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    more on valuations

    While so many investment managers maintain a more cautious approach to their asset allocation, the market has continued to remain fairly buoyant. This last month we saw a dip down in asset prices, yet the market remains at expensive levels when measured in historical terms.


    Source: Element Investment Managers

    A model that many fund managers use in order to present a bigger picture of possible future returns is to look back into history and analyse 5 year returns from various starting points.

    Sanlam portfolio manager, Claude van Cuyck was quoted in this week’s FM as saying that, while markets could rise above their fair value, investors should be cautious.

    Based on history from 1960 – which is the starting point for the most accurate data on the JSE – SIM as found that when the market PE moves above 15 times, then the real return averaged 3% over the next 12 months, 0% over 3 years, and 2% over 5 years.

    The chart above from Element Investment Managers, also analyses potential forward returns on the same basis looking at 5 year nominal returns from various starting points. While prices fell slightly in April, the market is still trading on an overall price to earnings ratio of 17,6 times.

    Their calculations indicate that from a starting PE of 17,7 times or higher, cash has outperformed the JSE All Share over the subsequent 5 year period 78% of the time.

    From these levels, the historical numbers reflect a 5 year return of 8,5%.

    At the same time that many local managers are cautious, foreigners with fewer and fewer attractive alternatives, continue to pour money into SA. This has been beneficial for the rand and has naturally helped to boost asset prices.

    The most recent statistics from the JSE reflect the following with respect to foreign purchases of South African assets for 2010 to date.

    • Net purchases of equities R11,1 billion
    • Net purchases of bonds R29,8 billion

    Foreign funding is always fickle and cannot be relied upon as permanent.

    Don’t hesitate to contact us if you would like to discuss your investment planning.

    Have a wonderful weekend

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-30, 17:04:46, by ian Email , Leave a comment

    Inflation and Other Indicators

    South Africa’s inflation rate for March came out yesterday. The annual inflation rate dropped to 5.1% at the end of March 2010 from 5.7% at the end of February 2010 and 8.5% at the end of March 2009. Inflation was in line with the consensus opinion.

    Over the past 18 months inflation has fallen to such an extend that it is now less than half of where it was in the middle of 2008 when oil prices nearly reached $150 a barrel. The chart below shows the relationship between the inflation rate, repo rate, and rand price of oil.

    Oil is a major input cost into many items, so it makes sense that the South African inflation rate is correlated with the rand price of oil (remember as goods and services are priced in rands we need to convert the US dollar oil price to rands). Items that are dependant on the price of oil include transport, as the price of petrol (oil based) is a major input, and food, where transport and production costs have a large fuel component. These two items are more than one third of the inflation basket.

    As the price of oil shot up, inflation followed quickly, but it wasn’t as quick to fall. Many companies increased prices as soon as input costs increased, but delayed dropping them as quickly, preferring instead to let their margins increase for a while. Ultimately the reduced costs filtered through the economy, and we are therefore benefiting from the lower inflation. Reduced demand as a result of the recession also impacted on prices, which is another reason why inflation has dropped as quickly as it has.

    In a surprise move Gill Marcus dropped the repo rate at the end of March to 6.5%, with the prime rate similarly falling to 10%. This was a surprise as the MPC committee usually takes a forward view on the inflation front, and as inflation had already breached its upper target of 6% (with it expected to fall deeper into the target range) economists had expected the Governor to keep rates on hold. Instead the rate got cut in an apparent move to try and prevent the rand from continuing its recent strength.

    As a small open economy South Africa is heavily dependant on global events. We therefore need to keep a health check on our fiscal and monetary health to avoid being severely impacted by adverse global movements.

    Take care,

    Mike Browne
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-29, 17:20:40, by Mike Email , Leave a comment

    Markets come under pressure due to Greece downgrade

    Global markets were under major pressure today on the back of the downgrades of Greece and Portugal debt. With the rating agencies placing a higher risk on the debt issued by the government of these countries, risk awareness across the globe and across all major asset classes suddenly spiked up.

    Nedbank economic unit recently published its Guide to the economy. Some of the opening comments were that “The global economic recovery developed some momentum in the latter part of 2009 and in early 2010. Stimulatory fiscal and monetary policies, asset price rises and some normalisation in financial markets helped demand to improve from the disastrously low levels experienced in early 2009 in the wake of the financial crisis."

    One concern raised however was that “Many countries have been left with a legacy of high government debt and impaired credit markets which will hurt medium term prospects.”

    We saw this unfold yesterday and today.

    In the past articles, we have commented on the increase in correlation of the global markets. The downgrade in ratings on Greece’s sovereign risk is a clear case in point which saw all assets tumble sharply.

    The risk in holding bonds in highly indebted countries became very apparent today as the traded interest rates on bonds jumped up sharply – i.e. the price tumbled. The yield on Greece’s two year note has risen almost fivefold this month according to Bloomberg with the risk of buying insurance on Greece, Portugal and Spain bonds in the form of credit default swaps soaring to record levels.

    There is still the large unknown as to whether Greece will be bailed out despite the announcement of joint EU and IMF funding.

    The chart below gives an indication of the escalation of risk in the credit markets of the 5 currently risky countries, i.e. Greece, Ireland, Portugal, Spain and Italy. Today these spreads escalated even further with reports that the Greek 5 year CDS rose to 911 basis points. – I.e. double the level displayed on the chart below.


    In the US, the Federal Reserve will announce today on any possible short term interest rate change. The consensus is for rates to stay at their ultra low levels of between zero to 0,25%. The unknown is what the Fed will state regarding its current stance on the duration of these low rates as being for an “extended period”.

    The yield on the 10 year note in the US is around 3,72%. Bloomberg reported that the US government will sell $42 billion in five year notes today. Translated to Rand this is around R300 billion!

    Traditional low risk assets are unlikely to be low risk over the next 10 years.

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-28, 17:22:56, by ian Email , Leave a comment

    RSA retail bonds

    Over the months, I have discussed the general increase in government indebtedness as tax revenues come under more pressure, expenditure remains high and the interest on accumulated borrowings eats into a higher proportion of annual tax take. This is not a fantastic environment for lenders.

    On of the ways that the local government has looked to raise funds is by offering retail bonds.

    Typically the government via its treasury operation holds weekly auctions of fresh bond issues, where the major institutions put in bids on the new bond issues. The bids are cleared at a certain price.

    For example last week the government auctioned R1,2 billion of its R207 bond and R0,9 billion of its R209 bond. Bids totalling R5,2 billion were received and the yield was 8,49% for the R207 and 8,685% for the R209.

    The R207 is a bond with a maturity on 15 January 2020 and R209 matures on 31 March 2036. These are long dated bonds, but the value of the bids gives an indication that there is still a large demand for this paper.

    The medium dated R157, which matures in September 2015 is currently trading at 7,75%.

    Typically investors into bonds which have a longer dated maturity will command a premium for the higher risk. This is clearly seen in the yields quoted above. i.e. those investors willing to lend funds to the government for a longer period of time are paid a slight premium over medium dated bonds.

    The government has however given an additional premium to retail investors. By way of comparison the retail bonds have a maturities of 2, 3 and 5 year – yet the rates are slightly higher than the bulk institutional interest rates. The current rate quoted for a 5 year maturity is 9,25%. This is therefore 1,5% higher than the current rate of the government R157 bond.

    The rates on the 2 year is 8,75% and the 3 year 9%

    The limit was R1m per person, but this has escalated to R5m per person.

    In addition to the fixed coupon bonds, the government also issued inflation linked retail savings bonds. Where investors are concerned that inflation will start to climb higher leaving their fixed coupon not compensating them, then they will want to consider buying the inflation linked bonds.

    The real rates on the 2 year is 2,25%, 5 year 2,5% and 10 year 3%.

    Remember that these bonds are nothing more than the government borrowing money from its citizens. The loan agreements have defined terms, which the lender effectively agrees to. Included in these terms is a penalty for early withdrawal.

    For those with a day off tomorrow, enjoy the Freedom Day.

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-26, 17:01:02, by ian Email , Leave a comment

    Benefits of Fixed Currencies

    I read an interesting report out of international investment house Sarasin earlier this week. The Quarter 2 House Report was penned by their respected Chief Investment Officer (CIO), Guy Monson. In part of the report he showed how a large percentage of the world is currently engaged in currency agreements with limited flexibility. See the chart below:

    This is an interesting concept, and one that no doubt can’t be completely examined in this forum, but I’ll share a couple thoughts on the matter:

    The idea of free markets is based on the premise that less regulation and intervention will result in improved efficiencies as capital is allocated efficiently. We all know that this is an ideology and that the inherent nature of humans (read greed, among others) prevents ideologies from becoming realities.

    While completely free markets are clearly not the answer, so too is the concept of completely closed markets. There is much efficiency to be gained through trade. Getting a balance is therefore crucial in the real world situation that we find ourselves in.

    Fixing your currency to a global player (read US dollar) has the benefit of increasing the confidence that your trading partners have in trading with you, as they are more certain of their price. Increased confidence equals increased trade, but this could come at the cost of the value of your currency moving significantly from its fair value.

    Relative to equities, currencies can trend far away from fair value over an extended period. It is a classic case of Minsky’s theory that stability (read in asset prices) breeds instability (read currency moving from fair value). Is the increased trade generated through stable exchange rates worth the pain that is ultimately felt when currencies revert to their fair value?

    The US has, in the past, been happy with China keeping their currency pegged to the US dollar. As China exported more and more goods to the US, their currency should have appreciated. By keeping it pegged they improved the competitiveness of the Renminbi (China’s currency) relative to the US dollar. The US benefited as the price of the goods that they imported remained depressed. They were essentially importing deflation into their economy.

    With a struggling economy, the US now needs to weaken their currency in order to stimulate external demand for their goods and services. This is why they are calling for China to revalue their currency.

    On the chart you will notice that little South Africa (0.7% of world GDP) has a floating currency. This is essentially as government has realised that we are an extremely small fish in a large pond, and that we are too small to cost effectively peg our currency to a larger player. Trying to protect your currency can be an expensive game for a small open economy. It is slightly easier for closed economies.

    It will be interesting to see how the chart’s dynamics change over the next 50 – 100 years. There is no doubt that it will look completely different in time to come.

    Enjoy your weekend.

    Take care,

    Mike Browne
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-23, 17:13:41, by Mike Email , Leave a comment

    Do deficits matter?

    I came across an article headed, “Do deficits matter” by William Hummel. Most countries around the globe are experiencing growing deficits. Because governments tend to ordinarily run deficits in times where tax receipts start to run behind budget and expenses escalate, deficits widen and the accumulated government debt increases.

    Today news noted that Greece’s budget deficit for last year reached 13,6% of GDP. This is an extremely high deficit and prompted downgrades, which effectively means that Greece’s existing and future cost of debt increases.

    The chart below reflects the SA government debt as a ratio of total GDP. After peaking in the mid 1990’s it started declining with excellent fiscal management and a growing economy. More recently and on a forecast basis this has started to increase once again.

    But is there really much concern for the average investor?


    Source: Absa Investments

    Some of the points made by the article had this to say on the budget deficits in the US.

    “The notion that the Federal government may go bankrupt because it is unable to service or pay off its debt is absurd. A sovereign government need never repudiate a debt in its own currency. If tax revenues or borrowing are insufficient to service the debt, it could simply print the money needed. In effect, that means borrowing from the Federal Reserve, which can be done without limit.”

    The burden of debt falls very unevenly on the population. Individuals paying higher taxes naturally pay a greater proportion of the debt and its related costs.

    The article continues saying, saying that typically there is no need to fully repay debt and as long as the government can continually roll the debt over by issuing new debt. “The only requirement is that total interest on the debt remains a relatively small fraction of total tax revenues. Currently about 8% of tax revenues go to pay interest on the debt held by the public.”

    With generally higher debts, we will see a curtailment of government benefits for government employees. Governments will naturally also need to raise taxes and so there are definite negative implications. The lenders to governments may suffer losses, but the general investor into equities should be less concerned about growing government debt.

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-22, 17:42:49, by ian Email , Leave a comment

    Who is the seller?

    Yesterday we looked at the brief summary of the current controversy surrounding US bank, Goldman Sachs. Despite the fact that this investment occurred a few years back between 2 large organisations, it is still important to make an assessment of some of the principles involved and try and distil to personal investing.

    Investing is just as much about risk management as it is about generating returns.

    Essentially the problem was one where, Goldman working with one of its clients, hedge fund, John Paulson, created an “investment product”, which Paulson could sell short and so benefit from a decline in price.

    Being an investment bank that typically passes on risks and takes a margin, Goldman Sachs then had to find a buyer (or number of buyers) – for the product that Paulson had sold.

    The losers were the buyers of or investors into the created product, which was established for maximum downside loss. With or without full disclosure from Goldman Sachs, the investor, inter alia a German bank would have supposedly considered the merits of the investment that was being marketed to them, considered the risk and then gone ahead and made the investment.

    But perhaps what they failed to fully anticipate or take into account was this:

    Who is the seller and why is he selling?

    It’s one of the most important questions that each investor must consider before parting with his investment funds. Rather than look for all the positives in the investment, try and make an assessment of everything that can go wrong, given that a presumably smart counterparty is making the sale.

    This is less so the case when trading liquid shares through a listed exchange on a secondary basis, where all buyers and sellers are centrally cleared, but it is especially the case where investments are made “over the counter” or where there is no or very little liquidity in the investment product being marketed.

    A few examples where investors should exercise far greater diligence in assessing who and why the seller is making the sale:

    • A private company issuing shares in a “pre listing” private offering
    • A private company issuing debentures
    • An investment company or bank marketing a structured product
    • An unlisted investment where the underlying assets do not have a recognised and liquid exchange.

    While it is impossible to always eliminate every risk, certain investments require a higher level of due diligence.

    Please don’t hesitate to give us a call, if you would like Seed to make an assessment of your current portfolio and assist with longer term investment and retirement planning.

    Kind regards

    Ian

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-21, 16:57:50, by ian Email , Leave a comment

    Daily Equity Report Tuesday 16 April 2010

    2010/04/20 20:38:47
    The JSE closed up 0.98% at 29012 with value traded at R 10.31 billion. Advances led declines 230 to 114 with 75 shares unchanged out of 419 active. Mining closed up 1.02% at 34933, while Industrials were up 0.96% at 27401 and financials ended the day up 1.05% at 21100.

    The best performing sectors of the day were Beverages Index up 4% at 77092, Platinum Mining up 3.1% at 85 and Consumer Goods Index up 2.2% at 22326, while the worst were Venture Capital down 3.2% at 75, Electronic & Electrical Equipment Index down 0.6% at 19842 and Household Goods down 0.5% at 130.

    There were 6 new 12 month highs today, including Sabmiller which closed up 4% at 22560, Metltd up 3.7% at 1670 and Hyprop up 1.6% at 5200.

    Of the major stocks Anglo was up 0.85% at 32740, Billiton gained 0.61% at 24823, Sasol gained 0.51% at 29650, Sabmiller ended up 3.96% at 22560, Naspersn gained 0.15% at 30547.

    Some of the top gainers included Net1ueps up 9.09% at 12000 , Iquad up 9.09% at 252 , some of the losing shares included Wildrness down 8.33% at 550 and Sephaku off 6.85% at 340

    The Dow was up 0.2% at 11117.06 and the S&P 500 up 0.6% at 1205.28 a few moments ago.

    Gold was up 0.3% at $ 1139.10/oz

    The rand was last trading at R 7.39 to the dollar, R 11.31 to the pound and R 9.93 to the Euro.

    Permalink2010-04-20, 20:41:13, by admin Email , Leave a comment

    Who is the seller?

    Yesterday we looked at the brief summary of the current controversy surrounding US bank, Goldman Sachs. Despite the fact that this investment occurred a few years back between 2 large organisations, it is still important to make an assessment of some of the principles involved and try and distil to personal investing.

    Investing is just as much about risk management as it is about generating returns.

    Essentially the problem was one where, Goldman working with one of its clients, hedge fund, John Paulson, created an “investment product”, which Paulson could sell short and so benefit from a decline in price.

    Being an investment bank that typically passes on risks and takes a margin, Goldman Sachs then had to find a buyer (or number of buyers) – for the product that Paulson had sold.

    The losers were the buyers of or investors into the created product, which was established for maximum downside loss. With or without full disclosure from Goldman Sachs, the investor, inter alia a German bank would have supposedly considered the merits of the investment that was being marketed to them, considered the risk and then gone ahead and made the investment.

    But perhaps what they failed to fully anticipate or take into account was this:

    Who is the seller and why is he selling?

    It’s one of the most important questions that each investor must consider before parting with his investment funds. Rather than look for all the positives in the investment, try and make an assessment of everything that can go wrong, given that a presumably smart counterparty is making the sale.

    This is less so the case when trading liquid shares through a listed exchange on a secondary basis, where all buyers and sellers are centrally cleared, but it is especially the case where investments are made “over the counter” or where there is no or very little liquidity in the investment product being marketed.

    A few examples where investors should exercise far greater diligence in assessing who and why the seller is making the sale:

    • A private company issuing shares in a “pre listing” private offering
    • A private company issuing debentures
    • An investment company or bank marketing a structured product
    • An unlisted investment where the underlying assets do not have a recognised and liquid exchange.

    While it is impossible to always eliminate every risk, certain investments require a higher level of due diligence.

    Please don’t hesitate to give us a call, if you would like Seed to make an assessment of your current portfolio and assist with longer term investment and retirement planning.

    Kind regards

    Ian

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-20, 19:33:18, by ian Email , Leave a comment

    Goldman Sachs in the news

    It is a global investment banking group that was founded in 1869 by German immigrant Marcus Goldman, joined later by his son in law Samuel Sachs. Almost ironic then with its German roots that the latest controversy was due to the bank supposedly selling collateralised debt obligations to IKB Deutsche Industriebank, a German bank, which was one of the first causalities in the 2007/2008 global crisis.

    Wikipedia reports that on average around 68% of Goldman revenues and profits are derived from trading. This is not necessarily speculative trading but rather taking bid ask spreads – i.e. acting as a market maker between buyers and sellers.

    Over the years it has been the subject of a lot of controversies. Last week the SEC in the US announced that it was suing the large US bank and one of its employees for allegedly materially misstating and omitting facts in disclosure documents for an investment product that it sold to amongst others the German bank.

    It appears that the bank here took a typical market making approach with this deal. According to the SEC, Goldman worked with US hedge fund firm Paulson and Co to structure and sell a complex package of mortgages to clients. This in itself is not problematic, i.e. the bank working with one client. What is of concern is that the full facts were not revealed when Goldman went to its next set of clients and effectively getting them to buy into what one of its clients (Paulson) was selling, without revealing the full details.

    I have written about Paulson’s funds before in these articles. US hedge fund manager John Paulson had the correct view on markets 3-4 years ago. He was concerned with the mortgage markets and wanted to benefit from the collapse. He therefore went to Goldman and arranged to short or bet against a pool of mortgages. His funds supposedly made $1 billion from the subsequent collapse.

    Goldman Sachs was instrumental then in creating this product that Paulson wanted to sell. Goldman then purportedly had to find buyers and this is where the German bank lost money.

    Goldman sat in the middle, making fees on both sides of the trade. Paulson apparently paid Goldman $15 million for creating and marketing the deal and supposedly it would have received fees for selling this to other clients.

    At that stage pre the credit crisis, there was no shortage of buyers and very few sellers (Paulson being a rare exception). This is typical of extreme pricing where there is a preponderance of either sellers or buyers, but where this majority is proved to be wrong.

    The pressure on Goldman put a negative pall on the markets which continued into Monday.

    But if this is truly a firm bull market in global equities, this too will soon be yesterday’s news

    Regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-19, 19:19:15, by ian Email , Leave a comment

    GMO report on China makes for interesting reading

    We have been looking at the report from GMO on China. Their view is that there are bubbles developing in Chinese assets, given that there is a lot of data pointing to a brewing bubble in assets.

    During the week, we looked at some of the points raised; let’s consider some of the other interesting aspects.

    •Easy Money

    Nobel laureate Friedrich Hayek claimed that asset price inflation followed from excessively low interest rates. Easy money feeds through to monetary and credit expansion, leading to inflation, either in the general price level or in asset prices.

    Where interest levels are kept below their “normal” level, business have an incentive to invest in projects whose returns lay in the more distant future, resulting in a misallocation of resources.

    The GMO view is that a rule of thumb suggests rates should track economic growth over time. They note that this has been the case in the US where the prime rate has averaged around 1% more than the US nominal growth over the past 40 years.

    But in China since 1990, the prime rate has averaged around 9% below GDP. See chart below.

    1st graph

    Keeping interest rates low has been part of the government’s policy to promote investment and subsidise state owned enterprises.

    •Fixed exchange rate

    The Chinese currency, the renminbi, is pegged to the US dollar. This has helped China boost exports and encouraged massive capital inflows, pushing the foreign exchange reserves to $2,4 trillion.

    GMO states that it’s a mistake to think that China’s enormous forex reserves make it invincible, but as one commentator, Michael Pettis, pointed out the only two countries which have previously accumulated such large foreign exchange reserves relative to global GDP were the United States in 1929 and Japan in 1989.

    •The credit boom

    In the same vein as easy money, GMO note that Beijing essentially ordered its banks to go out and lend. In 2009 new bank lending increased by nearly RMB 10 trillion, equivalent to 29% of GDP.

    Again these loans went largely to infrastructure projects, property developments, and state owned enterprises.

    They point out this lending could not have expanded without some decline in quality of loans.

    2nd graph

    As always some very interesting points raised by GMO.

    Have a great weekend

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-16, 17:23:40, by Carlos MENEZES Email , Leave a comment

    The Power of Diversification

    In many of the Daily Equity Reports that we have compiled over the years we have drummed in the importance of diversifying your investment. Despite the logic offered, many investors fail to fully grasp the ‘free lunch’ that diversification does, in fact, offer.

    In our view one of the main perceived shortcomings of diversification is actually its major strength. This ‘shortcoming’ is that a diversified strategy is never the best performing strategy over the short term, which is why investors like to throw it out after it has lagged a single ‘star’ asset class over a period. Case in point is the last 12 months or so. Some investors have forgotten that equities can produce large losses.

    The three charts below show the performance of equities versus a composite portfolio comprising of 50% equity, 10% property, 25% bonds, and 15% cash, rebalanced on a monthly basis. Each chart has a comment that investors typically make at the end of the period.

    “Why should I diversify my assets? It just dilutes returns!” – 28 February 2010 after the market has rallied nearly 50%

    “I’m never investing into equities again, they are just too risky!” - 28 February 2009 after one of the worst market crashes on the JSE

    “Fortunately I diversified my investments. It didn’t fall as much as the market, but I was still able to participate in some of the upside.” – 28 February 2010 investor who looks at the full period.


    Investors forget that while diversification is never the top performing strategy, it is also never the worst either. Avoiding permanent capital loss is key to growing real wealth over the long term and diversification dramatically reduces the risk of permanent capital loss.

    Another benefit of a diversified strategy is that it smoothes the returns that an investor receives thereby making it an easier strategy to follow. Since the turn of the century the composite portfolio has returned 15.6% pa versus the ALSI’s 16.1% pa. This return has been achieved with nearly half the volatility (10.4% vs 19.2%) and with a drawdown profile that is vastly superior to that of the market.

    While this analysis is performed on historical data, and we know that the future is never the same as the past, it does give us some indication that you are able to greatly enhance the risk/return profile of your portfolio by diversifying your investments.

    The specific mix that you should be invested into equity will vary from investor to investor. You should have a clearly defined investment strategy based on your personal circumstances. This may change over time as your personal circumstances change.

    If you would like to discuss your financial and investment planning, give Vincent a call or e-mail him on vincent@seedinvestments.co.za. We will send you some more information on how we can assist with your specific investment and retirement planning.

    Take care,

    Mike Browne
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-15, 17:23:58, by Mike Email , Leave a comment

    More on China

    There has been more than one global fund manager pointing to China with some concerns that asset price bubbles are developing. One noted fund manager is GMO. Another is Sarasin.

    In the report from US fund managers GMO, titled “China’s Red Flags”, they look at some indicators that point to a possible bubble in asset prices.

    The extent of infrastructure stimulus in China is clearly evident from this chart.


    Source: Sarasin and Partners

    A few of the points made in the GMO paper noted under the heading “Analysing the Chine Dream” are:

    1. The China Dream

    If the forecasts for urbanization and economic growth are correct, then demand for industrial commodities and consumer goods in China will rise exponentially in the years to come. Yet like the projections for internet growth back in the late 1990s, there’s a possibility that these forecasts may be exaggerated.

    Some forecast that urban population will grow by another 350 billion by 2025 approaching the 1 billion mark. Even assuming this materialises, quoting an academic expert on Chinese demography writes, “equating the expansion of the urban population with the growth of the middle class is simplistic”

    2. In the Communist Party of China we Trust

    As with Japan 20 plus years ago, where it was argued that Japan is different, many now claim that it’s the superiority of Beijing policies driving growth. History however argues against the sustained ability of central planning for an economy.

    He notes that “One of the wonders of modern China is that it has turned some of the world’s most ardent capitalists into fervent admirers of an economy managed by communists.”

    3. Investment boom

    In a typical market economy, investment would be expected to fall during a period of uncertainty, but in classical Keynesian economics, the Chinese government stepped up fiscal spend in 2009 with fixed asset investment climbing 30% and contributing 90% of last years economic growth. Investment rose to a record 58% of GDP.

    “Infrastructure accounted for more than two thirds of last years stimulus spending. Roughly a quarter of all investment was government-directed. Many projects, however, were clearly intended to meet the government’s GDP growth target.”

    Sectors have been discouraged from laying off workers. Investment has continued despite overcapacity in certain sectors such as shipbuilding, flat glass, iron, steel, cement and wind power as examples.

    Some interesting points are made. Asset price bubbles typically continue for longer than originally anticipated and China is probably no exception. I will look at some of the other points raised in this report later in the week.

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-14, 15:51:09, by ian Email , Leave a comment

    Characteristics of investment bubbles

    A recent report from US fund managers GMO, titled “China’s Red Flags” looks at the possibility of speculative manias existing in China. The country has been a major growth story with 1,3 million inhabitants, coming off a low income per capita and an economy that has increased sixteen fold over the last 30 years.

    Before looking at China, Edward Chancellor, looked for indicators and characteristics of bubbles in past manias and financial crises.

    He lists 10 characteristics:

    • Great investment debacles generally start out with a compelling growth story.

    e.g. railroads in 1920’s, internet in 1990’s

    • A blind faith in the competence of the authorities is another typical feature of a classic mania.

    • A general increase in investment is another leading indicator of financial distress.

    Capital is generally misspent during periods of euphoria.

    • Great booms are invariably accompanied by a surge in corruption.

    • Strong growth in the money supply is another robust leading indicator of financial fragility.

    Low rates lead investors to chase after higher yielding and riskier investments.

    • Fixed currency regimes often produce inappropriately low interest rates, which are liable to feed booms and end in busts.

    • Crises generally follow a period of rampant credit growth.

    • Moral hazard is another common feature of great speculative manias.

    • The economist Hyman Minsky observed that during periods of prosperity, financial structures become precarious.

    • Dodgy loans are generally secured against collateral, most commonly real estate.

    Therefore a combination of strong credit growth and rapidly rising property prices are a reliable indicator of very painful busts.

    He summarised as follows. “…. researchers find that rapid credit growth is the most important leading indicator of financial instability. The presence of an asset price bubble is the second most reliable crisis indicator. Low interest rates and strong money growth are also good warning signs. Real estate busts often produce severe and long-lasting economic downturns, while investment booms may result in a misallocation of capital. Classic manias have often been accompanied by a compelling growth story and an uncritical faith in the competence of the authorities. They are exacerbated by moral hazard and accompanied by rampant corruption.”

    I will look at his specific comments on China in a later report

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-13, 18:13:22, by ian Email , Leave a comment

    Categorising investment philosophies

    An investment philosophy is a coherent way of thinking about markets, how they work (and sometimes do not) and the types of mistakes that investors consistently make, in order to then take advantage. It represents a set of core beliefs about investors behave and markets work.

    But most investors and even many professional money managers and advisors have no investment philosophy. They then adopt investment strategies that seem to work, abandoning them when they don’t. So without a firm investment philosophy an investor will tend to shift from strategy to strategy.

    A book written by Damodaran, professor of Finance at Stern School of Business, categorised the following philosophies:

    • Market timing versus asset selection

    The broadest category of investment philosophies is whether they are based on timing overall markets or finding individual mispriced assets.

    Market timing is alluring because it pays well when perfected. But for the same reason it is difficult because of so many investors attempting it.

    • Activist versus passive investing

    A passive strategy is one of investing into shares or taking a minority interest in a company and waiting for the investment to generate a return from dividends and a rerating (i.e. some correction of the misvaluation). Index fund managers can also be included into this broader category.

    An activist strategy is one of taking an interest in a company and then trying to change the way that the company is run in order to make it more valuable. Venture capitalists and private equity investors would fall under this category.

    • Time horizon.

    Different philosophies will require different investment horizons. Passive value investors who buy stocks in companies that they believe are under valued may have to wait years for the market correction to occur, even if they are right.

    Investors that trade ahead of after earnings reports may only hold shares for a few days.

    At the extreme investors that can take advantage of mispricings of the same (or similar asset) across different markets may have a trading horizon of days or even hours.

    Ultimately it is important to define your investment philosophy, which in turn will then drive your investment strategies.

    To get a sense of Seed’s investment beliefs and process, click on our website.

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-12, 17:29:59, by ian Email , Leave a comment

    The dividend component

    As we have noted over time, the return that investors receive in the form of a dividend is an important component of the total return from an investment. It may not be the most exciting component.

    Study after study has indicated that while capital values can move materially over time, when dissecting the composite that makes up the total return, when measured over longer periods of time, the dividend is the biggest slice.

    Robert Arnott expounded on the various components of equity returns in the US over a period of 200 years, in an editorial in the Financial Analysts Journal in 2003, entitled Dividends and the Three Dwarfs.

    His conclusion – not unique – is that dividends were far and away the main source of the real return from stocks. This component dwarfs all the other constituents: inflation, rising valuations, and the real growth in these dividends over time.

    For the period 1802 to 2001 he calculated the total return from shares in the US at 7,9% per annum. $100 compounded at this return turns into $402 million.

    Breaking this down into its constituents over time, he shows the following:

    • 5% return from initial dividend yield
    • 1,4% return from inflation
    • 0.6% return from rising valuation levels,. i.e. a rerating of shares
    • 0,8% return from real growth in dividends

    The facts are contrary to a lot of wisdom which generally indicates that shares are firstly growth assets and the low dividend yield is of secondary importance. These stats indicate that real growth in dividends was less than 1% per annum. For the period 1965 to 2002 real per share dividend and earning growth was zero. Very similar stats are seen on the local market where over many years in totality, companies struggle to grow dividends ahead of inflation.

    Specific shares

    Picking up on a report from Investec I have highlighted 6 financial services companies and the consensus dividends and yields for the next 3 years.


    Source : Investec, I Net

    I have ranked these 6 shares by expected 2012 dividend yields. Despite the run up over the last 12 months in the market, analysts are generally pricing in a healthy increase in dividends over the next 3 years.

    Looking back over a 2 year period for these shares, it is interesting that the shares in this list with the highest dividend yield, i.e. African Bank and Coronation, were also the best performers.

    Over any shorter period of time, this is not always the case. However buying and holding cheaper shares (i.e. those with higher yields) provides for a certain margin of safety and a higher possibility of rerating in price.

    Investment planning

    It’s amazing how quickly this year is going, with the first quarter already behind us. If you would like to discuss your financial and investment planning, give Vincent a call or e-mail him on Vincent@seedinvestments.co.za. We will send you some more information on how we can assist with your specific investment and retirement planning.

    Have a wonderful weekend

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-09, 16:37:25, by ian Email , Leave a comment

    Local market

    March proved to be a fantastic month for local equities as the FTSE/JSE gained 7,87%.

    The Resources 20 index had a total return of 10,17%, the Industrial 25 index 5,62% and the Financial 15 index 7,58%

    Foreigners continued to be net buyers of equities (R4 billion) and bonds (R13,6 billion). This continued to push the rand firmer and dilute the impressive foreign returns.

    These gains reverse the losses for the year and bring the return on local equities into positive territory – with the FTSE/JSE up 4,5% for the 3 months.

    The sectors that have had a poor start to the year include mobile telecommunications, gold mining and fixed line services.

    General financials, retailers and software have been amongst the best performing sectors.

    JSE company earnings

    The chart below gives an indication of the previous periods from 1960, where earnings declined from a peak point to a trough.

    In the context of this history, it is clear that the most recent earnings decline of almost 30% has been substantial. This has started to bottom out and turn up. The market is anticipating a strong gain in company earnings.

    Relative prices

    In the last report, we said looking back over a 10 year period, it is very evident that local has been the pre-eminent investment decision. The global market has given you close to zero over the last ten years compared to a return in excess of 300% on the local market.

    The chart below compares the JSE in dollar terms to the S&P 500 index. The massive outperformance of the JSE, relative to the S&P is evident from the exceptionally low starting point in 1998/1999.

    As the note on the chart indicates however, don’t extrapolate the last 10 year outperformance into perpetuity.


    Source : Coronation

    Given the current starting point, there is a low probability that the next 10 years will be a repeat of the last 10 years. In fact probably because of the recent history, investors should continue to balance appropriately between local and offshore assets.

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-08, 17:53:43, by ian Email , Leave a comment

    global markets

    The MSCI World Equity Index, driven by both emerging and developed markets, closed at +6.2% for the month. Among the selected equity indices, the MSCI Turkey index rose by 16.1%, followed by MSCI South Africa at a positive 10.8%. The Dow ahs approached the 11,000 level, evident of the continued appetite for riskier assets.

    As we have been discussing in recent reports, the big asset allocation call over the next decade is going to be between investing in real assets or government bonds.

    History clearly indicates that the average global government bond fund has outperformed the average global equity fund over the 20 years to the end of 2009.

    Source : Orbis

    The outperformance did not occur in a linear fashion. From a starting position in 1990, global equities outperformed other asset classes, but then from 2000, US bonds, global bonds and US bank deposits all outperformed the average global equity fund by a wide margin.

    The overall result is a 20 year outperformance of bonds over equities

    • Average global equity funds – 5,1%
    • Average global bond fund – 6,3%

    Asset classes move in and out of favour over long periods of time and it’s very seldom that the best asset class over the last 10 years proves to be the best over the next 10 years.

    A comment from Orbis carries weight:

    “We have found the most reliable indicator of the attraction of an asset, or asset class, is their valuation at the time of purchase. Valuations of government bonds are currently very high, or put another way, the returns they offer in the form of yield are very low. In times of financial crisis, investors become keenly aware of the risk of nominal loss. Government bonds offer protection against nominal loss (absent the risk of default), but they are far from free of risk. If the objective is to increase the future purchasing power of ones’ savings, government bonds look risky to us given the high risk of real loss.”

    As to investing into global equities, Ken Fisher, a typical bull on the market, notes this, “One year into the current bull market I like what I see: globally improving fundamentals plus strong societal skepticism.”

    As to global asset allocation decision, our conclusion remains the same – while government bonds have outperformed over the last 10 and indeed 20 years, given their current starting valuations, this is unlikely to be the case over the next 10 and 20 years.

    Preference should be given to investing into the equity of global high quality cash generating companies, with low debt, and businesses expanding into the developing markets

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-07, 17:32:50, by ian Email , Leave a comment

    Some further points on choosing an investment philosophy

    A book on investment philosophies set out a roadmap to choosing an investment philosophy because there is no one investment philosophy that is best suited for all investors. A strategy that works for a patient investor and has substantial capital to invest may not work for an investor with unpredictable cash needs and a smaller portfolio.

    Last week we looked at personal characteristics under self assessment. In this article, let’s consider an investor’s financial standing.

    Financial Standing

    The following factors will invariably affect your investment philosophy. Since these invariably change over time you may have to modify your investment choices to reflect these changes.

    Job Security and Earning Capacity
    An interesting characteristic that we see with financial markets is that investors become more risk averse as the economy weakens.

    While this is a macro economic story for why this happens, we suspect that a great deal of what we see reflects personal insecurity. In the midst of a recession, even those with jobs worry more about their investments and demand larger risk premiums for investing in assets. The flight to quality and, at the limit, to riskless investments is exacerbated by natural and financial crises.

    Your investment philosophy will also be heavily influenced by what you perceive your earning capacity to be. With a high income and asset base, investors have far more degrees of freedom when it comes to selecting an investment philosophy.

    Another factor is that often high-income jobs come with less security and investors will have to invest accordingly. Ultimately an investor’s willingness to bear risk and their time horizon will be heavily influenced by both the level and predictability of earnings.

    Investment Funds
    Your choices in terms of investment philosophy expands as the funds at your
    disposal increase.

    If you have a few thousand rand to invest, choice is often limited, but with several hundred thousand rand to invest, more investment philosophies become viable.

    Cash Needs
    One of the perils we all face is unpredictable demands for cash withdrawals. If this occurs, you may have to liquidate your investments and lose any long-term return potential that you may have in them.

    Where cash demands are unpredictable, your investment style and philosophy will need to be adapted to cater for the shorter investment horizon.

    Tax Status
    Taxes are inevitable and therefore it is imprudent to select an investment strategy without considering your tax status. Investors who face high taxes on income should choose investment strategies that reduce their tax liabilities or at least defers taxes into the future.

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-06, 17:36:47, by ian Email , Leave a comment

    Choosing an investment philosophy

    A book on investment philosophies set out a roadmap to choosing an investment philosophy because there is no one investment philosophy that is best suited for all investors. A strategy that works for a patient investor and has substantial capital to invest may not work for an investor with unpredictable cash needs and a smaller portfolio.

    Over the next few weeks, I will consider some of the relevant points made. Indeed we always need to keep these in mind when we are consulting with clients.

    Firstly we will consider the personal characteristics under self assessment:

    Personal Characteristics

    Investors who select investment philosophies that do not fit their personalities are destined to abandon them sooner rather than latter. You cannot be a successful investor if you do not have a clear eyes view of your own strengths and weaknesses: Look at the following.

    • Patience: Some investment strategies require a great deal of patience, a virtue that many of us lack.

    • Risk Aversion: Your willingness to bear risk should play a key role in what investment philosophy or strategy you choose for yourself.

    • Individual or Group Thinker: Some investment strategies require you to go along with the crowd and some against it. Which one will be better suited for you may well depend upon whether you are more comfortable going along with the conventional wisdom or whether you are a loner.

    • Time you are willing to spend on investing: Some investment strategies are much more time and resource intensive than others. Generally, short-term strategies that are based upon pricing patterns or on trading on information are more time and information intensive than long-term buy and hold strategies.

    • Age: for individual investors, age clearly will make a difference in your choice of investment philosophy. As you age, you may find that your willingness to take risk, especially with your retirement savings, decreases.

    These are signs of a misfit in the investment philosophy:

    1. You lie awake at night thinking about your portfolio. Investors who choose investment strategies that expose them to more risk than they are comfortable taking will find themselves facing this plight. It is true that your expected returns will be lower with low risk strategies, but the cost of taking on too much risk is even greater.

    2. Day to day movements in your portfolio lead to reassessments of your future: While long term movements of your portfolio should affect your plans on when you will retire and what you will do with your future, day-to-day movements should not.

    3. Second guessing your investment decisions: If you find yourself second guessing your investment choices every time you read a contrary opinion, you should reconsider your strategy.

    We take this opportunity to wish you a blessed Easter weekend

    Kind regards

    Ian de Lange
    info@seedinvestments.co.za
    www.seedinvestments.co.za
    021 9144 966

    Permalink2010-04-01, 16:27:23, by ian Email , Leave a comment