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    Seed Weekly - Characteristics of Winning Shares

    The May 2014 edition of the Bank Credit Analyst produced a very useful report, discussing some of the merits of active versus passive fund management.

    Firstly this is not an “either or” debate. While it is impossible for the average active fund manager to outperform a passive index after fees are taken into account, there will always be successful stock pickers that do systematically deviate from their benchmark and successfully outperform the market on an ongoing basis.

    An active manager is one that relies on analytical research, forecasts, and their own judgement in order to decide which portfolio to construct. Passive investors, on the other hand, tend to construct a portfolio close to a given index – typically a market cap weighted index.

    Active managers will find more success where prices deviate substantially from their fundamental fair values. Two areas where this is often found are the small cap and emerging market universe.

    The report defined characteristics of superior active managers and then went on to define certain characteristics of winning stocks as follows.

    Firstly, small cap shares (i.e. size characteristics) have been associated with alpha (typically defined as the excess return above a benchmark index). Since 1926 small cap stocks have outperformed large caps by an average of 2.8% per year.


    BCA notes that value stocks have also outperformed and when ranking stocks by price to book ratio, those with low ratios (i.e. value stocks) have outperformed those with high ratios by an average of 4.8% per annum.

    BCA found that other value metrics have also been useful in predicting relative returns for stocks globally. These are criteria such as low versus high price to earnings, low versus high price to cash flow and high versus low dividend yields.

    Value stocks tend to outperform more in market downturns and underperform when markets are up strongly, offering a partial hedge against market risk.


    When looking at price momentum, an investor must consider the time horizon. Evidence suggests that over a short term horizon of one month, momentum is negative so that stocks that performed well last month tend to underperform this month (price reversion).

    Over medium term periods of 2 to 12 months momentum turns positive so that past winners continue to outperform, turning negative again over one to five years.

    Some of the reasons for shares, which have done well over the last year, continuing to outperform can be ascribed to institutional investors scaling in and out of positions, the persistency of buying and selling over several months, especially for large cap shares, and also a case of equity prices not immediately reflecting new information about a company.

    While a traditional passive fund tracks an index that is constructed using a market cap weighting, the independent research from BCA indicates that it makes a lot more sense to construct a portfolio using value and momentum factors. Indeed, this is exactly how we have designed the Seed Equity Fund. A value portfolio, using the four value criteria noted above, is systematically constructed and then equally combined with a momentum portfolio using price and earnings momentum.

    The result is a Fund that has the attributes of an actively managed portfolio and the proven ability to outperform traditional indices over time, yet at a lower cost.

    Kind regards,

    Ian de Lange

    021 914 4966

    Permalink2014-05-27, 09:47:51, by Mike Email , Leave a comment

    Seed Weekly - The Holistic View

    It is very important to optimize a client’s investment portfolio on a proper risk adjusted basis and the only way to do this accurately is by looking at the client’s investments on a holistic or “all inclusive” basis.

    I will illustrate by using the following example:
    John Doe is a 50 year old male that inherits R 4m from the passing of his parents. John approaches his financial advisor for advice on investing the R 4m.

    His asset base (before inheritance) consists of:

    We have assumed that the Family Trust is invested in income centric assets (as most of the other beneficiaries require a high level of income). His asset allocation (before inheritance) is replicated below:

    The advisor has 2 options with how he goes about giving John advice:

    Option 1:
    Establish an asset allocation based on John’s needs and advise him to invest the money in a well-diversified portfolio that matches this asset allocation. In this option the advisor only takes the R 4m inheritance into account when making the recommendation.
    Option 2:
    Here the advisor first considers John’s current asset base, establishes an asset allocation based on his needs and then decides how he can optimize John’s entire portfolio with the additional cash flow.

    We have assumed that John’s target asset allocation is as follows:

    The chart below shows the outcome of the 2 options described above. In Option 1 John invests into a portfolio that mimics his target asset allocation (described above). In Option 2 John invests 50% of the inheritance in equity and 50% globally and in doing so gets a lot closer (on a composite basis) to his target asset allocation than had his advisor given him advice purely focused on investing the inheritance.

    Option 1 would have been perfect had John not had any other investments, but the importance of taking a holistic approach is clearly illustrated in this example. The advisor not only needs the required tools to ensure that the initial advice is holistically based, but that his clients’ portfolio are continually tracked on this basis so that he can ensure that his clients’ portfolios are in alignment with the optimal strategy.

    At Seed we have developed the planning and reporting tools that ensure that we take great care, not only in planning holistically, but also reporting monthly on all of our clients’ investments, even the portion that isn’t under our management.

    Kind regards,

    Renier Hugo

    021 914 4966

    Permalink2014-05-20, 11:39:30, by Mike Email , Leave a comment

    Seed Weekly - Lonmin Plc Results

    Lonmin Plc, the world’s third largest producer of Platinum Group Metals (PGMs), recently released its Interim Results for the six months ended 31 March 2014. The company also used this opportunity to update the market on the latest developments regarding the ongoing wage disputes, and attempted to soothe investors with a recovery plan to ramp up production when the strike finally ends.


    Lonmin has a vertically integrated operational structure, ensuring that it is directly involved in the whole process from mine to market. Its Mining division extracts the ore, the Process division refines it and the Shared Services division provides infrastructure support to the two key units.

    On the Mining side, the company’s chief asset is the now infamous Marikana mine near Rustenburg, which contributes more than 90% to annual production. Its second mine, Limpopo, is located near Polokwane and is currently on care and maintenance. Lonmin also holds a 42.5% stake in Pandora, a joint venture with Anglo Platinum.

    The Process Division is responsible for converting the ore into refined metal. Concentrators are used to crush the ore into a liquefied concentrate, which is then sent to Lonmin’s smelting facilities. From the resulting metal-rich matte the company then extracts copper, nickel and ultimately refined PGMs.

    Interim Results

    As could be expected, the ongoing labour disputes had a devastating effect on Lonmin’s operations and subsequent results over the past six months. Total production was 3.2 million tonnes, of which 3.0 million tonnes was attributable to Marikana. This figure is down 43% from the 5.7 million tonnes mined in H1 2013. In Q1 the company suffered from safety stoppages and low productivity due to tensions around wage negotiations, while operations have been at a standstill for 9 out of a possible 12 weeks in Q2 as a result of the strike.

    The graph illustrates the effect of labour-related events on underground mining volumes at Marikana over the past 3 years:

    Platinum sales were down 19% on the previous period to 263,675 ounces, and management estimates that 155,720 of equivalent saleable ounces were lost due to the strike.

    The company has increased its focus on cost containment and cash conservation, and has reduced normal cashfows by 60%. Capital expenditure amounted to $46m, while net cash reduced from $201m to $71.

    The graph below illustrates the declining net cash position for the company:

    Over the past 18 months Lonmin made significant progress with its unit cost reduction program, but the recent low production caused costs to increase again by 46% to R 13,058 per PGM ounce.

    Lonmin benefitted from a weakening rand during the period, but the effect was partially offset by weak PGM prices.

    Earnings before interest, tax, dividends and amortisation (EBITDA) amounted to $103m after excluding strike-related special costs of $165m, down 39% from the $171m achieved in the previous reporting period.

    Lonmin’s operating loss for the half year amounted to $131 million when including strike related costs, compared to a $90m operating profit in H1 2013.

    Finally, Earnings Per Share (EPS) dropped by 71% from 12.3 cents to 3.5 cents.


    Ben Magara, CEO of Lonmin, admitted to the short term challenges faced by the entire platinum industry but remained optimistic on the future fundamentals of PGMs. Platinum demand stems mainly from automotive production, which is in turn reliant on a strong economic recovery in Europe and the USA. An exciting emerging opportunity also waits in the increasing manufacture of fuel cell driven cars. Demand for jewellery manufacture, although much less than automotive, also remains strong.

    Key risks remain a slowdown in emerging markets, global automotive sales not growing strongly, and the possibility of substitution materials being discovered in automotive applications.

    Lonmin’s short term priorities are to resolve the labour disputes and to safely ramp up production, while persisting with cash conservation strategies in order to protect the balance sheet.

    The Seed Equity Fund holds a 1.8% position in Lonmin, with the share forming a small part of both the Value and Momentum portfolios.

    Kind regards,

    Cor van Deventer

    021 914 4966

    Permalink2014-05-13, 10:49:59, by Mike Email , Leave a comment

    Seed Weekly - Global Equity or Bonds?

    As multi managers we spend a great deal of our time researching the best areas to allocate our clients’ capital – both at the underlying fund manager level, but often more importantly into which asset class and what region.

    The end of the Global Financial Crisis (GFC) came some 5 and a bit years ago and now seems like ancient history, but during the GFC investors couldn’t see how it was going to end – there truly were Armageddon stories going around. After a solid 5 years of performance from global equity markets investors can rightly be questioning the wisdom of remaining in global equities over other asset classes, like global bonds, that haven’t performed as well in this period.

    The chart below shows the relative performance of the Dow Jones Industrial (DJIA) and MSCI All Country World indices versus Global Bonds over the past 5 years. While the equity indices have more than doubled over this period (returning in excess of 17% pa) global bonds have largely tracked sideways, returning just under 4% pa. Should one be switching to bonds?

    At Seed our emphatic answer would be “No!”

    Firstly, we do expect equities to deliver materially higher returns than bonds over time. Secondly, and more importantly, global equities (here proxied by the DJIA) continue to offer significantly better value when compared to global bonds (here proxied by the US Government 10 Year Bond (US Govt 10 Yr).

    One of the best ways to value an asset is to determine the yield that it is offering and then the prospects in the growth of that yield. Higher yielding assets are naturally preferred to lower yielding assets. One unemotional way of valuing asset classes relative to one another is to compare the relative yields offered by different asset class compared to their historical relationship. This method is used as each asset class will have a different equilibrium yield dependant on its risk profile. When making an asset allocation decision we therefore want to determine whether we are being sufficiently compensated for taking on extra risk.

    The chart below shows the difference in yield offered by the DJIA and the US Govt 10 Yr over the past 40 years. It is evident from the chart that the current difference in the yield of the DJIA and US Govt 10 Yr is significantly (more than 1 standard deviation) higher than average. The conclusion from this chart is that equities are offering investors significantly better value than bonds.

    A factor that is further in favour of equities is strong expected economic growth in developed markets that will potentially have the impact of stronger earnings for longer (good for equities) and also rising interest rates (bad for bonds) as central banks around the world look to tighten monetary policy.

    Where our Fund mandates allow for global exposure, Seed has taken advantage of this valuation differential by being materially overweight global equity, while holding a minimum in global bonds. We have held this position for a while (as this valuation gap has been apparent for a while) and will continue to hold it as long as the valuation gap remains.

    Take care,

    Mike Browne

    021 914 4966

    Permalink2014-05-06, 10:24:30, by Mike Email , Leave a comment