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    Seed Weekly - Earnings Jump on the JSE

    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 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.

    Our local equity model has ranked local equity as expensive for around 5 years now, and our models currently indicate that the market is within 6% of most expensive valuations since 1986. 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.

    At the end of February, we have seen the market PE ratio come down from an all-time high of 23.5 to a less extreme, but still expensive, 19.8. The market PE ratio can decrease when either company share prices go down, reported company earnings go up, or both. During February, the JSE fell -3.1%, which accounts for some of the -16% drop in PE. We therefore did some further digging to investigate the earnings increase that would account for the rest of the change.

    Chart 1 : JSE All Share Index PE ratio since September 2011 (low of 12.1)

    Source: INET (28 March 2017)

    Investigating the PE ratios per sector on the JSE, it is clear that some very strong earnings had come through in the Resources sector, resulting in the PE dropping from 29.3 to 15.5 times. At face value, it seems as if Resources has gone from being as expensive as the Industrials sector to being as cheap as the Financials in a single month.

    Chart 2 : Sectors PE Ratios

    Source: INET (28 March 2017)

    This again highlights one of the pitfalls of using a historic PE ratio – a sector can appear expensive, just because the market already places a premium on strong earnings that have just not been reported yet. As soon as reporting season starts and the higher earnings come through from the data providers, a high company or index PE ratio can unwind very quickly.

    Table 1 : Illustration of the resource shares with significant changes in reported Earnings per Share during February

    Source: INET (28 March 2017)

    Within the Seed Balanced Fund, each of our two local equity managers have a wide mandate and are not restricted to specific sectors or industries. On a sector level, the consolidated local equity exposure within the Fund does not differ vastly from the JSE All Share Index at the moment. The combined portfolio has an active share of 55% with a slight overweight to Industrials, slight underweight to Financials and an on-weight Resources exposure.

    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.

    Permalink2017-03-29, 10:19:56, by Mike Email , Leave a comment

    Seed Weekly - The Shift to Passive Investing

    When it comes to investment management trends, the US tends to lead the world. One trend that started as a trickle to become a raging river is the flow of investment funds away from active managers over to passive fund managers.

    In his annual report for Berkshire Hathaway, Warren Buffett has over the past few years continued to endorse the idea of passive investing rather than active investment management. His advice is for investors to rather opt for a low cost S&P500 index fund (i.e. a passive index tracker).

    The statistics are proving that in the US at any rate, investors have started to listen to him and others. Morningstar reported, “In the U.S., the gap between active and passive flows has never been wider. U.S. index funds received $492 billion in 2016. Their active counterparts, in sharp contrast, saw $204 billion fly out the door.

    So just what is passive and active?

    A passive investment strategy is a fund or investment strategy that merely tries to replicate a certain index as closely as possible over time. Because the constituents and construction methodology of most indices, like the S&P500 index, are made available, a simple strategy is for a portfolio to exactly replicate this.

    Active investment management, on the other hand, is a style of investing where the portfolio manager aims to design a portfolio that will outperform the fund’s benchmark or index. The selection of shares and the weight of the shares will therefore differ from the index in attempt to produce a superior result.

    The pioneer of index investing in the US is Jack Bogle, founder of the Vanguard Group. This fund manager is now taking the lion’s share of money moving into the passive space. The chart below compares the flow of funds into active and passive strategies over the last 10 years.

    Chart 1: Flow of Funds to Active and Passive Managers in the US

    Source: Morningstar Direct, 22 March 2017

    Multi management is the blending of both asset classes and specialist asset managers within one fund. Therefore, while we discussed the merits of diversification last week, an investor can obtain these benefits within one multi-asset, multi-management fund.

    In our opinion, the rise of passive management merely provides more options to a multi-manager when looking to combine different investment assets, funds, and investment styles. A manager can combine the best of both worlds - passive strategies, which aim to extract merely the market return for an asset class at the lowest cost possible, with active strategies that aim to extract additional alpha (i.e. a return above the market).

    Active and passive strategies will typically perform differently in different market cycles. Normally, in strong bull markets, as we have witnessed over the last 8 years in global equities, passive strategies will tend to outperform. However, in choppy and sideways markets, often characterised by sector rotation, good active managers will tend to produce superior results.

    At the same time, passive strategies can be very specific. For example, on a global scale, there are passive index funds that only comprise healthcare shares, or only IT (information technology) shares. These can be used with great effect within a multi-manager portfolio.

    At Seed Investments, we are very positive about the global availability, and increasingly so, local availability of passive investment strategies. The expanding choice is excellent where we are looking to blend different styles and investments with low correlations.

    Kind regards,

    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.

    Permalink2017-03-23, 14:00:12, by Mike Email , Leave a comment