etc
    o Uses database to handle volume of information and then runs quantitative screens to isolate potential ideas, which are then passed on to the analysts.
    o The sector analyst then works on ideas, typically building a 3 year forward earnings and valuation model, after collating more information from management meetings, reports etc.
    o The share is included into a list for possible portfolio inclusion, where it is ranked against shares in the portfolio.

    On an ongoing basis then a manager is able to update valuations of their total universe of available shares and rank these against the prevailing market prices, looking for large discrepancies which will indicate possible upside.

    Consistently applying a proven methodology will prove a superior option to a hit and miss process. We like to see a fund manger applying some consistent process, which then helps in our understanding of how returns were generated.

    Feel free to contact me if you would like to discuss any aspect of your long term investment planning.



    Permalink2008-06-04, 17:32:24, by ian Email , Leave a comment

    What is Enterprise Value?

    Investment analysts use some complicated financial and accounting terms when going about their business. In order to understand valuations, it’s vital to have not only a clear understanding, but also at least a working knowledge of various terms. You may have come across the term Enterprise Value or EV in reports, but what is it and how does it link in with more well known terms.

    Enterprise Value is defined as the market cap of a company, plus its debt, less the cash and cash equivalents on hand.

    The enterprise value has relevance for valuing a company, especially where there is a possibility of a potential buyout. In many respects it’s a more accurate representation. Because a buyer of a company also assumes over that company’s debt, this must also be taken into account when placing a value on the total business.

    Conversely a buyer of a highly cash generating company, which has a large cash balance on its books can effectively deduct this balance from the price of the business

    The data reflected in the press is the market capitalisation of a company, which is the total number of shares outstanding (or issued) multiplied by the current share price. Two companies with the same market capitalisation may have very different enterprise values, given the varying structure of their balance sheets.


    o Company A with a market cap of R500m and net debt on its balance sheet of R300m has an enterprise value of R800.

    o Company B has a market cap of R500m and net cash on its balance sheet of R200m. It therefore has an enterprise value of R300m.

    Instead of only looking at price to earnings ratios, which do not take into account the company’s debt levels, analysts typically pay closer attention to the EV/EBITDA ratio. This is a type of modified PE ratio, taking enterprise value as a function of cash flow earnings before interest and tax. EBITDA is defined as earnings before interest tax depreciation and amortisation.

    A company that has the potential to generate a high excess cash flow over a relatively short period of time may possibly trade at a high current PE multiple, but a much lower forward EV to EBITDA ratio.

    One example is ARM – African Rainbow Minerals. This company produces Nickel, platinum, iron ore and manganese ore.

    It currently trades on an historical PE of over 40 times – so is very expensive. Its consensus forecast one year out is in the region of 22 times.

    But because the company has a high probability of super cash generation over the next 2 years, it’s appropriate to deduct the excess cash generation from the market value and calculate the EV/EBIDA ratio. Some forecasts that I have seen see this ratio dropping to low single digits 2 years out.

    On a forward basis, assuming high cash generation, the enterprise value is reduced substantially, giving a higher value to the company.

    That’s it for today




    Permalink2008-06-03, 17:10:34, by ian Email , Leave a comment

    Mobile Phone companies are in demand

    Mobile phone companies are prized assets. Penetration levels of cell phones into society have been far higher than the wildest expectations. South Africa’s two main licence holders, Vodacom and MTN have added massive value to shareholders over the years. Now both MTN and Telkom are in further discussions at shareholder level.

    A fund manager confirmed in a presentation a few weeks back that it was Koos Bekker from Naspers that lobbied for the allocation of a second licence, after government was initially only going to licence Vodacom – part of Telkom. That decision saw the formation of MTN, which is now a R276 billion market cap company.

    MTN moved aggressively into Africa and into the Middle East and has been approached by the Reliance Communication Group from India.

    Today Vodacom is owned 50/50 by Telkom and UK listed Vodafone, which acquired Venfin’s 15% stake a couple of years ago. At the buyout price, Vodacom was valued at around R107 billion.

    Now Telkom is a R76 billion market cap company with the bulk of the valuation attributable to its interest in Vodacom and very little for the low growth, but high cash generating fixed line business.

    Today it announced that it on Friday it received a non binding proposal from Vodafone Group plc to acquire a portion of its stake in Vodacom, subject to an unbundling of its remaining stake.

    It also received a letter from consortium comprising Mvelaphanda Holdings, which is also considering making an offer for the entire issues shares as long as the 50% stake in Vodacom is unbundled.

    Last week Vodacom announced some numbers ahead of the release of annul results next week.

    o Total customers up to 34m.
    o Revenue up 17,1% to R48,2billion.
    o Profit from operations up 15% to R12,5 billion.
    o Cash generation from operations up 17,8% to R16,3 billion.

    The Vodacom business is a fantastic business, but it needs separation from Telkom.

    MTN is far larger, given its advantage of being able to move into Africa. For the year to December it reported revenue of R73,1 billion and EBITDA earnings (earnings before interest, tax, depreciation and amortisation) of R31,8 billion – double that of Vodacom’s R16,5 billion.

    The Mvela bid was reported to be valued at around R90 billion, hence the immediate increase in the Telkom share price today.

    Telkom gained 7,6% today to 14750c.



    Permalink2008-06-02, 17:09:57, by ian Email , Leave a comment