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    Seed Weekly - Alexander Forbes returns to the JSE

    Financial services company Alexander Forbes Group Holdings became the 11th company to list on the JSE this year when it returned to the main board on 24 July. After initially listing in 1996, the company was bought out by a private equity consortium led by Actis in 2007. When the private equity owners indicated their intention to exit the investment, shareholders voted in favour of re-listing the group and selling a 34% stake to Mercer Africa, a subsidiary of Forbes’ long-time strategic US partner Marsh & McLennan.

    Company structure

    Alexander Forbes offers a wide range of services across the financial services sector. The group’s core businesses comprise Alexander Forbes Financial Services (AFFS), which offers retirement fund administration, employee benefits, healthcare consulting and actuarial services, and Investment Solutions (IS), which offers investment administration and multi-management services.

    The group’s product range is further diversified through Alexander Forbes Insurance, which offers motor, household and business insurance to the retail and institutional market.

    Geographic diversification comes via AfriNet, which offers employee benefits, risk services and actuarial consulting in Botswana, Kenya, Namibia, Nigeria, Uganda and Zambia. Alexander Forbes International offers similar services to clients in the UK, Abu Dhabi, Belgium, Ireland, and the Netherlands.

    Latest results

    The company’s latest results, for the financial year ended 31 March 2014, must be read in the light of a recent balance sheet restructuring operation. In order to simplify its balance sheet and provide more flexibility, the African Risk Services business was sold to the Marsh group, Guardrisk was sold to MMI, and selected UK operations were also disposed of.

    Post the restructure, and before the re-listing, the shareholding and capital structure were as below:

    For FY14, the group reported an 18% increase in net revenue to R4.4bn, with operating expenses increasing by 19% to R 3.4bn. The resultant R 1bn profit from operations is a 12% improvement on FY13. Investment income increased dramatically from R 129m to R 233m, while finance costs remained flat at R 843m.

    All divisions were able to increase net revenue and profits during the year, with profit from the international and African operations growing very strongly indeed.


    Alexander Forbes believes that the group is now well positioned for growth after the completion of the restructure and the re-listing. Management believes that their key differentiators are a strong institutional integrity and capacity, a high performance accountability culture, focused investment in leadership and increased employee engagement.

    The combination of AFFS and IS enables the group to offer a holistic service across the entire value chain, from administration and advice to managing underlying assets on a multi-manager basis. By aligning themselves with the global trend of integration and consolidation of service providers, the group hopes to grow its market share further.

    As a first growth strategy, the group aims to use its well-established institutional client base to expand its footprint in the SA retail space. AfriNet is the focus of the group’s second growth strategy, in which AF will continue to establish the brand in sub-Saharan African countries while leveraging off their established SA skill set. The third and final growth strategy is an increased focus on the public sector in Africa, often the largest employer in a country and a key driver of future African growth.

    Share Fundamentals

    The share opened at R 8.10 on the first day of trading, 8% higher than the initial public offer price of R 7.50. The share added a further 12% since, closing at R 9.10 on 28 July. In statements to the media, the group mentioned that it may pay out as much as 67% of its earnings as dividends to shareholders.
    Alexander Forbes is not held in the Seed Equity Fund or Seed Model Share Portfolio, but Seed will keep assessing the share in light of the results of the group’s growth strategies.

    Kind Regards,

    Cor van Deventer

    021 914 4966

    Permalink2014-07-29, 10:44:49, by Mike Email , Leave a comment

    Seed Weekly - The US Equity Risk Premium

    BCA Research agrees with the general consensus that US equities are fully priced or indeed even possibly slightly overvalued. They do say, however, that “Nevertheless, this does not mean the bull market is about to end. In fact, history has shown that valuation is a bad market-timing tool; equities can stay in over- or under-valued territory potentially for decades.”

    At the same time it is important for investors to always have a good understanding of the valuation of the market in order assess the level of risk. While there are numerous ways to look at the overall valuation of equities, one methodology is to look at the equity risk premium (ERP). The thinking here is that investors demand a premium in the yield for investing into a more volatile asset such as a listed share when compared to the yield on a government bond.

    The yield that an investor receives on a government bond – for instance a 10 year bond – is generally considered risk free because of the low probability of default. Because an investment into the shares of a company has a much higher degree of risk, it stands to reason that the yield demanded is higher than bonds – hence the equity risk premium. It is because of this premium in yield and the compounding effect of earnings that investors in equities will typically be rewarded with excess returns over time.

    The maths then to calculate this equity risk premium is fairly simple – it is the difference between the 12 month forward earnings yield and the yield on the 10 year government bond.

    This premium, however, has not been a fixed number over time as depicted in the chart below for the S&P 500. At certain times investors become more exuberant and demand a very low, or at times discount in the yield versus bonds. At other times investors become very nervous about risk assets and demand a high yield (i.e. lower valuation) relative to the lower risk bonds.

    In the 1980s to 1990s, the average equity risk premium on the US market was 80 basis points, which was very low because the stock market was overinflated and overvalued for more than a decade. Then into the late 1990 and early 2000 there was a major shift where investors no longer demanded a premium for investing into equities and in the years to just before the global financial crisis, investors demanded an approximate 200 basis point premium over 10 year bonds.

    With prices plummeting into the global financial crisis, yields moved higher and the equity risk premium spiked to over 600 basis points, but has since been dropping. The big question, however, is just what should this equity risk premium number be?

    The current yield on the US 10 years bond is around 2.5%. Assuming that the long run number should be 3.5% and that investors demand an additional 3% equity risk premium, this means that shares should trade at a yield of 6.5%. This yield implies a price to earnings (PE) ratio of 15.4 (i.e. 1/6.5%). Currently the US stock market, as defined by the S&P 500, is trading on a forward PE of 15.7, which means that on these assumptions it is in equilibrium territory.

    Investors can therefore take comfort that on this basis, overall valuations are reasonable but this does not guarantee that prices will not be volatile.

    Kind regards,

    Ian de Lange

    021 914 4966

    Permalink2014-07-22, 10:52:20, by Mike Email , Leave a comment

    Seed Weekly - A Penny Saved is a Penny Earned

    Seeing that July is national Savings Month it prompted me to re visit my personal finances just to access whether I am still on par with reaching my financial goals and specifically asking questions in the line of “Am I saving enough?”

    As a nation, South Africans do not have a culture of saving and seeing that only 4% of South African households earn more than R 40 000 per month* one may argue that we live from hand to mouth and are just too poor to save.

    I think the key here is to develop the habit of saving money automatically. When saving automatically you don’t spend time each month focusing on it and it becomes easier.

    Below are some tips of my own that assist me to be disciplined in my approach to saving money:
    • Have a plan and definite GOALS
    Whether it is for retirement or something simple, like saving for travelling or your children’s education, it is important to have a goal to save towards. Add a Rand value to it and write it down and always refer back to it for motivation and reference.
    • Start off by saving 10% of your monthly income
    I recently read the famous book “The Richest Man in Babylon” by John S Clason (I highly recommend it) and his “First law of Gold” is that if you save one tenth of your earnings consistently you will have enough to provide you with income in the future. Saving anything more is obviously even more advantageous but 10% is a good starting point.
    • Start early
    The time value of money and compounded returns play a massive role here. A simple example in the graph below shows 5 different people each saving R 1 000 per month up to age 65. Returns assumed at 12% and also assuming no withdrawals during the period invested.

    R 12m when saving for 40 years compared to just under R 1m when saving for 20 years speaks for itself. More notably and underlining the importance of starting early is the fact that by starting only 5 years earlier the 25 year old accumulates R 5.5m more than the 30 year old when both reach 65.
    • Cutting down on spending / Penny Pinching
    An easy way to increase saving is obviously to spend less. Assessing my bank statement at the end of a month and highlighting areas where I can improve in the next month helps with having extra money to save. Again I would challenge myself with goals and it can be as simple as to rather rent a movie and watching it at home compared to going out to the movies or playing one less round of golf per month.
    • Guard from loss/invest smart
    It is important to invest your savings in a product that beats inflation and doesn’t lose any capital over your investment period. There’s nothing worse than losing your hard earned savings by being invested in for example a money market fund which would not guarantee inflation beating returns. It is always wise to consult your financial advisor to make sure you invest your savings in an appropriate investment vehicle.

    By sticking to the above basic tips I have developed the habit of saving on a constant basis and as long as I follow them my savings can only go in one direction – upwards.

    Happy savings month,

    Renier Hugo

    021 914 4966

    Interesting money saving tips here
    * http://www.econ3x3.org/article/who-are-middle-class-south-africa-does-it-matter-policy

    Permalink2014-07-15, 10:42:10, by Mike Email , Leave a comment

    Seed Weekly - Value investing the Buffett Way (Part 7 2008 – 2012)

    2008 was the height of the Global Financial Crisis (GFC), leading into one of the strongest bull markets in history. Berkshire Hathaway managed to perform well during the recession as two core businesses sectors, insurance and utility groups, produced earnings uncorrelated to the general economy. Berkshire only lost 9.6% in 2008, whilst the S&P500 lost 37%. Although Berkshire underperformed the S&P500 in the following four years, their returns compounded from a higher base. Beware the investment activity that produces applause; the great moves are usually greeted by yawns.

    According to Mr Buffett his, and Charlie Munger’s, focus during the good and the bad years is to simply stay focussed on four goals:

    1. Maintaining Berkshire’s Gibraltar-like financial position
    • huge amounts of excess liquidity,
    • near-term obligations that are modest, and
    • dozens of sources of earnings and cash;
    2. Widening the “moats” around operating businesses that give them durable competitive advantages;
    3. Acquiring and developing new and varied streams of earnings;
    4. Expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.

    Keeping a cash buffer is extremely important. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations. This conservative approach to leverage might dampen returns, but having excess liquidity lets them sleep well.

    This liquidity facilitated Berkshire’s $15.6bn investment in 25 days of panic following the Lehman bankruptcy in 2008. They purchased convertible bonds worth $14.5bn in Wrigley, Goldman Sachs and General Electric at high yields. To fund these large purchases, I had to sell portions of some holdings that I would have preferred to keep (primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips). However, I have pledged – to you, the rating agencies and myself – to always run Berkshire with more than ample cash.

    Mr Buffett stresses the dangers of derivatives, especially when it may lead to extreme leverage or counterparty risk. He promises his shareholders that this will never occur at Berkshire. Charlie and I believe that a CEO must not delegate risk control. It’s simply too important. At Berkshire, I both initiate and monitor every derivatives contract on our books… If Berkshire ever gets in trouble, it will be my fault. It will not be because of misjudgments made by a Risk Committee or Chief Risk Officer.

    As mentioned previously, they don’t attempt to impress Wall Street. Investors who buy and sell based upon media or analyst commentary are not for us. Instead we want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it’s one that follows policies with which they concur.

    As always his prime focus is to increase shareholder value. Buffett still has no intention of paying a dividend. He will, however, repurchase Berkshire shares if they trade at a meaningful discount to intrinsic value. Because of Berkshire's size, it takes even more money to make acquisitions that move the needle. Buffett wants to save the company's cash for the remaining whales in the ocean.

    This was the last part of the 7 piece series on Warren Buffett’s annual letter to his shareholders. I can highly recommend that you read his 2013 letter yourself which can be found on their website, http://www.berkshirehathaway.com. Experience it for yourself; writing about it simply does not do justice.

    Kind regards,

    Lourens Rabé

    021 914 4966

    Permalink2014-07-08, 10:43:39, by Mike Email , Leave a comment

    Seed Weekly - Cash Alternatives

    Today’s article is a follow on from last week’s where we looked at the advantages of investing across a range of asset classes. This week we look at the options available for companies and investors that hold large amounts of ‘strategic’ cash (typically long term holders of cash) for one reason or the other.

    There is no free lunch in the investment world and this statement also holds true when looking to increase your yield/interest earned on cash type investments. In order to achieve higher yields we need to give up liquidity (longer notice periods), take on more credit risk, take on more capital risk, or accept a combination of the three. It is important to remember that whilst money market funds are generally seen as safe investments, they are not risk free. There have been money market funds in the past and there will be money market funds in the future which have capital draw downs.

    When I speak to clients with large cash holdings, I try to ascertain what portion of their cash will be held for periods in excess of 6 months (strategic cash holdings) and it is this portion of the cash holdings that is pertinent to this article.

    I have put together a mix of three income funds which have very different strategies when trying to extract that extra yield above money market. These funds are fairly uncorrelated and have given, and should continue to give, clients a good chance of outperforming money market funds without adding too much risk. Costs are hugely important when dealing in a low yield environment, so the moment you add on layers of cost like platform fees and financial advice fees, your probabilities of outperforming money market funds reduce.

    A brief summary of the funds follows:
    • The MET income Plus Fund is a credit fund with almost no duration risk. Whilst credit risk (i.e. the risk of a client defaulting) is easy to understand it is quite difficult to implement. The manager of this fund has a long track record in managing credit risk successfully. This fund is still new, but the Momentum Income Plus fund was previously managed by the same manager with the same mandate.
    • The Prudential Enhanced Income Fund is a valuation based, tactical asset allocation fund that invests across a range of income producing assets including property, inflation linked bonds, and offshore exposure to increase the yield given to clients.
    • The Cadiz Absolute Yield Fund is a combination of the above two funds and often mixes duration into the offering.

    Each of these funds has had, and will continue to have, periods of relative out and underperformance, but the average return of the three is relatively smooth. The benefit of multi management, through manager diversification, is evident in the thought behind the blend chosen. The charts below show the performance of the 3 funds, as well as their equally weighted blend, versus a traditional money market fund, both on a cumulative basis and on a risk/return basis (where risk is defined as downside deviation).

    For clients that have strategic cash requirements this mix of funds has been able to outperform money market on a consistent basis with very low volatility. In addition to this, the entire capital amount is available with three days’ notice. It is important to note that while this is mix that is currently recommended, things do change (e.g. fund manager movements) and investors therefore need to remain on top of any changes.

    Kind regards,
    Barry Hugo

    021 914 4966

    Permalink2014-07-01, 10:22:32, by Mike Email , Leave a comment