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    Seed Weekly - Fear and Greed

    Fear and greed are unfortunately the two emotions which drive most investor’s behaviour. My job as a Financial Advisor is to try and dilute this unhealthy situation by adding a good measure of rational thinking. Unfortunately the more fear or greed we experience, the more rational our arguments will appear to ourselves.

    One of the most common mistakes that people make is greed. This happens when we look at the Sunday papers and we see last year’s best performing fund. The average investor’s immediate reaction is “I need a bit of that action; I need to get into that fund as quickly as possible”. Obviously, in a years’ time that fund is not going to be the best performing unit trust and now you want to “get out of that fund as quickly as possible and move to the next year’s best performing fund”. I have often used the statement that “only using past performance to select funds is like driving whilst only looking in your rear view mirror, it is going to cause an accident”.

    I am constantly amazed at how otherwise rational people (Engineers and Accountants especially), can forget three or even five years of good performance and will suddenly start panicking and want to move everything into cash as soon as the market has moved sideways for a year or two. (My previous cash is king article expands on this).

    Financial planning is exactly what it says, you need to have a plan and you need to stick to it, chopping and changing the whole time will only lead to heartache. “Panic sellers” will always wait too long for their greed to override their fear and can never time their market re-entrance. They will always lose out on the biggest upswings after the bottom.

    If your fund has a 3 year benchmark, then measure it over three years. It is pointless selecting funds with a five year time horizon in mind and then changing those funds because of one year’s underperformance. If nothing has changed with the underlying Manager, mandate, process etc. and you are wanting to switch managers because of short term underperformance, you seriously need to relook at your fund selection process.

    The importance of having a financial plan which incorporates your needs, goals, time frames and special circumstances cannot be over-emphasized. Your financial plan is what keeps your decisions within a rational framework and negates the negative impact of fear and greed.

    Kind regards,

    Barry Hugo

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    www.seedinvestments.co.za

    Permalink2016-05-25, 08:54:12, by Mike Email , Leave a comment

    Seed Weekly - Passive vs Active Investment Management

    The age old debate pitting passive vs active investment management has raged on for decades, proliferating recently. This comes as a result of the struggles that active managers have faced in trying to outperform index benchmarks, particularly over the last five years. The trend is common on a global scale as well as in a South African context.

    The conflicting views, proponents of either strategy have, attempt to explain the benefits and drawbacks of both strategies. A critical point, and to the fore of the passive argument, is the fact that over time, active managers have been shown to be unable to consistently deliver “higher returns” than the index. Given that active managers charge a “higher fee” for their active management skill, failure to outperform the index over the long term questions whether the fee is justified – i.e. should we be allocating money to active managers?

    As a multi-manager, allocating money to different strategies in our funds, it is important to get this call right so that our clients can fully benefit from having the right strategies within our funds. Critical to this is understanding the merits of either passive or active investing without putting emotion into it or being married to any of the styles. Our aim is to always pick the strategy that fits best from an overall portfolio perspective, allowing us to deliver on our mandate with our clients. Factors like cost, the ability to outperform, minimising risk and capital protection are central to our analysis.

    The “Passive” Argument

    The benefits of passive investments are well documented in literature. What is likely most appealing from these reports is the low cost and the ability of these strategies to outperform most active managers. The Lipper survey using data up to December 2012, showed only 20% of active managers outperform the MSCI World Index over 5 and 10 year periods. Figures from the South African S&P Indices Versus Active (SPIVA) scorecard suggest that active South African fund managers, like their global counterparts, fall short when it comes to beating the index over 1, 3 and 5 year periods. A recent survey by Morningstar concluded that the expense ratio is the best predictor of future performance and with passive funds generally charging lower fees, they are expected to outperform.

    Low cost funds shown to have subsequent higher 5 year Total Returns as at 31 December 2015
    Source: Morningstar Research

    The “Active” Argument

    Proponents of active management argue that superior skill that certain managers possess can lead to outperformance over an index. Central to this is the ability of a manager to use her skill to manage downside risk. Active managers can make informed investment decisions based on their experiences, insights, knowledge and ability to identify opportunities that can translate into superior performance. Historical data suggests that active managers do better in down markets than up markets. Generally, passive investments tend to do better in more bullish markets but fall a lot more when the markets are under pressure as they realise the full downside of the markets. Furthermore, it is argued that passively managed funds have no chance of beating the index but will always lag their benchmarks by the amount of expenses and cash drag. Data used to analyse active managers is also perceived to be biased by some underperforming ‘closet’ benchmark huggers, particularly on a net-of-fee basis. These kind of managers appear more passive than active.

    At points in time, there is a good percentage of active managers outperforming the index. Data from 1980 using the US market.
    Source: Seed Research using Morningstar Direct

    Putting it all together

    Focusing on a snapshot of data at a specific point in time potentially has the danger of reaching conclusions influenced by the most recent market conditions. A sustained period of bullish markets, as experienced over the past 5 years, strongly supports the passive argument as passive strategies generally do well in bull markets. Similarly, the strength of the more skilled active managers becomes more apparent when markets face downside pressure or are moderately up. In this case, good stock selection and risk management should help to protect active portfolios from the full downside of the markets. Successful active managers therefore require both skill and breadth (number of independent active decisions made in constructing a portfolio) to outperform.

    There is a place for both passive and active management, especially if one has the ability to identify skilled managers. It is clear that if passive management delivers superior or at the very least similar returns to active management, at a lower cost, there is a compelling argument to simply go this route. Depending on an investor’s needs and constraints, time horizon and market conditions, a strategy of passive, active or a combination of the two may be appropriate. The market rewards different factors at different times and it is important to deal with the facts in this regard and not just a watered-down version of what was true at some point in time in the past.

    Kind regards,

    Tawanda Mushore

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    Seed is hiring: Visit the Seed Analytics and Seed Investment Consultants Linked In Profiles to view vacancies.

    www.seedinvestments.co.za

    Permalink2016-05-18, 08:35:44, by Mike Email , Leave a comment

    Seed Weekly - Local Equities - Expensive or Not?

    An important part of Seed’s multi management process is performing monthly asset class valuations using in-house quantitative models. This process covers all of the local and global asset classes that are suitable for inclusion in our multi asset class funds and model portfolios. The output of these models guide our tactical asset allocation decisions, where we under- or overweight certain asset classes in the short term, compared to our longer term target weights.

    Local equities form the core of our multi asset class products, and determining whether this asset class is cheap or expensive is crucial. One of the inputs of our valuation model is the Price/Earnings (PE) ratio, which is the multiple of annual earnings investors are willing to pay for a certain company, sector or the market as a whole. We have found that the total market PE is not a great leading indicator of stock market returns over the short to medium term, but does give a good indication of what to expect over the long term.

    Practically, this means that a high current PE ratio (expensive market) results in lower than average returns over the next five years, while a low PE ratio predicts above average subsequent returns. Of course, with many factors other than PE ratios at play, the model does not have a perfect statistical fit. In the past, during periods of exuberance, expensive markets have continued to perform well, and during times of pessimism, cheap markets have continued to lag.

    A potential shortcoming of the PE ratio, when applied to a specific company, is that it fails to allow for potential growth in earnings. This means that it might appear that investors are overpaying for the current level of company earnings, but if reported earnings grow strongly the ratio can quickly come down to more normalised levels.

    The graph below illustrates the model graphically, with the total market PE on the x-axis and the resultant 5-year nominal annualised return on the y-axis. With the current market PE at nearly 22 times, the model indicates that we can expect muted returns over the next 5 years, assuming that the modelled historical relationship continues to hold. It is clear from the graph that the PE is very high compared to the historical observations.

    Although the market in total might be expensive, there is always the possibility that there are pockets of value that might be overlooked. When applying the valuation model on a super sector basis, it is clear that Financials still offer some value at the moment, while Industrials appear very overvalued.

    At Seed, we have been viewing the local equity market as expensive for about 3 years, and therefore have remained underweight local equity in the Seed Balanced Fund. However, the volatility of equities has provided us with some good opportunities to add exposure in some months or to take profit in others. In addition, our equity exposure remains tilted towards Financials.

    Kind regards,

    Cor van Deventer

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    Seed is hiring: Visit the Seed Analytics LinkedIn profile to view vacancies.

    www.seedinvestments.co.za

    Permalink2016-05-04, 10:18:58, by Mike Email , Leave a comment