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    Lessons from the Yale Endowment

    Every year Yale produces an excellent report on their endowment fund (found here). This Endowment has arguably been one of the best performing investment pools over a sustained period, so we therefore take stock of their views and processes on an annual basis, and see if there is any relevance for Seed or our clients.

    The definition of a typical endowment is a pool of investments bequeathed to an institution to provide an income stream (for a stated cause) into perpetuity. An endowment typically needs to provide a level of income to the institution while retaining real purchasing power.

    Time Horizon

    The first striking quality that is evident is the Endowment’s extremely long term investment horizon (they discuss an investment horizon measured in decades or even centuries). Clearly the nature of an Endowment fund requires the long term horizon, but it is pleasing to see that the managers are matching this long term horizon with long term decisions. Yale’s long term horizon has enabled them to generate superior returns.

    Investors that take a longer term horizon can invest a greater portion of their assets into more volatile growth assets than those with a short term horizon. Over short periods long term investors could have worse performance than short term investors, but as your investment horizon increases the likelihood of the short term investor outperforming the long term investor decreases.


    Through gifts, Yale has been able to grow the size of the Endowment far quicker than through natural market growth. The difference in amounts in the chart below is a result not only of the additional gifts to the endowment, but also growth on the gifts.

    It is important for investors to consistently add to their investments (while they are still generating income). While the above example is an extreme illustration, the difference between an investor who purely reinvests an early pension payout and one who continues to save for retirement (in addition to reinvesting the payout) will be significant over a 30 year period.


    The annual withdrawal (drawdown) percentage from one’s pool of investments will give a good indication of the longevity that can be expected from that pool. The lower the drawdown rate, the longer one can expect the portfolio to last and vice versa. Since the Endowment should retain its purchasing power into perpetuity it will typically have a lower drawdown than most investors – who can eat into their principle.

    Yale has recently set their drawdown limits at 4.5% and 6% of Endowment assets. Any drawdown below this should result in real growth of the investment portfolio, and higher than 6%, on a sustained basis, will most likely result in the portfolio losing purchasing power. Investors should attempt, where possible, to limit the rate of the drawdown from their portfolios.

    Income Stability

    Setting a targeted drawdown rate is important, but investors need a large degree of certainty in their income levels. Large fluctuations in portfolio value (notably decreases) coupled with a fixed drawdown rate can result in an unpleasant experience for investors dependant on income from their portfolio. The Endowment therefore applies a smoothing method to its distributions which gives Yale relative certainty in the amount of income they will receive from year to year.

    While the drawdown percentage is an important metric, income stability is arguably more important. Investors need to balance getting a dependable income from their investments while not eroding their capital aggressively. By blending the prior year’s income with a percentage of current investment size, investors will be able to blend these two (often competing) needs. The Yale Endowment pays out 80% of last year’s income (adjusted for inflation) plus 5.25% of the Endowment’s current market value. This gives the university a smooth income profile without putting undue pressure on the real value of the Endowment.

    Asset Diversification

    An important part of any portfolio is to have some sort of diversification. In this way one is able to reduce the idiosyncratic risks inherent in specific asset classes/securities. Yale’s Endowment targets asset class weightings of between 4% and 33% across 6 asset classes. Of these 6 asset classes, 5 can be considered as growth assets (i.e. produce significant real growth over time) and the lone ‘diversifier’ is US Bonds – with a target of only 4%. Interestingly they only target a weighting of 11% to traditional US marketable securities (i.e. US Equity and Bonds)

    At Seed we invest the majority of medium to high risk clients across a broad range of assets that we expect to generate positive real returns. Ideally there is a low correlation between the performances of the asset classes which will mitigate, to a certain extent, the risk of large capital losses. Asset classes like cash and bonds have a tactical place to preserve capital in the event that expected returns from the growth assets is low – there will also be isolated times where these assets will offer good prospective returns, which the manager needs to take advantage of. When looking at valuations we believe that an investment’s domicile isn’t important. We seek to find undervalued assets irrespective of their domicile – regulations clearly limit our ability to implement these ideas across some of our portfolios.

    There are many other lessons that we have taken from this report, and we will most likely review some of them in the future. Chief among the lessons is that nothing in investments is static, from alterations in optimal asset allocation to changes in drawdown level and methods.

    At Seed we realise that this is the case and while our investment principles and processes are unlikely to change we will look to continually improve them on an incremental basis. Equally it is important for investors to regularly assess their portfolio versus their goals and aspirations – ensuring there is a decent fit is important to avoid disappointment.

    For those Facebook users interested in getting regular investment and economic updates click this link and 'Like' Seed's Fan Page.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2011-07-21, 16:36:07, by Mike Email , Leave a comment

    June Year End Companies

    There are some 470 companies listed on the JSE, including the Alt X. Many of them have elected to have a June year end. Unlike in the US where listed companies must report quarterly, local companies report every 6 months. Interims can be produced far quicker and do not need the final sign off from auditors, while the annual financial statements require this sign off, which necessitates a longer preparation time.

    The JSE recorded the total market capitalisation of all listed shares at R6.8 trillion, from R5.89 trillion year back – up 15.4%. This includes all new listings and any delistings. In US dollar terms this is around $1 trillion. According to stats on Wikipedia, the market capitalisation of the JSE in 2003 was $183 billion.

    5 of the top 6 companies listed by market capitalisation (i.e. the number of shares in issue multiplied by the share price – or value of the equity in the company at market price, an indication of the size of the business) have their primary listing on a foreign exchange.

    The 5 companies with their primary listing on a foreign exchange are British American Tobacco Plc, BHP Billiton Plc, Anglo American Plc, SABMiller Plc, and Compagnie Financiere Richemont SA.

    Some of the larger companies that will be reporting their annual results to June in August and September include BHP Billiton, Sasol, Impala Platinum, Firstrand, Shoprite, Remgro, The Bidvest Group, Steinhoff, Aspen, Massmart, and Woolworths. Also included is the largest listed property company Growthpoint.

    Latest news on BHP Billiton

    BHP Billiton – over the last few years this company has been unsuccessful in making some large acquisitions. The two biggest were Rio Tinto in 2008 and Canadian Potash in 2010. These failed acquisitions cost the company some $900 million. But this is a cash generating company that needs to find big acquisitions and so a few days ago it proposed a cash offer for 100% of Petrohawk Energy Corporation, which is a shale gas company.

    The acquisition price for Petrohawk is some $15.1 billion including debt of $3 billion and at a price at 49,5% above the 30 day average. Unlike the previous large bids, this potential acquisition has been approved by board of Petrohawk and now needs shareholder approval. In February BHP announced the $4.8 billion acquisition of Chesapeake Energy Corporation, also involved in shale gas.

    BHP Billiton shares have traded sideways over the last 9 months.

    Over the last 12 months, following its failed acquisition of Potash, it reactivated its share buyback programme. From November 2010 to June 2011 it has spent some $10 billion in buying back its own shares. Following this spend it is reported that it would have repurchased about $23 billion of its London and Sydney listed shares since 2004.

    June 2010 earnings per share came in at R17. Taking into account the interim, these are now on a rolling R23 per share. INet consensus is at R28.40 for June, which puts the current price on an estimated price to earnings ratio of around 9.2 times.

    Source: Yahoo finance

    Kind regards,

    Ian de Lange
    021 9144 966

    Permalink2011-07-19, 17:20:15, by Mike Email , Leave a comment

    European Debt Crisis

    The European sovereign debt crisis, which started in late 2009, has continued almost unabated as it moves from one European country to another.

    The problems in Portugal, Spain, Ireland, Greece, and now also Italy weigh heavily on the European Union as a whole. At its most basic level, the issue is one of public debt levels that are not sustainable, with ongoing and rising budget deficits adding to the overall debt levels.

    In May 2010, the European Financial Stability Facility was created, which is essentially a rescue package operation of around EUR 440 billion, with the aim to try and ensure a degree of stability across Europe.

    Initial rescue packages aimed at providing states with the ability to roll over debt as it matures have been agreed with Greece, Ireland, and Portugal, but these negotiations are ongoing.

    These European countries were able to borrow at low rates of interest after the introduction of the Euro. This in turn allowed their economies to perform well on the back of them taking on greater and greater levels of debt. But now it is payback time for the debtor nations.

    The European Financial Stability Facility was put in place in May 2010, aimed at preserving financial stability through providing financial assistance to struggling Eurozone states. It is going to be replaced by the more permanent crisis mechanism, the European Stability Mechanism (ESM), which is expected to come into force in early to mid-2013.

    Government bonds
    A government bond is a bond issued by a national government denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. Bonds issued by governments are usually referred to as risk-free bonds, because the government can raise taxes to redeem the bond at maturity. For a foreign investor or indeed where a government issues a bond in a currency other than its own, there is the currency risk.

    In addition to the currency risk is the risk of inflation. At a bond’s maturity, the purchasing power of the principal repaid is often likely to be less than the original investment. A bond is a debt instrument, where the issuer owes the holders the principal at a defined maturity date as well as interest or coupon payments on pre agreed dates, typically every 6 months.

    In essence then a bond is nothing more than a loan, where the issuer – normally a government – is the debtor and the lenders are a variety of creditors.

    Sovereign bond spreads
    Sovereign-bond spreads is the extra interest rate of one bond compared with bonds issued by another country. In the case of the Eurozone, Germany is considered the safest credit.

    The Eurozone debt problem:
    The map below gives an indication of the problem countries. Greece has a debt to GDP ratio of 143% - some indications are that it’s close to 160%, Italy’s debt runs at 119%, Ireland at 96%, and Portugal at 93%.

    Debt to GDP: Euro Map

    Source: Economist

    The chart below gives an indication of the debt of some of the major economies by way of comparison. Japan is by far the highest. It has however managed to continue to roll over debt as it matures because the bulk is yen denominated. By way of comparison, South Africa is running with a ratio of 40%.

    Government debt to GDP: major economies

    For over 10 years from 1998 to 2011 the yield on Greece’s 10 year government bond averaged 5,3%, reaching a record low of 3,2% in September 2005. But in 2011 it spiked up to 16,9% in June. It is currently trading at around 16,7%.

    Source: tradingeconomics.com

    The spike in yields is a clear reflection of the problems facing this economy. Politicians seem to be divided as to how to deal. Up until now it’s been a matter of kicking the problem down the road, extending some life-saving credit in return for some budgets austerity measures. But there is also growing dissatisfaction, especially from the camp that have to pay up for Greece’s profligate spending and low tax collections.

    It is increasingly looking like holders of debt are going to have to realise a knock on their capital.

    Italy's Government Bond Yield for 10 Year Notes rallied 122 basis points during the last 12 months. From 1993 until 2011 Italy's Government Bond Yield for 10 Year Notes averaged 5.9 percent reaching an historical high of 13.7 percent in March of 1995 and a record low of 3.2 percent in September of 2005.

    Yesterday, however, Italy issued treasury bills for the first time since borrowing costs started blowing out – they came to the market looking for 6,75 billion euros. The spread above the German bonds moved up to 3,27% and the yields traded at over 6% for the first time since 1997.

    The extent of the selloff can be clearly seen from the chart below, where yields had been trading around 5%. The 6% level has been highlighted.

    Source: tradingeconomics.com

    From 1997 until 2011 Portugal's Government Bond Yield for 10 Year Notes averaged 4.7 percent reaching an historical high of 12.9 percent in July of 2011 and a record low of 3.2 percent in September of 2005.

    The country saw the downgrade of its credit rating on government debt 4 notches to junk status by Moody rating agency last week. This had an immediate impact on the cost of funding for both government and corporates.

    The chart below reflects the spike in the yields on 10 year bonds. These yields moved up to 14,4% or a massive 10,7% above German bond yields.

    Source: tradingeconomics.com

    In a very similar way, yields traded at low levels throughout the decade, reaching a low of 3,1% in September 2005. However the crises saw yields jump up massively.

    Source: tradingeconomics.com

    The spikes in the yields, the ongoing talks and wrangling about debt bailouts for these countries and the rating downgrades, all point to a high possibility of actual defaults on the debts.

    Bonds as an investment
    Traditional investment portfolio theory has advocated the inclusion of bonds in a portfolio. Bonds have different risk and return characteristics compared to other investors such as equities, which has made them attractive additions to a balanced portfolio. However as with all investments, the recent past can never be extrapolated into the future as a given. The charts above reflect the fact that for many years while yields remain fairly steady, bonds gave the appearance of a low risk investment. As the risks however materialised and yields spiked to a truer pricing level, so holders of these bonds have and continue to sustain massive losses.

    With the yields at 12-16% there may now be an argument that these bonds represent value. This may well be the case, but we would not be advising an increase in exposure, because it is not that clear that there is true value. In general we continue to advocate a minimal exposure to global bonds.

    Kind regards,

    Ian de Lange
    021 9144 966

    Permalink2011-07-14, 17:39:07, by Mike Email , Leave a comment

    The Pain of Loss is Rational

    There are many articles that discuss the behavioural finance concept called prospect theory, or loss aversion. Essentially this concept refers to the tendency for investors to feel more pain per unit of loss than joy per unit of gain.

    Behavioural finance is built around the notion that humans – and by extension investors – aren’t rational. The research of our irrationality should therefore lead to either better returns, or reduced anxiety, as we at better understand why our natural instincts are out of whack with rational behaviour.

    Loss aversion could, however, have some of its roots in rational behaviour – at least along the lines of my thinking. This is because losses and gains in investments aren’t equal. For every unit (percentage) lost an investor requires an increasing gain in number of units (percentage) in order to get back to the original starting point.

    An investment’s first 10% loss is pretty similarly matched by a required 11% gain (1% difference) to get back to the starting point. At a 20% loss this difference increases to 5%, and at a 50% loss the required differential increases to 50% - i.e. one needs a 100% gain to get back to square one. From this point the chart goes parabolic.

    The chart gives some sort of explanation as to why investors (with investment horizons longer than 5 years) generally aren’t too fazed about losses of around 10%. 20% losses become a bit more of a problem and any loss in excess of 50% is a big cause for concern!

    Naturally no investor wants to lose even 1%, but the reality is that one is required to take on risk when investing in order to grow wealth in real terms on a consistent basis. This will typically result in a portion of one’s capital being put at risk. Over periods of between 5 and 10 years an investment into growth assets should be able to withstand capital reductions of up to 20% - 30% and still beat inflation. When the drawdown is much more than this, investors will have difficulty getting back to respectable real returns.

    At Seed we stress the importance of having growth assets in your portfolio (although each client is different) but at the same time we ensure that all our portfolios guard against permanent capital destruction. Ideally clients won’t lose more than 20% of their capital over any period, but in extreme situations this could increase slightly further.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2011-07-07, 19:13:55, by Mike Email , Leave a comment

    SharenetCFDs slash rates by 43%

    Here is some great news for investors trading equity CFDs with SharenetCFDs:

    From midnight on Sunday the 3rd July 2011, Sharenet CFDs in association with IG Markets reduced the commission rate of trading JSE-equity CFDs from 0.35% to 0.2%.

    If a difference of 0.15 doesn’t sound like much, know that commission rates have a significant impact on long-term returns. As the example below shows, even a slight drop in commission rate results in a considerable saving for you as the investor.


    Assuming the opening and closing of a R200,000 Angloplats position at 5% margin (R10,000):

    Furthermore, the more frequently you trade, the greater savings you will make on a lower commission cost. At the end of the day, you’ll have more cash to withdraw or to add to your capital.

    Commission is also calculated on the basis of the total transaction size, rather than margin size. Thus the costs of commission will be augmented by the leveraged portion of your transaction. The larger the leverage portion, the greater the commission saving as a percentage of your margin.

    Unlike the cost of interest, commission can’t be easily adjusted without impacting on the size of a transaction, so it makes sense to choose a low-cost commission broker like SharenetCFDs in association with IG Markets.

    Commission rates will continue to be charged on the opening and closing of positions, with a minimum charge of R100.

    This reduction in commission rates is just another way SharenetCFDs is showing our dedication to maximising your trading potential.

    For more information, please contact:
    (021) 700 4800

    Permalink2011-07-06, 09:28:24, by Natalie Email , Leave a comment