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    Relying on Rocket Power

    Today we participated in a teleconference with Pimco which was presented by head of European portfolio management, Andrew Balls. The call covered Pimco’s cyclical outlook including an update on their global economic outlook and financial market trends. Pimco is well known as a global fixed income management company headed up by Bill Gross. They have managed money since 1971, over this time producing superior returns and growing their assets under management to over $840bn as at 30 June 2009.

    Pimco have been strong exponents of a ‘new normal’ paradigm that we’ll experience in the next 10 years, this outlook is diametrically opposed to what for the past 15 years has been considered ‘normal’ . In this state we’ll see higher inflation – although this factor still has some time before it will become apparent – increased regulation of markets and economies, de-leveraging, and hence more saving and less consumption. All these factors will contribute to lower economic growth going forward, and it is around this framework that Pimco bas their investment decisions.

    Within this longer term framework they take a look at shorter term outlook to make more tactical decisions. On a one year view they see that the global economy is going to come out of the deep recession (indeed many countries have already come out of recession) but the recovery isn’t going to be as strong as the consensus view that we’re going to experience a V shaped recovery.

    They describe economic growth/recovery coming from 3 rockets, namely:
    • Rocket 1: Government
    • Rocket 2: Inventory levels
    • Rocket 3: Private sector

    In the latter half of 2007 and into 2008 as private sector demand began to drop off, first slowly and then more rapidly, and companies de-stocked we saw that rockets 2 and 3 were in reverse, and this is what plunged the world into a recession. The tail end of 2008 and into 2009 has seen co-ordinated government stimulus (both fiscal and monetary) which coupled with a re-stocking around the world has helped economies come out of recession.

    Rocket 3 is still not assisting which is what needs to happen to ensure that the strong recovery becomes sustainable. The private sector has been scarred and areas that in the past have been leading indicators in improved private sector spend, namely vehicle and housing demand, have been largely conspicuous in their absence, and Pimco expects this trend to continue.

    Re-stocking is a once off rocket. Government spending can only happen as long as they are able to borrow. The world requires an improved appetite from the private sector in order to return to ‘old normal’ levels of growth on a sustainable basis.

    In summary Pimco believe that swift government action has prevented a global recession, but that growth going forward will be more muted. This more muted growth means that return expectations need to be lowered.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-09-30, 18:05:41, by Mike Email , Leave a comment

    Retirement Fund Survey cont

    Continuing with our look at Sanlam’s retirement fund survey, we look at some of the points that come from the member’s survey. Sanlam conducted 600 telephonic interviews with members of various funds.

    29,8% of the replies indicated that they don’t know the life company funds in which their retirement funds are invested.

    While 96,8% of those interviewed consider it very important to save for the future, 58% consult with a financial advisor. It is understandable that not everyone can or needs to consult with an independent advisor, but this percentage is likely to increase over time.

    Upon resignation from a retirement fund, it is typically advantageous to preserve the accumulated benefits into preservation fund. However less than 45% indicated that they understand what a preservation fund is.

    Preservation funds are held independently from the company fund, so that just prior to termination of services with a company, a member will look for options of where their cumulative fund balance can be transferred to. While no additional contributions can be added to the preservation fund, the member will have the election upon reaching normal retirement age to retire from the fund. The current tax free incentives for retirement funds continue with the preservation funds.

    The question was asked what retirees would do if they had less money at retirement than they would like to have?

    The question was answered as follows:

    A more recent development in the retirement fund industry has been the offering of lifestage models as investment choice. We will look at the specifics of this in a future article.

    As always for those who need to visit the planning for their retirement, please don’t hesitate to visit www.seedinvestments.co.za

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-29, 19:45:57, by ian Email , Leave a comment

    Retirement Fund Survey

    The retirement industry in South Africa is exceptionally large at an estimated R3 trillion in assets. Sanlam Employee Benefits, as a large participant in this industry, produce an annual survey of retirement funds and members, known as the Benchmark Survey.

    It is a comprehensive survey interviewing 200 principal officers of sand alone retirement funds, 100 interviews with the participating employees of umbrella funds and 600 interviews with retirement fund members.

    The report covers various detailed questions on these and other issues pertaining to retirement funds:

    • Administration
    • Popularity of investment choices
    • Details on feedback
    • Risk and disability benefits attached to investment
    • Trustees
    • AIDS strategies
    • Contribution details
    • Preservation and withdrawal from funds

    For most members of a retirement fund, be it a defined contribution or a defined benefit fund, they will not save sufficient capital to replace their final salary in full. The ratio of starting pension or annuity that a lump sum can buy as a percentage of final salary is known as the replacement ratio.

    The difference between expectations of this pension and what is actually achieved remains high. The report indicated that 75% of people surveyed are targeting a replacement ratio of between 80 and 100%. They note that this is in stark contrast to the observed replacement ratio of 30%.

    At the same time many South Africans do not feel that they are ready for retirement, with some 30% indicating that they would delay retirement while 54% plan to work for a wage or salary in their retirement. At the same time the report indicated that the observed average retirement age has dropped slightly from 63,2 years to 62,87 years in 2009.

    What was interesting, but not necessarily surprising, was the percentage of questions, especially on the investment section, that were answered “don’t know”.

    Unfortunately for a multitude of reasons, investors generally have poor visibility and understanding of, in the case of defined contribution funds, their own assets. Their assumptions regarding future contributions, returns, inflation and ability to retire is also typically not based on a concrete model. The hope that the retirement fund will be largely sufficient, can lead to inadequate planning on discretionary funds.

    All investors with 10 years and less to retirement should start to update their projections and plan accordingly. If you find yourself in this position, visit www.seedinvestments.co.za to determine if we can assist you, or contact us as per details below.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-28, 18:29:47, by ian Email , Leave a comment

    Value Investing

    Following up on a study in the outperformance of value stocks called Contrarian Investment, Extrapolation and Risk, US value biased fund manager, Brandes recently produced a report titled Value vs. Glamour revisited.

    The study first looked to dissect a portfolio of shares between those with high price to book ratios and those with low price to book ratios. The price to book is a measure which broadly provides an indication of value.

    With a universe of US shares, after eliminating the smallest 50%, they divided this into 10 deciles, with decile 1 having the highest price to book ratios and decile 10 the lowest price to book ratios. The result is 2 portfolios – decile 1 the glamour portfolio and decile 10 the deep value portfolio.

    Next they looked at the relationship between the valuations differential and the subsequent 5 year returns. This differential was taken by dividing the price to book for decile 1 by price to book for decile 10.

    The study started in April 1968 and the subsequent 5 year performance for each portfolio was monitored.

    This process was then repeated starting year a year later. Again the value differential between the two portfolios monitored and the subsequent 5 year outperformance monitored.


    • The medium differential in price to book was 11,1 times.
    • In February 2009 this ratio was over 20 times. i.e. the most expensive shares compared to the least expensive shares as determined using price to book was at a factor of 20 times.
    • In April 2009 value shares at a median price to book ratio of 0,5 while glamour shares had a price to book ratio of 7,69. Dividing the 1 by the other gives a ratio of 15,38 times.
    • In February 2000, when glamour shares were exceptionally expensive, this ratio reached a peak of 81,1 indicating that glamour shares were more than 80 times more expensive than value shares.
    • From that point, value shares outperformed glamour shares by a massive 50,6% annualised over the next 5 years.

    Source : Brandes Institute


    • Most of the time over a 5 year period value shares – as defined with low price to book ratios – outperform glamour shares.

    • At points where there is a greater disparity in valuation between value and glamour shares, there is a high probability that the subsequent 5 year outperformance of value shares increases.

    The rerating in shares in 2009 saw growth shares re-rate up as investors became less risk averse. The same is not necessarily true of value shares. Over time, but especially in times when glamour or growth is expensive, investors want to be positioned in value.

    Have a great weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-25, 17:02:10, by ian Email , Leave a comment

    Inflation Slightly Down – Interest Rate on Hold

    Tito Mboweni’s last meeting in charge of the SARB was held on Monday and Tuesday, with the committee ultimately deciding to keep the repo rate on hold. Central / Reserve Bank Governors around the world are keeping a sharp eye on each bit of economic data that comes out, not only in their own country, but also in other influential countries. While much of the world is just coming out of recession the ‘all clear’ flag has not yet been waved and Governors around the world need to know when the ‘all clear’ will be given – if it comes at all – or if a ‘new normal all clear’ will eventually prevail.

    Just a recap of some of the more important facts to come from Stats SA on the August CPI figure:
    • Inflation down to 6.4% pa from 6.7% for the year ended 31 July 2009. CPI is still out of the target 3 – 6% range (it’s now been 30 months since we were last in the target range). The level of inflation was in line with expectations.
    • Transport is still deflationary over the past 12 months – transport index down 2.7% over this period – but the rate of deflation is falling. This indicator is largely influenced by petrol prices, and so will have upward pressure when September’s CPI is released, but should offer some relief the following month (expectations of a fuel price fall in October).
    • Inflation in Limpopo is the only province where inflation is in the target range (5.7%), while Mpumalanga is the province with the highest inflation rate (7.4%).
    • Food and non-alcoholic beverage inflation is starting to come under control. It was up only 0.1% for the month and 6.8% over 12 months. Downside on this figure was provided by oils and fats (-1.2%), bread and cereals (-0.5%), and meat (-0.5%). Remember these items have come from a high base, so being deflationary doesn’t necessarily mean they’ve become cheap.
    • The price of alcoholic beverages and tobacco increased by 2.5% in August, and by 12.6% over 12 months.

    The statement from the MPC highlighted the following key facts:
    • CPI to enter target band on a sustained basis in the second quarter of 2010.
    • Rand strength has helped to keep inflation down, but remains a key risk should it weaken sharply.
    • Inflation expectations have fallen, but remain above the upper end of the target range.
    • Administered price increases (electricity, etc) and growth in real unit labour costs (i.e. wage increases above inflation that aren’t based on increased productivity) are the main upside risks.
    • The local economy remains weak and in recession.

    Overall it looks like we are heading in the right direction, but only improving ever so slightly. In light of this ‘light at the end of the tunnel’ it is probably pragmatic to keep the repo rate at 7%. We are at all time lows, and the Governor is conscious of not dropping rates too low. At the same time, we are not in the position to even be contemplating a rate hike. We will most likely see rates staying at this level for some time to come unless there is a severe shock to the system.

    Enjoy Heritage Day, and be sure to pull your braai out!

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-09-23, 17:42:56, by Mike Email , 1 comment

    Sterling weakness

    Because all currencies float relative to one another with no real tangible underpin and a myriad of risk factors, they are incredibly volatile relative to one another. We saw the pound drop to a five month low against the euro and also lose ground against a relatively weak US dollar.

    A Standard Bank fixed income research report noted that both the US dollar and sterling are the victims of quantitative easing – i.e. printing.

    The report went on to say, “And while we are not in favour of the Bank [of England] doing any further QE [quantitative easing] at this stage, we’d not be surprised at all to see the MPC push bond purchases up to GBP 200 billion or more in November and cut the deposit rate to penalise banks from holding excess reserves at the Bank.”

    “More QE could spell more sterling weakness…”

    In March the Bank of England announced that they would pump £75 billion of new capital into the British economy, which was the first time in the UK’s history that this measure was adopted. The current ceiling is £175 billion and the Bank of England has indicated that they are open to further loosening of monetary policy.

    According to Wikipedia, the pound sterling is the world’s oldest currency still in use. It is the currency of the United Kingdom, its crown dependencies (Isle of Man and the Channel islands). It is the third largest reserve currency after the US dollar and the euro and the fourth most traded currency after the US dollar, euro and the Japanese yen.

    The official name is pound sterling.

    The Bank of England was formed in 1694 and began to issue paper money.

    Prior to World War I, the UK had one of the strongest economies, holding 40% of the world’s overseas investments. This all changed after the war where it owed £850 million, mostly to the US.

    In 1940 and agreement with the US pegged the pound to the US dollar at a rate of 1 = $4.03, but this rate was devalued by 30% on 19th September 1949 to $2,80.

    With the breakdown of the fixed exchange rate system, the pound free floated from August 1971 rising to $2,65 in March 1972.

    The pound has fallen against the euro over the last 12 months. A year back 1 euro would buy 79p. Now it’s up to 90,5p and may even head for parity with the euro.

    The graph below is from Investec Asset Management and reflects the major currencies exchange rates versus longer term trends. It reflects the weak pound versus its own history.

    The prevailing concern is the loose monetary conditions in the UK relative to other regions, the weaker domestic economy, weakness,

    Source : Investec Asset Management

    Its not just monetary policy but the fiscal policy that is of concern as the UK runs a large deficit.

    All indications point to the possibility of the weakness continuing for a while yet. When combined with very low interest rates, this is not ideal for investors holding UK cash.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-22, 17:19:45, by ian Email , Leave a comment

    Market Wrap

    The JSE All Share index touched 26000 this week. Today it ended slightly down, but there are many share prices are trading up at new 12 month highs, giving an indication that liquidity has returned and investors have been willing to increase their risk levels.

    Gold in US dollars remains above the important $1000 level. In New York this morning it has moved up to over $1017. Gold has been above $1000 before, but given its steady advance over many years, without spiking up, the ongoing trend appears to be intact.

    The price of oil has also been in a steady upward move this year from its low of around $34 / barrel at the end of 2008 it has steadily moved up to its current $70/barrel having traded up to $74.

    Bond yields have drifted lower on strong demand. The yield on the shorter term government bond, the R154 has come back to 7,24. The medium term R157 with a maturity in 2015 traded at 8,06% and the R204 with a maturity in 2018 at 8,57%.

    The rand has been incredibly strong over the past few weeks and indeed this year, but lost some ground today, still trading at R7,44 / US dollar, R12,09/pound and R10,95 / euro. This is concerning the Reserve Bank and may push them to lower rates next week, despite the 5% cut already in 2009.

    The rally in local share prices, bonds and the rand has largely been a function of global investors piling into risk assets and in search of yield and dollar returns. In a meeting today, an investment manager reiterated what I spoke about yesterday, saying that in discussions in London last week there are now no bears, “everyone” is bullish.

    Furthermore we are also starting to see the sentiment changing from one of selling on the rallies, to buying on the dips.

    The manager also mentioned that given last years scare on liquidity, global managers are now far more aware of how liquid their portfolios are. Therefore they are increasing their exposure, but with a finger on the trigger, willing to pull back quickly if need be.

    Locally a number of shares made new highs, especially the retailers. This list included Mr Price, Shoprite, Clicks, Foschini, Spar, Pikwik, and Cashbuild.

    On that note have a fantastic weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-18, 16:57:49, by ian Email , Leave a comment

    Investor psychology

    It is absolutely amazing how quickly investor sentiment can change, moving prices and values quite quickly in a short space of time. Just 6 months back at the beginning of March, the pervasive sentiment was a negative one – and for lots of very good reasons.

    Now just 6 months later mass global pessimism has quickly turned back to an optimistic view, taking prices back up.

    And then many investors wonder what causes asset prices to be so volatile!

    Investorpedia defines Market psychology as “The overall sentiment or feeling that the market is experiencing at any particular time. Greed, fear, expectations and circumstances are all factors that contribute to the group's overall investing mentality or sentiment.”

    Now we know that there is no such thing as “the market”, but it’s the composite of all participants that contribute to the pervasive mood.

    Mentor to Warren Buffett, Benjamin Graham humanised market sentiment by creating an imaginary investor, called Mr Market. His moods can fluctuate anywhere between incredible optimism and overwhelming depression. One day he will nominate a higher price to buy or sell, the next day he might increase it, lower it, or even appear uninterested in whether he buys or sells.

    It’s this sentiment that drives volatility and hence market inefficiency.

    As a fund manager pointed out this morning in a presentation, if markets were perfectly efficient, with all participants having exact future knowledge then there will be no opportunity for profit. Because a current price is the discounted value of all future cash flows, if these future cash flows were known perfectly, as was the one true discount rate, then a true price could be established, which would not fluctuate over time.

    The reality however is that markets move at varying speeds from optimism to pessimism and back again – not on a consistent or defined basis, but with a high degree of regularity that it is a truism that markets are mean reverting.

    Astute investors, whatever their methodology and processes used, will look to take advantage of this fluctuation from the mean. I.e. they will look out for deviations and take the other side of the trade.

    Deviation from the mean, or volatility can and only does occur when the mass of investors take an increasingly optimistic view or an increasingly pessimistic view of specific shares, bonds, market sectors or even geographic regions.

    As the local JSE touches 26000 and earnings have declined, so the value has declined dramatically from 6 months back. The historical price to earnings now across the market is at 15 times. 6 months back it was less than 9 times historical.

    While optimism is self fulfilling, as it escalates, so investors should rather look to reduce exposure.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-17, 17:10:08, by ian Email , Leave a comment

    Cyclical Capital Expenditure

    If you look around you will notice that cycles are everywhere (not bicycles). Knowing which cycles are influential and what part of the cycle you are in can help you plan how you should react. One area where cycles are very prevalent is in the economy, both locally and globally, and by extension business and markets are affected greatly depending on which cycle you are looking at and what part of the cycle you are in.

    Many governments around the world use their size to try and influence various factors in their economies (and sometimes even outside of their economies) and many times they try and implement counter cyclical measures to even out the economy. Their success or failure naturally depends on how much ‘ammunition’ they are able to use in relation to other potential players and the timing of the usage.

    One measure that is taken locally is for the Reserve Bank to increase foreign reserves when the rand gets strong. If done responsibly dealing in the forex market can have the effect of slightly reducing the volatility of the rand. It should also increase the value of their reserves as they buy forex when the forex is relatively weak. As we saw, however, in 1998 they don’t have the ammunition to completely influence the movement of the rand, and have now learnt to use the forex market as a tool of managing reserves rather than a mechanism to influence exchange rates.

    In other areas the government looks to balance out its expenditure and investment with the private sector. When the private sector is strong they are able to retire debt and, as Ian mentioned yesterday, reduce debt as a function of GDP. This is because the private sector leads the way, and spends as the prospect of a good return on investment is high.

    Return on investment is logically a leading indicator for private capital expenditure, and so when the real return on investment goes negative we see capital expenditure falling (companies generally only make investments that they will be profitable). Private capital spend has now fallen into negative territory as a result of the slowing of the local economy. This can be seen in the chart below.

    Source: SIM

    It is in times like this where the private sector is in distress that we look to the government to increase spending to help prop up the economy. The government has a greater responsibility than just making profitable investments at the expense of other objectives.

    South Africa is in a desirable position in that the government was fiscally responsible when the economy was strong, and now has the ability to raise capital in the debt market at reasonable rates. Debt to GDP levels will increase during the recession, but hopefully by not too much that it handbrakes the ability of the countries economy to recover (by increasing the debt repayment amount too much).

    After years of strong private capital expenditure we have entered a tough period, let’s hope this isn’t an extended downturn, and that government will balance this lack of expenditure out through their on expenditure.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-09-16, 16:43:03, by Mike Email , Leave a comment

    Relative size of bond markets

    Given the explosion of debt across the developed and emerging markets over the decades, the primary and secondary market for buyers and sellers wishing to trade this debt is enormous. The sheer scale of this market is dramatically seen in the size of the debt market in the US.

    The US debt market is the biggest in the world, but when compared to the local SA bond market the disparity is disproportionally magnified.

    The nominal value of local debt is R827 billion as at the end of March follows. Over the last 2 years at least the total value of debt outstanding has not risen dramatically.

    From a purely government perspective, debt as a function of the country’s GDP has steadily been falling.

    Source : Bond Exchange

    Half of the total issued debt in South Africa is direct government at R436 billion with state owned enterprises comprising another R85 billion. The balance is banks, securitised paper, corporates, commercial paper and water authorities.

    This total market value in US dollar terms is approximately $110 billion.

    This pales into insignificance when one looks at just the new issuance in the US debt markets for the first half of 2009 – i.e. just the value of new debt issued in 6 months.

    According to the US Securities Industry and Financial Markets Association, total new issuance in the first half of 2009 came in at $3,42 trillion (this includes new equity issuance of $124 billion), up from $3,01 trillion in the first half of 2008.

    The US government was a big net borrower, with Treasury raising $860 billion and Federal Agencies a further $704 billion.

    Mortgage backed security issuance came in at just over $1 trillion for the first half of 2009.

    With Lehman’s collapsing exactly one year back, new issuance collapsed in Q3 and Q4 of 2008 coming in at “just” $1,7 trillion for these 2 quarters.

    Years of new debt being issued has brought the size of the total outstanding US bond market debt to a phenomenal $34,2 trillion at the end of March 2009. This is some 311 times the size of the total outstanding debt that SA has .

    In 1996 this total outstanding debt across the US government, municipalities, corporates, asset backed and Federal Agencies was $12,2 trillion and so has almost trebled in the 12/13 years.

    The big question is where are the global net savings required to lend to these borrowers?


    Ian de Lange
    021 9144 966

    Permalink2009-09-15, 18:05:27, by ian Email , Leave a comment

    Sasol's free cash flow

    This morning oil from coal business, Sasol released their annual results to June. It was a case of much weaker profitability, but excellent cash flows. Ultimately it’s the cash flow that is important, but because of how earnings are accounted and the nature of the actual business there can and often is large discrepancies between reported profits and reported cash flows.

    Sasol is a global company, with many divisions. Its biggest line of business is synthetic fuel from coal and gas.

    In 2009 its earnings were down 39% from R22,4 billion to R13,6 billion. Headline EPS declined 33% to R25.42/share. The main reason for the large decline in profits was the decline in oil price and the large loss in the chemical cluster of R2,2 billion compared to prior year operating profit of R6,6 billion.

    In addition profitability was negatively affected by competition related fines in the wax business of R3,9 billion (being not tax deductible resulted in higher tax) and the Inzalo share scheme costs of R3,2 billion.

    At the same time that there was a substantial decline in profitability, cash flow generation came in at R48,2 billion – an improvement of 39% over the previous year. So operating profit fell to R24,7 billion, but cash flow from operations was nearly double this figure.

    In the past a negative factor that some investors have noted on Sasol has been the lack of available free cash flow from operations. Free cash flow is operating cash flows before depreciation or amortisation, less capital expenditure and dividends. This is the amount of cash flow that the company has left over after it has paid all its expenses including investments.

    In the case of Sasol a lot of the profitability has come at the expense of huge and ongoing capital expenditure programmes, diminishing its free cash flows. Over the longer term, shareholders should enjoy a higher return from the larger company, but this invested capital expenditure is not risk free.

    In 2009 after paying dividends, higher tax and finance charges, shareholders had R31 billion in cash retained compared to R18 billion in 2008. Capex then took R15,6 billion of the R31 billion.

    Management have reprioritized capital expenditure over the next 2 years to R15 billion per annum. They have also suspended the share repurchase programme and with improved working capital management enhanced the cash position.

    The net effect is that cash on the balance sheet increased from R4,3 billion to R20,6 billion at year end.

    In the previous 2 years the combined profit was R41 billion with cash flow from operating activities of R33,7 billion. Of this, capex took R22,8 billion and so the reversal in the cash position in 2009 has been big.

    Using diluted earnings per share of R22,8, the share price trades on a historical multiple of 13 times. The share was trading on a multiple of 6,6 times. The company has a market capitalisation of almost R200 billion and ranks 6th largest on the JSE.

    The price is off substantially from its peak. Despite the lower earnings, this is a long term story linked to the global oil market.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-14, 17:45:37, by ian Email , Leave a comment

    Sources of return

    An astute local investment manager again reiterated to a small group this week that total returns from an asset only come from 2 sources. The day by day or week by week price movements are not in themselves indicative of the longer term returns.

    Returns come from:

    • The income / dividend generated and declared by the investment over time; and
    • The pull to par effect. i.e. buying at the best possible discount to intrinsic value and waiting for the re-rating back to par / normalised level.

    The first component – i.e. the income component - can typically only come from holding the investment over a period of time typically measured in years.

    The second component is the re-rating from a cheaper initial level to a more normal or sometimes even expensive price. We all know that the danger to investors is when this works in reverse – i.e. an expensive asset declines in price negating any income received.

    This same approach should be applied across all investable assets.

    The combination of higher starting yields and more attractive valuations typically occur after major shake out periods.

    As an example of this working in practice, global investment firm Schroder’s looked at real property returns over various rolling five year periods from 1971. These were then divided into 3 distinct periods - periods when the economy was operating at equilibrium, at full capacity at the start or where the economy was at spare capacity at the start. The metric used was the output gap which measures the level of spare capacity in the economy.

    Source: Schroders

    Although not infallible, the output gap looks like a useful indicator. In the 9 instances where the output gap was above 1 at the start (i.e. a strong economy), subsequent property returns generally disappointed (as indicated by the black bars).

    On the other hand investing where there was an initial large negative output gap (i.e. weak economy) resulted in 8 out of 12 times producing subsequent superior returns (as indicated by the blue bars).

    Currently the global output gap is very negative.

    That’s it for the week. Have a wonderful weekend and enjoy the rugby

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-11, 17:07:26, by ian Email , Leave a comment

    Local fund managers going offshore

    As a matter of course we spend a fair bit of time with various investment managers. A question that we often ask of local fund managers when they purport to have the ability to invest on global markets is this: “Does a south African fund manager really have a good understanding of how to invest globally?”

    The answer in many cases is a surprisingly yes.

    A few points on this:

    • Given that local managers have built up some expertise in emerging markets, this is a definite positive attribute which can be used when researching companies especially in other higher growth emerging markets.

    • In fact this extends to analysing many first world domiciled companies that are increasingly generating profits from emerging markets.

    • A point made this week by a local manager, is that despite the fact that there are thousands of global companies in the indices alone let alone across the various exchanges, one does not need to have a solid understanding of them all. Rather, good managers build up a solid understanding of a smaller universe of companies and then invest into a subset of these.

    • Where a fund manager has a repeatable and proven process, then he may have an advantage on the international arena. For example local fund managers have a good understanding of the drivers of cell phone operators, banks and beverage companies operating in an emerging market economy, which can then be extended to similar companies globally.

    • The availability of information has definitely levelled global playing fields. I.e. irrespective of where companies are domiciled or where the fund managers are located. With sources of data from the likes of Reuters, Bloomberg and the internet etc, the availability of information and data is now ubiquitous.

    • The physical location out of the traditional New York or London for a global fund manager is an advantage, if one assumes that there is a high degree of “herd instinct” with many fund managers, especially the larger “institutional” type managers which often have a bias to constructing their portfolios close to the global indices.

    • Some local fund managers running global funds have a greater appetite and ability to search out and research the “smaller” global companies, which many New York / London based fund manager cannot invest into because of the sheer scale of funds that they are managing. I.e. smaller fund size is not a disadvantage, but rather an advantage.

    The skill or lack thereof, does not reside in the physical location of a fund manager. We will not avoid looking at a global fund manager because of this factor, but rather concentrate on what are the more important attributes.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-10, 17:12:51, by ian Email , Leave a comment

    Gold Breaks Above $ 1 000

    We have been keeping a closer eye on the price of gold than we would usually since the collapse of Lehman Brothers nearly 1 year ago. The reason for us doing so is that gold can display some properties that not many other assets are able to.

    It is fairly common knowledge that gold exhibits a couple key characteristics and two of them are that gold can either be held as an asset or as a currency. Holders of gold as an asset would be holding this commodity on the premise that its price will increase and their return will be captured in asset price appreciation. This assumption is generally founded on a commodity cycle occurring.

    Another reason for holding gold would be for its ability to store real value. With monetary supply around the world reaching epic proportions this reason has been gaining some traction for the following reasons:
    • In uncertain times investors like to hold real assets.
    • Historically low interest rates have reduced the yield on holding cash. As commodities don’t pay out a yield, when cash rates decrease the opportunity cost of holding a non yielding asset (read gold) decreases.
    • Money supply now will result in inflation in the future if governments don’t withdraw the liquidity in time when the velocity of money increases again. High inflation periods have typically been good times to hold commodities.

    It is interesting to compare two gold charts. One is denominated in euros and the other US dollars. You will notice that the price in USD is back at similar levels that it was at in March this year, while in EUR the price is down over 10%. The shape of the two graphs is also slightly different indicating the relative strength of the currencies over this two year period. In general the USD has depreciated relative to the EUR, but there have been periods of USD strength, notably around October last year.

    Looking from another perspective, it’s interesting that the largest pure gold mining company, Barrick Gold, has announced that they will be eliminating all of their gold hedges which will be funded by a $3bn share issue. Basically a lot of gold companies have historically hedged their book (entered into contracts to deliver a fixed amount of gold at a fixed price) to reduce the volatility in their profits. A company that is increasing their hedge book is essentially expecting the price of gold to fall, while those unwinding expect the asset to rise in price.

    Management don’t always get these decisions right, but the decision by Barrick is a clear indication that they expect the gold price to continue to track higher.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-09-09, 18:13:06, by Mike Email , Leave a comment

    Year to date performance

    Many investors have a tendency to despise high volatility in their investment performance. However when it come to high positive volatility, then it’s only those investors that are short the market that are not satisfied. This has been the case in 2009 as prices have rebounded strongly from low points.

    But for many South African investors, the very strong rand in 2009 has masked the dollar returns that global investors have extracted from the local market as well as other global and emerging markets.

    The graph below indicates the performance of the local market versus the Morgan Stanley World index and reflects the recent outperformance of local markets against global markets.

    Source : INet Bridge, Investec

    In rand terms the JSE All Share index total return to the end of August has given investors 18,3%.

    Rand appreciation has benefited global investors in the local market and they have achieved a dollar return of 43,2% to the end of August and an incredible 88% in US$ since early March when markets were at their lows.

    Still for the year this has slightly lagged the MSCI Global emerging markets index return of 51,1% in USD for 2009.

    Year to date the best performing sectors have included pharmaceuticals, media, household goods, life insurance, while the worst performing sectors have included food and drug retailers, chemicals and real estate.
    The extent of this snapback in prices has reduced the value of local shares to the point where on various metrics its generally back to a long range fair value.

    One valuation indicator is the dividend yield. The higher prices, combined with lower corporate earnings and payouts, have reduced the high dividend yield of 5% back to the current 3,2%.

    source: Inet Bridge,Investec

    The numbers give a clear indication that performance from an investment in listed shares is definitely not smooth.

    That’s all for today

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-08, 17:33:41, by ian Email , Leave a comment

    Lehman Brothers collapse anniversary coming up

    The month of September is the anniversary of the collapse of Lehman Brothers. The bank was put into liquidation on the 15th September 2008, which then sparked a massive decline in asset prices around the globe. Now while the world is almost one year on from this calamity, it is still a long way from out of the woods.

    Immediately and since that major default a year ago, there have been a number of bank defaults on the one hand and government / central bank initiates on the other, to try and prop up weak and failing financial situations.

    After the Lehman Collapse, Bank of America took over Merrill Lynch, warren Buffett’s Berkshire injected 5 billion dollars into Goldman Sachs and in the UK HBOS had to be rescued with further government capital injections into RBS (Royal Bank of Scotland) and Lloyds.

    By the end of 2008 most global economies were into recession, if not officially, then definitely unofficially.

    Central banks have continued to do the one thing that they know best – keep interest rates as low as possible and boost the supply of liquidity.

    Over the weekend finance leaders from the G20 countries met in London ahead of the actual summit of leaders which will meet on 24th and 25th September in Pittsburgh USA.

    On the agenda are new requirements for a revision to banks capital adequacy requirements. i.e. just how much should banks hold as part of their capital – higher capital means lower risk, but lower profitability.

    The graph of bank shares to FTSE350 reflects an increase in caution in recent weeks. This with talks of greater regulation, the anniversary of Lehman’s collapse, talk of exit strategy from providing liquidity and also the pullback in shares in China are all factors that are negatively influencing the market.

    Source : Ecowin

    The fact is however that central banks have pumped around $ 2 trillion in liquidity into the global economy with a further $250 billion available via the IMF. They will be very wary of withdrawing liquidity too quickly and so while asset prices will be volatile, there is some underpin from central bankers.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-07, 18:02:57, by ian Email , Leave a comment

    US unemployment data

    The consensus for US new job losses in August was 230 000, but these came in better than expected at 216 000. The initial July estimate of job loses was raised from 247 000 to 276 000. The pace of decline is at least slowing after peaking at 741 000 in January, which was the most since 1949.

    While the pace of job losses is slowing, the cumulative impact of these job losses means that the total official jobless rate jumps to 9,7% from 9,4%. This is a 26 year high and getting very close to the psychological 10% level.

    These numbers bring the total number of job losses from December 2007 to 6,9 million which is the biggest decline in any post World War II economic slump.

    This does not however tell the full story – because if adjusted for part time employees and discouraged worker – who are no longer considered to be unemployed – then the jobless rate jumps to 16,8%.

    The graph below reflects the sharp rise in unemployment in the US as it heads for an official 10%

    Source: Wells Fargo

    There has also been a sharp increase in part time employed for economic reasons over the last 18 months.

    Source: Wells Fargo

    The period unemployed as measured by the average weeks unemployed has also pushed out to the highest levels since at least 1980 from 16 weeks at the start of the recession to a current 25 weeks.

    Naturally high employment, especially in a high consumption economy is critical. But while the data are not conducive to growth, the direction is possibly more important and investors will be looking for turning points from this very weak level.

    That’s all for today. Have a super weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-04, 16:59:26, by ian Email , Leave a comment

    Cash for Clunkers

    Now as an owner of large stakes in car manufacturers, the US found a novel way of moving stock – providing a cash back incentive to owners of older vehicles to trade these in for new models. At face value the plan worked incredibly well with annualised sales of new vehicles moving up from around 10,5million to an annualised 14,5 million in August.

    The plan, which ended on the 24th August, paid up to $4500 per trade in and was initially limited to funding of $1 billion, but then quickly expanded to a total of $3 billion.

    New car sales were boosted from a low of around an annual 10,5 million to an annualized 14,1 million in August. However for the full year, Moody’s is forecasting an annual 11,5 million, which although up on 2008 is still far below the nearly 17 million in new vehicle sales in the US earlier in the decade.

    But the incentive saw sales in August itself spike up 26% from sales in July – also because new purchases would have been held back in July.

    Dealers apparently submitted claims of 690 114 nearly depleting the $3 billion in appropriated funds for this initiative.

    Wells Fargo, along with others, estimates that the rebates will have the effect of borrowing sales from the future. New sales will definitely tumble in the coming months, but many of the trade-ins would have been on outright owned vehicles, now replaced with new vehicles and a payment book, resulting in lower discretionary spending in the months ahead.

    Essentially the deal transfers capital from taxpayers to the car buyers, who possibly would have at some stage had to trade in their vehicles anyway.

    The big questions then – “is there a net gain to the economy” or is this merely a short sharp shot in the arm to a particular sector under pressure, which just happens to also be where the government has a direct interest. The US government owns 61% of General Motors and 10% in Chrysler.

    The chart below reflects the annualized sales stepping up dramatically.

    Source: Wells Fargo and US Department of Commerce

    History reflects that high government involvement in private enterprise does not work well and so only time will tell whether this artificial boosting and distorting of the private market by the government will prove beneficial.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-03, 17:26:22, by ian Email , Leave a comment

    Discovery Results

    In a tough operating environment for financial companies Discovery has been able to release some excellent results. In a very short time Discovery has been able to grow an incredibly strong brand and is locally known mainly for their Discovery Health and Discovery Life operations. In addition to these two operations they have Discovery Vitality and Discovery Invest, and then PruHealth and PruProtect offshore.

    Some of the highlights from Discovery’s annual report include:
    • Operating profit up 32% to R1.7bn.
    • New business growth of 20%.
    • Diluted embedded value per share up 12% to R35.83.
    • An increase of 31% in the dividend to 58.5c.

    This is clearly a company that has been able to grow despite operating in a tough sector in tough economic times.

    On the face of it Discovery has been able to build such a strong company over such a short period as they have come into the market with new, innovative products backed by systems and procedures that don’t have to take into account legacy business. They could essentially start the business from a clean slate, while other established companies have only been able to slowly adapt to changes.

    The Vitality system that was implemented looks to not only provide rewards to Discovery’s clients, but also improve their health, thereby reducing the cost of medical bills, and also extending their life expectancies. This ultimately not only improves the client’s quality of life, but also Discovery’s bottom line.

    Another great business decision has been their ability to integrate the various group companies. The more products that the client uses in the Discovery portfolio, the cheaper their products become. Essentially the businesses are cross subsidizing one another.

    In terms of the earnings drivers, the two established South African businesses (Health and Life) drive the lion’s share of the business, contributing over R1bn and R1.1bn respectively in earnings. Vitality generates a further R40m, while their other businesses are still in their loss making stages. Discovery Invest, for instance, made a loss of R122m over the year. It is understandable for new ventures to be loss making to start off with as they grow their market share (as with any start up), but if Discovery is able to grow their business at the same rate that they have in the health and life business I’m pretty sure that they will soon be making a profit.

    Discovery is a quality company and understandably trades at a premium to the market (PE of 14.93 compared to the market’s 13.35). Despite the excellent results, the share price was down just over 1% today in line with the broader market.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-09-02, 18:50:52, by Mike Email , Leave a comment

    What is the new normal?

    Pimco’s Bill Gross has penned an article titled “On the course to a New Normal”. As a global bond investment manager Pimco must try and understand the business environment in which they find themselves as well as try and assess the landscape going forward.

    Their over riding themes are delivering, deglobalisation and re-regulation. Extending this theme a bit further, he expanded, saying that these themes lead to a number of broken business or economic models. He highlighted the following, which are well worth considering:

    1. “American-style capitalism and the making of paper instead of things. Inherent in the “great moderation” of the past 25 years was the acceptance of a sort of reverse mercantilism. America would consume, then print paper assets and debt in order to pay for it. Developing (and many developed) countries would make things, and accept America’s securities in return. This game is over, and unless developing countries (China, Brazil) step up and generate a consumer ethic of their own, the world will grow at a slower pace.

    2. “Private vs. public-driven growth. The invisible hand of free enterprise is being replaced by the visible fist of government, a temporarily necessary, but (if permanent) damnable condition itself in terms of future growth and profits. The once successful “shadow banking system” is being regulated and delevered. Perhaps a fabled “110-pound weakling” may be an exaggeration of where our financial system is headed, but rest assured it will not be looking like Charles Atlas anytime soon. Prepare to have sand kicked in your face, if you believe you are a “child of the bull market!

    3. “Global economic leadership. It’s premature to award the 21st century to the Chinese as opposed to the United States, but if the last six months have been any example, China is sort of lookin’ like Muhammad Ali standing over Sonny Liston in 1964 yelling, “Get up, you big ugly bear!” Not only has China spent three times the amount of money (relative to GDP) to revive its economy, but it has managed to grow at a “near normal” 8% pace vs. our “big R” recessionary numbers. Its equity market, while volatile and lightly regulated, has almost doubled in twelve months, making ours look like that ugly bear instead of a raging bull.

    4. United States housing and employment. Old normal housing models in the U.S. encouraged home ownership, eventually peaking at 69% of households .…. Subsidized and tax-deductible mortgage interest rates as well as a “see no evil – speak no evil” regulatory response to government Agencies FNMA and FHLMC promoted a long-term housing boom and now a significant housing bust. Housing cannot lead us out of this big R recession no matter what the recent Case-Shiller home price numbers may suggest. The model has been broken if only because homeownership is declining, not rising, sinking to perhaps a New Normal level of 65% as opposed to 69% of American households.”

    He continued saying that this “new normal” as he terms it “cannot easily be modelled econometrically, quantitatively, or statistically.”

    They therefore assume the following strategic conclusions.

    1. Global policy rates will remain low for extended periods of time.
    2. The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
    3. Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.
    4. Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
    5. The dollar is vulnerable on a long-term basis.

    Food for thought

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-09-01, 17:46:14, by ian Email , Leave a comment