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    The Case for Investment in Africa

    Over the past few years the attention paid to Africa as an investment destination has increased dramatically – more recently Africa has been given a major platform by various asset management companies. Africa is another ‘investment story’ and as with any investment story, investors should remain sceptical until they have found out why the story is being told.

    There are a couple reasons for the increased coverage:
    • Legislation was recently changed in South Africa to allow retirement funds an additional 5% allocation to Africa on top of their 25% offshore allowance – this has radically boosted the demand for African investment options, and the supply has followed in close pursuit.
    • Performance over the past 18 months has been excellent (after a poor 2011) – product providers can therefore offer a product with a ‘compelling investment case’.

    At Seed we think that the first reason is a good reason – essentially it allows retirement fund investors a broader investment universe. The second reason shouldn’t be a major consideration. We would rather look at performance through at least one investment cycle – and then also determine how African investments are expected to perform in relation to other high risk investment options.

    The basis for the investment case (to be differentiated from a ‘feel good story’) is one of shifting demographics, notably the growth in the middle class population over the next 10 – 30 years (depending on the specific country).

    A couple charts can show how a small shift in income distribution can have a large impact on the demand for certain products. Chart 1 below shows how the average Kenyan in 2011 earned US$832pa vs US$478 just 7 years prior, and how this 74% increase in income resulted in car sales growing 385% as a bulge of Kenyans moved into middle class! Note that there is still a large portion of the population that still doesn’t earn enough to buy a car.

    Chart 1: Kenyan income distribution

    Source: Imara

    Chart 2 gives a graphic illustration of the per capita demand for beer across various developed and developing countries. Notice that, in general (excluding us South Africans and the Angolans), beer consumption is extremely low in comparative to the other developing countries (like China, Peru and Argentina), and even more so than developed markets. Make no mistake, beer companies aren’t expecting consumption to move to levels seen in Australia and the UK, as these countries have big beer drinking cultures. What they are hoping for is for per capita consumption to increase 3 or 4 fold (putting them on par with China) on a growing adult population base. If this kind of growth can be achieved over the next 30 odd years – the companies supplying these countries with beer will be sitting pretty.

    Chart 2: Beer consumption in selected countries

    Source: GondoVisio

    While the shifting demographics are naturally key to the success or otherwise of Africa as an investment destination, Africa is fortunate in that it is relatively politically stable when compared to the past 40 – 50 years and at the same time governments aren’t heavily indebted – see Chart 3 below.

    Chart 3: African Government debt versus Developed Markets

    Source: Momentum Asset Management

    There are risks attached to any investment, and investing in Africa is no different. There are just different risks that need to be managed when compared to other countries.

    At Seed we haven’t yet taken an active position in Africa, but are currently in the process of further investigating the investment case. Should we make an allocation of our clients’ capital into Africa we want to be very sure that they will be adequately rewarded. An investment in Africa (like any other investment) needs to be done at the right price (i.e. ensure that the markets aren’t overly expensive) and with an investment horizon far in excess of the 3 – 7 year horizon that we typically have at Seed. Further, the manager should be benchmark agnostic, spend the majority of his time ‘on the ground’ visiting companies in his investment universe, be significantly co-invested in the fund, and have been through a full market cycle.

    Take care,

    Mike Browne

    021 914 4966

    Permalink2013-05-28, 16:10:55, by Mike Email , Leave a comment

    Richemont – Against the Tide

    Compagnie Financière Richemont (Richemont) is one of the world’s top luxury goods groups, with several prestigious brands in its stable and access to markets around the world. In addition to managing its existing portfolio of brands, Richemont also endeavours to identify and acquire lesser-known brands in order to build them up over the long term. The company’s overall growth strategy envisions that each brand should be established in its own right by the development of competitive products and effective marketing programmes.

    Richemont has its headquarters in Switzerland, and its listing on the JSE is courtesy of the company’s long-standing link to the Rupert family. The company was created in 1988 when all the international assets owned by the Rembrandt Group were spun off into a separate entity. Richemont then had direct holdings in Cartier Monde and Rothmans, and indirect holdings in Alfred Dunhill, Montblanc, and Chloé. Over the next 20 years Richemont acquired various direct and indirect stakes in Purdey, Vacheron Constantin, Van Cleef & Arpels, Jaeger-LeCoultre, IWC, and A. Lange & Söhne, amongst others. In 2008, Richemont restructured and Reinet Investments was formed as a separately traded vehicle to hold all the non-luxury goods businesses.

    Recent results

    Richemont released an impressive set of annual results for FY13 last week, and the market reacted positively with the share price jumping up 8% in a single day. These results were largely driven by an increase in sales, once again proving that economic uncertainty around the world has little effect on the appetite for luxury products.

    Richemont reported an increase in sales of 14% to € 10.15b, which amounts to a 9% increase on a constant currency basis. With sales around the globe, varying exchange rates have a huge influence, and in FY13 the company was favoured by a weak Euro. The Group’s solid sales growth across all product segments and regions was mostly the result of growth in the company’s own retail network.

    Sales growth in Europe (incl. Middle East and Africa) was especially strong at 17%, and was driven by increasing tourism from Asia and a weaker Euro. Growth in sales in Asia Pacific has slowed down considerably from figures of +36% in FY11 and +45% in FY12 to only +5% in FY13 on a constant currency basis.

    When examining sales by product line, it is clear that the larger lines – Watches, Jewellery and Clothing – show strong growth, while the smaller lines are struggling.

    Operating profit increased by 18% for the period, and the impressive operating margin was extended by a further 80 basis points to 23.9%.

    Operating expenses increased in line with sales at 14%, with the company unable to curb selling, distribution, and administration expenses. Profit for the year and diluted earnings per share both increased by 30%, mostly due to non-cash charges related to the strengthening of the Swiss franc not recurring in FY13.

    Richemont has increased its capital expenditure by 27% to € 612m, which is 6% of sales, with an increasing weight given to manufacturing compared to the previous year. The company’s balance sheet remains very healthy, with 17% of the assets available in cash to back any potential acquisitions.

    A generous dividend of 1.00 CHF was declared, up 82% from last year’s 0.55 CHF, in order to celebrate 25 years of Richemont and to demonstrate management’s intention to grow dividends steadily over the long term.

    Current Valuation

    The Richemont share price has increased by 70% over the past year, with last week’s jump contributing to 26% growth in the last 30 days alone. At a PE of about 22 the share is a bit more expensive than the market, and the dividend yield of 1.13% is not that attractive compared to other Industrial shares. A low dividend yield for an investment holding company can be seen as encouraging, as management can potentially make better use of cash through acquisitions than paying it out to shareholders.

    This share offers an opportunity for local investors to gain international exposure quite easily, and the appeal of Richemont’s products throughout economic cycles will ensure that these investors remain content.

    The Seed Equity Fund, which blends a Value and Momentum portfolio, has an exposure of 2.3% to Richemont as part of the Momentum portfolio.

    Kind regards,

    Cor van Deventer

    Source: www.richemont.com

    021 914 4966

    Permalink2013-05-21, 12:53:33, by Mike Email , Leave a comment

    “Smart Beta” Tracking Funds

    Globally there is an increase in index tracking unit trusts (also known as mutual funds). According to Morningstar’s latest global flow report, passive products captured 41% of estimated net flows – USD 355 billion – worldwide in 2012, with 22% of the world’s mutual fund and ETF assets already invested in passive strategies. Index funds grew faster than active funds in almost every geographic region in 2012, including Asia, Europe and the US.

    In the US, passive strategies grew by 10% last year, and now cover a quarter of total assets under management.

    A traditional index such as the JSE All Share index (ALSI) or the Top 40 index is constructed using the market capitalisation weight of the shares in the investment universe – i.e. a company such as SAB Miller (with a market capitalisation of R840billion) has a weight of 11.6% in the Top 40 index, while Woolies (with a market capitalisation of R63 billion) has a weight of just 1.3%. The difference in the weights has everything to do with the relative sizes of the two companies and nothing at all to do with the relative investment merits.

    Be that as it may, this typical approach to tracker fund construction has been widely used and enjoys investor acceptance because so many “active” fund managers fail to consistently beat the index.

    But a fund that tracks such an index does have its drawbacks. For example as shares and the sectors in which they are classified become more expensive, so the index tracker funds are forced to include them at larger weightings. Conversely a share may fall in price (with a probable increase in its value) and therefore constitute a smaller weighting in the portfolio, forcing a market capitalisation tracker fund to disinvest.

    Relative price movements can be seen in the main sector weights of the ALSI, which is what a typical tracker fund would try and replicate. At the peak of the commodity cycle in 2008, local resource shares comprised over half of the weight of the ALSI. A typical market capitalisation weighted tracker fund would be forced to replicate this index, despite there being better value in the other sectors.

    There are, however, other ways to construct an index and increasingly these, so called “smart beta” funds, are gaining more and more acceptance. Instead of using traditional market capitalisation weights, an index of shares can be constructed using a range of fundamental factors. For example when constructing a value portfolio one may look for factors such as the price to earnings ratio, the dividend yield, cash flow or price to book information.

    In this way, smart beta funds do not track traditional market capitalisation indices, but are developed to track specific desirable features of shares in the investment universe. Smart beta funds are therefore designed to outperform traditional indices.

    The Seed Equity Fund

    On 30 April 2013, Seed launched the Seed Equity Fund, which invests directly into local equities and listed property under advice from Paul van Rensburg, professor of finance at UCT. Paul, who is also portfolio manager and founder of SalientQuants, has an excellent long term track record managing quant-based portfolios.

    The Fund consists of two smart Beta building blocks constructed using fundamental factors – a Value portfolio and a Momentum portfolio. The Value component aims to capture the value effect in markets by purchasing shares that are under-priced relative to earnings, book value and dividends. Conversely, the Momentum component endeavours to capture the momentum effect in markets by purchasing shares that display strong recent price and earnings momentum.

    The sector breakdown reveals a Fund that is constructed very differently from the ALSI, with 16.4% in resources, 32.7% in industrials, and 50.8% in financials and property. Because of the construction of the portfolio on fundamental factors, there is an expectation that such a fund outperforms a simple market capitalisation method over time and this has been the case, as depicted in the chart below.


    *Value Portfolio and Momentum Portfolio returns are simulated up to Dec 2009 and live thereafter, including a 1.00% pa management fee. Seed Equity Fund returns are simulated using a 50/50 split between Value and Momentum, including a 1.00% management fee.

    If you would like to learn more about index funds and specifically the Seed Equity Fund, please do not hesitate to contact us.

    Kind regards,

    Ian de Lange

    021 914 4966

    Permalink2013-05-14, 11:04:19, by Mike Email , Leave a comment

    Diversification – Benefits of Low Correlation

    Everyone has heard that you should have a diversified portfolio, but is your “diversified” portfolio actually providing you with the maximum benefit?

    The aim of diversifying your portfolio is to reduce the risk (i.e. volatility) of the portfolio for a certain expected return. The key in diversification is to take into account the correlation between the different components of the portfolio.

    The correlation is the statistical measure of how two assets move in relation to one another. If two assets are perfectly positively correlated (ρ=1) they move in lock step, if the one goes up the other will also go up and vice versa. At the other end of spectrum is perfectly negatively correlated assets (ρ=-1), if the one goes up the other goes down. Uncorrelated assets (ρ=0) sit in the middle as there is no relationship between the movements of the two assets.

    The graph below shows the risk/return plot of 4 portfolios made up out of two assets with different correlations. Each curve represents the different risk/return combinations dependant on the weight of the securities in the portfolio.

    The maximum benefits of correlation are observed when assets are either uncorrelated or negatively correlated with each other. It is possible to create a portfolio where the risk (standard deviation) is less than either of the two assets, with the expected between the two assets.

    Another way to look at how diversified your portfolio is, is to look at how the assets react in periods of negative market returns in relation to each other and the market. The assets might have a higher correlation with each other in down periods which reduces the benefit of diversification. At Seed we pay careful attention to how assets react in relation to one another in down markets, as this is when the benefits of diversification are best experienced.

    A portfolio will ideally be constructed with assets that have negative or low bear (down market) correlation and high bull (up market) correlation. This will ensure that the portfolio is better at preserving capital in negative periods and delivering good returns in positive periods.

    While correlation is an important metric, investors must also make sure that the expected return is acceptable. It is pointless adding a negatively correlated asset to a portfolio when the asset’s expected return is negative in most market environments.

    As always, we are available for any questions regarding investment or retirement matters.

    Kind regards,

    Gerbrandt Kruger

    021 914 4966

    Permalink2013-05-07, 12:33:38, by Mike Email , Leave a comment