London Calling 2019....Version 4.0

The preparation for our annual offshore trip was a lot more organized than in 2018, in that this year Andrew arranged his visa with a three-week buffer period. Our Airbnb was once again secured well in advance, and all that remained was for us to get to London and soak up the opportunity to meet with a cross section of Global fund managers. The agenda for this year was to expose ourselves to either fund managers or asset classes that were not currently in our consideration set or part of our current solutions. Once again, we were not disappointed.

 The timetable and meetings were arranged by Fundhouse . . . as a team effort, between their London and Cape Town offices. This was one of the original factors that attracted us to them, as we knew that we would require a seamless solution of both local and offshore solutions to meet our clients needs. It has been fascinating to watch the growth of the London office over the 4 years. The size of the team has ramped up from 2 people to 7, the coverage of funds from 50 to 300 and most importantly the reputation that they have built, and therefore access they have to Fund Managers, has become the envy of the competition in London. (An example of this was the willingness of a US Manager – Sands Capital – to travel to the UK for a meeting with us during the week.)  When questioned by us on their relationships with Fundhouse, the fund managers feedback was always very positive:  the due diligence processes they run are honest, objective and add huge value to the fund managers themselves. They are being approached more and more by substantial offshore advisors to be their Discretionary Fund Manager as their reputation becomes further entrenched. It helps that they are salt of the earth people as well!

Meeting with Sands Capital, US fund managers at The Lanesborough Hotel

  
Investment Themes to Consider

China:  looms large on the radars of most Fund managers – some very bullish whilst others are apprehensive.  It just so happened that our visit coincided with the Trade Wars between the US and China, which made this issue very topical. The conundrum facing many global managers is, “What does China look like in 10 years?”.

Currently China makes up only 4% of the MSCI Worldwide Index (compared to 53% for the US). This seems to be in complete contrast to the relative weighting of its economic importance globally, where it makes up 18% of global GDP relative to the US’s 15%.  Importantly from a future perspective, Chinese students make up 35% of the global STEM graduates (science, technology, engineering, mathematics) compared to 5% from the US and hold 42% of the world’s patents (again compared to 18% in the US). This is no longer a ‘copycat’ economy! As the MSCI relative weighting increases, the relative holdings of global managers will have to increase furthering the case for a significant allocation to China.  In addition, the swing to “new economy” tech driven businesses like Alibaba, Tencent and JD.com have supported the case for Chinese equities. However, counter-balanced against this are several issues an investor will need to consider. Some of these being:

·        The lack (or perceived lack) of transparency, governance and compliance

·        The limited access to good investments (although these are increasing) via the complicated holding structures imposed on non-Chinese investors

·        The size and quality of the potential market – the consideration set is a pool of over 7,000 companies.

·        Language challenges.

We will work with Fundhouse to answer the question:  Do we access China directly in a specific China Fund; or do we do as part of an emerging market exposure?  We are clear that we don’t want to do so via an Exchange Traded Fund – where State Owned Enterprises make up >50% of the Chinese index.  Investing in China will require specific knowledge of the market rather than a ‘spray and pray’ approach.  Lots to think about and process.

Private Capital:  We had a fascinating morning with several teams from Schroders at their new offices on London Wall (recently opened by the Queen!). Schroders is a listed global Investment manager, with a significant shareholding still controlled by the Schroders family. They manage in excess of USD 536 billion (that is ZAR 7.5 trillion which is in excess of the market capitalization of the JSE Top 40 companies) and employ over 5,000 people worldwide. The session with the “Private Assets” team was hugely insightful. There appears to be a trend that companies are no longer listing to raise capital, but rather doing so in the Private Capital market – through debt and/or equity. In this way they do not have to face the challenging environment and exposure that a listing brings to management. It is a hot topic now – given some of the returns being experienced by managers – but the challenge is how do we get access to these markets for our clients as they are typically fairly illiquid and ideal for institutional investors. There are solutions for the individual investor, but these are typically very expensive and not well established. Hence another topic that makes it onto the “To Do” list to research.

Views from the new Schroders offices

Observations:  Our last few observations from an investment viewpoint are as follows:

·        Value, as a style for investment management is very difficult to find at present in London. It is a style that investors are familiar with in the SA context given the make up of the SA equity market. But true value managers in the UK are few and far between. Most managers have a ‘value’ metric, but it is always trumped by the quality metric. Something that we do not have the luxury of in South Africa!

·        Warren Buffet and his philosophies have a resounding following in the managers that we met on this trip. The idea of finding a quality company that can compound its earnings over the very long term and then buying it at a reasonable price, resonated amongst many managers we spoke with. This makes sense but is important to be considered in the context of a portfolio view. The last thing we must do for our clients is to create a solution filled with essentially the same philosophy managed by different names.

·        Volatility is often used as the measure of risk within a portfolio. The higher the volatility (ie the frequency and variance of asset prices) , the higher the risk of the underlying investments. This is classic investment theory that is eschewed by the managers we encountered. Their thinking, which thankfully aligns with how Andrew and I think, is that the permanent loss of capital is the correct risk measure.

Other Notes from 5 days in London:

·        London seemed to be less busy than our last trip – there were less people on the pavements and in the pubs (although you will always find someone in a pub!) Brexit may be the cause on some of this, but apparently another is the migration of local citizens out of London to smaller centres, given their inability to afford the cost of living.

·        Brexit continues to occupy a lot of time, energy and column inches! However, there is an overwhelming feeling from the people on both sides of the vote that they feel let down by the government

·        Construction seems to have cooled considerably. We did spend a session with a developer who does bespoke residential investments in South West London, who says that he is still very busy (one of his projects is targeting the serviced short-term let apartments). But as for the massive constructions with many cranes we had referred to before … these appear to have been delivered and not replaced with new projects.

·        The locals get massive utility and enjoyment from their public spaces – no matter how big or small. Given that we were staying 150 metres from Hyde Park we witnessed first-hand the sheer number of people walking, riding, jogging and just enjoying the weather and fresh air. It saddens me when one takes a walk-through Company Gardens, how unkempt and dirty and riddled with crime that it is. We have a way to go.

·        Restaurants . . . it continually astounds me as to how many options one has if you wish to eat out. From the simplest sandwich and juice bar to the many Michelin restaurants …. the choice is endless. The number I have come across (using Google) is 39,338 food service establishments – and this number feels light.  It does introduce cut-throat competition and we were amazed to see this week that a restaurant we ate at just last week – Jamie Oliver’s Barbecoa @ St Pauls – has now been placed under administration!

·        Enablement of goods/ services/ products through other platforms. For example, the simple technology of our door handle for the Airbnb that opens with a specific code versus having to exchange keys.

·        Legislation of some of these platforms can be used for good outcomes. For example, the implementation of an emissions tax in the city has led to many Uber vehicles & buses to be electric/ hybrids. The company that can win that race (and driverless cars) will have a significant outcome!

Finally, our trip has reinforced our belief that it adds great value to us and ultimately to our clients. The ability to sit in front of managers and question their thinking and process directly (as opposed to via a fact sheet), as well as to evaluate their relative abilities is a privilege, but also a differentiator. It provides a global view and allows us to have some fun at the same time!

Politics and Portfolio Positioning

In December, delegates will come together for the 54th ANC National Conference during which new officials will be elected to lead the party for the next five years. This is a contentious issue, because the president of the ANC will almost certainly become the next president of the nation in 2019, or earlier. Although there are several comrades battling it out for the seat at the head of the table, this is really a race between Cyril Ramaphosa and Nkosazana Dlamini-Zuma.

The elective conference concerns investors for three primary reasons: Firstly, this election is a break from tradition. The deputy president of the ANC is generally expected to become the president, as has been the case in the past. Given Dlamini-Zuma’s support from various senior leaders in the ANC, this is no longer guaranteed. Secondly, the market impact of the outcome is binary – it’s one or the other. There are two broad factions in the ANC at the moment: the modernists and the traditionalists, where Ramaphosa is representative of the former and Dlamini-Zuma of the latter. The modernists are generally viewed by the market as more progressive, moderate and business friendly. In contrast, the traditionalists are less favoured by the market because of their perceived preference to maintain the status quo. The two outcomes appear to have little overlap, which makes it binary. Thirdly, following Brexit and Trump’s presidential win last year, it’s become clear that unexpected outcomes can’t be ignored, and that the probability and impact of each should be carefully considered. Here, the probability of either is frustratingly opaque.

So, how do we look at portfolio positioning when the market faces a major political event with a binary, yet highly disparate outcome?

1.     Face the realities

While a market friendly political dispensation might buy us some time, weak economic indicators have increased the likelihood of a downgrade to the extent that we consider it the base case scenario – regardless of the outcome in December. Just two weeks ago, Finance Minister Malusi Gigaba released his first Medium Term Budget Policy Statement (MTBPS), which painted a refreshingly honest, yet depressing picture of the country’s finances: Economic growth projections (which government revenue is dependent on) for the next few years were effectively halved, while government expenditure is expected to increase by over 7% per year over the next three years. Consequently, the revenue shortfall is expected to rise to R90 billion by 2020/21 (from R50 billion in 2017), pushing government debt to GDP out to 61%, from 50% in 2017. Ratings agencies have, understandably, responded negatively to the statement.

Fund managers differ on the degree to which a downgrade is priced into the market, with some even arguing that it’s fully priced in. Since the MTBPS, bond yields have risen from 8.6% to over 9.3% and the Rand weakened to over 14.30 to the US Dollar, from 13.30 ten days before the statement. The All Share Index has never been higher, as the Rand hedge stocks responded well to the weakening Rand. If a downgrade in our debt ratings is only partially reflected in bond prices given what’s happened after the MTBPS, we should expect yields to rise and the Rand to depreciate further if our debt is officially downgraded.

2.     Assess the probability of outcomes

Both Ramaphosa and Dlamini-Zuma are part of the same institution (the ANC), so the elective outcome therefore has less to do with the individuals themselves and more to do with the broader groups they represent. Suppose then the following two scenarios: Scenario 1 sees the Ramaphosa-led modernists take over in December. Scenario 2 is where the Dlamini-Zuma traditionalist camp wins. Our assessment is that there is strong support for both candidates but that it’s unclear at this stage who will take over the reins in December. Therefore, a prudent way to look at this is probably to meet somewhere in the middle, so to assign a 50/50 probability to either scenario.

3.     Measure the magnitude of outcomes

We would expect the outcome of the election to have the largest impact on bond yields and the currency. Bond yields are driven by the trust investors place in the ability of the bond issuer to repay the outstanding debt. If the risk of default rises, investors demand higher yields in compensation. Importantly, bond yields and prices are inversely related, so as yields increase, bond prices fall. The value of the Rand is determined by the supply and demand interaction in relation to another currency. Financial flows out of the country for example increases the supply of Rands relative to say US Dollars, causing depreciation.

So, let’s consider the market impact of our best-case and worst-case scenarios. In Scenario 1, the market reacts positively to a Ramaphosa win and to the expectation that things will improve. We would expect bond yields to decline, the currency to strengthen (resulting in Rand-hedged equities declining) and domestically exposed equities rally. While this would be good for economic growth over the longer term, the short-term impact on portfolios is likely to be negative, given the Rand strength impact on offshore assets and Rand-hedged equities.

In Scenario 2, the markets are expected to react poorly to a Dlamini-Zuma win, because of the expectation that there will be less positive change, and more of the same.  This results in higher yields, a weaker currency (boosting offshore holdings and Rand-hedge equities), and less support for domestic equities.  Again, while this would be seen as negative for economic growth over time, we would expect it to be positive for portfolios in the short term as the weakening rand results in offshore assets and the Rand-hedged equities running.

While we have assumed that both scenarios are equally likely and that the typical market reaction will be different directionally, we don’t expect the impact of either scenario to necessarily be equal in magnitude. Consider bonds for example. Bond prices in South Africa have been artificially propped up by foreign investors this year, as part of a broader search for higher yields in emerging markets, given the low yields prevailing in developed markets. This pushed bond prices into mildly expensive territory. Post the MTBPS, yields rose resulting in a fall in bond prices closer to fair value.  If Nenegate is anything to go by, markets react more to bad news than it does to good news. The big question is how much of the downgrade is priced in when considering the impact of either scenario on bond prices.

The argument for equities is slightly different. Equities have been relatively expensive for a while now, but in contrast to the bond markets, it has rallied since the MTBPS, with the index reaching an all-time high of 60,000 on November 6th. Most of this performance was carried by the Rand-hedge industrial stocks and the commodity producers that earn revenue offshore, and therefore benefitted from the currency depreciation. These share prices will likely be supported by continued Rand depreciation. Shares that are inextricably linked to the South African economy for their earnings - think banks, retailers and most property counters - will feel continued pressure if the current economic situation continues or deteriorates.

4.     Incorporate views into portfolio positioning

Although the probability of either scenario is equally likely, the risks remain to the downside in our opinion. Portfolios are therefore positioned as though Scenario 2 is more likely to occur. In a low growth environment, with high systemic risks and an asymmetric payoff profile biased to the downside, our portfolios are positioned to protect against capital loss, instead of allocating to growth assets (like equity and property) where they provide less compensation for the risk taken.

Practically, this is implemented by maintaining a well-diversified portfolio, with an overweight exposure to offshore assets (to protect against Rand depreciation), an underweight exposure to bonds (to protect against capital losses as yields rise) and an underweight position to local growth assets like property and equity.

London Revisited

Given how much value we got from our trip last year to London, we were really excited to head off again in late May to get our annual offshore fix. Our 2016 trip was incredibly insightful for our fledgling business, as it very quickly contextualized South Africa’s relative size in the investment universe (you will recall Blackrock and Legg Mason’s AUM at that stage were $ 5.2trillion and the JSE market cap was at     $ 186 bn). In addition, the different styles of asset management were quite revealing in that, as South Africans we are programmed to accept larger “bets”, whilst offshore they are very comfortable with small incremental returns across a very broad set of holdings. I guess the investment universe is so much bigger.

Fundhouse, our partners on our Investment Committee, were once again excellent in crafting an agenda that I am comfortable not many SA advisors would be able to put together. Their growing reputation amongst UK based Fund managers, reflected in their recent award as the “Best Ratings/Research Service for Advisors” in the UK, gave us access to a broad cross section of managers – some we use and others were exposed to for the first time. The trip lived up to all expectations and then some.

But before recapping our thoughts on the Investment world we encountered there were a few things that really stood out for us on our trip this time.

·         Getting around London via taxi or bus is time consuming. Central London is bumper to bumper, even though there has been a concerted effort to expand the public transport network with new Underground stations and overland lines. The use of cycle transport seems to be growing apace, and we often used the Boris Bike system to get around.

·         Property Development, be it new build or renovation seems to be continuing. We mentioned the number of cranes in evidence last year, which seems to have dropped off a little. A lot of that stock has now been developed, which has delivered large blocks of rental stock, and makes buying residential property a slightly more challenging capital allocation call. We were fortunate to meet up with a London based ex-South African who showed us around for the morning, looking at many investment opportunities and previous projects he had completed. It was clear to us that there are opportunities for capital upside or yield, but they need to “scratched” out, with hard work and a great network. The shadow of Brexit also sits over the London residential market, challenging the demand side of the equation.

       We often marveled that London had become purely a shopping destination. Was London not once the place to travel to experience Buckingham Palace, the Tower of London a host of excellent museums? I am sure that these are still popular but rampant consumerism seems to have overhauled the cultural experience. Oxford Street, Regent Street, The Kings Road ….. in fact, any road …. was awash with people looking to shop at a range of global brands represented in numerous outlets. And access to food was comfortably addressed by a swathe of restaurants and fast food outlets. I guess the sheer volume of people living and visiting London need to get fed!

·         The growing impact of technology – good and bad! The BA IT glitch (The Bad) ensnared us on our first attempt to return. Whilst the woefully inadequate number of BA staff informed us at Heathrow of our current predicament ….. “we do not know what is going on and because ALL systems are down, we cannot help you either!” …….. we got busy on our iPhones. In just short of 5 minutes we had:

§  Contacted our families to update them

§  Booked a hotel on lastminute.com (given the BA mess, hotels were running at 96% occupancy)

§  Booked return flights within 24 hours using our Emirates app

§  Booked an Uber back into London

§  Re-arranged our meetings back in Cape Town

Given that flight and hotel bookings are driven by computer algorithms, the systems were very quick to recognize the spike in demand, and adjusted by shifting prices up automatically. Great if you are the business selling, and not ideal if you are the schmuck at Heathrow.

·         We arrived on the day of the Manchester attack, and left prior to the latest act of terrorism in Borough Market. The response by Government was to significantly build their police and army presence in the capital. It was not uncommon to see large groups of police or army personnel, fully armed, in public spaces. This did not seem to sway the masses as they carried on with life under the famous UK slogan  …… Keep Calm and Carry On!

Some High-level Investment Observations

1.      The Passive vs Active management debate is a major issue offshore. In the US, significant flows are being invested via trackers and ETF’s versus active managers (this is reportedly greater than 50% of flows). All this to save management costs and due to managers not fulfilling on the mandates (i.e. underperforming). Some active managers in the UK see this as an opportunity as they can take advantage of some of the ETF structural issues such as capital flowing into ‘popular styles’ rather than fundamentally good investments. Risks in ETF’s were highlighted, i.e. using an emerging market ETF which is massively overweight sovereign SOE’s. The question being asked – “Would you want to invest in Russian utilities?” Some of these risks were however just managers talking to their book.

Our view on passives is that they can play a role in a portfolio, depending on where in the market cycle you understand yourself to be. If markets are perceived as cheap, passives are a good way to get the beta of the market cheaply. However, if you have a concern about valuations, stock picking should become more important and one would want to be underweight ETF’s as the gearing to the downside is 100% correlated.

2.      Both Emerging Market and Value managers are experiencing a meaningful resurgence in their sectors. Both have had a torrid last 3 years, with significant outflows and negative performance during this time. Money is finding its way back as investors seek out sectors showing signs of profit growth. Valuations are cheaper in EM than DM and the margins are improving with positive earnings revisions numbers coming through.

This aligns with our views, and we have taken overweight positions in both these areas within our solutions.

3.      Many fund managers used to extol the virtues of the “Top Down” or Macro approach. This has been replaced by the bottom up view – looking for unique opportunities. Given that we have come through – and are still experiencing a period - where the “normal” risk /return profiles of each asset class are practically inverted. By this we mean that cash used to be low risk, low return and equities high risk, high return and bonds somewhere in between. This is now a little on its head in that cash is giving you no return, some bonds negative returns and equities are the “safe haven” asset class! So, I guess asset managers may have responded in the only way they could ….. seeking out opportunities bottom up! Once they have built the portfolio in this manner they then overlay other risk parameters (i.e. sector, country exposures etc.)

4.      All managers are watching and waiting for QE (Quantitative Easing) post the global financial crisis, to normalize. Green shoots of economic turnaround (i.e. growth of some sort) will encourage central banks to remove liquidity from the system. This will hopefully align with an environment that see’s interest rates increasing and assets classes reverting to their “normal” valuation metrics. The Managers were consistent in their thinking that QE had to go before we could contemplate anything vaguely described as normal.

5.      All the managers we saw had their views on what is successful and what “secret sauce” they had that was different from their competitors. In addition, the proliferation of their product offering seemed to be based not on what was needed to meet best advice but rather by what could sell. The choice is vast.

So, working with a team like Fundhouse has enabled us to see the wood for the tree’s and identify those managers whose promise was not lived out by actual management and performance, and whose solutions were more for shareholder return than investor return!!

These trips add so much colour to our view on the world and are very fortunate to be able to participate in an outing like this. The valuable insights and experience gained will no doubt add value to our business and processes and ultimately to our clients.

And again, no trip would be complete without making the most of the sights and sounds of London.

All the best,

Paul and Andrew

Looking Ahead - January 2017

Greetings to you and your family. We trust that you had a relaxing, fun and enjoyable Christmas and New Year break. All the best wishes as well for a healthy and adventurous 2017, may the challenges not be insurmountable ….. and may the Boks have a change in fortune!!

Our return to office was quite different to previous years.  After a very special family holiday for the Finlayson clan, there was no reluctance to head back to work and face a challenging corporate machine, as we have both done for the past 15 years. This was replaced by the excitement of getting back in the saddle and focusing on our own business. Our desire to create an exceptional Multi Family Office wealth management business, is still front and centre in our minds. Our first year ended in a place that we are very comfortable with and gives us good impetus to keep working to reach the goals of our clients and of Maven Wealth. Some touch points from last year:

·         The investment returns of our solutions, have been good, given the challenging investment environment (do we need to rehash 2016 and Brexit, Trump and the Zuptas!!)

·         Our client feedback has been positive, with the focus on the whole balance sheet being a key differentiator.

·         The relationships with our professional partners both locally and offshore (providing technical support in the areas of investment management, fiduciary services [covering tax, Wills and trusts] has grown from strength to strength.

·         We received a clean bill of health from both our Compliance Officers and Auditors, which was expected, but always good to get.

·         And both the number of clients and the assets that we manage have put the business on a trajectory from which we can keep growing in the targeted manner that we desire. As we have said to each client, we want to be different, by having deep relationships with a limited number of clients. We are still fully committed to this and our results and efforts to date do support this view.

So, the focus now turns to 2017 and beyond. We expect it to be both an exciting and challenging year. There are several areas on which we are focusing:

1.      From an investment management perspective, the things that we will be watching and debating at our Investment Committee’s will be:

·         How will the Trump presidency actually play out? Whilst we now understand that Meryl Streep may be an average thespian, this is a side show to the real issues of the global capital markets, trade agreements, US equity returns etc. How will the relationships between China and the US develop whilst Trump is at his tweeting best! Does the USD strength keep trucking along? It will be important to mute out the noise and focus on the underlying drivers such as monetary and fiscal policies.

·         How will the UK Brexit? It seems that the powers that be do not have a plan, but the people have spoken. How does this mess untangle and what are the financial market impacts?

·         Closely aligned to the above point is that France and Germany have elections later this year. These will be closely followed as to the long-term sustainability of the Eurozone .. and the balance sheets of the countries who form part of this grouping.

·         Who will succeed President Zuma ….. President Zuma if the ANCYL has its way! This shift in leadership must take place whilst being in the crosshairs of the global ratings agencies. We are expecting some volatility in the Rand this year.

2.      We have started planning our trip in May to meet our offshore fund managers. We did this in 2016 and had an eye-opening experience in London (please refer to our Note from that trip on our website under “Insights” www.mavenwealth.co.za). We will return to London with our Fundhouse partners and meet more of the people and teams making the investment decisions on the ground.

3.      It has always been our intention to create a community amongst the Maven Wealth network. The idea being that it would be an outstanding outcome if our clients could benefit in their work and personal lives by having access to others who have relationships with Maven Wealth. We are conceptualising plans on how we can bring this idea to life. Ideas are welcome!!

4.      Ensuring that the governance and implementation of our investment thinking continues to happen without issue. Our processes and structures that are in place will ensure that these are not compromised.

5.      Growing our team. We have reached a point in our evolution where another pair of hands is a necessity to ensure we can continue to deliver on our promise to our clients.

6.      Monitoring changes and improvements in technology that can make us more efficient and keep us ahead of the industry

7.      To keep growing our client base. To ensure that Maven Wealth is sustainable, we do need to keep growing our client base in a targeted manner (as discussed). We put a lot of effort in developing ‘Balance Sheet roadmaps’ for families and their wealth and will continue to do this. Feedback received is that our approach is unique and adds tremendous value. Your assistance in helping us to engage with the right new people is greatly appreciated.

I guess that is it for now. We look forward to reconnecting during the year and making 2017 a year we will look back upon favourably.

Kind regards,

Paul and Andrew Finlayson

Trumped

We woke up yesterday to encounter another Ground Hog Day scenario. It wasn’t Brexit this time, but the rise of Donald Trump to the Presidency of the United States. Two different situations, but two entirely unexpected results (particularly if you were a Pollster). It would seem, that the “common man” or as Trump said “The Forgotten man and woman”, be they living in central USA or central UK, has had enough with the political and financial elite and have made their choices at the ballot boxes.

Interestingly we discussed the potential of a Trump victory at our last Investment Committee meeting in October. We put the probability of a Trump upset at “MODERATE” and therefore made no knee jerk decisions to change our current investment solutions. The reason is that there are two potential outcomes with Trump winning. The first is that, if the rhetoric during his campaigning is to be believed then foreign policy would shift fundamentally with a potential strong devaluation of the USD. The second which is almost diametrically opposed, is that the outcome is good for big business which forces the markets to rally with a continuation of the 3 year USD Bull rally. As you can see, fairly diverse outcomes from a risk we saw as unlikely to happen.

So what do we do now? The immediate impact was felt on the currency markets with the GBP and EUR strengthening to the USD (but only by a %). However, in the course of the day, the USD rallied against the major currencies and is back to the same levels as the day prior to the election. Prior to equity markets opening, the Dow Jones Futures index was initially significantly weaker, but has also strengthened as analysts attempt to digest the impact of the change. In fact, the day closed with the Dow Jones in positive territory! As we monitored the currency markets throughout the day, the volatility was obvious, but possibly not as extreme as the Brexit decision in June.

We read a very well balanced article re the future prospects of the global economy given this dramatic change, from the team at Investec which is worth sharing:

 “By contrast, a radical change in direction by the world’s largest economy is not so easy to dismiss. America’s embrace of open trade has been the most important locomotive force for the global economy in the post war period. Donald Trump represents a re-appraisal of this stance. There are few companies, global or local, whose response to this result will be an increased appetite for new investment. Increased risk-aversion will likely continue to weigh on growth until the extent of America’s turn inwards is better understood.

At the same time, investors’ assessment of future prospects will be coloured by soundbite-driven media. Trump’s most divisive rhetoric will be used to highlight the worst possible potential implications of the result. In this climate, an overshoot of pessimism is more likely than not. The risk of such an overshoot is particularly high in the very near term. Financial market stability would be best served by a seamless and dignified transfer of power. Investors worldwide will be looking to Donald Trump to display a very different, conciliatory side to his character to gain reassurance about the next four years.

Having painted a cautious picture, we should also provide suitable perspective. This is not the first time that America’s choice of President has puzzled outside observers – Ronald Reagan ultimately surprised everyone. Donald Trump is a maverick, but he can clearly get things done. With the Presidency and both houses of Congress under Republican control, the logjam in the American legislature that has existed for much of President Obama’s term is broken. At the same time, a fracturing of Trump’s support within his own party provides a check on his executive authority. Once the dust has settled, there is a good chance that the most polarising Presidential race in recent memory will result in greater cross-party cooperation in the legislature. Ultimately, restrained by both the American congressional system and the need to win over sceptical business interests, he will be incentivised to build bridges - quite literally if his fiscal plans are implemented. For America, the reality of a Trump Presidency is likely to be less bad than many currently fear.

It is our opinion that it is too early to make any drastic changes. The movements being experienced currently will be more emotively driven rather than fundamentally. We are currently structured relatively conservatively and feel no current need to down weight risk any further. Conversely, if the markets present an opportunity, we may consider adding to the equity portion of the portfolios.

London Calling

PERSPECTIVE: Reflections from 30 000ft

London. It is a destination that is well known to most South Africans and a place that many have previously, or still do, call home. Geographically it is 'the centre of the world' and would hardly be called an exotic destination by modern standards. Every day, 12 million people journey in via road, rail, underground and increasingly, by foot and bicycle, to help turn the wheels of the UK and global economy.

Paul and I spent the past week in the City where we met a range of partners and service providers who assist us with the delivery of our offshore solutions. There is a growing demand (correctly so in our opinion) from clients for insights into offshore markets and we believe strongly in the need to advise our clients through our own experience – hence the desire to sit face to face with the people who are managing our money and guiding us from an offshore trust and structure perspective. In partnership with the team from Fundhouse, we met with investment managers from a wide range of companies responsible for a number of asset class strategies. In addition, we met with a number of direct equity managers and hedge fund managers.  

High level observations: Markets, asset classes, portfolio construction and general thoughts

·               It may sound obvious, but the global investment market is enormous. We are used to an industry where a few managers dominate and the market is typically driven by a handful of shares. London (and no doubt the other global financial centers like NY, HK, LA, Beijing etc) is awash with global money managers, each managing billions of GBP/ USD, staffed by teams of 100's of investment professionals. For example, two of the managers we met with were Blackrock and Legg Masson who manage a combined $5.2trn of assets! For perspective - the market cap of the entire JSE is $186bn and Coronation manages approximately $40bn.

·               As the SA demand flattens, SA managers are increasingly looking offshore for opportunities. Some have done this successfully - Investec Asset Managers is the best example - but the reality is that they will have to compete with global organizations with established distribution and research teams in most major centers. The potential exists for them to be too stretched.

·               The size of the fixed income market makes the equity market seem like a small aside. However, it is in a very tough place at the moment. Long bond rates (the interest rate the governments have to pay you to lend money to them) in most EU countries are flat to negative. Concerningly, investors continue to expect managers to deliver the same historical returns at the same level of risk. This isn’t possible. (more on alternatives below) 

·               SA is irrelevant. As tough as this is to accept, it became increasingly obvious with each new discussion. Given the array of choices available to managers, there needs to be a very obvious and attractive opportunity to attract a manager to our markets. When they did make an allocation, it is tiny relative to other positions and can be easily substituted/ removed.

·               The scale of the markets results in portfolios with a greater number of positions (shares) than we are used to in SA. Here, the commonly held belief is that a high conviction portfolio with 20-30 stocks is the best way to invest. Offshore, it is not uncommon to have portfolios with in excess of 300 stocks. The thesis is that they get more of the investment calls right than wrong and can eke out incremental gains across the portfolio - resulting in a lower risk, but still successful outcome for investors.

·               There is no single way to get results. We met with growth investors, value investors, hedge fund managers, emerging market managers, fixed income managers and asset allocators. Some managed concentrated portfolios and others very diverse portfolios. Each has a unique approach to the markets and most have been successful. The key is settling on a strategy and following through with this. To quote Ben Graham:

“To invest successfully over a lifetime doesn’t need a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework”

·               The London property market is booming. There are currently 62 cranes involved in large scale construction and the city is transforming into a reflection of the global market place that it is. In my opinion, it runs the risk of losing some of its English charm as each new glass and steel skyscraper replaces a low rise building that has stood for 100's of years. From an investment perspective, we would be reluctant to invest in UK property directly at present – particularly in London. It is difficult to gauge the demand for the property, but there is significant supply at serious prices (think R20m for a 1 bedroomed apartment near the Thames). In addition, UK tax law has made investing in your personal name less attractive.

·         The conundrum for investors continues where yields on both bonds and cash are zero or close to it. This forces cash into equity markets where the dividend yields are more attractive than the cash rates. This anomaly forces equity prices higher, despite the weakness of economies.

·         At the time of writing, Brexit was on the radar but not front of mind. The fund managers we met with expect the UK to remain in the EU. This is in contrast to some of the polls and certainly some mainstream press. It may be a case of them having a bias to this outcome? (Interestingly the most efficient predictors - the bookies currently have the 'Stay' outcome as a 4-1 favorite while the polls are roughly even). The preferred trade we came across is to be long the GBP vs the Euro. Should the referendum favour the 'Leave' camp, there is consensus that there will be a lot of volatility with the currencies under pressure. We continue to favour the USD with this uncertainty.

Conclusions and the impact on our investment strategy

·         After a period of underperformance, we believe emerging markets present some interesting opportunities. We are cognisant of the associated risk and volatility, but feel that the time is right to have some exposure. Currency does need to be taken into account when making these investments as long-term developed market currency strength can assist with the return outcome.

·         The belief that, as an individual, you can manage global investments (or even a portfolio of investments) can be seriously challenged. The universe is very large to cover and to find all opportunities. This trip has reinforced our belief in the relationship we have forged with Fundhouse. Their ability to provide deep, independent insights, due diligence and analysis of the markets adds immense value to our process.

·         Given the downside risks that currently exist, passive investment strategies may suffer, should equity markets come under pressure. We believe that it is an appropriate time to allocate funds to active managers who can seek opportunities outside of the main/ large cap indices and are therefore currently underweight our target passive allocation.

·         Alternatives need to be considered. We are considering hedge fund and absolute return funds as an alternative to long only equity funds. The Ucits (unit trust) structure offshore, with its strong governance overlays, provides investors with some viable alternatives.

·         We believe that alternatives to pure fixed interest investments should be included in a portfolio. There are a number of ‘total return’ type funds that can seek returns in variations of fixed interest investments and have a broader range of alternatives. We are currently including these in our portfolios

·         Despite the concerns around pricing of offshore markets, we believe that the opportunity set continues to justify an overweight offshore position – particularly given SA specific risk.

Finally, I called this piece 'Perspective', primarily for the perspective gained through the work experience. However, while we were abroad, we were reminded of the value and enjoyment of working together – sharing a vision for our business and our clients. It confirmed our belief that the path that we have chosen is the correct one and will give us the platform to add huge value to the lives of others in due course. And, if we can have some fun along the way, even better!

Junk Status: Facing the realities of a potential downgrade

There has been widespread media coverage and speculation regarding South Africa’s (SA) credit rating and the likelihood of a downgrade to “junk status”. But what does “junk” actually mean and how will it impact SA savers and investors?  In this article, we look at the world of credit ratings, why SA is facing a further downgrade and what that could mean for South Africa and the various investment opportunities in the market.

Credit Ratings: What are they and why do they exist?

There are three main global credit rating agencies: S&P Global Ratings (S&P) and Moody’s Investors Service (Moody’s) control 80% of the market and together with Fitch Ratings (Fitch), they control 95% of the global ratings market.  These are private companies that have carved out a critical, but often controversial niche for themselves as they have considerable influence by determining the credit-worthiness of countries and companies alike. The credit rating itself attempts to provide an indication of a debtor's (this could be a country or a company) ability to pay back debt. Obviously, where there is a greater likelihood of the debt being repaid, the risk of the debtor is lower and a higher rating they will be given. The opposite also applies. Ratings agencies are positioned to assist investors in making investment decisions by giving an indication of the perceived risk and assigning a rating to a potential debtor. It is this position that gives them immense power in the global financial environment.

The agencies use different notations for the various ratings (which adds to the confusion) – the table below sets out the various rating definitions:

In addition to the rating, the agencies will also provide an indication of the direction in which they see the rating heading.  If their opinion is that the credit rating is likely to worsen going forward they will put it on negative watch, and similarly if they believe there is likely to be an improvement, they would indicate the trend as positive.

Credit rating of South African government bonds

The debtor in this case is the SA government and the loans are SA government bonds. In determining the credit rating, the agencies are effectively forming an opinion on the likelihood of the SA government defaulting on the terms of the loans provided to them by investors.  The chart below shows the history of credit ratings for SA foreign denominated debt since 1994:  

As can be seen in the chart, the rating agencies don’t always agree: while all three rating agencies do still regard SA foreign denominated government bonds as investment grade, S&P have given the lowest possible investment grade rating (BBB-) and put it on negative watch while Moody’s this week chose to maintain its rating of Baa2 (on a negative watch) which means it still has another rating tier to go before “junk”.

There is general consensus in the market and amongst economists that SA foreign denominated government bonds will be downgraded to “junk” status at some point this year by S&P (i.e. a move to BB+), and Moody’s will move the rating to Baa3, their lowest investment grade rating.  S&P review the rating every 6 months with the next review in June and then again in December – the question seems to be less about whether a downgrade will happen rather more about whether it will be June or December.  

However, it is important to distinguish between different types of debt issued by the SA government – they issue debt both in local and foreign currency.  The rating agencies consider these separately (as shown in the table below).

For both S&P and Fitch, the rating of local currency SA government debt is higher than the foreign currency debt (which is often the case due to higher risk associated with currency).  S&P would need to drop the credit rating 3 levels to move local currency SA debt to “junk”.  So all the discussion and debate around the potential downgrade to junk this year applies to the SA government debt issued in foreign currency (approximately 10% of the total debt). 

Why the potential downgrade?

In simple terms, South Africa is facing a downgrade for two reasons:

1.             Slow growth – along with the rest of the world, SA faces lower levels of growth than forecast (and these forecasts continue to fall).  There are a multitude of reasons for the slowdown including depressed commodity prices and reduced global demand for commodities, but also a lack of willingness to invest with all the current uncertainty around government policy.

2.             Fiscal outlook – effectively this relates to the ability of the country to control spending given the tax base so that excess spending does not need to be covered by issuing more debt.  With low growth and high unemployment, tax revenue is under pressure and spending on benefits is rising.  The government’s target to limit gross debt to 50% of GDP is going to be very difficult to achieve.

All of this is not helped by concerns around the independence of the Treasury and the South African Reserve Bank.  The long held belief of the international community in the strength of this independence was severely tested late last year with the “Nenegate” debacle. Political upheaval, which has led to calls for President Jacob Zuma to resign, is compounding the economic risks.

As a result, rating agencies are expressing a concern that the ability for SA to meet future loan repayments is deteriorating.  They will be looking very closely as to whether SA is able to control its spending (and ideally reduce it) while implementing government policy to spur growth.  Cutting spending in an election year is going to prove challenging. 

What impact would the downgrade have?

There are two main impacts of a downgrade:

1.             Reduction in Foreign Investment: 

-                Large foreign institutional investors (included pension funds, hedge funds and asset managers) will in many cases not be allowed to invest in any asset with a “junk” rating (prescribed by their investment policy/guidelines).  This means they will not invest in SA bonds or they will sell their existing investments.

-          For index or passive investors, they invest in line with an index and will often use the World Government Bond Index (WGBI) for global bond funds.  The index will exclude any “junk” status bonds.  However, the local currency denominated SA debt is included in the WGBI (not the foreign currency debt which is facing the downgrade).  Therefore, if the country loses its investment-grade rating on its foreign currency debt, the local currency debt is not impacted and it will not force widespread selling from rand-denominated South African government debt by the passive managers.

-          However, despite the higher credit rating on local currency debt, there is potential for a knock on effect and for investors to sell down their rand denominated bonds as well.

2.       Cost of borrowing:

-          A lower credit rating implies that there is more risk associated with buying the debt.  As a result, investors demand a higher return on that investment (i.e. the yield needed is higher to attract investors).  Therefore, a downgrade would raise the cost to the SA government (and SA companies) of borrowing money.  Effectively more tax revenue will need to go towards paying higher interest on debt.  We already run at a budget deficit in SA (i.e. we spend more than we earn using debt to make up the difference) so this higher costs of borrowing will enhance the deficit. 

-          This higher “cost of borrowing” makes capital more expensive (and less accessible for SA companies) which generally has a knock on effect of reduced investment and growth. 

-          The foreign denominated debt of SA corporates will also be under the spotlight and it is likely that their corporate credit ratings will also be downgraded (resulting in higher costs of refinancing)

These impacts will then impact the price of SA assets - most notably SA bonds and corporate credit.  Yields on SA fixed income have risen materially over the past 6 months and the view of many asset managers is that the impact of a downgrade is already priced in (if not entirely then to a significant degree).  In other words, if the downgrade did go ahead, the view is that yields would not be materially impacted as the negative news is already anticipated in the price of bonds.

There is also the potential for knock on effects to the currency on the back of foreign outflows and an indirect impact on the equity market driven by the economic uncertainty and risk perception of investors.

On the positive side it appears the threat of the downgrade is driving constructive dialogue between government and business in SA which has been sorely lacking for a number of years now, and there is an increased focus on curbing government spending by Minister Gordhan.  Regardless of whether it is too little, too late to avoid a downgrade, both of these developments will start to move the economy in the right direction.

Implications for our client portfolios

Given these views relating to the currency and yield markets, as well as concerns for growth and asset prices around the world, we continue to maintain a defensive position in our portfolios. We believe very strongly in managing the downside of a family’s investments. We know that opportunities to grow a capital base will present themselves in due course. However, given the uncertainty across most asset classes – both in SA and internationally – we do not believe that now is the time to be taking undue risk. Whilst having defensive exposure across these asset classes, we believe we will be rewarded for showing patience at this time.

Maven in the news

http://www.bloomberg.com/news/articles/2015-12-11/wealth-managers-say-zuma-shock-has-clients-seeking-rand-escape

Markets the catalyst for political change

The past week has been one of the toughest I have endured, not only as someone involved with investment markets, but more so as a regular South African citizen. For years I have considered myself one of the positive minority. One of the guys who will seek the silver lining behind the dark cloud that is often SA Inc and reassure my family, friends and clients "that it will all be okay". However, that was significantly tested last week as the reckless President ignored all the common sense advice offered to him and fired his finance minister, only to be replaced by someone best described in golfing parlance as a hacker. All at a time when the South African economy is crawling along and the global financial community is sharpening the knives, ready to downgrade our already poorly rated bonds to 'junk status', alongside economic superpowers such as Suriname, Mongolia and Macedonia. Needless to say these countries don't have much appeal to investors, causing the cost of borrowing to escalate and generally putting ongoing pressure on the economy. 

However, we may well reflect on this time as the moment when something so bad happened that something good can come out of it. Is this the moment when Zuma has overplayed his hand and the collective will of South Africans is united behind a common cause? Certainly the 150, 000+ signatures to the #zumamustfall petition indicate an awakening of the previously largely apathetic populous. Added to this are the organised marches and social media campaigns. This might just be the swinging of the pendulum.

Then the euphoria of Sunday night. After the Blitzbokke provided us with an oasis of joy amidst the maelstroom of SA politics, an announcement was made that Pravin Gordhan had returned from the wilderness of Co-operative Governance and Traditional Affairs to the hot seat of economic power. One can only imagine the crisis meetings behind the scenes. In a method that seems unique to South Africa, fellow politicians and big business maintained their game face while negotiating behind closed doors. On Sunday, at a time when the public lamented the lack of action,  a senior banking exec was overheard to say that the correct trade was "long ZAR, long banks" - hardly imaginable on the previous Friday. This had to be an indication that big business had finally flexed its muscles. 

The catalyst for this change has largely been the market. The currency, acting as the scoreboard for the government, very quickly indicated the state of the game. From an already weak R13.60/ USD, the currency rapidly weakened to almost R16/ USD with the bond and equity markets also blowing out to the tune of R500bn. Whilst we could petition JZ to "pay back the money" for Nkandla, there is nowhere this money can be recovered from, other than the market and the improving sentiment. On the scoreboard, the currency is now trading at R15/ USD - certainly an improvement, but still leaving the economy in a vulnerable position with inflationary pressure and potentially higher interest rates looming.

As one reads the financial and news columns, you are left with an overwhelming feeling of: "you can't make this stuff up". Will history reflect on this moment as the time when South Africa got its mojo back? Only time will tell. 

Real advice starts with 'why?'

I recently met a prospective client to discuss their 'situation'. The interaction began as these matters often do - with an exchanging of an investment statement and a request to give feedback on the current portfolio - to see if there were any improvements or suggestions we could offer. There were a number of these and we duly went away, put our heads together and returned with an analysis. Typically, this analysis considered all of the quantitative elements: what percentage of the portfolio was invested offshore compared to local markets; what diversification had taken place; how many counters were included in the share portfolio; what was the long-term intention for the capital etc. Whilst this analysis added some value, it felt a little 'thin' and somewhat 'commoditised'. 

In the course of the feedback session however, we began to talk. And I mean really talk. We moved off the numbers and started to discuss real issues. We got to understand where the money had been made, why it had been invested the way it had and what it was ultimately to be used for.  As it turns out, there was more to the family than was initially thought. The father - the creator of the wealth - had discovered he has a debilitating illness. In addition, he has 3 adult children and there are some financial dependency needs within the family. Until this point, the estate planning and succession needs have been relatively simple, but suddenly this situation has changed and a new approach is required as the prospect of curators and legal complications loom.

The longer the conversation went on, the more we realised that this was the advice that really mattered. By gaining these insights, we have the ability to remove the potential for the train wreck that we can see coming down the line and give the family the peace of mind that the hard-earned capital will be used as it was intended and not be the cause of ruin in the family. 

The process reinforced our belief that it is only through our clients willingness to share their 'full' stories that we can really make a difference in their lives. This revelation can only take place through a large amount of trust which has to be built over time, and by not being afraid to be bold and ask the question "why?".