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    Post modern portfolio theory

    I attended a brief presentation put on by the Institute of Investment Analysts Society last year. The topic was, “Is it time for Post Modern Portfolio Theory” presented by a US investment manager. At Seed Investment Consultants we have been using this methodology for constructing portfolios, so I was very surprised when only one of the other managers attending had even considered it.

    Portfolio construction is really asset allocation. This is the building of various investment classes to construct a portfolio with the aim of meeting a certain return and risk objective. Studies, together with intuition, have revealed that asset allocation is a key determinant of investment performance.

    Equally important is that asset allocation is an important tool to reduce risk.

    And these are the 2 main ingredients that all investors want – maximum returns for the lowest risk.

    It’s generally understood therefore that asset allocation or portfolio construction is a very important process for long term wealth generation. However most private investors do not have a detailed strategic asset allocation plan. This is in stark contrast to professionally managed portfolios.

    So let’s take a brief look at modern portfolio theory and post modern theory.

    If we look at modern portfolio theory we do find some deficiencies:

    In a nutshell modern portfolio theory looks at asset class returns over time as well as their volatility (positive or negative), which it defines as risk. Certain assets, such as equities will have high historical returns, but high volatility, while others such as bonds will have lower returns and lower volatility.

    If these assets are plotted on a graph with return on the Y axis and risk on the X axis, then an efficient portfolio (combination of different assets) can be plotted, which is one that for a given level of risk generates the highest expected return.

    No problems here, except that risk is defined as volatility, which is mathematically known as standard deviation. Because risk is equated with standard deviation, low volatility means low risk and vice versa.

    I.e. risk has often been equated with high standard deviation. But is this really correct?

    Most investors will understand that this can produce nonsense. For example an asset class producing steady losses of around say 7% per annum, will display a low standard deviation, but is clearly not an attractive or indeed low risk investment.

    On the up side, positive deviation is also counted as risky, but any investor achieving 15% in year 1, 45% in year 2 and 22% in year 3 will be satisfied, despite the fact that standard deviation is high. The portfolio theory says the risk is high, but the investor says no problem.

    I think that the central issue revolves around the definition of risk.

    Investors think of risk in a far different way: The 2 biggest risks are:

    • Risk of losing capital
    • Risk of not meeting long term goals, such as having sufficient capital at age 65.

    Post modern portfolio theory

    When risk has been more accurately defined, then standard deviation or volatility is removed from the portfolio construction process. In its place comes downside risk. This is really where investors get concerned – losing capital on a permanent basis and not being able to achieve longer term goals.

    With downside risk optimisation when constructing a portfolio, no cognisance is given to volatility, past or expected. The result is a portfolio that is designed to achieve the longer term return goals, but with lower risk.

    Don't hesitate to give me a call if you are looking to retire soon.

    Have a great weekend


    Ian de Lange
    082 921 0220

    Permalink2008-08-29, 17:57:30, by ian Email , Leave a comment

    Listed property and Growthpoint

    From January to end of June the local property index fell 28% as inflation and interest rates rose and with the global debt crunch. Then in a quick rebound from beginning of July to now, the index is up 24%. While still around 17% below its last year peak, the historical yield still trades around 8% and there appears reasonable value.

    Many investors were surprised by the large decline in capital values of property, which more than wiped out the income returns, especially given that the asset class was supposed to be stable.

    But the reality is that when an asset becomes in such demand that there are more buyers than sellers, and the price gets ahead of its long term target, then the probability of a correction becomes higher.

    While net rental streams from property are generally reliable with a steady profile and a lower volatility than say company dividends, the values placed on those earnings (i.e. capital prices) are a lot more volatile based on the prevailing sentiment.

    Growthpoint is the largest listed property company with a market capitalisation of R18,4 billion. It has 436 properties values at over R27 billion. The difference between the market cap and the gross value of the properties is debt on the balance sheet.

    Property investments have excellent attributes to use gearing or leverage. Listed property companies make use of gearing to enhance shareholder returns. At the end of June the company’s loan to value ratio (i.e. debt to value of property and listed property investments) was 30,9%. This is a fairly conservative gearing ratio compared to many private property investments, but at around R9 billion it’s high in absolute terms.

    With larger size comes the ability to raise debt at lower costs and naturally the lower the cost of debt, the higher the effect on shareholders returns. 98,2% of its debt is fixed at an average rate of 9,4% for a weighted 10 years, and therefore the company has little exposure to interest rate risk for the next 2 years.

    With the benefit of hindsight, the company had impeccable timing in the raising of additional capital from the PIC on behalf of the Government Employees Pension Fund, when it raised R1,65 billion on a forward yield of below 7%. I.e. an issue price of R16,50 per linked unit.

    Most property companies have been property owning companies only with all property management activities outsourced. Growthpoint was no exception, but in anticipation of the REIT – Real Estate Investment Trust structure, during the last financial year they acquired the property fund management and related activities from Investec Property Group Limited for a consideration of R1,6 billion.

    This appears a full price to Investec, because the annual cost of this fund management service to Growthpoint was in the order of R145m per annum, which they now save. I.e. they paid a multiple of around 11 times.

    During the year, the company acquired property to the value of R2,3 billion with office properties accounting for some R1,55 billion and retail R654m.

    Surprisingly enough, despite the much slower economy and interest rate hikes, the company has managed to keep vacancy levels at low rates, only slightly above those in 2007. This could however continue to escalate in the year ahead and is always an important factor to watch in a property company.

    For the year to June it managed to grow its distribution growth to 106,5c per linked unit – a gain of 14,4% which was slightly ahead of general consensus.

    The price gained 3,45% today back to 1438c. The one year forward dividend yield is around 8,5%. With these results out, analysts may lift expectations slightly.

    The long run real return from property is in the order of 6,75%. Remember that rental streams generally keep up with inflation and so a forward yield of 8,5% looks attractive compared to long run real returns.

    All investors, even those with living annuities should be monitoring the ongoing allocation to the various asset classes. Ideally this should be presented in a consolidated format across all your assets. Don't hesitate to contact us to discuss how this can be achieved.

    Kind regards

    Ian de Lange

    Permalink2008-08-28, 18:48:28, by ian Email , Leave a comment

    Inflation Hits 13.4%!

    This is a large rate of increase in anyone’s books, and for the 16th month CPI-X fell outside of the Reserve Bank’s target range of 3 – 6%. We can expect this period to last for a while longer.

    I had a look at the history of the CPI-X value, and since it only goes back to 1998 I couldn’t find a higher level than its current 13%. To extend the data set I took a look at current headline inflation (CPI), and looked back over its history to see when it was last higher than it is now. I had to go all the way back to September 1992 to find a higher CPI (it came in at 13.5% for the twelve months to September 1992). I can safely say that I’m sure that most people don’t need to look at the official numbers to realise that they’re feeling the pinch.

    I was at a multi-manager conference last week, and it was interesting to hear the fixed income managers’ views on what they think the SARB should be doing, where they expect inflation to go, and how they think the rand perform. While they had divergent views on many of the above mentioned factors they all believed that we were near a peak of inflation and that the next move for rates is that they will fall (some think earlier than others).

    As mentioned earlier, inflation is at historical highs and most managers expect it to start tapering off. It is at this stage, we must remember, that it is generally the point in the cycle that the Reserve Bank is able to start relaxing monetary policy (i.e. dropping interest rates), which should in turn help support a sagging economy by making it more attractive for companies to borrow.

    While Tito Mboweni has, in the past, been criticised for using an iron fist while raising rates we are now in a position where he is able to offer support, unlike the ailing US economy, where interest rates sit as low as 2%, with inflation soaring. The US Fed is mandated to target both inflation and growth, and is now stuck between a rock and a hard place. If they raise rates they increase the likelihood of the US economy falling into a deep recession, but on the other hand if they drop rates anymore (to help the economy) they risk fuelling inflation even more.

    Having a close look at the inflation numbers for July, we can see that a 67c a litre increase in fuel had a big impact on the number. The good news is that August’s petrol price fell 30c and we can hopefully expect another decrease of over 100c at the beginning of September, and just as fuel can push inflation on the upside, so significant decreases can ease the inflation number on the down side.

    It is in the tough times like this that opportunities are created. It is not all doom and gloom, and pretty much all countries in the world that have a targeted inflation rate are out of their range.

    Enjoy the rest of your week.

    Kind regards,

    Mike Browne

    Permalink2008-08-27, 17:34:48, by Mike Email , Leave a comment

    Some good points from Peter Bernstein

    Peter Bernstein, US author, investor and educator, was born in 1919, graduated magna cum laude from Harvard in 1941 and wrote numerous books on various topics including economics, portfolio management, and risk. His book, Against the Gods, The Remarkable story of Risk, is a fascinating read.

    I came across an interview he did a while back and have extracted just a couple of answers he gave to some questions to Money magazine.

    : What are investors' most common mistakes?

    A: Extrapolation. Leaving fund managers in a down year to go with whoever's hot. The refusal to believe that shock lies in wait. Believe me, individual investors are not the only ones who mire themselves in this mistake. It is endemic throughout the investing community.

    Q: How can investors avoid being shocked, or at least reduce the risk of overreacting to a surprise?

    A: Understanding that we do not know the future is such a simple statement, but it's so important. Investors do better where risk management is a conscious part of the process. Maximizing return is a strategy that makes sense only in very specific circumstances. In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.

    Q: You've often written that something important happened in September 1958. What was it?

    A: [For the first time in history,] stocks began to yield less than bonds, and it was not something tentative. The lines crossed without any period of hesitation and just kept on going. It was just, zzzoop! All my older associates told me that it was an anomaly and it could not last. To understand why that happened and what that meant -- and to recognize that what was accepted wisdom for a couple hundred years could turn out to be wrong -- was very important. It really showed me that you don't know. That anything can happen. There really is such a thing as a "paradigm shift," when people's view of the future can change very dramatically and very suddenly. That means that there's never a time when you can be sure that today's market is going to be a replay of a familiar past.

    Markets are shaped by what I call "memory banks." Experience shapes memory; memory shapes our view of the future. In 1958, younger people were coming in who had a different memory bank. That's also what happened [in 1999] when tech stocks were enormously exciting; most of the new participants in the market had no memory of what a bear market is like, and so their sense of risk was muted.

    How strong is the memory of the inflationary nightmares of the 1970s? Anybody under 50 did not really experience it, in the sense that they were [then] too young to be decision-makers. I believe sustaining that memory is more important to the future than all the vivid memories of the bubble and its aftermath.

    Some important points made here. Investors cannot simply extrapolate recent past results. Risk reduction is just as, if not more important than maximising returns. Sometimes markets go through important structural changes.

    Kind regards

    Ian de Lange
    082 921 0220

    Permalink2008-08-26, 18:32:27, by ian Email , Leave a comment

    Some views on market timing

    In the recent past, with the exceptional asset price volatility, I have come across many private investors who are making large market timing calls. While we are of the view that the reasoning is often flawed, we are not the type of investment manager saying, don’t worry “its time in the market and not timing the market” that is important.

    Trying to time the market is a highly charged emotional issue to investing. Many academic studies indicate that it does not make sense, but on the other hand practical experience shows that it can make a huge difference.

    As with most loosely defined terms, “timing the market” is such term that needs to be clearly defined.

    Let’s look at some points that we think are valid:

    o Firstly we believe that history shows that relative asset class risk has been much more stable than relative asset class returns.

    o Overvaluations are corrected over a very much shorter time span, than they take to develop, with the turning points almost impossible to call in advance.

    o Over the longer term, asset class performance will revert to the mean, taking into account that the mean may structurally move over time.

    So while we agree with the notion that periodic market timing will probably do more harm than good to the long run portfolio return, given the assertions above, systematic market timing DOES make a lot of sense.

    o If relative asset class risk is relatively stable over the longer term, then use this to limit portfolio risk rather than maximise portfolio returns.

    o If overvaluations have the tendency to snap back quickly, and asset class returns revert to the mean, have a basis for assessing, both the current and longer term asset class valuations and adjusting accordingly.

    When constructing your portfolio don’t try to minimise risk by buying and selling after a price move. Rather spend the time assessing absolute and relative valuations and systematically underweight the more expensive asset class and overweight the relatively more attractive asset class.

    The key word is systematically. This is not “day trading”, and not “market timing” in the commonly imagined sense.

    So if you have made or will be making large scale market timing calls, we think its best to have a thorough and consistent process.

    Kind regards

    Ian de Lange
    082 921 0220

    Permalink2008-08-25, 17:01:45, by ian Email , Leave a comment

    Another look at passive versus active investing

    Yesterday I spent some time at a fund manager seminar covering various topics and providing plenty of insight into selected fund manager processes and current thinking. An issue that is increasingly relevant and very contentious especially when you put an active manager and an index tracking “fund manager” in the same room is that of active manager alpha.

    In other words can an active fund manager outperform an index?

    We all know that following on from the creation of indices, it was not long before institutions replicated processes for investors to be able to invest in these indices. In the US, the Standard and Poor’s Depository Receipt was launched in 1992 and tracks the S&P500 index. Its informally knows as Spyders or spiders.

    Locally the Satrix 40 Exchange traded fund tracks the JSE All Share top 40 index. It provides a passive approach for investors in which to invest.

    In answer to the question of whether the active outperforms passive investment management, Cannon Asset Managers – an active manager – highlighted the following points.

    o Alpha (out performance above an index) is highly cyclical in SA. I.e. At times lots of managers outperform and at times most managers are underperforming.
    o Taking a closer look, they found that while long term out performance was in the order of 1,25% per annum, this has tended to escalate when the Financial and Industrial index was outperforming the resources index. And vice versa when resources were outperforming, active managers under performed.
    o This makes sense when it’s a known fact that the JSE All Share index is highly concentrated around Anglo American and Billiton and in total resources are approximately 50% of the index. Most managers don’t achieve the high resource exposure levels of the index and so struggle to even match, let alone outperform in a commodity bull market.

    Following on from this, an investor cannot expect a portfolio to outperform an index if the fund closely represents the index.

    This is a very important consideration for us. i.e. active managers with portfolios very close to the index, so called index hugging. In this case it’s debatable whether active management fees should be paid – i.e. it may be more appropriate to by a cheaper index tracking ETF.

    The answer to the active versus passive approach may be one of first assessing the cycle and then trying to determine whether to under or overweight passive.

    I will be looking into this in more detail.

    Don't hesitate to contact me if you would like to have greater ongoing insight into your portfolio construction.

    Have a super weekend


    082 921 0220

    Permalink2008-08-22, 17:35:48, by ian Email , Leave a comment

    Bad Debts Weigh on Retailers

    It's been a tumoultous year for the retail sector and many forsee another tough year ahead as consumers tighten their belts and look for every opportunity to spend less. With Woolworths, Truworths and Massmart all releasing their full-year results today, it's evident that rising interest rates and the general uncertainty in the economy is impacting on our major shopping chains.

    Woolworths have reported that they have lost market share in their food segment and have seen bad debt rocket up to 80%. The second half of the year has improved, largely as a result of the company's stricter credit policies, but what is obvious is the fact that consumers are spending less then before. Woolworths' share price is evidence of this by dropping by 28% over the course of the year.

    Truworths reported an increase in full year headline earnings but a 66% growth in bad debts saw the share price drop by 1.9% today.

    Massmart reported slightly better results, with a 23% increase in full year headline earnings. Despite a downturn momentum in the economic cycle, performance across all four of the group's divisions remained balanced and produced a strong overall result for the group.

    The retail index has shed almost 14% this year, struggling against the 8% drop recorded by the All Share index.

    However, analysts haven't given up all hope on the sector. Many see it as a good long term investment prospect and with the advent of 2010 and lower interest rates, it could still be a good addition to your long term investment portfolio.

    Permalink2008-08-21, 17:00:00, by Marika Email , Leave a comment

    Taking Another Look at Hedge Funds

    As an asset class there is definitely a place for hedge funds in any high net worth client’s portfolio. This is something that we have mentioned before. Hedge funds have a place as they are generally an asset class with real returns uncorrelated to the market, and one needs to ensure that the hedge funds that you have selected have these characteristics in order to justify their position in your portfolio.

    You may ask why I’m bringing this point up now.

    July returns for hedge funds have been slowly trickling onto my desk, and it’s evident that there is a broad dispersion in returns, with some giving a decent positive return (in a month when the ALSI was down 8.72%), others matching the market, and still others that fell by significantly more than the market.

    As investment consultants we need to look and understand how and why some of these managers weathered the carnage seen in July, and why others were affected even more than the market. As hedge funds are less regulated than the unit trust market there is a larger onus on the investor/investment consultant to perform due diligence, to have a thorough understanding as to how the manager is mandated to invest, and be aware of the manager’s thinking and positioning at all times.

    Hedge funds typically have a much broader mandate than your average unit trust or personal share portfolio, so it stands to reason that returns can potentially be more diverse. While returns can be more diverse, they are typically much more stable as a result of the broader range of instruments that they are able to invest in, and the strategies that are used.

    Tracking hedge fund returns over time we can see that this is indeed the case in reality. We see consistent returns, and then every now and then some funds produce either large positive or negative returns. Taking a closer look at when these events occur it typically happens at turning points in the market, when superior foresight is rewarded. The nature of a geared investment can magnify returns (up or down), and one needs to be cognisant of these potential risks at the outset of your investment in order to evaluate how they affect your investment decision.

    What does this all mean to you as an investor?

    1. Hedge funds remain an important part of your overall strategic asset allocation.
    2. Extensive due diligence is crucial before deciding on which managers to entrust with your capital.
    3. Daily and weekly monitoring of mandate limit compliance is very important.
    4. Diversification among a number of hedge fund managers with different strategies is advisable.
    5. Constant monitoring of, and feedback from, the manager is vital to ensure that the strategy hasn’t changed, and that the manager follows a consistent approach to investing your capital.

    A robust approach to investing in hedge funds will result in a portfolio that has a better risk/return profile than one without hedge funds. The reality is that, as with all investments, uninformed decisions will generally produce undesired results, so the process that you (or your consultant) go through on selecting and monitoring your investments is important in ensuring that you get the desired results.

    I trust that I have provided some food for thought. If you would like to discuss our approach with us in more detail please don’t hesitate to contact Ian on 021 914 4966 or ian@seedinvestments.co.za.

    Kind regards,

    Mike Browne

    Permalink2008-08-20, 17:26:34, by Mike Email , Leave a comment

    Three prong approach

    Merrill Lynch strategist put out some sound advice last week in a small piece. Relaying that investment performance during 2008 continues to be a year of surprises, with expectations at the beginning of the year for many assets turned on their heads. They expect this to continue and therefore support the long standing axiom of investing, that of portfolio diversification.

    We have spoken about portfolio diversification as a risk reduction tool that helps investors “sleep at night.” Merrill Lynch is saying that one’s portfolio is probably not well diversified if one is troubled by daily, weekly and even monthly gyrations in financial markets.

    Chief strategist, Richard Bernstein highlights the fact that at the beginning of the year, the consensus focus was on “hot” emerging markets like China and India, but so far these markets have dropped substantially.

    China SSE Composite index

    A focused portfolio on a higher risk region – given the expensive valuations – would have seen a large decline, while diversification into developed markets would have fared better.

    For sure the Chinese market was definitely looking very frothy. The index peaked at just over 6000 in October last year, falling to 2344, a decline of 60%.

    A decline of this magnitude requires a gain of some 155% to get back to breakeven again – not likely to occur in a hurry.

    Merrill’s view on long term wealth creation is 3 pronged.

    o Lengthen your investment time horizon
    o Compound dividend income
    o Maintain a well diversified portfolio

    While very simple, they believe most investors choose to ignore.

    We however like to believe otherwise


    Ian de Lange
    082 921 0220

    Permalink2008-08-19, 20:11:31, by ian Email , Leave a comment

    Trust Basics

    I spent this morning at an update seminar on trusts and estate planning. Having also had a meeting last week with a trust office on this topic, it’s been highlighted to me the necessity for the proper consideration, planning and administration in this area. Without this been seen as advice in any way, I will just highlight a few pertinent issues.

    Trusts are a long standing part of the South African landscape having been developed under Roman Dutch law, but also regulated in terms of the Trust Property Control Act.

    They serve multiple purposes, but just in the focused area of investments and investment planning, trusts definitely have their purposes. One of the biggest reasons that investors establish a trust is to peg the value of their estate for estate duty purposes.

    The basic premise is that once one divests himself of an asset, whether by selling or by donating, to a trust, then that asset is no longer his. The beneficial ownership passes to trustees who will manage and administer the trust assets in terms of the trust assets.

    An important point is that each trustee acts in an official capacity, which is fiduciary in nature. I.e. standing in special relation of responsibility to another.

    Important points

    o It is important that original owner of the trust assets does not retain control.
    o Look out for the deeming provisions of the Income Tax Act.
    o Ensure that an attorney or trust office has worked through an old trust deed, updating where necessary.
    o Ensure that there is proper accounting and record keeping.
    o Ensure all major decisions have been recorded and authorised by the trustees in the form of signed resolutions.
    o Avoid blanket authorisations.
    o Record minutes of meetings of trustees.


    o Have an authority to act only when authorised in writing by the Master of the High Court
    o Changes to address must be notified within 14 days of the change
    o Because trustees have a fiduciary duty to the trust and beneficiaries they must avoid any conflict of interest.
    o Trustees must ensure that all personal interests in agreements entered into with the trust have been declared to the other trustees.
    o Trustees must act with care, diligence and skill which can reasonably be expected of a person who manages the affairs of another.

    A trust and founder’s last will and testament needs to all work in concert. Unfortunately these are aspects that so many leave for any day, but it’s worth taking the time to ensure all up to date.

    That’s all for now.

    Kind regards

    Ian de Lange
    082 921 0220

    Permalink2008-08-18, 17:15:11, by ian Email , Leave a comment

    Relative performance of emerging markets against developed

    Emerging markets have strongly outperformed over the last 5 years at least, but technically the relative relationship between these two main indices are starting to favour the MSCI World index. While we place more emphasis on fundamentals, when the technical picture starts to confirm, it enhances our conviction levels.

    MSCI stands for Morgan Stanley Capital International and is an index of shares from 23 developed markets around the world, calculated since 1969. Being a wide representative it is a very common benchmark for global mandate funds.

    The providers of the index are MSCI Barra. They calculate over 100 000 equity, REIT (property) and hedge fund indices daily – its big business.

    On an ongoing basis the indices are reviewed, with underlying securities moving in and out of the index, rebalancing, new indices developed etc.

    They estimate that some USD3 trillion of global fund money is now benchmarked to their indices.

    With an increasing reliance of global fund managers on indices, index weightings and index performances, it is of high importance when there is a possible shift in one main index relative to another.

    The chart below is the MSCI Emerging Markets index in red against the MSCI World index in blue. Over this time period, MSCI EM have strongly outperformed, but over at least the last 12 months, this out performance has slowed as global markets have all come under pressure.

    Chart: MSCI EM relative to MSCI World.

    This reflects a 5 year history with the long out performance of EM trend now being broken.

    Over the last five years the US dollar has also been weak relative to a basket of currencies. The most followed currency index is the US dollar index. The weekly chart has shown strength through a long downward cycle and again this could be indicating a place to pause relative to other currencies.

    The US dollar strength has certainly coincided with declines in the US dollar price of most commodities, with some sharp falls in the resource companies.

    This is of particular relevance for South African investors, i.e. those with a large portion of their capital in an emerging market.

    We have been adopting an overweight global versus local tactical asset allocation for the last 12 months. While no guarantees, we think that this may still only be the start of a longer term reversion trend developing. We will be on the lookout for more evidence.

    Because local assets have outperformed global developed markets for so many years, some advisors have been reluctant to have more than 10% exposure to global.

    In addition to the benefits that come with diversification, there appear to be signs of a reversal of the strong EM out performance. We believe that investors must have adequate global diversification and make use of the R2m allowance and offshore swap capacity.

    On a monthly basis we provide clients with statements reflecting actual underlying exposure across the various asset classes, including offshore. It’s very important to track this relative to a defined investment strategy. This is also very important for living annuities, where the investment risk remains with the investor.

    If you would like to have a monthly consolidated statement detailing your total investment position, asset allocation and performance reporting, but currently not receiving this, don’t hesitate to contact me to discuss advice and management of your portfolio.

    Have a wonderful weekend

    Kind regards

    082 921 0220

    Permalink2008-08-15, 17:50:33, by ian Email , Leave a comment

    Emerging markets versus developed markets

    Emerging markets have strongly outperformed over the last 5 years at least, but technically the relative relationship between these two main indices are starting to favour the MSCI World index. While we place more emphasis on fundamentals, when the technical picture starts to confirm, it enhances our conviction levels.

    MSCI stands for Morgan Stanley Capital International and is an index of shares from 23 developed markets around the world, calculated since 1969. Being a wide representative it is a very common benchmark for global mandate funds.

    The providers of the index are MSCI Barra. They calculate over 100 000 equity, REIT (property) and hedge fund indices daily – its big business.

    On an ongoing basis the indices are reviewed, with underlying securities moving in and out of the index, rebalancing, new indices developed etc.

    They estimate that some USD3 trillion of global fund money is now benchmarked to their indices.

    With an increasing reliance of global fund managers on indices, index weightings and index performances, it is of high importance when there is a possible shift in one main index relative to another.

    The chart below is the MSCI Emerging Markets index in red against the MSCI World index in blue. Over this time period, MSCI EM have strongly outperformed, but over at least the last 12 months, this out performance has slowed as global markets have all come under pressure.

    This reflects a 5 year history with the long out performance of EM trend now being broken.

    This is of particular relevance for South African investors, i.e. those with a large portion of their capital in an emerging market.

    We have been adopting an overweight global versus local tactical asset allocation for the last 12 months. While no guarantees, we think that this may still only be the start of a longer term reversion trend developing. We will be on the lookout for more evidence.

    On a monthly basis we send out detailed investment statements to each one of our clients. Because we drill down into the portfolios, we have a clear understanding of how much is allocated to offshore (split to asset class). We present this graphically, so on one statement you have a snapshot of your total investment position. We naturally include performance reporting as well.

    Reporting is across discretionary funds, property, living annuities, share portfolios etc.

    Contact me if this is what you are currently lacking and would like to put in place.

    Kind regards

    082 921 0220

    Permalink2008-08-14, 18:21:22, by ian Email , Leave a comment

    10 Market Rules to Remember

    Ian and I spent yesterday afternoon at a presentation by valuation driven investment company, Coronation. Like all managers who use a valuation approach (as opposed to investing into momentum shares, shares that have an excellent ‘story’, or other such techniques) they have struggled not only on an absolute basis, but also relative to a resource heavy market index over most of the past year.

    They again reiterated the fact that being different from the market is crucial if you are going to beat the market, but that you are also going to underperform the market at some stage or the other. Value managers have benefitted over the last month or so as resources have felt some pain, while financial and industrial shares have enjoyed some much needed gains.

    The Coronation fund manager, Neville Chester, ended his presentation with a slide of “10 Market rules to remember”, and I found them quite relevant:

    1. Markets tend to return to the mean over time.
    2. Excesses in one direction will lead to an opposite excess in the other direction.
    3. There are no new eras – excesses are never permanent.
    4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
    5. The public buys the most at the top and the least at the bottom.
    6. Fear and greed are stronger than long-term resolve.
    7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue chip names.
    8. Bear markets have three stages – sharp down – reflexive rebound – a drawn out fundamental downtrend.
    9. When all the experts and forecasts agree – something else is going to happen.
    10. Bull markets are more fun than bear markets.

    Particularly eye catching to me are points 2 and 6.

    As with most things in life excess generally results in ensuing pain. Whether it’s taking that extra helping of food, running an extra ‘few’ kilometres, having ‘one’ more drink, borrowing just that ‘little’ bit more than you know you can afford, or holding onto that outperforming share for just a ‘couple’ more days to eke out that last bit of profit. Having a robust plan before any activity, and sticking to it, is crucial to ensuring that you don’t get caught up making emotional decisions (point 6). Diets, professional sport training regimes, and strict lending standards are robust plans and, if followed properly, generally result in the desired outcome over the long term.

    In the same way one should have a robust investment plan that adequately deals with the myriad of risks that are out there. Once again merely having a plan isn’t sufficient to achieve your goals; you need to have the long-term resolve and conviction to stand by your decisions.

    Finally, point 10 is relevant at the moment. We would all much rather live in a world of the eternal bull market, but this is unfortunately not how global markets operate, owing mainly to human nature. Bear markets must be endured, but as Ian pointed out yesterday tough times are generally the foundation for better times ahead.

    Enjoy the rest of your week.

    Take care,

    Mike Browne

    Permalink2008-08-13, 17:30:47, by Mike Email , Leave a comment

    Market volatility is not necessarily bad

    A report on Bloomberg had this comment, “About $70 billion is invested in commodity hedge funds, more than double the amount three years ago, according to estimates by Chicago-based Cole Partners Asset Management, which invests in such funds.”

    Many commodity prices have fallen back including agriculture, metals and also oil, which today traded around $110. A few weeks back it was over $140/barrel, up from around $70/barrel a year back.

    It’s very questionable as to the extent that index funds and hedge fund have moved commodity prices, but there is no debate that their involvement has increased dramatically from a few years back and therefore must have had some influence.

    The disparity in returns from actively managed global hedge funds has increased. Many global macro funds look for themes, which they can run with. They need to be nimble to move when these markets turn.

    More novice investors have a mistaken belief that they have some ability to foresee catalysts which will spark a turnaround, but professional fund managers know that this is not likely on a consistent basis.

    In the last couple of weeks, two value fund managers have made this exact comment, i.e. trying to anticipate the catalyst that will ignite agreed value shares is almost impossible. The better approach is to have a value bias as opposed to trying to chase growth shares.

    Market volatility affects all types of investors, short term, long term value and the various hedge fund managers in varying degrees. But its not necessarily negative – in fact volatility is very useful especially for active value managers.

    This is because in times of panic quality companies are often sold down, where weak holders “sell out at any price” to meet liquidation calls. I.e. investors want to move to cash and everyone heads for the exits.

    Monthly and year to date returns across many funds have been poor compared to longer term averages, but I am convinced that the foundation is being established for normal equity returns for the next few years across many value shares. Invetsors with too high a cash component to their portfolios should be looking to take advantage of lower prices

    Don't hesitate to contact me to discuss.

    Kind regards

    Ian de Lange

    Permalink2008-08-12, 20:14:14, by ian Email , Leave a comment

    What investors should avoid

    When we meet with a fund manager, we don’t waste time discussing past performance and ask for his assessment of future performance. Rather we try and understand their investment process and beliefs and how this has played out in various past periods. In this way we try and understand what the manager looks for, how he is likely to respond to events and also what scenarios he is likely to avoid.

    I have quoted John Train’s book, The Money Masters. In it he summarises some of the “Investment Dont’s” from his various discussions.

    Some of these include:

    o Avoid popular stocks.

    I.e. stocks that are on everyone’s list. Its not that the business won’t do well or even that the stock will never rise; it’s just that you will first have to work off that overvaluation, which takes time. He refers to “IBM, then selling for 300, was a “religion stock” in the late 1960’s. The company fulfilled its owner’s dreams: earnings went up 700% in the next decade, and the dividend rose 10% percent. Still for ten years the stock never rose above 300.

    o Avoid Fad Industries

    These are variations on poplar stocks

    o Avoid New Ventures

    Venture capital is for active professional management, not passive portfolio management.

    o Avoid “official” growth stocks

    Shares that have the official growth label are often already priced for this expected growth into the future. They are likely to disappoint.

    o Avoid heavy Blue Chips

    Here they point out heavy industry blue chips with static earnings. Examples include GM in the US. I think that this may be an over generalisation, because it all comes back to value. An industry that has gone ex growth may still prove to be an excellent investment if purchased at the right price.

    Avoiding certain shares is just as important a decision as including others. We like to understand some of the process that a manager goes through.

    Kind regards

    082 921 0220

    Permalink2008-08-11, 17:26:21, by ian Email , Leave a comment

    Remgro and Richemont set to unbundle BAT

    The big news today was undoubtedly the unbundling of British American Tobacco held by Remgro and Richemont. In some respects it’s the end of an era, given that Rupert started his business empire with tobacco in 1941. Despite the diversification locally and offshore, it’s always been a core holding.

    The tobacco interests were consolidated into Rothmans in 1972, which was later merged with British American Tobacco, which is the world’s second biggest cigarette producer.

    The interest into BAT is held by Remgro, a SA company and Richemont, a Swiss based company. Their combined interest of 30% is held through a Luxembourg company, R&R Holdings.

    Because R&R Holdings was structured as a so called Luxembourg 1929 with an adverse tax change coming into effect in 2010 on dividends, Remgro and Richemont had no choice but to unwind this structure.

    The announcement today then sees the expected unbundling of BAT shares to shareholders of Remgro and Richemont.

    At the same time a new investment company incorporated in Luxembourg, called Reinet Investments. Initially this will be capitalised with 10% of Remgro’s and Richemont’s existing stake in BAT. I.e. 90% of BAT will be unbundled and 10% retained.

    Initially Reinet will then just have an interest in BAT, but through this process will also have a rights offer, whereby shareholders can tender BAT shares.

    BAT has a market cap of £36.34, approximately R535 billion, so on a secondary listing on the JSE will rank as up there with Anglos at R545 billion and Billiton at R504 billion.

    Tobacco companies are excellent cash generators and therefore as strong defensive companies have been excellent investments. Now BAT trades on a PE of over 17 times and is therefore not cheap.

    At Richemont level, this deal will now separate the operating businesses from the investment holding business. The new Reinet should in time prove to be an interesting investment opportunity.

    The announcement was positive for both Remgro and Richemont, in an otherwise lethargic market.

    That’s all for the week. Have a super sporting weekend

    If you would like to make a time to discuss your specific investments and investment planning, please don’t hesitate to contact me.

    Kind regards

    Ian de Lange
    082 921 0220

    Permalink2008-08-08, 15:37:54, by ian Email , Leave a comment

    Anothyer contrary indicator

    I have spoken about apparent anomalies when it comes to investing. Here is another one. Most investment banks and services firms have a range of economists and investment strategists. They are heavily relied upon, but in many instances forecast because they are asked to do so and not necessarily because they know. Instead of following the consensus view, there is a strong argument for going against it.

    History tells us that forecasting is difficult business.

    According to a study done by Bing Xiao, a Bloomberg News statistician, the performance of the recommendations of six Wall Street strategists from January 1997 through March 2001 trailed the return of a static allocation.

    These strategists have access to their firm’s research analysts who are performing detailed company analysts, access to economists and access to large amounts of data on valuation, sentiment, and corporate health. Even with all this, their track record has not always been that good over the years. This is especially the case when their calls are measured on an increasingly short term horizon.

    It is also dangerous and in many cases opinions are tempered to serve personal interests:
    From 1997 through 1999, the investment strategists at Salomon Brothers, Oppenheimer, and Merrill Lynch - all staunchly bearish - stepped down from their positions or left their firms as the market moved higher (see chart).

    When stocks turned down, it was the bulls who found themselves out in the cold. In the two years ending 2002, the strategists at Merrill Lynch, Lehman Brothers and CSFB – some of the most bullish among their peers – were fired. Lehman Brothers and CSFB fired their optimistic strategists in late 2002, right at the market's trough.

    Ironically in a similar vein, Merrill Lynch’s chief strategist, Richard Bernstein, has developed a “Sell Side indicator”. Note, sell side analysts are those working for brokerage houses, while buy side are those working for investment managers. The indicator is based on other Wall Street strategist’s consensus equity allocations, and in his opinion is one of their most reliable market contrary indicators.

    I.e. When Wall Street is extremely bullish, then this is time to get bearish and vice versa, when most strategists are bearish, its time to get bullish.

    The model has a reasonable predictive ability.

    The current model – see below - is that Wall Street is recommending an underweight of equities (i.e. less than 60% in a balanced portfolio). This has not happened in 8 years – see chart below.

    Note that throughout the 1980’s and 1990’s when equities strongly outperformed bonds, Wall Street was generally advocating an underweight position, escalating only after the market had peaked. It’s quite possibly that the “underweight recommendation” may persist for some time.

    From Merrill Lynch: “The latest reading (31 July) is 57,9%, which is down from last month’s 58,6%. Within the current model, any reading at or above 63,8% generates a “sell” signal, whereas any reading at or below 51,6% generates a “buy” signal. Thus the indicator remains in “neutral” territory this month.”

    So not yet a strong enough signal that markets are at the bottom, but definitely giving some backing to the probability that a lot of bad news is already in the price.

    Don't hesitate to give me a call to discuss any aspect to your retirement or investment planning


    Ian de Lange
    082 921 0220

    Permalink2008-08-07, 17:58:08, by ian Email , Leave a comment

    Platinum Counters

    Platinum companies have given shareholders excellent returns over the last several years. Since the turn of the century until 19 May this year the Platinum and Precious Metals index appreciated by close on 1 500% (1 491.16%)! This massive increase in price came as a result of resource companies rerating over this period, and also on the back of an increase in platinum price from $ 433 (R 2 667) an ounce to $ 2 160 (R 16 183) an ounce as at 19 May 2008.

    Since this date, however it has all been downhill for these shares, and they were down over 40% from 19 May 2008 until yesterday’s close as the platinum price fell to $ 1 555 (R 11 476).

    Today has been a much happier day for platinum shareholders.

    Just after 8am this morning enormous diversified resource conglomerate Exstrata made an unsolicited cash offer for Lonmin, a platinum company with its primary listing in London and a secondary listing on the local JSE, the offer was at GBP 33 a share, a 42% premium on its closing price yesterday. This kind of offer clearly had a massive impact on the price of Lonmin’s shares, platinum companies, and resource companies in general. Lonmin opened up 45.5% on its closing price, and ended the day up 50% at R498. This price appreciation came despite the Lonmin board releasing an announcement that the offer was entirely unwelcome.

    The Lonmin board feels that the offer undervalues their unique assets, and they can be justified in their views as their share price traded at R609.80 in July last year, which is more than 20% above the current Exstrata offer.

    Other platinum related news out today was a trading statement by Impala Platinum. They advised shareholders that they expect earnings for the year ended 30 June 2008 to be 115% - 125% higher than the corresponding period to 30 June 2007. The share price actually retreated slightly on the news, although still ending the day up 9.52%.

    The platinum index closed the day up 11.81%, with 10 platinum companies in the top 20 movers for the day. Prices are still some way off highs achieved in May this year. All in all not a good day to be short these companies, as some serious capital could have been wiped off!

    On a more broad view, the JSE ended the day up over 2%, driven strongly by resource companies.

    Take care,

    Mike Browne

    Permalink2008-08-06, 18:13:24, by Mike Email , Leave a comment

    Sappi gains on announcement of Europe closures

    I think that it’s always important to look for apparent anomalies in the market as a means of identifying possible opportunities. A case in point was today’s announcement from Sappi that due to overcapacity and unrelenting input cost pressure, Sappi is contemplating ceasing production at 2 European mills. The market responded positively taking the price up 3,7%.

    For the June quarter Sappi spoke about the ongoing issues for this global paper company. These included.

    o A global economic slowdown which will impact demand.
    o Margins in European businesses will remain under pressure due to high input costs.
    o A recovery boiler rebuild with US$12m impact to profits.
    o Unrelenting input cost increases.

    Sappi’s main business is coated paper with Europe its biggest market. Europe coated paper prices have been declining for 7 years now, while the major input cost being pulp, steadily increasing, putting enormous strain on margins and profitability.

    Overcapacity of supply of coated paper has resulted in Sappi being unable to pass on any input price increases to its customers.

    The result is weak profits and a share price to match.

    Today’s announcement that its actually looking to close down production should ironically be positive for the industry and for the company and this is the way investors saw it. Slowly the fragmented supply in Europe will reduce, which will lead to an improvement in prices for the end product, improving the profitability of this company.

    Historically Sappi’s earnings have been very volatile. In fact this is no different from any other commodity company. Investors want to be looking to buy into a company with currently depressed earnings which are likely to improve over the next few years. These earnings should ideally be acquired at low prices.

    Currently on low historical earnings, Sappi is on a PE of 7,7 times. Analysts are not that excited, with the consensus a “sell”.

    However management seems to be now a lot more aggressive to do what it takes to get the business a lot more efficient, including closing down production.

    The share price has been under pressure for such a long time, but investors taking a 2- 3 year view should be rewarded. Some of the portfolios in which our clients are invested have started to buy Sappi at these prices.

    In years past, Sappi’s price has run hard on the combination of

    o Strong earnings growth off a low base
    o Coming off a depressed valuation

    Feel free to contact me at any stage to discuss your specific investment planning.


    Ian de Lange
    082 921 0220

    Permalink2008-08-05, 17:39:08, by ian Email , Leave a comment

    Debt crisis in the US continues

    PIMCO estimates a total of 5 trillion dollars of mortgage loans are in risky asset categories and that nearly 1 trillion dollars of cumulative losses will finally mark the gravestone of this housing bubble. Inflation data reflects price increases, but the US Federal Reserve is likely to hold interest rates at their meeting on Tuesday at the 2% level.

    With a value of around $20 trillion and with around half of this supported by mortgage debt, the US housing and debt market is large. While in total this may not appear to be too leveraged a position, the risky debt was that created in the last few years at the top of the housing cycle.

    But this also puts into perspective Pimco’s concern that $5 trillion mortgage debt is into risky category and this may result in total losses of around $1 trillion in the finance industry’s cumulative balance sheets. More to come?

    Reports are indicating that due to a legal quirk originating in the Great Depression in the 1930’s while banks can repossess homes of defaulters, they cannot easily pursue borrowers for any balance outstanding on the main mortgage on their homes.

    One anecdotal report from BBC World reads likes this:

    In May 2006, at the height of the housing boom, Karen Trainer bought a $500,000 apartment in California - with money borrowed from her bank. By this year, Karen still owed $500,000 on her mortgage, but her apartment was worth $200,000 less.

    So she was deep in negative equity and, to make matters worse, the interest rate on her loan was about to increase. "I thought 'this is crazy'," Ms Trainer says. "It just does not make financial sense."

    As a successful professional, Karen could comfortably have managed the higher mortgage payments her bank demanded. Instead, she decided to stop her mortgage payments altogether and let her bank repossess her apartment.

    Her credit record will be badly damaged by the decision, but Ms Trainer expects this to recover soon. "Generally speaking, within 5 years you are about back where you were, so my husband and I decided we'll take the hit and live with it."

    An asset price deflation leads to a debt deflation. House prices enter into a negative feedback loop as houses are repossessed, sold or where owners merely walk away from the house and its mortgage.

    The US monetary authorities sit in a precarious position. Despite holding the Fed Funds low, rates on debt have escalated as the risk was repriced. We will be watching the Fed announcement and his views o the current position closely tomorrow.


    082 921 0220

    Permalink2008-08-04, 17:07:19, by ian Email , Leave a comment

    One of John Templeton's First Trades

    John Templeton (29 November 1912 – 8 July 2008) was one of the world greatest global investors. He established Templeton Growth in 1954, now part of the global Franklin Templeton group, becoming a multi billionaire. The writer John Train, author of the Money Masters wrote about him, with the following introduction.

    One day in 1983, just after war had broken out in Europe, a young man named John Templeton called his broker at Fenner & Beane (one of the predecessors of Merrill Lynch) and gave one of the oddest and most annoying orders a broker could ever hope to receive.

    “I want you to buy me a hundred dollars’ worth of every single stock on both major exchanges that is selling for no more than one dollar a share.”

    The broker might have refused the order, which was a nightmare to execute and a most unsatisfactory way to earn a negligible commission, except that Templeton had worked for him as a trainee two years earlier.

    After a while he reported that he had bought Templeton a hundred dollars’ worth of every stock on either exchange that was no entirely bankrupt.

    “No, no,” said Templeton, “I want them all. Every last one, bankrupt or not.” Grudgingly the broker went back to work and finally completed the order. When it was all over, Templeton had bought a junkpile of 104 companies in roughly $100 lots, of which 34 were bankrupt. He held each stock for an average of four years before selling. The result was no joke at all: he got over $40 000 for the kit – four times his cost.

    Some of the transactions were startling. He bought Standard Gas $7 Preferred at $1 and sold at $40. He bought 80 shares in Missouri Preferred – in bankruptcy at twelve cents and eventually sold out at $5. (It eventually went over $100: had he sold at the top, that particular $100 would have turned not into $4000, but $80 000)

    A singular aspect of this transaction was that Templeton didn’t have $10 000 in cash. He was convinced that stocks were dirt cheap, and that of them all the neglected cats and dogs selling for less than $1 were the best values. When the war started in Europe he reasoned that, if anything, it was going to pull America out of its economic slump, and virtually all stocks would rise. So he had gone to his boss and borrowed the entire amount.

    That one extraordinary transaction set the pattern for Templeton’s later ones.

    Next week I will look at some of his investment beliefs.

    All the best

    Ian de Lange
    082 921 0220

    Permalink2008-08-01, 16:22:38, by Marika Email , Leave a comment