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    A 30 year track record comes to an end

    Despite the fact that the MSCI World index in USD terms is up around 5% for the year, there are many very experienced global fund managers that have had difficulty in generating positive returns. Included here are some global hedge fund managers, who until now have had excellent long term track records.

    One such fund manager is Stanley Druckenmiller, who started his fund, Duquesne Capital Management in 1980 and has generated average returns in the region of 30% per annum since 1986. A couple of months ago the fund was down around 5%, but by the end of October was trading flat for the year. Since inception the fund never had a losing year.

    A contributing factor to the fund closing was the large size of the fund, where it becomes more and more difficult to generate large positive excess returns. Just prior to closing down and returning funds to investors, the fund was around $12 billion.

    For about 12 of these years that he managed his own fund, he overlapped by also managing George Soros’s Quantum fund from 1988 to 2000 as that funds investment strategist.

    It was during his tenure that the Quantum Fund made a $1 billion profit on the devaluation of the British pound in 1992. The fund put a large trade on the likelihood that the Bank of England would be forced to devalue the pound, on the basis that the Bank did not have sufficient reserves to prop up its currency and it could not afford to raise rates. The pound was forced out of the Exchange Rate Mechanism (ERM), the precursor to the single European currency, resulting in a massive windfall for the Soros fund.

    While this 30 year old fund management business has now closed, former colleagues announced this month that they will be starting a new fund next year - Point State Capital with start-up fund of $5 billion, including $1 billion from Druckenmiller.

    The performance from Druckenmiller compares very well to the quoted returns generated by Warren Buffett with his Berkshire Hathaway company, which reported a compounded change in book value from 1965 of 20,3%, also with many of the higher returns generated in the former years, when the investment company was far smaller than its current market value of $197 billion.

    An investor looking to place funds with an investment manager will always want to see some track record. There however is often a degree of trade off between good performance into the future and a long historical track record. Two reasons for this could include superior initial performance attracting more capital, making it more difficult to replicate the superior performance and changes in the motivation of the founding fund managers once a degree of material success is achieved.

    Investors looking to select a fund manager will often want to have some track record, but still have the advantage of a relatively small size on their side.

    Have a look at www.seedinvestments.co.za

    Kind regards

    Ian de Lange
    021 9144966

    Permalink2010-11-29, 16:54:12, by ian Email , Leave a comment

    Irish bailout

    Over the weekend, Ireland formally applied for aid from the European Union and the International Monetary Fund (IMF). The bailout details in general terms are that the EU will back Ireland’s filing for loans of roughly EUR90 billion.

    This is the second domino in the Euro zone after Greece and according to reports is probably not the last. The bailout so far for Greece was 110 billion Euros.

    Unlike Greece where the debt was public debt, in the case of Ireland, the sheer size of bank loans, became a threat to stability, as foreign depositors withdrew, causing a run.

    Finance Minister, Lenihan was reported as saying, “Clearly because of the size of their loan books, the huge risks they took, they became a threat not only to the state but to the entire euro region. The banks will be downsized to the real needs of the Irish economy, to Irish consumers and Irish businesses. That has to be the primary focus of Irish banks.”

    The 2 biggest banks will need at least 5 billion Euros immediately.

    EU/IMF will likely seek strict conditions on its loan including tax increase and spending cuts.

    There may be a possible increase in the VAT rate, which is already at 21%.

    The EU could also put pressure on Ireland to increase its corporate tax rate from a low level of 12,5%.

    The bailout may assist the euro in the shorter term, but there is still debate as to whether it will work for Ireland itself in the medium term. Looking at the earlier example of Greece, which received a EUR110 billion bailout in May, the idea should be that by now bond risk premiums, which spiked up should be at far lower levels.

    But this chart below shows that risk premium spreads of Greece bonds against German bonds (the Euro benchmark) are still at very much the same level as in May – i.e. +-9% premium, which is a clear indication that investors are pricing in risk, making it extremely difficult for these countries to raise their own debt in order to repay the bailout packages.

    Source: Ecowin, Standard Bank

    The risk premium on Ireland’s 10 year bonds over that of Germany widened to 6,5%, but was down at just over 5%.

    The problems in Euro zone countries like Greece, Ireland, Spain and Portugal, will continue to weigh down on the euro. At the same time the US Federal Reserve is weakening its currency with the $600 billion easing program.

    Both these major developments favour both developed and emerging currencies outside of the dollar and the euro, but this does not necessarily hold true for global companies domiciled in the US and Eurozone.


    Ian de Lange
    021 9144 966

    Permalink2010-11-22, 17:32:54, by ian Email , Leave a comment

    Start of most powerful seasonal effect

    Monday 22nd November marks the beginning of the most statistically significant seasonal effect of the year that runs through to 10th January 2011. This period includes the very powerful "Santa Clause Rally" from 14th-23rd December. As you can see from the below picture, apart from December and the "Easter Rally" in April, seasonality is very much a tale of two halves.

    The 1st half of January delivers the strongest seasonal performance whilst the 2nd half of December the 2nd strongest. The four distinct strong seasonal periods from November 23rd to January 10th are depicted below:

    The 2nd half of November and the first half of December both carry a warning though - although they are strong performing periods, their statistical significance (shown by the Sharpe ratios) is on the low side, since the standard deviation of returns is too wide.

    The conclusion is that for the seasonal effect with the highest statistical significance you should focus on the period of 14th December through to 10th January. Every year we play it with an ALSI futures contract just for fun. The current ALSI-Dec10 expires on 15th December so your'e best climbing into the ALSI-Mar11 contract on the 16th December.

    Permalink2010-11-19, 16:24:48, by dwaine Email , Leave a comment

    Interest rates drop by a further 0,5%

    The Reserve Bank dropped their key repo rate today by a further 0,5% at their monetary policy committee (MPC) meeting. This had already been priced in by the markets and so was effectively discounted.

    A number of factors led the local Reserve Bank to reduce rates to this 30 year low. These included:

    • Year on year inflation rate at 3,2% is at the bottom end of the target band of 3% - 6%.

    • Producer price inflation peaked at 9,4% in June 2010 but in September came down to 6,8%.

    • The expectation for inflation for the full year is now at 4,3%, remaining at this level for 2011 and increasing to 4,8% in 2012. This represents a slight downward shift from previous expectations.

    • The market expectation of inflation can be calculated using nominal and inflation linked bonds. According to the Reserve Bank this has declined significantly to around 5%.

    • Recent resumption of quantitative easing in the US, against deflationary fears indicates that monetary policy in the US is likely to remain expansionary for some time. This is having spill over effects on emerging market economies.

    • Domestic GDP expectations remains subdued and below trend growth. The forecast that the Reserve Bank is making is for GDP growth at 2,8% for 2010, 3,3% and 3,6% in 2011 and 2012 respectively.

    • The main risks to inflation outlook emanate from cost push factors, including wage trend and administered prices, with food and petrol also identified as possible longer term risks.

    The result of all these factors according to the MPC was that “The Monetary Policy Committee has taken cognisance of the improved longer term inflation outlook and assesses the risks to this outlook to be fairly evenly balanced. The domestic economic recovery remains fragile, and the adverse global developments make the growth outlook more uncertain. The MPC believes that while monetary policy cannot determine the long term growth path of the economy, it can impact on cyclical deviations of output from potential output. The view of the MPC is that there is room for further stimulus, given the weakness in the supply side of the economy.”

    This allowed the bank to drop interest rates by 0,5% but they have tried to emphasise that this is likely to be it, saying that the scope for further downward movement is seen as limited.

    The rand remained fairly steady, unlike the last rate cut, where it immediately strengthened. It was last trading at R6,99/dollar.

    Seminar in Cape Town

    We would like to invite you to attend our bi-annual seminar, hosted by Seed Investment Consultants and SDK Chartered Accountants (SA). The following topics are included: a current market outlook, a look at tax efficient investment vehicles, and the SARS voluntary disclosure program.

    Date: 25 November 2010
    Time: 5:30pm for 6:00pm
    Venue: Southern Sun Newlands, Main Road, Newlands

    Please email Myrna at Myrna@seedinvestments.co.za for more details.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-11-18, 17:12:39, by ian Email , Leave a comment

    A brief summary of global economies

    Before we start today’s report, we’d like to invite you to attend our bi-annual seminar, hosted by Seed Investment Consultants and SDK Chartered Accountants (SA). The following topics are included: a current market outlook, a look at tax efficient investment vehicles, and the SARS voluntary disclosure program.

    Date: 25 November 2010
    Time: 5:30pm for 6:00pm
    Venue: Southern Sun Newlands, Main Road, Newlands

    Please email Myrna at Myrna@seedinvestments.co.za for more details.

    Two years back, the global economy plunged into a very sharp recession following the Lehman Brothers failure in September 2008. Taking a top down view across global economy, I have provided a summary of some highlights across the globe.

    As an aside, I noticed that with the recent auction of Lehman artwork and assorted items was the commemorative plaque from the opening of Lehman's Canary Wharf office in 2004. This was sold for £28 750 – way above the original estimate of £1,000 to £1,500.

    Industrial production across the 30 economies that comprise the Organisation for economic Cooperation and Development (OECD) plunged just short of 20% year on year. In the time following this massive decline, there has been a sharp uptick, which was definitely assisted by massive monetary easing. However in terms of global industrial production across the 30 OECD countries, this is still 10 percent below its prerecession peak.

    The chart above from Wells Fargo Securities reflect the sharp downturn and subsequent uptick in the global economy.

    Some pointers across various economies.

    • Core inflation in the US is below 1% for the first time since the early 1960’s. This is one factor that justifies the monetary easing

    • Most major central banks will maintain an accommodative interest rate policy – i.e. lower rates for longer

    • Some central banks have started hiking interest rates. Included here is Australia and Canada.

    • Unemployment rate in the US is running at 9,6%.

    • The economic recovery has been uneven across the 16 countries that comprise the Euro zone, with the likes of Germany strong, but Ireland continuing to contract.

    • The UK economy remains weak with the VAT increase in January 2011 likely to negatively impact consumer spending in 2011.

    • Australia avoided an official recession. The reserve Bank was one of the first to start hiking interest rates from September 2009.

    • Singapore’s GDP growth came in at 10,3% for the 3rd quarter year on year, dropping from the 19,6% in the second quarter. The GDP for the full year is expected at around 14,5%

    • Chinese GDP rebounded in 2010, but has more recently slowed due to government tightening of loan growth. Quarter 3 year on year GDP came in at 9,6%.

    While global economics are important, we continue to place a higher emphasis on the valuations of various asset classes as a better predictor of future returns. If you are in Cape Town, please join us at a seminar, where we will expand on this in more detail. See details above.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-11-17, 17:24:47, by ian Email , Leave a comment

    Global merger and acquisition activity

    This last weekend saw BHP Billiton call off its unsolicited $39 billion bid for Canadian Potash Corporation, the world’s largest fertilizer maker, after the Canadian’s effectively blocked it.

    This would have been the world’s biggest deal this year, had they manage to clinch it – but it was not to be. This left the company with no option at this stage, but to start to give back some of its excess cash to shareholders, in the form of share buybacks. The price gained 1,28% to R269 today.

    In many respects the unlocking of values in global equities, relies on strong merger and acquisition activity.

    Source: PriceWaterhouseCoopers

    The chart above reflects global Merger and acquisition activity from 1999. Peaking in 2007, just prior to the financial crash, it fell substantially in 2009, but has probably bottomed out.

    Many asset managers make use of prices paid by these “off market” deals to value listed companies. At the same time a completed private equity deals provide both an underpin as well as a pricing barometer for valuing listed equities.

    Some of the points from a recent Price Waterhouse Coopers report were:

    • In emerging economies the M&A markets are strong
    • Outside emerging markets, there is still some caution due to a possible double dip recession.
    • While there has been an improvement in activity levels, completion of deals remains tough.

    A poll today in an online news service announced that 2011 could see a big pick up in M&A activity to a possible $3 trillion. This is still off the peak of 2007’s $4,2 trillion.

    Anecdotal evidence from fund managers also indicates that there is a pick up in M&A activity. This is all positive for global asset prices.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-11-15, 17:24:47, by ian Email , Leave a comment

    Heady Heights

    We march on toward the levels of the 2008 pre-crash peak. The chart below shows how after a short period of funds outflow(we were expecting a mild correction, but it was more like a pause), funds-flow returned to positive liquidity, boosting the market even higher.

    Many of the myriad of traditional indicators are screaming an overbought market,including market-breadth. Here's one of them below, depicting the percentage of JSE shares trading above their 50-day simple moving average. It is not so much the reaching of 70 we need to be concerned about, but when this indicator drops below 70 that the correction is usually finally upon us. You can read about this interesting view of the market HERE.

    Here is another intersting and reliable fellow, called the Absolute Breadth Index. It was created by Norman G. Fosback. This simple yet powerful market breadth indicator is often dubbed the "Going Nowhere" indicator. It looks at the absolute value of the difference between advancing shares and declining shares. It does not matter whether advances exceed declines or vice-versa as this indicator is only interested in the amount of net (up or down) market activity going on. The idea is that as this indicator drops to record lows it depicts an undecided market or a market rolling over as shares change hands for zero changes in price (quite often a sign of when the smart money is offloading shares to the dumb money)It is thus useful (and reasonably accurate) to identify the market-topping process.

    Markets can remain overbought for some time, especially now when global structural forces such as currency depreciation, massive liquidy and foreign inflows keep headed our way for our perceived "commodity market" safety. Keep enjoying the ride, but make sure you have a chair to sit on when the music eventually stops.

    We will be taking a view on these breadth indicators, and many others, when discussing the state of the equity market in our training course on Saturday 20th November at the Sharenet offices in Cape Town. There are still a few seats left.

    Dwaine van Vuuren

    Permalink2010-11-12, 17:16:16, by dwaine Email , Leave a comment

    Money supply is boosting asset prices

    Before we start today’s report, we’d like to invite you to attend our bi-annual seminar, hosted by Seed Investment Consultants and SDK Chartered Accountants (SA). The following topics are included: a current market outlook, a look at tax efficient investment vehicles, and the SARS voluntary disclosure program.

    Date: 25 November 2010
    Time: 5:30pm for 6:00pm
    Venue: Southern Sun Newlands, Main Road, Newlands

    Please email Myrna at myrna@seedinvestments.co.za for more details.

    With the announcement coming from the US Federal Reserve last week that they would print a further $600 billion in order to acquire longer tern Treasury securities, alternative options such as gold are trading at new highs in dollar terms.

    The new injection of US billions is in addition to bringing interest rates to nearly 0% and purchasing more than a $ trillion dollars of Treasury Securities and US backed mortgage securities.

    The dual mandate of the US Federal Reserve is to promote a high level of employment and low, stable inflation.

    Writing in the Washington Post on the 4 November, chairman of the US Federal Reserve, Ben Bernanke said that “….lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending."

    One asset, gold, priced in depreciating US dollars, has continued to reflect the weakening purchasing power of US dollars. It moved to a new high of $1422/oz today.

    Gold is a safe haven asset and in times of uncertainty, ultra low interest rates, demand has continued to push the price up.

    The last real bull run was in the 1970’s when gold started the decade at around $35/oz and peaked at over $850 in early 1980. Most of the price appreciation occurred in the last 2 years of this bull market as the price moved up sharply from $200 at the beginning of 1979 to the $850/oz just over a year later.

    The chart below superimposes that rally with the current price starting in 2001, producing one view of the possible further upside for the yellow metal.

    Source: Sarasin, Ned Davis September 2010

    Other commodity prices are also trading very strongly up. These include sugar at 30 year highs, silver at 30 year highs, palladium at 9 year highs, coffee at 13 year highs, copper near a record, tin at new highs.

    Until now local investors have had the firm performance in US dollar terms negated by the firm rand. This also holds true for gold shares. However these moved up firmly today, with Goldfields and AngloGold trading at new 12 month highs.

    So far there mere announcement of the further increase in the supply of money is having some desired effect – it looks set to continue, but its not all going to be plain sailing.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-11-09, 16:44:58, by ian Email , Leave a comment

    Is this a secular bull market?

    Whenever we look at the market from a macro level, we always refer to some of our long-term investment quantitative timing models, one of which is the SuperModel Investment Timing system, to gauge if we are in a secular bull or bear or to see how favourable equities are.

    This particular model tells us the bull is still alive and well, but not kicking as much as it was 6 months ago.

    But even within these long-term bullish periods, market entry risk can vary considerably. There are many ways to guage this entry risk, with the oldest being the observed market P/E ratio. This is currently around 17.4 (depending when you read this) which is certainly at the top-end of the historic scale

    There is of course a high correlation between market P/E and subsequent 5 year returns and the below chart would imply a current expected return (at a P/E of 17.5) of 37.5% over 5 years, or 6.57% per annum compound, versus the average return of 11.8% p.a at the average P/E of 14.5 times.

    The correlation over a 12-month horizon is a lot looser, as shown below, but nonetheless implies a expected 12-month return of 7.34%:

    Our local market is of course subject to global structural forces as evidenced by the unprecedented foreign inflows into emerging market bonds and equities which is likely to accelerate with the recent approx $800Bn treasury purchase programme announced by the FOMC. Many SA economists think this phenomenon may persists for 2-3 years to come. As evidenced by the post Walmart/Massmart aquisition and subsequent gains in the JSE retail sector, what we may consider fully priced, some foreigners may view as cheap and drive prices up even further.

    Assuming this phenomenon continues to drive up asset purchases, it is not unfeasible to evenutually witness frothy 19x P/E ratios, which at the current JSE earnings-per-share of R1,780 would imply further upside to 33,820 for the JSE or 7.95%.

    Statistically speaking though, structural inflows and QE aside, current P/E's bring with them a lot more market risk and share selection now becomes even more important. If you are joining us for our inaugural course on mechanical market timing and share selection strategies on 20th November, we will be using live data in our JSE Share Watchlist program to demonstrate exactly what types of shares you should be looking at and how to time your purchases to lower your entry risks.

    Dwaine van Vuuren

    Permalink2010-11-05, 17:00:00, by dwaine Email , Leave a comment

    Broadening the Mandate

    Before we start today’s report, we’d like to invite you to attend our bi-annual seminar, hosted by Seed Investment Consultants and SDK Chartered Accountants (SA). The following topics are included: a current market outlook, a look at tax efficient investment vehicles, and the SARS voluntary disclosure program.

    Date: 25 November 2010
    Time: 5:30pm for 6:00pm
    Venue: Southern Sun Newlands, Main Road, Newlands

    Please email Myrna at myrna@seedinvestments.co.za for more details.

    When investing your hard earned capital with a manager it is important that you decide on an appropriate mandate, with agreed upon mandate limits, with your investment manager. It is key to ensure that you know what your goal is and what tools you’re giving your manager to achieve that goal.

    The most important part is setting the goal, but almost as important is agreeing on the tools to be used. Just as a builder needs to know whether he can use steel supports in the construction of an office block (as opposed to only being allowed to use bricks) so a manager needs to be informed of what types of instruments and strategies he’s allowed to use in the management of your portfolio.

    While it important not to restrain your manager to such a degree that he’s unable to express his views fully, you also need to ensure that he doesn’t have carte blanche, as this could lead to an outcome far different from your agreed upon goals. Getting the balance isn’t an exact science, but some sort of middle ground is typically the best.

    The chart below shows the performance of the ALSI over a six and a half year period (green line). On this chart is the performance of two portfolios (real data – net of fees) in red and blue. The second chart shows the drawdowns of these two portfolios over the same period (from high points).

    If you were posed with the question of which portfolio you wanted to invest into, it would seem to be a no brainer. While the ‘blue’ portfolio has been able to outperform the market with far lower volatility (which is a GOOD result), the ‘red’ portfolio has given you nearly double the return with a lower volatility and drawdown experience.

    Surprisingly to the casual observer both of these portfolios are managed by the same manager! The ‘red’ portfolio is his hedge fund, and the ‘blue’ on is his unit trust. The biggest reason for the difference in returns is his ability to more fully express his investment views in the hedge fund. Here he can take bigger positions in the shares he likes and take short (negative) positions in shares that he doesn’t like, while in the unit trust he has more limitations as a result of the increased regulations in this product.

    Another reason that the hedge would outperform is that it is only priced monthly. The manager therefore doesn’t have to worry about cash flows into and out of the fund on a daily basis (that he has with the unit trust).

    Clearly if the manager wasn’t as skilful as he is, then the extra freedom given in the hedge fund would result in worse returns. It isn’t a given that if you give your manager more freedom, he’ll perform better for you.

    Importantly each investor needs to determine for themselves (and potentially with an advisor) what kind of tools to give to the managers of their investments. There will always be a middle ground between giving the manager carte blanche and shackling them completely.

    Take care,

    Mike Browne
    021 9144 966

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    Permalink2010-11-04, 18:06:36, by Mike Email , Leave a comment

    The local unit trust industry

    The quarterly unit trust statistics of fund sizes and flows provides insight into the thinking of SA investors. The unit trust industry started in 1965 in South Africa with just 2 funds.

    By 1980 it had grown to almost R700 million and 12 funds. The September 1987 quarter (just prior to the market crash of October 1987) saw a sharp increase in the net inflows. After the crash net inflows dropped by 80%.

    At the end of 1999 total assets in local funds had grown to R112 billion across 260 funds.

    By the end of September 2010, total investments across local unit trusts were R879 billion across 937 funds – 60% of these are classified as retail funds and 40% institutional.

    Of the net quarterly inflows of R28,8 billion, 99% was allocated to domestic funds (as opposed to worldwide and foreign). Allocations to foreign funds is therefore down drastically from 9% at the end of 2009.

    Drilling into this further, 71% of these net inflows were allocated to fixed income funds, 25% to asset allocation funds and 4% to real estate funds.

    This allocation to fixed income is up sharply from 2009 when 42% was allocated to local fixed income funds.

    Of the R28,6 in net inflows for the quarter to local funds, just R32 million (0,1%) was allocated to local equity funds. R3,6 billion was allocated to prudential variable equity funds, R7,3 billion to fixed income varied specialist and R13,2 billion to money market funds.

    Looking at just the domestic funds, over time money market allocations have grown to be the biggest component with 32% of total funds, asset allocation funds with 24%, equity funds at 22%, fixed income funds at 18% and real estate 3%.

    With local investors allocating a large portion of new monies to fixed interest and money market funds, and proportionally very little to local equities, it is clearly not this money pushing up local equity prices. We do know that foreigners have been big buyers of local fixed income and equities in 2010, slowing a bit over the last month.

    Tomorrow sees the US Federal Reserve make an announcement on further printing of USD. Initial expectations are that there will be a planned $500 billion.

    The local JSE ended down 28 points to 30609.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-11-02, 17:20:57, by ian Email , Leave a comment