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    Seed Weekly - Is this the end of the world as we know it?

    As many of you will know, I have been a financial planner for more than 20 years and in those 20 years there were certain foundation assumptions that were made with regards to Estate Planning. As my old Tax Professor used to say “Paying no Estate Duty is easy, you just give your entire Estate to the Church”. It should be noted however that the essence of Estate Planning has always been paying the least possible estate duty within the framework of your wishes. Now with Davis Tax Committee second interim report and the publication of the Taxation Laws Amendment Bill (Second Draft), it would appear that many of the mechanisms which we used to use for Estate Planning are now in danger. It must be noted however that these are proposals and they could therefore change before they are finally implemented in the Income Tax Act.

    The two most interesting aspects of the Davis Commission are as follows:


    Scraping Inter-spouse Abatement

    The Section 4Q abatement has been the backbone of Estate Planning for many years and the scrapping of this abatement along with the CGT exemption and Donations Tax exemption between spouses could cause huge liquidity problems in many estates going forward. Davis has however softened this blow by proposing an increase in the Primary Estate Duty Abatement to R 15 000 000.00 per tax payer. Davis is also proposing to increase the rate of Estate Duty to 25%.

    Taxation of all income and Capital Gaines within the Trust

    A number of Tax Planners misused the conduit principle vesting Income and Capital Gains in the hands of beneficiaries. Whilst the tax advantages of the practice are obvious, it does however undermine the actual purpose of why the trust was created (By vesting the capital in a beneficiary you lose the protection of the trust).
    The Taxation Laws Amendment Bill (Second draft 23 September 2016) also brings two interesting changes to our post retirement and estate planning landscape:

    Section 7C

    The use of interest free loans has long been a mainstay of our Estate Planning Landscape; it has allowed a person to transfer an asset to a Trust without incurring donations tax and without placing an undue burden on the finances of the Trust. Now whilst the amendments are rather complex and you definitely need to discuss them with your tax planner and probably your financial advisor, in a nutshell there will be an annual donation on any interest free/ low interest loans.

    Disallowing the offshore exemption on an annuity from a local Retirement Fund

    A number of people who were employed by multinationals and up until now have received exemptions on pensions for the time they spent working offshore, will now find that that exemption will no longer be in place.

    Please remember that these are proposals but you would ignore them at your peril. One needs to assess how these changes will impact your financial planning and start putting contingency plans in place.

    Kind regards,

    Barry Hugo

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

    Please click here to view our disclaimer. For more information please visit our website.

    Permalink2016-10-26, 11:01:33, by Mike Email , Leave a comment

    Seed Weekly - Asset Class Valuations – The Year to Date

    An important part of Seed’s multi management process is performing monthly asset class valuations using our 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. Let’s take a look at how our views on some of the local asset classes and currencies have changed for the year to date.

    In terms of the Price to Earnings ratio, the local equity market has been extremely expensive for the whole year. The ratio has been above 21 since March, compared to the 10 year average of 15.9 and 30 year average of 14.4. Earnings have come down 16% for the year to date, and are now at very low levels versus our trend model and the Graham and Dodd average, which is an inflation-adjusted number smoothed over seven years. This is illustrated in the graph below:

    Source: Seed Investments

    On a sector level, we have seen significant changes in the relative valuations. Financials, weighted down by political uncertainty and the prospect of a ratings downgrade, have become cheaper and cheaper. Resources have had an excellent run this year, and the PE relative to the broader market has increased significantly.

    Local bonds have remained relatively attractive for the whole year since the December 2015 yield blowout, although yields have come down significantly since. The average 10-year yield of 9.0% for the year appears attractive vs. the short term average of 8.2%, but not against the 30 year average of 11.4%.

    This asset class has been very volatile for the last year, presenting the chance for opportunistic trades but requiring excellent timing. At Seed we have retained our preference to take on some duration risk in via our property exposure, where the yield can grow, rather than bonds.

    The real return on cash is the 3 month JIBAR rate, which is the rate used for interbank lending, less annual inflation. The two rate hikes this year have seen JIBAR rise to 7.4%, while inflation has come down to 5.9%. As a result, cash has offered an increasing real return for the past two years, unlike the period from 2011 to 2014. Therefore, the optionality that cash offers to the multi asset class investor has become even more attractive.

    Source: Seed Investments

    For the year to date the ZAR has strengthened tremendously, from R15.46 to R13.72 at the end of September versus the USD and from R22.55 to R17.59 versus the GBP. Of course, these moves are partly in reaction to the severe weakness towards the end of 2015. The ZAR has now returned to the levels of a year ago against the Euro and Dollar, and is approaching the long term Purchasing Power Parity fair value vs. the GBP. History has taught us that the Rand will not necessary return to PPP fair value and stay there, but might strengthen beyond that level and stay overvalued for some time.

    But how has this influenced Seed’s asset allocation decisions this year? In the Seed Balanced Fund, local equity exposure has been brought down to a 35.2% average this year, compared to the 50% benchmark weight. In addition, with the local market remaining expensive, the decision has been made to reduce equity even further.

    A currency hedge was put in place towards the end of 2015 to protect our offshore exposure from Rand strength, which seemed inevitable at the time. This hedge successfully offset the negative effect of Rand appreciation in the global portion of the Seed Balanced fund this year.

    We have also made increased use of cash-plus type strategies, which use floating rate instruments that yield a certain percentage above the JIBAR rate. With JIBAR increasing considerably, the yield on these strategies has been very attractive indeed.

    Kind regards,

    Cor van Deventer

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

    Please click here to view our disclaimer. For more information please visit our website.

    Permalink2016-10-19, 11:22:11, by Mike Email , Leave a comment

    Seed Weekly - A low turnover investment strategy

    A low turnover investment strategy has a lot of attraction, not least of which is lower brokerage fees. Many fund managers, however, adopt an approach that sees them buy into a company only to sell out again in one quarter. Higher and higher turnover is more and more typical of fund management today, but we ask: “Does a lower turnover strategy have merit?”

    Warren Buffett, who is arguably the best investor the world has seen, makes the comment “Our favourite holding period is forever”. He, together with his partner Charlie Munger, have been managing the assets of listed Berkshire Hathaway since 1965.

    His success has largely come about because he thinks about investments in multi decades, and not in monthly or quarterly terms. He first bought into American Express in 1964, Coca Cola in 1988 and Wells Fargo in 1989. An investment into Berkshire Hathaway stock from 1965 to end of 2015 returned 20.8% per annum versus the S&P500 compounded average of 9.7%.

    Another investment model that requires only an annual rebalance of the portfolio is known as the “Dogs of the Dow”. The Dow Jones Industrial Average index comprises 30 of the largest companies in the US. This index itself changes infrequently. The portfolio theory selects the 10 shares out of the 30 that have the highest dividend yield and holds these for one year, rebalancing annually.

    Under this model, an investor annually reinvesting in high-yield companies should out-perform the overall market. Performance has not always beaten the Dow or S&P500 indices, but it is a proven methodology.

    Over the 10 year to 2015 the Dogs of the Dow portfolio returned 10.6%, and since 2000 the portfolio returned 7.9% per annum. Over these periods it outperformed the Dow index itself, which has returned 9.1% and 6.3% per annum.

    A fund manager that we follow and invest into adopts a strategy of trying to buy shares in good companies, not to overpay and then do nothing – i.e. have an ideal holdings period of “indefinite”. The fund performance over 5 ½ years has been 16.3% against the MSCI All Country World Index of 7.7% per annum.

    Finally there is one investment fund that has truly demonstrated the benefits of long holding periods. One of the longest running funds with almost zero turnover is the Voya Corporate Leaders Trust Fund. The trust fund goes back to its original founding in 1935 with the original founders buying an equal number of shares in the New York Exchange top 30 shares by dividend. The Trust's founders believed companies that could prosper in the Great Depression would succeed in all economic and market conditions.

    The decree was that holdings could not be sold, unless in exceptional circumstance, such as bankruptcy, spin offs, etc. Therefore, only in certain rare circumstances can a share be sold and none added, unless directly tied to one of the original. For this reason, turnover is essentially at 0% and the fund is managed on an “autopilot basis” The fund is not necessarily diversified across sectors because of its original construction. It therefore has an overweight position in energy, basic materials and industrial companies, and is underweight in technology and healthcare.

    The 30 holdings are now down to 22 shares. Over time there have been name changes, mergers, etc, but no active management of the original shares. Current holdings also now include Warren Buffett’s Berkshire Hathaway, because this company issued shares when it bought railroad company Burlington Northern Santa Fe in 2010. The original 1935 holding was Atchison, Topeka and Santa Fe Railway, which merged with Burlington Northern Railroad and Santa Fe Railway in 1996.

    The performance over the last 40 years has been ahead of the S&P500 and the Dow Jones. Over the last 10 year to the end of June, it has returned 7.99% against the 7.42% of the S&P500 index.

    One of the metrics that we look at when allocating money to a fund manager is their turnover. We are not necessarily against higher turnover in a fund if value can be added, but generally speaking higher turnover reflects lower levels of conviction, and is not necessarily ideal.

    Sincerely,

    Ian de Lange

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

    Please click here to view our disclaimer. For more information please visit our website.

    Permalink2016-10-12, 10:17:26, by Mike Email , Leave a comment

    Seed Weekly - Portfolio Construction

    Portfolio construction is a vital part of portfolio management. At Seed Investments it is an area that is extremely important, both when assessing other portfolio managers and also when managing solutions for our clients.

    What is portfolio construction?” you may ask?

    Portfolio construction is the process of building an investment solution, such that its performance is as consistent as possible. This is done through selecting assets that are uncorrelated with each other as well as getting their position sizing correct. In a Fund that has a relatively conservative risk budget (i.e. don’t lose capital over any 12 month period) but that at the same time has a moderate return objective (i.e. CPI + 4% pa over rolling 3 year periods) risk needs to be taken in order to generate the required return, but that risk needs to be managed and controlled in order to ensure the capital preservation target isn’t breached.

    Perhaps that easiest way to describe how portfolio construction works in the real world is to work through an actual example. The Seed Stable Fund has the same risk and return objectives as described above and has been able to deliver on these objectives through a meticulous focus on portfolio construction.

    The charts below show the risk and return of the underlying strategies within the Seed Stable Fund for the 12 months ending 31 August 2015 and 31 August 2016 (i.e. 2 non overlapping periods). Some key take outs are:

    • Property: High Yield strategy 12 month return drops sharply from 17.6% to -2.5%
    • Equity: High Yield strategy 12 month return rises sharply from 1.5% to 13.7%
    • Global: Absolute strategy 12 month volatility rises sharply from 8.5% to 17.2%

    Despite the sharp moves in the underlying strategies, the Fund’s 12 month return shifted up from 8.9% to 10.6% with its volatility only marginally moving from 4% to 4.5%.

    Source: Seed Investments, 3 October 2016

    Source: Seed Investments, 3 October 2016

    The Fund has been able to consistently achieve its risk and return objectives over this period as the performance of the underlying strategies are uncorrelated with each other, and the sizing of the strategies has also been prudently thought about. Property: High Yield has been highly volatile over this period, but the weighting has been kept lower than the other strategies, resulting in its volatility having a low impact on the overall Fund’s returns. Equally, while the Income: Flexible strategy has a very low volatility over both periods, its return has also been on the low side, and its low weighting within the Fund has also therefore been justified.

    Going forward, with equity markets at extremely expensive levels, we have increased the diversification of the equity centric strategies (Equity: High Yield) and (MA: TAA – Multi Asset – Tactical Asset Allocation) by including a third equity strategy (MA: Opportunistic) and also reduced the aggregate weighting to these higher risk strategies (as well as Property: High Yield) in favour of Income: Flexible as the return OF capital becomes increasingly more important than the return ON capital.

    By constantly reviewing our portfolio construction in this manner we strive to ensure that the risk and return objectives of all our Funds meet their stated benchmarks.

    Take care,

    Mike Browne

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

    Please click here to view our disclaimer. For more information please visit our website.

    Permalink2016-10-05, 08:34:50, by Mike Email , Leave a comment