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    Release of June inflation data

    Today saw the much awaited release of inflation data for the month of June. Once again the official numbers exceeded most expectations, with headline inflation coming in at 12,2% and CPIX at 11,6%. But these numbers surprised very few consumers where prices across most goods have been up sharply over the last 12 months.

    Food inflation came in at 17,6% from 17%

    Administered prices were up at 18% from 16,7%. This was partly due to Fuel. Electricity hikes will add to this in the months to come.

    Measurement of inflation as CPIX. i.e. inflation excluding interest on mortgage bonds started in 1997 and the 11,6% is at a record.

    There has been some reprieve as the rand has strengthened and oil prices have fallen to around $122/barrel from almost $150/barrel and this will start to have a positive impact.

    Then there is the debate that Investec triggered about the delay in rebasing and re-weighting the inflation basket, which should shave off a few percentage points of the current inflation and quite possibly see the official inflation back into the target by the end of 2009.

    As expectations of inflation rise, so it starts to impact the second round effects, mostly wage settlements and these have been of the order of 10% to 12%, putting further upward pressure on official inflation.

    So now the outlook going forward is very clouded with so many positive and negative factors coming into pay.

    While difficult to predict exactly what is important is the probability that a decline in inflation next year has on rate cuts. An interest rate peaking environment should provide an underpin to asset pricing, especially those assets that have suffered because of their interest rate sensitivity.

    The local market was positive today. Yields on long bonds were steady at 9,43% for the R157.

    The graph of current versus forecast inflation into 2009 is from Vunani Securities.

    Kind regards

    Ian de Lange
    082 921 0220

    Invitation to Baby Boomer Seminar: Don’t retire, refire

    Don't Retire – REFIRE
    Lynda Smith, Wisdom Preserver from Refirement Network will share on this topic. Refirement Network helps the Baby Boomer generation (those born between 1946 and 1964) to understand why their road to the future will be so different from their parents and grandparents. Go to www.refirementnetwork.com for more details.

    Investment pitfalls in retirement
    The Seed Investment Consultants will share on your strategy to ensure a great future.

    Vincent Heys (actuary) and Ian de Lange (CA(SA)) from Seed Investments Consultants will discuss what the major investments pitfalls are leading up to retirement and in retirement. The discussion will particularly look at ways to enhance your retirement capital in order to secure the standard of living you planned for yourself. This presentation will be interesting for those baby boomers with questions like: How much capital do I need for retirement? What investment strategy should I follow? What is the probability that my capital will outlive me?

    Cape Town
    19th August

    17th September

    Contact helena@seedinvestments.co.za for more details.

    Permalink2008-07-30, 17:28:22, by ian Email , Leave a comment

    Are insiders seeing value in Foschini

    A director’s purchase or sale of shares is but one indication of possible value in a company’s share price. In many cases it’s not the most accurate predicator because directors have considerations other than value when considering buying or selling. But now and again certain directors have a keener ability to gauge intrinsic value in their own share price.

    I think one of these is Jannie Mouton, executive chairman of PSG group, who has bought and sold PSG shares, giving shareholders a good indication of possible value or lack thereof.

    Another director may be Michael Lewis of Foschini. He is son of Stanley Lewis, former chairman of Foschini and former controlling shareholder in Lewis.

    The Lewis family through the pyramid holding company, Lewis Foschini Investment Company (Lefic) controlled Foschini until 1999, when the pyramid was collapsed and underlying shares in Foschini distributed, leaving the Lewis family with a stake of around 4,5% in Lewis.

    Michael Lewis is an independent non executive director of Foschini and in the first half of 2002 he had accumulated 14m shares in Foschini at a cost of almost R100m, at just over R7/share. These share purchases were around 5% of the issued share capital.

    The beginning of 2002 was only a few month post the September 11th 2001 New York disaster and global markets were still under lots of pressure. Investors were generally lethargic.

    But the large acquisition proved to be a good investment, i.e. made at a good price. He sold the following shares.

    Jan 2006 – 5m shares at R54,50, realising R272,5m
    July 2006 – 2,3m shares at R44 realising R100m.

    The timing of the sale may have been a bit early, but after peaking at R54 it fell to R40 before moving up very strongly again to over R70, before collapsing back to just below R30.

    Nevertheless a price from R7 to R54,50 for a good portion of his holdings is excellent.

    So when Michael Lewis starts to come back into the market again for the same company at current prices, value investors should take note.

    Recent purchases by M Lewis

    March 2008 0,877m shares at R36 total value of R32,1m
    July 2008, 0,588m shares at R34,60 total value of R20,3m
    July 2008 0,437m shares at R34,73 total value of R15,2m
    July 2008 0,18m shares at R35,48 total value of R6,4m

    He is possibly looking through the immediate concerns on the consumer front and seeing value with dividend yields of over 7% and 8% going forward. Only time will tell if these prove to be good entry levels, but clearly some insiders are excited about the prices presented.

    That’s all for today.

    Remember don’t hesitate to give me a call to discuss any aspect to your investments. I am always available on my cell – 082 921 0220.



    Permalink2008-07-29, 17:07:04, by ian Email , Leave a comment

    Laws of Investing

    Moving a home of office, it's always a good opportunity to do some cleaning up. We moved our office on the weekend. While using the opportunity to throw away some old reports, handouts, brochures etc, I came across one brochure from an asset manager, with some wise words for all investors.

    These are some principles that fund managers, Fraters put out in their brochure.

    1. The Law if Simplicity

    We are all tempted to create structures to protect our dependents or to save tax.

    A word of caution. Structures are:

    o Expensive to maintain or dismantle
    o Based on historic tax laws – these can change
    o Based on historic relationships – these too can change.

    Structures can cause costly complications down the line. If it can be kept simple: keep it simple.

    2. The Law of Cost and Distance

    The further that one moves away from holding an investment directly, the more layers of costs sit in between. Make sure that all costs are adding value.

    3. The Law of Flexibility

    If a product does not offer flexibility, you should never even consider it. You don’t know when you are going to need money in an emergency. If you cannot withdraw your money at short notice with little loss, you may as well not have saved it in the first place. You are entitled to ask about penalties –so ask in detail.

    We would disagree slightly here saying that in aggregate investors pay a price for having full flexibility and liquidity. For instance the returns from private equity are higher than those from listed equity over time, but with the former investors forego the benefit of liquidity. For a defined allocation of your investment capital it may be appropriate to forego some liquidity benefits for higher returns.

    Please see our new contact details below.


    Ian de Lange

    New contact details:

    Phone number - 021 9144 966
    Unit 2, 3rd Floor
    Waterfront Terraces
    Carl Cronje Drive

    Permalink2008-07-28, 17:06:20, by ian Email , Leave a comment

    A brief look at relative valuations

    Opportunities in the market are created in times like this when pessimism drives prices to below realistic valuations. Investors can look back on 5 years of the JSE producing compounded returns of 33% returns, but the foundation to these superior returns was the tough 2002 and 2003 years.

    The best entry points occur when investors are most pessimistic. Naturally these times are easier to identify with hindsight, but using past data helps one to gain a better understanding of unfolding events.

    Remember the components of total return include:

    o Initial dividend yield
    o Growth in that dividend over time as company earnings grow
    o Possible rating change. (preferably positive, but sometimes negative)

    A value investor gets excited when shares start to trade at higher dividend yields, because this is generally indicative of low expectations built into the price, which in turn means a higher probability of future positive rating change.

    The overall market dividend yield currently approximates 2,8%, but a basket of value shares can be constructed with dividend yields of 6% and 7%.

    I spoke on CNBC this morning about portfolios using this time to continue to down weight basic materials versus the index and increase banks and retailers, where they have not already done so.

    The current JSE All Share weightings are:

    Oil and Gas 6,8%
    Basic materials 50,1%
    Industrials 6,7%
    Consumer goods 11,5%
    Healthcare 0,6%
    Consumer services 4,3%
    Financials 13,2%
    Technology 0,4%

    Remember index allocations for vanilla index construction are not indicative of where the value lies.

    Have a look at this chart, courtesy of Investec, which indicates the extreme relative pricing of banks against resources using Firstrand and Anglos as proxies.

    This plots the relative dividend yield of Firstrand against Anglo American. At the peaks, the subsequent out performance of the better priced share is tracked against the market.

    For instance in 1998 Firstrand was very expensive relative to Anglo American and subsequently banks underperformed. In fact at that stage very few fund managers wanted to own resources because they had underperformed for a long time and this was detrimental to their performance.

    Now, quite the opposite. That is not to say that it’s a given that banks will immediately start to outperform, but from an absolute and relative valuation perspective one needs to consider how this affects your asset allocation.

    Have a wonderful weekend

    Kind regards

    Ian de Lange

    New Offices.

    Seed is moving on the 26th July to new offices:
    Unit 2, 3rd Floor
    Waterfront Terraces
    Carl Cronje Drive

    Phone : 021 9144 966

    Permalink2008-07-25, 16:57:19, by ian Email , Leave a comment

    Global Interest Rate Decisions

    We have discussed the SARB’s interest rate decisions and their policy ad nauseum in our articles, so I thought that today it would be a good idea to take a look at some other countries, and how they manage their interest rate decisions.

    Most countries will typically have a similar structure as South Africa, an independent Central/Reserve Bank setting interest rates according to their mandate. Unlike South Africa, however, many other countries have a dual mandate of minimising inflation whilst maximising growth.

    Today I read about three countries’ interest rate decisions. Interestingly there were three different decisions, one raised, one remained steady, and the other one cut. Also interesting is that one of the countries has a developing economy (Brazil), another has a small developed economy (New Zealand), and the third has a large developed economy (England).

    Can you guess which country made which decision?

    Starting in the west, Brazil raised interest rates for the third time in a row, this time by 0.75%, bringing the increase in rates since they began hiking earlier this year to 1.75%, interest rates are now at 13%. Brazil is in a similar position to where South Africa was 18 months or so ago. Domestic spending is still extremely strong, and this is one of the factors stoking inflation. Their Central Bank is mandated to keep inflation between 2.5% and 6.5%, and it now stands at 6.3%. Like in South Africa economists are warning of the effects that raising rates will have on the economy, especially where a lot of the inflation is being imported. While this should be a concern growth is still at a robust 5.8%, but we’ve seen how this figure can quickly drop in the face of rising rates.

    The Bank of England kept rates steady at 5%. The BoE have a nine member committee that votes on such matters with seven voting for rates to remain on hold, one for a cut, and one for an increase. The vote to increase rates caused jitters in The City (stock market) as to what the next move would be. While there was consensus among the members that raising rates would help to bring inflation down to its target of 2%, it was felt that the effect on the economy would be too negative, and that a decision to keep rates steady made sense.

    For the first time in five years New Zealand’s Reserve Bank cut interest rates, despite inflation jumping increasing to 4% (1% above the top of their target range). The rationale behind this decision was an economy that shrank in Q2 2008. The Bank believes that a cooling economy will do more to reduce inflation, and that by dropping interest rates by 0.25% they will hopefully provide a stimulus to the economy to prevent it from experiencing a recession. As would be expected with a rate cut the local currency (NZ Dollar - kiwi) weakened on the news. The kiwi has been a popular destination for carry trade money, and with this first cut (with more expected to come) the currency could face further weakness. This potential weakness could, in turn, spark inflation again, and so we can see that our Reserve Bank isn’t in a unique position!

    We were at Investec earlier today talking to a fund manager, and managed to catch John Stopford’s, joint head of fixed income, views on Investec’s inflation calculations. It was an interesting discussion, and helped us understand the issues at hand.

    Enjoy your evening.

    Kind regards,

    Mike Browne

    Permalink2008-07-24, 19:03:24, by Mike Email , Leave a comment

    Price volatility and value

    The current market is extremely volatile. I don’t think that this is the time to try and be too clever. One day share prices are falling by 5 and 6%, the next day they are trading up by 7% and 8% and then reversing the next day. Today almost R15 billion was traded.

    A fund manager mentioned last week a discussion with a stockbroker, who said that at least 50% of the turnover on the market is institutional basket and derivative trading. I.e. the typical long only fund manager with R1bn or R3bn is not necessarily driving prices up and down by 7%. It’s some of the hedge funds and the institutional structured products that need to trade in the so called spot market to match what is happening with the derivative positions.

    Ask any value manager and they will not be too concerned with large swings in prices on a day by day basis. If anything it merely re affirms the concept that prices are not always efficient, i.e. exactly match the value of the underlying business.

    Any CEO of any listed business will disagree that the value of the business that he is managing can be up or down let’s say R10 billion in a day. Standard Bank gained 8,5% today to R120 billion. Did the business value increase by R10billion in one day? Very probably not.

    Old Mutual gained 10,5% today. Did the value of its business increase by R8 billion today. Again very probably not.

    The fact is that share prices are ALWAYS more volatile than the incremental value appreciation or depreciation of the underlying business. As I have mentioned previously investors need to have an understanding of the range of values of listed businesses, but this information is collated and assessed from earnings, cash flows, gearing levels, market penetration etc and not from the share price

    Value investors therefore update their range of values as information becomes available, typically every 6 months and continually compare to the quoted prices. Investors should get excited when the gap between realistic values and prices opens up. Price volatility merely provides possible opportunities for these possible gaps to be bigger than would generally be the case.

    That’s all for today on a generally more positive day on the local JSE.

    As always any questions, please don’t hesitate to contact me. Or larger investors looking to consolidate their portfolios with on ongoing dedicated asset management, don’t hesitate to contact me for a confidential discussion.


    Ian de Lange

    Permalink2008-07-23, 17:57:48, by ian Email , Leave a comment

    US real returns over 10 years

    In many respects local investors reduced ability to externalise their investments has been advantageous. Emerging markets have outperformed global developed markets for many years now. This became evident to me when I saw a chart of the 10 year annualised total returns of the US S&P500 index.

    In most investors book, 10 years is a very reasonable investment period. Too much focus on the monthly, quarterly and even annual performance can be detrimental, but a 10 year investment horizon can be classified as long term.

    Over this period of time an investor should be able to generate real returns. Remember real returns are total returns from an asset, i.e. capital growth and income or dividends, less the annual inflation.

    But when the 10 year annualised return for US shares is plotted on a graph its very evident that this has fallen to the point where at the end of June 2008 investors have received exactly Nil return per annum over the preceding 10 years.

    Real returns: S&P500 10 year total return – CPI 10 years annualised

    In the early 1980’s investors that had maintained patience over a 10 year period were not rewarded with any real returns, and in fact some had sustained an annualised negative return per annum for 10 years.

    However the winners were those who ignored the recent history and invested any time from around 1982 and maintained, selling out at the market peaks in the early 2000’s and maintained their investments.

    Those exuberant investors who bought into the late 1999 and 2000 US share bubble and held on those investors that have gone nowhere in 10 years.

    To me it reiterates the extremely important concept of buying right. i.e. not overpaying for an asset, no matter how glossy the prospects appear. Investors who overpaid for assets at the turn of the century have suffered even taking a 10 year investment horizon. I think even extending the term out another 10 years will not justify paying over the top for an asset.

    What is exciting is that this low historical return environment is starting to set the base for a more exciting next 10 years.

    Investors need to be sure however that they are positioning correctly and not chasing yesterday’s returns.

    Don’t hesitate to give me a call to discuss any aspect on this and how it affects your personal investments.


    Ian de Lange

    Permalink2008-07-22, 17:25:39, by ian Email , Leave a comment

    Tigerbrands announces details of Adcock

    Over the years Tigerbrands has been the source of many unbundlings of subsidiary companies and now it’s doing it again with the intended separate listing of Adcock Ingram.

    There was some concern at the beginning of the year that the contravention of the Competition Act by Adcock Ingram would hamper the separate listing of Adcock, but the company went on to pay a fine of R53,5m and the listing was merely delayed

    Tigerbrands is essentially a FMCG (fast moving consumer goods company) with a number of strong brands. It acquired its interest in healthcare a few years back, but strategically this does not fit in neatly with the core business.

    The price of Tigerbrands has fallen, from around R200 to R146. At this price its market cap is R25,1 billion.

    It is a major shareholder in Sea Harvest. The company owns brands such as All Gold, Black Cat, Jungle Oats, Oros, Beacon, Tastic etc.

    Two large companies that it has unbundled over the last few years include:

    o Spar, in October 2004, which now has a market cap of R8,4 billion

    o Astral, a food processing company in April 2001 now with a market cap of R3,8 billion.

    Adcock will list on the 25 August. Tigerbrands shareholders will receive one Adcock share for every one Tigerbrands shares held.

    Adcock comprises 2 main divisions, pharmaceutical and hospital products. Pharmaceutical manufacturers, markets and sells branded and generic prescription and over the counter products.

    The Hospital division provides various products such as fluids, pumps wound care and disposables to hospitals.

    This unbundling will see the company closer to its original business of foods. It started as a milling and baking company and 9 years ago changed its name from Tiger Oats to Tiger Brands.

    Adcock is a substantial business in its own right with turnover approaching R3 billion and profit for the year to Sept 2007 of R578m.

    The company will list with net debt of R250, which does not look onerous.

    In late trading Tigerbrands was up 1,3% to 14597c.Its one year forward dividend yield is 5,6% and PE 9 times.

    It is widely held across the various unit trust funds.


    Ian de Lange

    Invitation to Baby Boomer Seminar: Don’t retire, refire

    Don't Retire – REFIRE
    Lynda Smith, Wisdom Preserver from Refirement Network will share on this topic. Refirement Network helps the Baby Boomer generation (those born between 1946 and 1964) to understand why their road to the future will be so different from their parents and grandparents. Go to www.refirementnetwork.com for more details.

    Investment pitfalls in retirement
    The Seed Investment Consultants will share on your strategy to ensure a great future.
    Vincent Heys (actuary) and Ian de Lange (CA(SA)) from Seed Investments Consultants will discuss what the major investments pitfalls are leading up to retirement and in retirement. The discussion will particularly look at ways to enhance your retirement capital in order to secure the standard of living you planned for yourself. This presentation will be interesting for those baby boomers with questions like: How much capital do I need for retirement? What investment strategy should I follow? What is the probability that my capital will outlive me?

    Cape Town
    19th August

    17th September

    Contact helena@seedinvestments.co.za for more details.

    Permalink2008-07-21, 16:39:55, by ian Email , Leave a comment

    How profit updates provide a possible indication of value

    With many companies having a June year end or interim, we are starting to see profit updates coming through. Analysts and investors will always watch these very closely, and indeed they provide an excellent indication of what is priced into the market.

    As I have discussed in past reports, the movement of the share price action after the release of a trading update gives some indication of what is already priced into the company valuation.

    Because investors assess current prices taking into account their assessment of company profits into the future, one of three things can occur on a trading update.

    o The update, positive or negative, is more favourable than currently priced into the share, in which case the price is supported and moves up relative to the market.
    o The update, positive or negative, is less favourable than anticipated and priced into the share, in which case the price is very likely to decline.
    o The update is in line with what was anticipated resulting in no major price move.

    An efficient market should result in very little price moves as company’s provide updates, but this is seldom the case as we saw today

    A couple of examples today included Woolies, JSE and Murray and Roberts

    Woolies share price has been under tremendous pressure from a peak of R25 a year ago to around R10 - a massive decline of 60%.

    Their year end is June and today they released a trading update saying that “Trading conditions in the second half have deteriorated substantially with a further decline in consumer spending as a result of additional interest rate hikes and increases in fuel and food prices. Middle and upper middle income consumers have felt the pinch of the current economic conditions particularly strongly. This is the heartland of the Woolworths customer.”

    The anecdotal evidence supports the view that the environment is extremely tough.

    They go on to say that comparable store on store sales are up 6,5% for the year while food inflation came in at 13,1% and clothing inflation at 8,5%.

    Their troubles Australian operation, Country Road has shown some resilience and produced record profits.

    While growth in sales is nominal, the company at least expects growth in profits to also be positive. So all in all not too bad, but definitely NOT a fantastic environment for a retailer.

    But the price moved up and at the close was up 5% to 1040c. In other words a possible scenario 1.

    Murray and Roberts has been a fantastic performer over the last few years capitalising on the boom in gross domestic fixed investment spend. It also has a June year end and also issued a trading update.

    Its share price has moved up from R20 in 2005 to over R100 last year, declining to around R80.

    Today it reported that fully diluted headline earnings for the year is likely to be up between 60% and 70%. This is slightly better than previously reported at the Interim stage. On a diluted basis, the increase is expected to be up between 130% and 140%.

    The company did not give an update of its order book but by all accounts these results are excellent and while likely to slow off a low base, should still remain strong at least for the next few years.

    However the price fell and at the close it was down 4,2% to 8521. I.e. scenario 2 above.

    It’s been an interesting week on the JSE. No real market on Monday and then over the last couple of days record volumes and massive price increases across banks and retailers and many industrials.

    That’s all for now

    Have a super weekend and enjoy the rugby.


    Ian de Lange

    Invitation to Baby Boomer Seminar: Don’t retire, refire

    Don't Retire – REFIRE

    Lynda Smith, Wisdom Preserver from Refirement Network will share on this topic. Refirement Network helps the Baby Boomer generation (those born between 1946 and 1964) to understand why their road to the future will be so different from their parents and grandparents. Go to www.refirementnetwork.com for more details.

    Investment pitfalls in retirement

    The Seed Investment Consultants will share on your strategy to ensure a great future.
    Vincent Heys (actuary) and Ian de Lange (CA(SA)) from Seed Investments Consultants will discuss what the major investments pitfalls are leading up to retirement and in retirement. The discussion will particularly look at ways to enhance your retirement capital in order to secure the standard of living you planned for yourself. This presentation will be interesting for those baby boomers with questions like: How much capital do I need for retirement? What investment strategy should I follow? What is the probability that my capital will outlive me?

    Cape Town
    19th August

    17th September

    Contact helena@seedinvestments.co.za for more details.

    Permalink2008-07-18, 17:23:28, by ian Email , Leave a comment

    Components of Value

    Yesterday I mentioned four investment tenets from a value investor. Another interesting aspect that is not always well understood is the various components that need to be analysed when trying to determine a value or more accurately a range of values for any business.

    Whether market prices are moving up, down or sideways analysts need to have a firm process to independently value businesses.

    The exact methodologies used to value businesses will vary from manager to manager and as any businessman knows there is not one value for a business, but a range of possible values.

    Also at times certain sectors and types of businesses are in favour as market conditions become favourable and vice versa.

    A value manager will however try and understand and place a value on the following 3 main components.

    o Firstly one needs to put a value on the replacement value of the existing operation. i.e. to start a new operation, what would be the cost of plant, property, equipment, brands and trademarks. These values may not be accurately reflected in the balance sheet, but for many businesses this is an important base component of value.

    o Secondly place a value on the normalised continuing operations. Here an analyst normalises profit margins, profits and cash flows of a business and discounts these to arrive at a current valuation. i.e. tries to determine a present day value to the ongoing free cash from generated by a business.

    o Thirdly look at a possible growth element in earnings for whatever reason. Naturally this is the most difficult component to value. A value manager will want to build very little expectation in here, and prefer to be surprised if it does materialise.

    Over time then a manager can construct a range of realistic values for businesses and compare them to current market prices.

    When the market is expensive there will be fewer companies that trade below intrinsic value and vice versa.

    A manager then plots potential upside or downside of prices to analysed intrinsic values. The graph below reflects this plot by Coronation over time.

    This chart goes back to April and while values of businesses have declined, prices have declined even further and so potential upside to intrinsic values has now increased, giving an indication of greater value.

    Invitation to Baby Boomer Seminar: Don’t retire, refire

    Don't Retire – REFIRE
    Lynda Smith, Wisdom Preserver from Refirement Network will share on this topic. Refirement Network helps the Baby Boomer generation (those born between 1946 and 1964) to understand why their road to the future will be so different from their parents and grandparents. Go to www.refirementnetwork.com for more details.

    Investment pitfalls in retirement
    The Seed Investment Consultants will share on your strategy to ensure a great future.

    Vincent Heys (actuary) and Ian de Lange (CA(SA)) from Seed Investments Consultants will discuss what the major investments pitfalls are leading up to retirement and in retirement. The discussion will particularly look at ways to enhance your retirement capital in order to secure the standard of living you planned for yourself. This presentation will be interesting for those baby boomers with questions like: How much capital do I need for retirement? What investment strategy should I follow? What is the probability that my capital will outlive me?

    Cape Town
    19th August

    17th September


    Ian de Lange

    Permalink2008-07-17, 17:49:47, by ian Email , Leave a comment

    Investment tenets of a value manager

    As part of our ongoing due diligence on asset managers, we need to spend time getting to know the portfolio manager, their investment approach, investment philosophy possible biases, track record through various cycles etc.

    Its one thing to look at a portfolio of shares, agree with the inclusion of some shares, disagree with others, then look at the past performance track record, but this is not enough to make a quality decision on whether the fund should be included in your portfolio or not.

    I have discussed in the past some of the criteria that we use.

    A value fund manager that we met with this morning has the following key investment tenets, which I think have merit for all investors to consider:

    o Mean reversion. i.e. low profits and returns mean revert as do high profits.

    o Normalised operating conditions. i.e. analysing profits of a business through economic cycles. This is very applicable now across sectors such as banks on the one hand moving into a depressed cycle and resources on the other near the top of a strong upward cycle.

    o Focus on the long term, not the next 3 years when valuing a business. The next 3 years are important, but typically comprise only around 15% of the total value of a business.

    o Emphasis on facts and less on forecasts. For example many investors place too high a reliance on growth forecasts and pay up too high a price for possible future strong earnings. Analysts and economist’s forecasts are notoriously prone to error.

    These tenets speak to a strong value bias. Many studies have proven that often time a value bias outperforms a growth strategy.

    The simplistic approach of comparing the performance of highly priced shares against cheaper priced shares reflects the outperformance of value.

    Chart: cumulative capital appreciation from simple value and growth strategies

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


    Ian de Lange

    Permalink2008-07-16, 17:04:51, by ian Email , Leave a comment

    Timing of raising debt and equity

    Reading a follow up article on the US mortgage companies, Freddie Mac and Fannie Mae, I came across an quirky comment from a hedge fund manager on their capital adequacy saying, ``The good news is that Fannie Mae has all the capital that it needs. It just has the capital in the wrong form with too much debt and not enough equity.”

    Indeed in the current global debt crisis, this is an interesting observation. Up until recently, capital in the form of debt was relatively easy and cheap to come by.
    At the same time equity was relatively cheap and easy to come by for most global companies. – the world was awash with liquidity looking for a home.

    The more astute corporates took advantage by loading up on their capital requirements.
    We have some understanding of what transpired in the US, where banks and mortgage originators with an implied guarantee from the US government and the advantage of ultra low nominal (negative real) interest rates were encouraged to step up their debt to equity exposure.

    Now the high debt exposure is hurting badly.

    As you know debt and equity are 2 forms of capital with different characteristics. Over the longer term equity is the more expensive form of capital, but it comes with some advantages, the biggest being that it does not have obligatory annual servicing costs, i.e. interest.

    The third form of financing is preference shares, which is a combination of ordinary equity and debt, but more closely resembles debt.

    An investor must remember that many times the aspirations of the corporate in raising capital is at odds with the investor. The corporate wants to obtain funding at the cheapest cost – the investor wants to invest at the best value.

    This point is often forgotten, especially when the marketing hype presents a seemingly favourable picture for an investor.

    Companies will look to raise long term debt when interest rates are low and the demand for “lower risk” debt is high.

    Likewise when it’s cheap to raise equity, many companies will look to take advantage – either list on a market or raise additional capital by way of rights issues.
    I can think of two more recent examples where a favourable scenario for corporates was not exactly favourable for investors.

    o A few years ago banks ability to raise preference share funding. Essentially perpetual debt at a fixed ratio of prime. Great for the corporates, but until now, not for the investor

    o The mini listing boom into 2006/2007 in the Altx and construction sector. Great for the corporates but generally not for the investors who paid too high a price.

    Investment managers will always analyse not only current returns on equity, debt equity ratios, but also company’s reliance on ongoing fresh doses of capital for expansion.
    When it gets more expensive for companies to raise equity and we have few new companies coming to the market looking for cheap equity, investors should get more excited about prospects.

    That’s all for today


    Permalink2008-07-15, 17:41:19, by ian Email , Leave a comment

    Freddie and Fannie

    In keeping government out of banking relatively simple in SA has had the relatively pleasing consequence of avoiding what is occurring in the US with their Freddie Mac and Fannie Mae. Bill Bonner notes that “Freddie Mac and Fannie Mae are to America's great empire what the East India Company was to the British Empire in the 19th century...and the Louisiana Company was to France in the 18th. Huge, stupid, and probably fatal.”

    Fannie Mae (The Federal National Mortgage Association) is a US government sponsored enterprise founded in 1938 to provide liquidity to the mortgage market.

    Freddie Mac (The Federal Home loan Mortgage Company) was founded in 1970 as competition to Fannie Mae.

    It does this by essentially purchasing pools of loans and packaging them into securities. For this it charges guarantee fees and guarantees the principal and interest on underlying loans that it has purchased.

    In order to finance these purchases of mortgage loans, they in turn raise capital by selling packaged mortgages as mortgage backed securities. Given the implicit government backing of these companies, the debt raised was highly rated.

    But …

    As house prices have fallen sharply and borrower’s ability to repay come under considerable pressure, so Fannie Mae and Freddie Mac’s balance sheets came under considerable pressure to the point where they are basically insolvent.

    If one or both couldn't function, the result would be chaos.
    Their liabilities – mortgage-backed securities (MBSs) and other debt – add up to some $5 trillion.

    Even in the context of the US economy this is massive. The total funded US federal debt is around $9,5 trillion.

    The total US GDP is around $14 trillion.

    The US mortgage market is around $11 trillion and so the 2 government sponsored entities control a massive portion of this important market.

    These liabilities are currently not considered part of the US government’s balance sheet, but with the implicit government backing now morphing into a real backing of these debts by the US government, these debts will slowly have to be allocated to the US government, putting further pressure on an already beleaguered US dollar.

    This is nothing less than taking US taxpayer money. Tomorrow the U.S. Federal Reserve chairman Ben Bernanke presents his half-yearly update on monetary policy and the economy to Congress.

    The government backing has provided some relief to markets. Locally there are few instances of interposed entities between banks and borrowers. While providing no guarantees, it means that a similar occurrence locally is highly improbable.


    Ian de Lange

    Permalink2008-07-14, 18:23:46, by ian Email , Leave a comment

    Market Timing

    I apologise for those readers who haven’t received the Daily Equity Report for the last couple of days. There was a problem with sending them out, that has hopefully now been rectified. In this regard I have decided to briefly summarize these two reports that had a similar theme. The full versions can be accessed on Sharenet’s website. For those readers who did receive the report I apologise for the repeated content.

    On Wednesday I looked at the consequences to your returns of missing the best performing days on the JSE since April 2003, while on Thursday I examined the gains that could be achieved if one was able to stay out of the market when it had its largest down days. Over a period of 1 300 days (since the end of April 2003) being out of the market for just 13 days (1%) can have a rather large impact on your portfolio’s performance. Being in the market for the full period would have resulted in a 275% return, missing the 13 worst days (worst 1%) would have elevated your return to 532%, while missing the best 13 days would have resulted in your return for the period falling to 126%.

    While no-one will be able to predict the best and worst performing days, there are lots of ‘investors’ who attempt to jump in and out of the market. Unfortunately many studies have shown that most ‘investors’ can’t time the market and that by jumping in and out of the market ‘investors’ are more likely to erode capital, especially after transaction costs, than increase their returns. I use investors in inverted commas as this kind of practice is more akin to speculating. There are some experienced traders who are able to add value by getting in and out of the market, but they are few and far between, and their success varies significantly.

    For most investors the primary function of the stock market should be to generate long term real returns in order to retire comfortably. For these investors a strategy that is rigorous in its construction and that doesn’t require attention all day everyday is the one that is most likely going to produce the most satisfactory results.

    As you can see from the above graph even if you are able to miss the bad days your portfolio will be exposed to drawdowns. Over the period of review the market only generated positive returns on 55.6% of the days, meaning that 44.4% of the days were down days. Realising that your returns will be lumpy is important to ensuring that you don’t react emotionally when your portfolio has a down turn.

    Good luck to the Springboks tomorrow!

    Have a good weekend.

    Kind regards,

    Mike Browne

    Permalink2008-07-11, 17:18:48, by Mike Email , Leave a comment

    Having a Crystal Ball

    In the efforts of being impartial to both sides of the story I decided to have a look at the impact of being able to perfectly predict when those terrible days on the market come, and thereby having the foresight to pull your investments out on these days. As with the results that I produced yesterday, these were also startling!

    By missing out on the worst 1% of days you can improve your return from 275% up to 532%, while being out of the market on the worst 5% and 10% of the days will make your returns look like they’re on steroids! Returns of 1950% and 5196% respectively would’ve been achieved! These can be seen in the graph below.

    As with missing all of the best days it is impossible that you will be able to miss all of the worst days without that mythical crystal ball. Another aspect to consider is that if you start jumping in and out of the market you will become classified as a trader, and your portfolio will then attract income tax at your marginal rate, as opposed to capital gains (at a quarter of your marginal rate – for individuals) for those who stay invested through the whole period.

    Another aspect that has been totally ignored is that in order to constantly make these kinds of calls (albeit that you will often be wrong and risk eroding your capital) you would need to be dedicated to your trading. This is an aspect of investing that many amateur investors overlook. Having a complicated strategy that is capable of producing excellent returns is also a strategy that is capable of producing poor returns if the management isn’t top rate, and if enough time isn’t dedicated to the strategy.

    For most people having a strategy for their total assets should be the first step to deciding how the various portions of their investments will be managed. Maybe you have reached the stage where you have the time and sufficient excess capital to be able to play around on the market with a portion of your investments without putting your retirement goals at risk. More likely than not you’ll need the majority of your assets working towards your retirement.

    Take care,

    Mike Browne

    Permalink2008-07-10, 17:46:06, by Mike Email , Leave a comment

    Time in the Market

    I got quite a few interesting emails from readers today, commenting on yesterday’s report on money market instruments. The two extremes were: a reader who asked whether it would be wise to disinvest his entire portfolio to cash; while another, who’s been in cash since June last year, asked whether he should now be looking to invest.

    For individual investors it is important to have an investment strategy with a clear idea of your strategic asset allocations. Tinkering around these allocations can, within limits, add value to returns. Going to the extremes of being totally disinvested can have dire consequences to your portfolio returns over the longer term.

    Only some experienced investors can get away with timing the markets, for most investors this kind of timing will lead to wealth erosion. Unless you have dedicated yourself to getting a firm knowledge of how the market operates, both on a fundamental and behavioural level, you have no hope of consistently adding value through moving in and out of the market over time. We profess to be unable to consistently time the markets, but do look at valuations and make decisions to under/over weight asset classes accordingly.

    For the investor whose primary goal is to secure his retirement, his primary objectives should be to determine his optimal strategy (or have a consultant assist) and then stick to the strategy. While the strategy should allow for deviations from your optimal mix, coming out of the market completely should be a no go.

    One of the oldest axioms in investments, which still holds today, is “It’s not about timing the market, it’s about time in the market.” By consistently compounding market return, you should over the long run generate good real returns, while chopping and changing will moderate your real returns. When investing one needs to realise that returns are lumpier than smooth money market returns.

    I had a quick look at the impact of missing some of the best performing days since the end of April 2003 (the start of the bull market). My findings were quite startling!

    By missing only the top 13 performing days (1% of days in the sample) you would see your return drop from 275% to 126%! Missing the top 5% and 10% of the days are clearly more devastating. In both instances you would’ve ended up with negative returns, -27% and -74% respectively.

    Admittedly missing out only on the upside is an unrealistic assumption. I will have a closer look at other possibilities, and how they would influence your portfolio returns, tomorrow.

    Take care,

    Mike Browne

    Permalink2008-07-09, 17:23:24, by Mike Email , Leave a comment

    Money Market Performance

    With global equity markets being hard hit and not many sectors being spared, many investors have been tempted to put their investments into a money market (cash) account to take advantage of the high local interest rate environment.

    Taking your money out of the market at its peak, in hindsight, would have been an excellent decision, but the problem is that one can very rarely predict when the market’s going to peak. Equally, moving all of your investments from equities to cash only now (if you have been overweight financials and industrials) wouldn’t be the wisest move. Investors who have been sitting on the sidelines have an interesting decision to make, to hold back, or get into selected investments.

    To get a better idea of the attractiveness of cash I had a look its performance over the past 10 years or so, during high and low inflation periods, and when inflation’s been rising and falling.

    The first thing that I noticed is that while nominal interest rates go up in times of high inflation, the real return generally decreases. While this isn’t an attractive result on a real basis, we must remember that rising inflation also negatively impacts the real returns of growth assets. I then had a look at the effects of current inflation on future money market returns. I did this by lagging the money market real return by 12 months to see what kind of real returns we can expect going forward, and got the following result.

    The graph indicates that real returns generally increase after periods of high inflation. The caveat is that this is usually accompanied by a decrease in inflation; hence higher real returns going forward will be more dependent on inflation coming off its high levels than purely by inflation being high.

    Nominal returns should remain high going forward, and while this results in a higher income tax bill (for those investors whose interest income is above the exemption), a higher ‘guaranteed’ return is distinctly appetising.

    For the reasons mentioned above, our clients’ portfolios currently have an overweight portion of their total portfolios allocated to money market instruments. This cash will be deployed to other growth asset classes when value emerges.

    One needs to remember that cash should only form part of your total investment strategy, as you are guaranteed to lose money on an after tax real basis over the long term.

    Take care,

    Mike Browne

    Disclaimer: Nothing in this report should be considered personalized investment advice.

    Permalink2008-07-08, 17:26:33, by Mike Email , 1 comment

    Inflation in the Real World

    Most people are most probably sick and tired of hearing the dreaded ‘i’ word. After experiencing years of low inflation and high asset returns, we have relatively quickly moved into a period of high inflation and low asset returns, and while everyone has an opinion on how long these conditions will last, no-one can say with certainty when it will end.

    High inflation isn’t good news for most investments.

    It is quite clear that the level of inflation is an important determinant in how consumers feel the pinch, but what is also important is the direction of inflation’s movement. When inflation is in a downward trending environment (as we experienced from the end of 2002 through to mid 2004) wage earners generally benefit from salary increases at levels higher than inflation. On the flip side, when inflation is rising salary earners’ wage increases will typically lag inflation, leaving the employee not only struggling with nominal price increases, but also on a real earnings basis.

    An example of this is that at the end of 2002 employees were probably negotiating wage increases of around 12% (the existing level of inflation). This was at the peak of inflation, and 12 months down the line inflation had dropped to an annualised 0.3%, with an average rate for the year of 5.8%! Employees scored, while employers were left paying out inflated real wages. The opposite is currently the case.

    This is one of the reasons why Tito Mboweni is particularly tough on interest rates. Increasing wage demands due to increasing inflation is called second round inflation, as it comes around after inflation has already increased. It is an increase in employees’ expectations with regards to inflation, and if not nipped in the bud can contribute to spiralling inflation as it becomes a self fulfilling prophecy.

    One sector of the market traditionally able to tolerate inflation better than others is the food retail sector. As a result of their products being necessities, as opposed to luxuries, they have strong pricing power when compared to luxury goods producers.

    We have seen that they aren’t immune (witness Woolies’ share price woes – although they admittedly have a large clothing and credit business) as in hard times customers will trade down, i.e. shop at Checkers instead of Woolies.

    Today the Shoprite Group released a trading update, indicating that they expect turnover to increase by 22% for the 12 months ended June 2008. Getting good results like these in the tough environment is probably in part due to customers trading down, but also due to management’s decision to cut margins on basic food stuffs. It is yet to be seen what the growth in earnings will be. These retailers typically have very high turnover with low margins, and the slightest change in margin can have a large impact on the bottom line (earnings).

    The company’s share price is currently 21% off its high achieved in May this year, and ended the day down 1.24% compared to the ALSI which was flat.

    Have a good week.

    Take care,

    Mike Browne

    Permalink2008-07-07, 17:12:45, by Mike Email , Leave a comment

    Looking Longer Term

    Yesterday I wrote about the disorder that we have seen in the markets of late. At the risk of repeating myself when markets are significantly down this is when opportunities start to emerge.

    Don’t get me wrong, just because a share is cheap, doesn’t mean that it will make you a lot of money. There may very well be valid reasons that the company is trading at low levels. It is however a good place to start.

    Just to give you an illustration of how far the market has pulled back I have attached a graph of the 12 month rolling returns of the ALSI and major sectors. It is not a pretty sight. These are total return series, and thus have dividends reinvested. If it weren’t for the dividend component the ALSI would now be in negative territory for the past 12 months. Financials are down over 30% over the past year. For the 12 months to date the ALSI’s total return has been 0.2%.

    This is where the heading of the article ‘Looking Longer Term’ becomes the focus. From these depressed levels, and taking a long term view (at least 5 years, but ideally 10 years and longer) one should be able to generate good returns through careful share/fund manager selection. Note that I use the word ‘should’.

    Investing isn’t an exact science, it is more about looking at the various factors involved (be it inflation, earnings/dividend growth, GDP growth, current PE vs historic PE levels, etc), and then using experience and common sense to try to increase the probability of success to acceptable levels. By not putting all your eggs in one basket and continuously sticking to this method you will be able to ride out the abnormalities that always crop up from time to time.

    Below is a graph of rolling 5 and 10 year returns of the ALSI (on an annualised basis). In this 13 year period the market only had a negative 5 year nominal return for 22 days, excluding the impact of dividends. If total return data was used for this period it wouldn’t have gone negative.

    While 12 month returns being flat, on a rolling 5 year basis the returns are still at high levels, which would point towards returns being muted going forward.

    What this graph does hide is the individual shares, and individual fund manager performances over this period. We must not be sucked into making investment decisions purely on the position of the ALSI (unless of course you are investing into tracker funds). Within an expensive (cheap) market there will generally be pockets of value (over-priced shares), and one needs to be able to identify where these pockets are, avoiding the expensive ones and focusing on the ones showing value.

    Once again it all comes down to making sure that you do your homework, and making sure that you are fully informed when making investment decisions.

    Have a good weekend, good luck for the Springboks!

    Kind regards,

    Mike Browne

    Permalink2008-07-04, 17:30:02, by Mike Email , Leave a comment

    Blood on the Streets

    Markets continue to be hit both locally, and abroad. On the local front hardly any shares were spared, with only around 20 shares (with a value of over R1) up for the day. Shares in the green included: MTN, Eqstra, and Rainbow.

    Negative sentiment and news abounds, a case in point is car sales – in South Africa new car sales for June were 21.5% lower than they were in June last year, while US car sales were down 18.3% over the comparable period. The US consumer is clearly under the kosh, with the worst performance in car sales in the first half of the year since 1993, so it isn’t just we South African’s feeling the pinch. Car sales are generally a leading indicator for economic trends, and the weakness here doesn’t bode well for other industries in months to come both locally and abroad.

    Bloomberg reported more bad news that Mutual and Federal plan to make 600 of their 3 000 employees redundant (retrench or offer early retirement) by the end of the year, that’s 20% of the workforce! While this is bad news for employees, it will reduce staff costs (while hopefully not negatively affecting the company’s turnover), which can be seen as a positive for M&F investors.

    When there’s much doom and gloom, as there currently is, opportunities will start to emerge. As investors we need to make sure that we remain alert for such opportunities.

    Many directors clearly think that their own company offers good value. I just had a browse through recent directors’ dealings and the majority were purchases. Directors generally have a good working knowledge of not only how well their company will do, but also the state of their industry.

    Remember, when investing into a company you need to answer two important questions:
    1) Is this a good company?
    2) Is the market value above or below fair value?

    It is generally advisable to focus mainly on high quality companies, as they will generally have a more predictable earnings stream. Once you have decided on which the quality companies are, you can then decide which of them are trading cheaply. Buying a company that has a fair value of R1/share for 50c/share gives you a higher chance of success than buying that same company at R1.50/share.

    Astute investors who slowly took profits as the market went up are now the ones who have cash in the bank earning a high interest rate. It is also these investors that will have the capital to start deploying it into quality companies at prices not seen, in some cases, for over 3 years.

    Woolies closed the day at R9.50, a price last seen in April 2005. This remains a quality company. Another quality company, RMB Holdings closed down 2.4% for the day at levels last seen in January 2005. Investec closed at R43.44 a price that it was last at in October 2005, having closed as high as R104.40 in May 2007. All quality companies significantly off their highs, with forward dividend yields of 9.2%, 7.6%, and 17.0% respectively!

    The struggles of JD Group have been well documented, and it is now trading at levels last seen at the beginning of June 2003, over 5 years ago at the start of the bull market. The share moved up over R100 and closed today at R23.75.

    Kind regards,

    Mike Browne

    Permalink2008-07-03, 17:45:42, by Mike Email , Leave a comment

    Socially Responsible Investing

    Socially Responsible Investing (SRI) has been in existence, in some form or the other, for around 250 years. Many people believe that it first began in 1758 when the Quakers banned members from participating in the slave trade (buying and selling humans). SRI definitely has progressed since those early days!

    Industries that are often excluded from the SRI universe include tobacco, weapons, and gambling. SRI has slowly been gaining more traction, with its scope now embracing not only socially responsible considerations, but also environmentally sustainable entities. The JSE for instance has a SRI Index.

    Issues that are taken into account for the JSE SRI Index include environmental impact, human rights, corporate governance considerations, etc. All companies that form part of the ALSI are eligible for the SRI Index with the Top 40 companies automatically getting evaluated, and mid and small cap companies are invited to participate on a voluntary basis. The 2007 review assessed 72 companies, of which 57 were successful, 34 Top 40 stocks, 18 Mid Cap stocks, and 5 Small Cap stocks (the full list can be accessed from the JSE’s website).

    In the past SRI didn’t get much attention.

    Typically the client would draw up a list of companies that he didn’t want the manager to invest in, essentially screening the investment universe and that was the extent of the process. Nowadays managers seek more and more to engage with companies to implement socially responsible and environmentally sustainable practices, and this generally improves not only the company’s image, but also the company’s performance. With the performance of the socially responsible companies improving there is added incentive to the investment industry to include SRI procedures into their modelling as well as incentive to the listed companies to improve their practices.

    Since the inception of the SRI Index on the JSE at the end of 2004 it has outperformed both the Top 40 Index and ALSI. Over this 3 and a half year period the SRI Index has been above the ALSI and Top 40 97% and 95% of the time respectively, returning 1% pa more than the Top 40, and 2.5% pa more than the ALSI. Below is a graph of the various indices.

    As you can see from the above chart investing responsibly not only offers the investor the chance to ‘feel good’, but also offers the opportunity to out perform other investment styles.

    It will be interesting to track the changes to the SRI Index over time as more and more companies seek to form part of the index.

    Take care,

    Mike Browne

    Source: JSE, Wikipedia

    Permalink2008-07-02, 16:19:23, by Mike Email , Leave a comment

    Half way through 2008

    We are now 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 the credit crunch came, 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 R118, 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 is 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

    Permalink2008-07-01, 16:34:26, by Mike Email , Leave a comment