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    Local or Global Equity?

    The rand has been in a broad weakening phase versus the US dollar (and other hard currencies) over the past 30 months, which has been exacerbated in the past 2 months. The rand has weakened by over 30% against both the USD and EUR since the end of 2010, with chart 1below indicating how this has been a one way bet for a while now.

    Chart 1: Rand vs USD and EUR

    The rand weakness over this period has resulted in excellent rand returns for any investment based in developed markets. Seed clients have joined in this performance as all of our Funds and portfolios have been overweight global assets over this period.

    Now that the rand is trading relatively close to its long term fair value, the relative attractiveness of the underlying asset classes becomes more important when making the decision to allocate between local and global assets.

    When looking at the relative attractiveness of the local stock market (as proxied by the ALSI) to global markets (simply using the S&P500 as a proxy), we take a whole range of factors into account (of which the relative attractiveness of the currencies is but one input).

    Chart 2 below shows the relative performance of the ALSI versus the S&P500 over the past 25 years when both are measured in USD – i.e. a like for like comparison. Clearly there have been periods where the S&P500 outperformed (notably the end of 1994 – to the end of 2001) and the ALSI outperformed (2001 to the end of 2010).

    Chart 2: Relative Performance (in USD) of ALSI vs S&P500

    Since the end of 2010, until now, the ALSI and S&P500 have each done approximately 30% in their local currencies, but the rand weakness has meant that the S&P500 has outperformed. There is still some way to go for the S&P500 to reach its 25 year ‘fair value’ versus the ALSI, and we have seen in the past that markets typically overshoot fair value (both on the way up and on the way down).

    With developed markets coming off a low base, after the poor performance from these markets for much of the first decade in the 21st century, we expect that there is a lot more value in developed markets when compared to emerging markets. The relative PE multiples reflect this view, and can be seen in chart 3 below:

    Chart 3: Relative PE of ALSI vs S&P500

    Save for a brief period in 2009 when US profits fell spectacularly (profits fell by over 90% from January 2008 – July 2009, only to rise by 963% over the next 18 months) the ALSI has been expensive versus the S&P500 on a PE relative basis since the end of 2006. We expect that this relative differential will move closer to its long term average over time – the ALSI has typically traded at a discount (i.e. lower PE) to the S&P500 as a result of the extra premium required to invest in SA companies.

    As mentioned at the start of the report these are merely a few of the factors that we look at when making the decision between local and global equities. Further factors would include looking at non US markets, and the fact that there are more opportunities within the broad global equity universe when compared to the relatively concentrated local market.

    Seed clients have been underweight local equity since the beginning of 2013, and this has helped the relative performance of our Funds year to date. We continuously monitor the relative attractiveness of equity markets, as well as their attractiveness relative to other asset classes.

    Take care,

    Mike Browne

    021 914 4966

    Permalink2013-06-25, 17:10:26, by Mike Email , Leave a comment

    Brait – A diamond in the rough?

    Brait is an investment holding company with its primary listing on the Luxembourg Stock Exchange and a secondary listing on the JSE. It differs from most other well known holding companies in SA in that the majority of its investments are in unlisted businesses geared to emerging markets.

    Brait started off as a private equity fund manager in 1992 by raising capital for its first fund, Brait I. Three further private equity funds followed, with Brait III and Brait IV each being South Africa’s largest independently managed private equity funds at the time of launch. The company’s first three funds are now fully realised, and achieved an exceptional gross rate of return in excess of 30% pa.

    In July 2011, Brait successfully changed its business model from a private equity fund manager to an investment holding company through a R 6.4bn equity capital raising, which together with the debt component of R 2.2bn was considered the largest capital raising in Africa at the time.

    Underlying Investments

    As part of its investment criteria, Brait seeks underlying investments that are up to R4bn in size, offer a targeted internal rate of return in excess of 25%, demonstrate growth in earnings and/or strong cash flow generation, and are leaders in their respective market segments.

    The majority of Brait’s underlying investments are concentrated in Pepkor (61%), Premier Foods (10%) and Iceland Foods (10%). Further investments include the Brait IV private equity fund (4%), with holdings in Consol and Primedia, and DGB (2%), a producer and exporter of local wine with the brands Douglas Green and Boschendal in its stable.

    Pepkor, headquartered in Cape Town, was founded in 1965 and now operates in 14 countries across 3 continents. It is SA’s leading retailer operating in the low income market, and sells everything from clothing and footwear (Pep, Ackermans, JayJays, Shoe City) to house wares (Pep Home) and cellular products (Pep Cell). Pepkor trades in 11 African countries, and also expanded to Australia with the acquisition of Best & Less in 1998 and to Poland and Slovakia via the brand Pepco.

    Premier Foods is a key staple foods producer in SA, operating 11 bakeries, 5 wheat mills and 16 distribution depots nationwide. Some of its flagship brands include Blue Ribbon Bread, Snowflake Flour and Iwisa Super Maize Meal. Premier Foods has a significant exposure to the informal market, which accounts for over 60% of bread sales in SA, through its well-priced flour products. Brait expects the company to drive growth through optimising its existing milling and baking operations in SA and also expanding into the rest of Africa.

    Iceland Foods is a UK based national food retailer that focuses on frozen foods but also offers regular groceries and fresh fruit and veg. The company was founded in 1970 by current CEO Malcolm Walker, who was forced to leave Iceland in 2001. The company floundered in his absence, and Walker made his return in 2005 as a member of the consortium that took the company into private ownership. Since Walker’s return sales have grown by more than 50%, profitability has been fully restored and Iceland now has a 13% share of the UK frozen foods market. The company has an extensive footprint across the UK, has over 24 000 employees and is known as an innovative and rewarding company to work for.

    Financial Results

    Brait has recently released its annual results for the financial year ended 31 March 2013, and investors will be more than pleased with the strong growth figures. Net Asset Value (NAV) per share increased by 29% from R 20.59 to R 26.64, well in excess of Brait’s targeted growth of 15% per annum. Underlying holdings are valued by applying specific multiples to the earnings received from each investment. Pepkor was valued on a 8.0x multiple, and Premier Foods and Iceland Foods on a 6.5x multiple. These multiples have not increased from the previous financial year, indicating that the growth in NAV is a direct result of the growth in earnings from the underlying companies. It can also be noted that these multiples are vey low in comparison with listed competitors in these sectors, resulting in quite conservative valuations for these investments.

    The breakdown and quarterly growth of the NAV per share is as below:

    Further highlights include an increase in Normalised Headline Earnings per Share (HEPS) of 34% to R 5.79 per share and the proposal of a bonus share issue of 26.64 cents per share, an increase of 29% on the previous year.

    Brait has also experienced R 274m in cash inflows from its investment portfolio in the financial year, including a R 128m Pepkor dividend and R 118m from realisations within the private equity fund and smaller investments.

    A further R 1.5bn of capital was raised in August 2012 from the issue of perpetual preference shares, and Brait now has cash and facilities of R 2.7bn available for new investments should opportunities arise.

    A unique opportunity

    Brait offers investors access to a unique portfolio of unlisted investments characterised by its exposure to emerging markets and lower income groups. The underlying investment portfolio is defensive in nature, cash-generative, and is ever diversifying in terms of geographic and sectoral exposure.

    We believe that Brait’s investments can deliver sustainable growth in challenging market conditions, and it is included at a 3.4% holding in the Seed Equity Fund as part of both the momentum and value portfolios.

    Kind regards,

    Cor van Deventer

    021 914 4966

    Permalink2013-06-18, 12:45:00, by Mike Email , Leave a comment

    Dividend Aristocrats – The New Nifty 50?

    The original Nifty Fifty stocks from the 1960’s and 1970’s were the type of shares that were supposed to be buy and hold shares. They were characterised as having consistent earnings growth and high PE ratios. A Barron’s article put it as “They were so-called one-decision stocks you were supposed to buy and put away forever because these supposedly elite growth companies would continue to grow no matter what.”

    Many of these companies have indeed continued to grow, despite protracted bear markets, especially in the bear markets of the mid 1970’s and the early 2000’s. Some of the names included well known Coca Cola, IBM, McDonalds, and Johnson and Johnson. But then there were others such as Burroughs, Digital Equipment, and Eastman Kodak, which have all long gone.

    Standard and Poor’s, which produces the well know S&P500 index, also produce what is known as the Dividend Aristocrats index. This is a subset of the top 500 companies, which have increased their dividend pay-outs for at least 25 consecutive years.

    The companies that make up the Dividend Aristocrats cover ten different business sectors with both growth and value holdings. The index of shares is then equally weighted across the various shares and each quarter re adjusted back to an equal weight.

    The list declined from 52 companies in 2009 to 42 companies in 2010, as many companies cut their dividend pay-outs. The index then remained steady in 2011 and in 2012 one company was removed and 10 added.

    The chart below reflects that over the last three and five years the Dividend Aristocrat index has outperformed the larger S&P500 index mostly because these shares did not decline as much as the broader market in the 2007/2008 financial crisis. Over the last 12 months however the returns from the two series have been neck on neck.

    Source: S&P500

    BCA Research have a view that given the scarcity and low quantum of yield available for investors, the dividend attributes of these types of shares could become even more in favour than is already the case, potentially pushing up valuations to inflated levels. These shares are attractive for investors because of their fixed income type qualities.

    BCA do point out, however, that while there is a belief that defensive stocks typically weather market shakeouts or corrections, the reality is that they rarely do. I.e. there is investment risk when investors overpay. A lot, however, does hinge on the actions of central bankers with regard to keeping interest rates low and providing liquidity. Over the last few weeks we have seen interest rates rise, once again causing some headwinds for shares, but resulting in losses for bondholders.

    Kind regards,

    Ian de Lange

    021 914 4966

    Permalink2013-06-12, 08:49:21, by Mike Email , Leave a comment

    A Closer look at Risk Measurements

    From a fund of fund perspective it is always useful to conduct a proper analysis on a wide spectrum of managers. One way to do this is by conducting quantitative analysis, which enables you to screen and compare managers with different characteristics. The quants allow one to gain a better understanding of the fund and its strategy and can be easily interpreted. Depending on the ratio investigated, the investor either prefers a high or a low number.

    One way to use quant analysis is to calculate different risk/return measures. As there are numerous measures, the question one needs to ask then is what do you define as risk?

    In laymen’s terms, portfolio risk would usually refer to the volatility of returns. The statistical measure for this is called the standard deviation (also known as volatility risk). Essentially it measures the movement of returns around the average return of the fund.

    Unfortunately with finance, statistics and maths aren’t always that straight forward. Apart from a list of statistical assumptions one needs to accept, one major flaw of using standard deviation as a measure of risk is that it penalises upside (good) and downside (bad) movements, even though upside movements are sought after. Although standard deviation may be misleading, it is a highly popular measurement and is used in the calculation of the Sharpe ratio.

    The Sharpe ratio measures the return above the risk free rate (usually assumed to be cash) relative to standard deviation, where a higher Sharpe ratio is preferred. Below is a comparison of the Sharpe ratios between the ALSI, ALBI and ASISA Multi Asset Medium and High Equity Funds.

    Based purely on the Sharpe ratio, the ASISA South African Multi Asset Medium Equity class had the best risk adjusted returns over all periods. Moderate funds have a maximum equity exposure of 60%, and for this reason their standard deviation tends to be lower since returns are not as volatile as with the ALSI. This does not mean that it would have provided the best return but rather that this asset class would have provided you with the least volatile risk adjusted return above cash.

    At Seed, we try and form an objective opinion about every asset that we invest into. While historic returns aren’t a reflection of the future, when conducting quantitative analysis the past forms an observable character of a fund and this is then used as a proxy for certain characteristics which can be expected going forward.

    Since the Sharpe ratio has many flaws we at Seed place more credibility on the Omega ratio. The Omega ratio is relatively new and not so well known to the investment public, but is especially useful for comparing managers when one is benchmark cognisant. This is especially useful for comparing funds that aim to track a certain benchmark.
    For the Omega ratio, the benchmark will essentially form an integral part in the outcome of the ratio. As seen below, the Omega ratio can be seen by dividing the area above the benchmark by the area below the benchmark.

    The Omega ratio measures the probability of outperforming a set benchmark over the probability of underperforming that same benchmark. The ratio thus defines any returns below the benchmark as a loss, which can also be seen as its interpretation of risk. Apart from its statistical superiority, it is also easy to interpret - the higher the Omega, the better.

    The calculations behind the Omega ratio are a bit daunting and should you require any further information or would like to know more about the ratio and its uses, feel free to contact us and we can send you a research study we have conducted on quantitative measurements.

    Warm regards,

    Lourens Rabe

    021 914 4966

    Permalink2013-06-04, 16:32:21, by Mike Email , Leave a comment