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    Investment Horizon

    An investment horizon is the total length in time an investor is expected to hold a security or portfolio. Knowing an investor’s investment horizon aids in optimising the portfolio with enough risk assets. An example of this is saving for a holiday in a few months time, the investment horizon is less than a year and thus the investment needs to be of low risk. On the opposite spectrum is a person saving for their retirement that is more than 10 years away, they would be able to take on more risk and get a better average return over the period.

    One of the biggest risks when there is a mismatch in the investment horizon and the level of risk in the portfolio is the risk of permanent capital loss. When you disinvest from a portfolio while it is at a loss, the loss is then realised and the possibility to recoup the loss is removed.

    To illustrate the above mentioned statements, we look at three portfolios with different levels of risk:
    • Multi Asset Low Equity portfolio – Moderately Conservative
    • Multi Asset High Equity portfolio – Balanced
    • General Equity portfolio – Aggressive

    For ease of calculation we used the average manager return for each of the above ASISA categories. The rolling returns were calculated for different time period to simulate different investment horizons for each of the portfolios.

    The graph below shows the range of possible returns for each of the portfolios for different investment horizons. The returns were annualised for periods longer than 1 year. If you were invested into the Low Equity portfolio your return over 1 year would have ranged between -1.2% and 23.3% depending on the start date of the investment. Looking at the 1 year range of returns, all of the portfolios experienced at least one year where returns were negative.

    The first thing that you will notice from the above graph is that the range of returns become smaller and smaller as the investment horizon is increased. Secondly the minimum return increases, for the Equity portfolio the minimum over a 1 year period was -33% and over a 5 year period 6%.

    When looking to make an investment with a 3 year investment horizon one can consider a fund in the MA High Equity category. Over a rolling 3 year period the chances of a capital loss are reduced with the probability of providing a better return over the period than a fund in the MA Low Equity category. A portfolio invested 100% into equity will not be an ideal investment as you run a risk of having a capital loss at the end of the 3 years.

    As with everything else in life nothing is certain. These calculations were performed on historic data. While the average return, minimum, and maximum return will differ for future investment, the crux still remains relevant. One needs to select the correct level of risk for your portfolio depending on your investment horizon of the investment.

    As always, we are available for any questions and feel free to contact us with any question regarding investment or retirement matters.

    Kind regards,

    Gerbrandt Kruger

    021 914 4966

    Permalink2013-03-26, 10:31:36, by Mike Email , Leave a comment

    Earnings Weakness

    At the beginning of each month we take an in depth look at the valuations of a variety of asset classes. We mostly have standard valuation metrics that we look at – we want our process to be as consistent as possible – but, from time to time when anomalies arise, we also look at other factors (or the same factors from different angles). When there are anomalies in the output, we perform the extra research in an attempt to get a better understanding of the factors at play. Ultimately the human touch is important in an investment process – you can’t solely rely on output exported into an Excel spreadsheet when managing investments.

    The results at the beginning of March proved a case in point. In February the market was down nearly 2%, but rather than being cheaper than the previous month (when using the market PE ratio as the valuation technique) it was significantly more expensive (PE of 16.6 at the end of February compared to 15.2 at the end of January).

    Fortunately the PE ratio is a simple formula. If P is down and the PE ratio is up, it simply means that E (earnings) must be down. When I took a closer look, I saw that the market’s earnings were down over 10% during February, with the vast majority of the fall coming on 15 February – see Chart 1 below. It just so happened that Anglo American (AGL) reported a 55% (in USD) drop in earnings on the 15th. Essentially Anglo’s poor results had a major impact on the market’s earnings falling (and consequently an increasing PE).

    Chart 1: ALSI Earnings during February

    This surprised me, so I decided to take a closer look at the market’s earnings over time. I was interested to see that there have been some significant earnings drawdowns over the past 27 years. But while earnings have fallen significantly over this period – see Chart 2 below, the market has typically fallen more. The market falls/crashes have also typically occurred before the fall in earnings (lending support to the fact that the market is forward looking and anticipates poor earnings).

    Chart 2: Drawdown of ALSI (P) and ALSI (E), i.e. Fall in Price vs Fall in Earnings

    When looking at this is data from some other directions I saw that earnings are typically half as volatile as the price and that there’s not much correlation between the monthly returns and the monthly earnings growth. Over a rolling 12 month period the largest gain in earnings has been 49% for the 12 months ending 31 July 2001 and the worst period ended on 28 February 2010 with earnings contraction of 32%.

    Interesting, February 2013 was the biggest monthly contraction in earnings over this 27 year period, the previous worst being -9.7% in August 2009. While this kind of analysis doesn’t give us all of the answers, it does at least help us understand where the change in valuation has come from.

    Into March we have used the rising market to reduce our allocation to local equities across our unit trusts and range of portfolios. For more information on the Seed Flexible and Seed Absolute Return Funds, you can download the latest (February) fact sheets by clicking here.

    Take care,

    Mike Browne

    021 914 4966

    Permalink2013-03-19, 09:52:24, by Mike Email , Leave a comment

    The Investor and the Rhythm of History

    In the recently released Berkshire Hathaway annual CEO letter to shareholders, super investor Warren Buffett included the comment that although the immediate future is uncertain, American businesses will do fine over time and stocks, which are tied to business performance will do just as well.

    He noted that while there will be periodic setbacks, investors and managers are in a “game that is heavily stacked in their favour.”

    Credit Suisse release an annual report titled the “global investment yearbook”. In this, they analyse the returns of the equity and bond market across 22 countries around the world and three regions for periods which extend back to 1900.

    The annual Credit Suisse report has quantified just what this outperformance has meant to investors who have had the ability to have a longer term investment horizon.

    Credit Suisse also compiled an aggregate index across all 22 countries weighted by the starting year equity market capitalisation.

    The results are interesting. On the aggregate index including the US, the long run (113 year) real return (i.e. after inflation) for an investment into equities has been measured at 5% pa and 1.8% pa for bonds. When measured from the start of the 21st century, however, global equities (with the high weighting to the US) have given 0% real return pa and bonds 6.1% pa.

    Figure 1 – Including the USA

    Because the USA comprises such a large percentage of the weight in this index, they also compiled a data series excluding the USA in order to eliminate the possible “success” bias of the USA. Reducing the number of contributing countries to 21, the real return on world equity markets ex-USA comes down to 4.4% pa and global bonds just 1.4% pa.

    It is also interesting to note that the return has been similar to the index that includes the USA over the last 50 years and since 2000.

    Figure 2 – Excluding the USA

    According to their analysis, the biggest stock market in 1900 was the UK, which comprised 25% of their index, while the USA made up 15%. By the end of 2012, the UK had shrunk to 8% and the USA had grown to 45%. South Africa had shrunk from 3% to 1% of the total world stock market.

    It is always important to track long run history in an attempt to try and understand the future. As Mark Twain supposedly quoted, "History does not repeat itself, but it does rhyme.”

    Kind regards,

    Ian de Lange

    021 914 4966

    Permalink2013-03-12, 08:54:32, by Mike Email , Leave a comment

    2013 National Budget Review

    I initially planned to entertain you with a look at portfolio risk; however, since the flavour of the week seems to be Finance Minister Pravin Gordhan’s budget, this will have to wait as we look at some of the budget highlights.

    From an economic perspective, it was clear that Pravin Gordhan did not want to shock anyone with the 2013/14 budget. All the main rates are relatively unchanged. Mr Gordhan is counting on faster economic and income growth going forward, expecting GDP growth of 2.7% in 2013 increasing to 3.8% in 2015. Due to tight fiscal conditions, spending cuts of R10.4bn will be implemented over the next three years, shrinking the budget deficit from the current 5.2% to 3.1% in 2015/16 and to stabilise the debt ratio.

    Income Tax:
    Minister Gordhan proposed income tax relief of R7bn, but this mainly compensates for the so called “bracket creep” which is where wage inflation pushes taxpayers into higher tax thresholds. 47% of the tax base is represented by people earning between R60 000 and R150 000 pa. They will receive R1.9bn or 26.6% of the tax relief. 2% of the tax base earns more than R1 000 000 pa, and they will receive R450m or 6.4% of the total tax relief. The maximum marginal tax rate will remain at 40% of taxable income above R638 600 pa.

    For your retirement:
    From 2014, an employer’s contribution to a retirement fund on behalf of an employee will be treated as a taxable fringe benefit. Individuals will be allowed to deduct up to 27.5% of the higher of taxable income or employable income for contributions to pension, provident or retirement annuity funds. The maximum allowable deduction per year will be R350 000, and any contributions above this cap will be carried over to the following year.
    The exemption on interest earned for individuals older than 65 increased by R1 500 to R34 500. For individuals younger than 65, it was increased R1 000 to R23 800.

    Sin tax:
    Sin tax is calculated on a percentage basis of the overall sales price. Beer prices are up by 7.5c, spirits R3.60, wine 15c, and 60c on a packet of cigarettes.

    The national fuel levy will increase by 22.5c/l whilst the 7.5 c/l as implemented for pipeline construction two years ago will now expire; essentially increasing by 15c/l increase, bringing the levy to R2.13. The levy for the Road Accident Fund increases by 8c/l to 96c/l of petrol. Carbon tax will be implemented on 1 January 2015 at R120 per ton of CO2.

    Infrastructure and development:
    Although some critics say that South Africa doesn’t have the capacity to spend the money allocated to infrastructure and development, over the next three years the plan is for R827bn to be invested into building and upgrading new infrastructure. This includes R1.8bn to increase the number of school teachers. The youth wage subsidy is also back (albeit diluted somewhat), R500m will go towards creating jobs for young people.

    VAT remains unchanged at 14%. Foreign businesses, such as iTunes, who distribute products and services in South Africa will also need to register as VAT vendors.

    It was inspiring to see Pravin Gordhan’s strong response against corruption. A new Chief Procurement Office is being set up as a means to combat corruption. He praised the fact that some 216 corruption cases have been successfully settled.

    So… what are the risks?
    There were no surprises, and SA will continue on the same strategy as has been followed for the past three years. The Ministry expects CPI to remain between 5% - 6%. The budget deficit was revised upwards from 4.8% to 5.2% of GDP. Net debt is expected to stabilise at 40% of GDP. No mention was made about increasing personal tax on the super wealthy, or the new mining profit tax, but this may still come. Minister Gordhan did, however, warn that if growth did not pick up, there could be tax rate adjustments.

    The spirit of the budget seems to be in the direction of anti-corruption, controlling expenditures, boosting revenue by job creation and stimulating growth. Minister Gordhan makes it clear that the time of wasting money is over. State spending should be effective.

    These are some of the highlights of the 2013 budget. The real risks lie in the implementation of the budget and especially controlling the expenditure. One thing is certain, the level of taxation is not decreasing anytime soon.

    Warm Regards,

    Lourens Rabe


    Feel free to look at the complete budget online.

    021 914 4966

    Permalink2013-03-05, 14:09:08, by Mike Email , Leave a comment