VCS Agency - Lunar Capital

Share Focus: Discovery

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Discovery’s purpose is to make people healthier and enhance and protect their lives. Does it make a good investment?

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Goals Conceded, Saved, Missed and Scored

Archive / By VCS Agency

In a football league, the team that becomes the champion at the end of the season is the team with the most points¹. Three points are awarded for winning a game, one for a draw and zero for losing. A game is won by scoring more goals or conceding less than the opponents.

Recent irregularities, scandals, rumours, and negative reports on various companies have created lots of angst amongst investors. In this article, we dwell on some of the companies that have been caught up in these events and how it impacted the Lunar BCI Worldwide Flexible Fund (Lunar), if at all.

Did we concede any goals that we could have prevented?
Did we save any goals that would surely have been scored if we didn’t defend well?
Did we miss goals that we should have scored?
Did we score goals because we were well-positioned?

Viceroy Research

It started in December 2017, firstly with the sudden resignation of Marcus Jooste, CEO Steinhoff. This was followed a day later with Viceroy Research’s report on Steinhoff. Steinhoff’s shares drop by approximately 90%.

Since then, we had rumours of negative reports on Aspen, a published report on Capitec by Viceroy, a published report by 360One on the Resilient group of companies and a scandal involving DSTV, a subsidiary of Naspers.

How was Lunar affected?

Steinhoff (SHF): Lunar was not invested in Steinhoff. Our main reasons for not investing in Steinhoff were 1) as a group, it did not fit in with our investment themes; 2) we also viewed the company too complex to understand; 3) we were uneasy with the company’s strategic direction. Steinhoff had large holdings of PSG and Shoprite in its portfolio, and Lunar was invested in both of these. So, tactically, we decided to reduce our holdings in these 2 businesses even though we liked them. Our view was that Steinhoff (and management who were highly leveraged) would be forced sellers of their holdings to repay bondholders and lenders. We would thus be able to acquire both PSG and Shoprite at better prices later. As it turned out, this was correct for PSG but not for Shoprite, as PSG’s shares dropped, but Shoprite’s in fact rose. We avoided the Steinhoff issue but were marginally caught in the waves that it created. The net result was no significant impact to our fund. We view this as a goal saved.
Capitec (CPI): When Viceroy did come out with its second report, it was a surprise that its report was on Capitec. Lunar was not invested directly in Capitec, but we were invested in PSG. Approximately 50% of PSG’s net asset value was and still is made up Capitec. This report came at an inopportune time for us, as we had started rebuilding our holdings in PSG. We successfully bid in the Steinhoff sale of PSG shares. PSG, in our opinion has excellent underlying businesses, a very strong management team, and it was trading at a discount of approximately 17% of its net asset value. Their businesses fit in well with our investment themes. We were of the opinion that Capitec was overvalued because the share price was implying much higher growth than what it could likely achieve. But, our view was that the discount was a sufficient cushion. Once the Viceroy report came out, we stopped building up our position and again reduced our stake in PSG. We do not agree with most of Viceroy’s allegations and would most likely add to our holdings in PSG once the dust settles and Capitec is trading at a better price. This has impacted the fund marginally and we view it as a goal conceded. The question we ask ourselves is: Could we have avoided it?
Aspen (APN): Before Viceroy’s report on Capitec came out, the market speculated that one of the companies that Viceroy is targeting is Aspen. This put some pressure on the Aspen share price. Lunar was and still is invested in Aspen. In fact, we increased our stake somewhat when the share price came down. The business fits in well with our investment themes and whilst in the past valuation was an issue, it is trading at much better value now. There is no impact on the fund holding Aspen, in fact it allowed us to buy increase our holdings at better prices. We view this as a goal scored.
Resilient (RES) and related companies NEPI, Fortress, and GreenBay: We have generally been quite negative on the property sector, especially those with large shopping centre holdings. We were and are still not invested in any of these. In the property sector, we prefer the logistics warehouse plays, those leased to logistics and internet retail businesses like DHL and Amazon. Goals saved.

Naspers (NPN): The issue with Naspers is not the same as those above, other than one of its subsidiaries (DSTV) was involved in some dubious transactions with the SABC and ANN7 (previously owned by the Guptas). This scandal may have had a marginal impact on its share price. However, Naspers was one of the top performing shares on the JSE last year on the back of a significant increase in the share price of Tencent, its Hong Kong based investment. Lunar was not invested in Naspers, even though it met our investment themes, for the following reasons:
- A large portion of Lunar’s offshore investments are in technology companies (Amazon, Facebook, Alibaba, Nvidia). We did not want to over-expose the fund to the technology sector by also adding Naspers as an investment;
- Whilst Naspers trades at a discount to its net asset value, our view is that the discount is justified as the remaining businesses in the Naspers stable run at a loss, and that Naspers does not own its shares in Tencent, it only has rights to the earnings and dividends in the company.

                                                               ____________

So, how did we perform as a fund in the five scenarios above? Overall, we played a good defensive game, avoiding many goals that could have been scored against us. We got caught somewhat in the whirlwind of activity around Steinhoff and Capitec, which created repercussions for our holding in PSG. But, we also managed to take advantage from the situation around Aspen. Perhaps we missed a big goal by not investing in Naspers, but we would have been proper fools if there was a big correction in the technology sector.

Lessons learnt

This is a good time to reflect on our investment guiding principles:

We buy quality businesses at fair prices.
We debate and identify the thematic trends that will deliver growth in the 3-10 year horizon. Our portfolio will be concentrated, reflecting the thematic trends and companies we want to be invested in.
We only buy companies that we understand: how they make their money, what their risks are, and what their strategy is, etc.
When prices are low, we gear up; similarly we sit on cash when prices are high.
We measure and report our performance – and we strive to be honest about the reasons for our success/losses.
We meet regularly and debate as a group what the investment themes are, the companies to consider investing in, the investment philosophy/style, etc.
We take every opportunity to learn and refine our investment management skills and our knowledge of the companies we are invested in.
We keep an investment diary: we write-up the investment philosophy, the selected investment themes, the investment case for each company we consider investing in and then check back when we divest, the reasons for our success/failure.

We think that these guiding principles are still intact and some valuable lessons have been learnt in the last few months:

Aggressive short-sellers will become a more prominent feature of the South African markets. This will present both risks and opportunities.
The risk of permanent loss of capital increases as the market becomes frothier. But, staying out of the market can be even more hurtful to the investor. Finding, the right investments and balance in the portfolio becomes even more critical during these times.
Volatility is not risk. Risk is being invested in a bad or over-valued business.

1 If two or more teams have the same points, then the team with the largest goal difference is the winner. There are further rules if goal difference is also the same, but we won’t go into that detail here.

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Lunar BCI Worldwide Flexible Fund End of Year 2017 Report

Archive / By VCS Agency

Market Overview

The calendar year 2017 was another roller-coaster year for the investment markets in South Africa and globally. Some of the more significant events include:

Ratings agencies downgraded South African sovereign debt to junk status, citing political and economic risks facing the country;
Serious allegations of mismanagement and corruption in state-owned enterprises, including Eskom, Prasa, SAA and the SABC;
President Zuma reshuffled his Cabinet resulting in amongst other changes, Pravin Gordhan and Mcebisi Jonas being replaced by Malusi Gigaba and Sfiso Buthelezi as Minister and Deputy Minister of Finance respectively;
A volatile Rand, starting 2017 at around 13.75 to the US Dollar and ending the year at 12.35. The Rand reached 14.40 to the USD during the year;
The resignation of Markus Jooste as CEO of Steinhoff and the related fraud at the company;
The ANC NEC elections which ultimately resulted in Cyril Ramaphosa being elected as ANC President, but more-or-less evenly split along factional lines in the rest of the NEC.

These and other factors such as valuations and market sentiment played out in the market:

The JSE All Share Index rose by 21% (including dividends), led by Naspers (+71.3%), Discovery (+62.4%), Capitec (+58%);
The Nasdaq increased by 28.24% for the year in USD and by 16.02% in ZAR.

Performance

The Lunar BCI Worldwide Flexible Fund reported an increase of 9.64% (after costs and fees and including distributions) for the year and 9.47% since our inception on 1 June 2016. The following factors were the main drivers of our performance for the year:-

We held higher levels of cash (20% as at year-end) as we were of the view that there was higher levels of risk in the market;
Small cap shares were under severe pressure. Whilst not a big part of our portfolio, we held and subsequently sold at a loss underperforming small cap shares (Consolidated Infrastructure, Rhodes Food);
Whilst we held no Steinhoff’s in our portfolio, our holdings in PSG and Shoprite were impacted. Steinhoff and related entities own large stakes in PSG and Shoprite and they were and still are sellers of these holdings to raise cash and meet the obligations of creditors:
- We mitigated our risk by reducing our exposures to PSG and Shoprite, but are of the opinion that these are still great businesses.
Our best performers during the year were:
- South Africa in ZAR: Discovery (+64.07%), FirstRand (31.28%), PSG (27.08%)
- Offshore in USD: NVDIA (+99.25%), AliBaba (+55.56%), Amazon (+52.32%), Facebook (+47.10%)

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We would have liked to have performed better than we did but are satisfied that most of our major investments have performed well. Our positioning was somewhat risk averse during the period. Where an investment did not pan out the way we envisaged, we analysed the reason/s for it and used that to improve our investment process.

“The stock market is a device of transferring money from the impatient to the patient.” – Warren Buffett.

We have been patient, and will be until we think it is time to be more aggressive.

Portfolio

Our portfolio composition is as follows:

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Outlook

There are a number of concerns in the global political and economic environments:

Likely interest rate increases in the developed economies;
A potential credit and related real-estate bubble in China;
The policies that the new ANC leadership will articulate and the ability of government to execute on it is still very uncertain;
Geopolitical tensions in Korea and the Middle east;
High valuations in the stock markets:
o The PE ratios of selected markets currently are:
– S&P 500 (US) has a PE ratio above 22;
– Nasdaq has a PE ratio above 27;
– JSE All Share Index has a PE ratio above 22.
These are high from a historical perspective, making the market appear to be overpriced, but there are large variations between individual stocks.

We anticipate that volatility will likely continue to feature in the market. Theme and specific stock selection will again play a key role in our portfolio composition and ultimately performance.

Theme Review

Our investment themes for 2017 were:

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We believe that by-and-large these themes are still intact and we have refined these as follows:

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We have refined these themes to better reflect the opportunity that they represent and the changes since we last revised our investment themes:

Millennials stamp their economic authority
o As millennials enter the ages when they start settling down, we believe that they will become a more important economic power. This will reflect in how they shop (on-line), where they buy homes and settle down (cities) and what they value (experiences, environment, family).
Baby Boomers need care
o As the Baby Boomer generation reach retirement age, they will need care (financial, health, services, drugs). In general, longevity has increased which implies that these services are required for longer and that the aged are healthier than previous generations. They will seek retirement villages that better cater for their healthier lifestyles.
Cities are where its happening
o The migration from rural areas and small towns to cities continues, with increased demand for housing and services (water, electricity, transport). The trend of megacities dominating economic activity globally is still intact. Foreigners continue to acquire properties in mega-cities.
African Middle Class taste the good stuff
o Globalisation and the increasing wealth of the middle class in Africa shape how they change their spending habits (supermarkets, global brands, travel).
Economic power drifts and shifts
o In the last few decades global GDP has shifted from the developed markets to developing markets by a ratio of approximately 80/20 to 60/40. China has been a large beneficiary of this shift, but other markets like India, Turkey, Brazil and Indonesia have also benefitted.
Resource scarcity spurs innovation
o The demand for energy has spurred the revolution in renewable energy. Agricultural technologies have also significantly improved yields in food production. We anticipate similar innovations in water and energy technologies. Commodity cycles will continue to ebb and flow providing investment opportunities.
Technology disrupts the status quo
o Information, pharmaceutical and genetic technologies will continue to develop and potentially disrupt industries and businesses. Blockchain technologies in particular have the potential to disrupt. It will be fascinating to watch how this plays out and what investment opportunities it will bring. The rise or death of cryptocurrencies will also potentially provide fascinating viewing and maybe opportunities. Similarly, looking out for the next block-buster drug or killer-app will be key in unlocking investment opportunities.

Where we do identify potential companies to invest in, we will apply our minds in determining what fair value is for those companies. We will only buy those that we believe provide the right rewards for the risk that we take. We wish to obtain above average and real returns at a portfolio level for our investors.

* * * * *

Thank you to our clients, staff, directors, and business partners for your support, guidance and friendship. Whilst there are significant risks in the financial markets at the moment, there will be opportunities from which to profit. It is left to us to identify these risks and opportunities by continuing to improving our investment philosophies and methodologies and ultimately providing a platform for growing the wealth of our families and communities.

Lunar BCI Worldwide Flexible Fund End of Year 2017 Report Read More »

Share Focus: Facebook

Archive / By VCS Agency

People use Facebook to stay connected with friends and family, to discover what’s going on in the world and to share and express what matters to them.

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Delaying Gratification

Archive / By VCS Agency

Delayed Gratification

In the world today, you can get most of what you want from a simple click:

Want to eat? Click.
Want a cab? Click.
Want a book to read? Click.
Want to know which of your friends are going to be in Johannesburg over the holidays? Click.
Want some entertainment? Click.
Catch up on news? Click

Gratification is almost immediate.

You want to invest? Click.

Unfortunately with investing, there is almost always no immediate gratification. In fact, if you invested in a predominantly equity based investment, then market gyrations can even have the opposite effect of gratification – causing you serious consternation as the value of your investment rises and drops.

In investing, your gratification comes only years later.

We know that it is “time in the market” that gives you the best opportunity to grow your wealth. Having the patience to allow your investments to get the benefit of compound growth over many years will most likely result in real growth in your wealth. But most of us are not wired to wait many years to see results – we want to see immediate results.

Incentives

The Vitality program from Discovery (a Lunar BCI Worldwide Fund core holding), incentivises healthy living. Whilst one can see the benefits of healthy living within a few months, the real benefits are substantially more in the long-term. So by providing Vitality points for day-to-day healthy living (exercising, eating healthy food, regular check-ups, etc.), Discovery has found a way to provide some early gratification for behaviours that one may only get the benefit of much later in life. Needless to say it is also good for Discovery’s business to have healthy clients.

At Lunar Capital, we regularly ask ourselves how we can incentivise investing.

If you have the patience to regularly invest over the long-term, then you don’t really need short-term incentives. But most of us do not have the patience and want some form of instant gratification. We need incentives to make us invest for the long-term. We need a Vitality programme for investors.

History and Culture of Investing

In South Africa, our history tells us that the majority of the population of this country were left on the economic side-lines. They did not have any way of learning about investing from their families as most families lived from hand-to-mouth.

Those that were in the economic mainstream would in all likelihood have had the benefit of learning from their parents about the importance of investing or seen first-hand the benefits that investing brought to their parents. They may also have had the experience of having a savings account or better still an investment account opened in their names when they were young. In this way they learnt early on about interest and compound growth. With this first-hand experience, they learnt about the value of delayed gratification in investing.

Post 1994, the Black middle-class in South Africa grew quite quickly. But investment levels in this sector is still very low. There are a variety of reasons for this, like providing support to the extended family and having to start building their economic lives from virtually nothing. But not having the first-hand experience of the value of long-term investing has also played a big role in low investment levels within our communities.

And hence our drive at Lunar Capital to improve the knowledge of investing within these communities. As a small business, we cannot afford to develop and run an incentive programme like Vitality at this stage. So, we try to incentivise people differently.

Teach a man to fish

By sharing our insights and the insights that we learn from others, we aim to make our clients more knowledgeable so that they can invest on their own. They can be more selective when acquiring the services of professionals, using them only for specialised requirements. In this way they reduce their costs and are also not influenced by the biases (some incentive induced) of their professional advisors.

Similarly, we also provide tools that allow investors to better track their net worth and their asset and liability profile. In this way, they can track the growth of their net worth and make informed decisions on where and how they need to invest to meet their long-term financial goals. We have run free workshops to help people track their investments and develop an investment strategy for themselves. Many people find that by tracking their investments over a few years and by observing this growth, this in itself becomes an incentive to invest more.

We also recently started a Share Focus campaign where we aim to regularly feature a company and provide some of our views on that company so that individual investors can use that in determining whether to invest in that company or not.

Unfortunately, none of these are the kind of incentives that provide instant gratification. What we aim to do is to “wire” into our clients and followers the importance of improving their knowledge of investing (LEARN); being invested over the long-term (INVEST); and by delaying gratification, getting much bigger rewards later on (ENJOY).

Learn to delay gratification

In a long-term experiment with children, where a child is put into a room with a marshmallow. The child is told that she can get two marshmallows if she does not eat the marshmallow in front of her until a bell is rung after approximately 15 minutes (quite long, especially for a child).

What was found was that those that could hold out, generally performed better in life as they grew into adults. One can interpret from this experiment that those who have the ability to delay gratification, will get bigger rewards later.

This is exactly the case with investing. Those that can delay gratification will earn outsized rewards later on. Develop a strategy to invest for the long-term and stay the course. The benefits will be much bigger than what you give up now.

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Share Focus: Stadio BEE Offer

Archive / By VCS Agency

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Stadio (SDO) recently unbundled from Curro, which is part of the PSG family. Stadio will continue
to be part of the PSG family. Post the unbundling, they have announced a capital raising rights
offer) as well as an offer to raise R200m from invited BEE participants.

View our Summary

https://lunarcapital.co.za/wp-content/uploads/LC-Share-Focus-Stadio-BEE.pdf

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Thinking about my biggest investing mistakes

Archive / By VCS Agency

Shhh..

As the Naspers (NPN) share price keeps on powering ahead, I can’t help thinking why did I ever sell the Naspers I bought for my wife’s portfolio a few years back (Shhh.. please don’t tell her).

In 2010, I bought some Naspers for my wife’s account for around R298 per share. Within a period of a few months, the share price rose by over 50% and I thought that this couldn’t get any better. Who wouldn’t want to earn a 50% return in a few months? So, I sold them to lock in the 50% gain. And since then, all I’ve done is painfully watch Naspers go higher and higher (not in a smooth line, it has had a few very sharp downwards movements too). Today, it is trading at over R3000 per share – so, by locking in a 50% gain, I (actually my wife) lost out on a 1,000% gain.

Mistakes

Every investor who has been in the markets for a long-time, will be able to relate stories like the one above.

To paraphrase Warren Buffett, there are two categories of mistakes that an investor can make:

Mistakes of Commission; and
Mistakes of Omission.

Mistakes of Commission

A mistake of commission is one where we consciously made a decision which was a mistake. Examples are:

We decided to purchase an asset, but we overpaid for it, i.e. it turns out to be a bad investment;
We decided to sell an asset, but we under-priced the asset. We thus miss out on the opportunity to realise the true value of the asset. This can also be called an opportunity cost. The Naspers example above means that we had an opportunity loss of 950%, even though we did not lose any actual money.

Mistakes of Omission

Mistakes of omission on the other hand, are mistakes that are made when we omit to do something. An omission may be that we miss to see an opportunity. Or worse still, we see an opportunity, but fail to act appropriately. In this case, we purchase too little of a great asset which is being offered at a bargain price. Charlie Munger, who is Warren Buffett’s business partner, regards mistakes of omission the more costly of the two types of mistakes for investors.

Common investing mistakes and possible remedies

Let’s walk through some common investing mistakes and how one could possibly avoid them.

Mistakes of Commission

Buying and asset and overpaying for it:
- Buying a very good business but at an inflated price. This often happens towards the end of a bull market. One is often influenced by sentiment – so-and-so stock is performing well and therefore it is a must-have in your portfolio. Arguably, if everyone knows that a particular company is doing well, then its share price should reflect its popularity (i.e. it is unlikely to be cheap). To minimise this type of mistake, one has to be able to analyse a company’s underlying value and only invest in it if the price is less than its intrinsic value.
- Buying into a bad business, thinking that it can be turned around. It is true that one can buy a bad business at a good price and earn a decent return from it and that businesses can be turned around, but this is not the case for all bad businesses. One of my own philosophies is to simply ignore bad businesses irrespective of whether they offer value or not. It does not fit into my style of investing, so I stick to what I know best. However, if a good business goes through tough times, then I will look at it closely and possibly decide to invest in it if my assessment is that it can be turned back to its previous glory.
- Getting caught up with a “great tip” from someone well-regarded or who simply talks a good story. Media and especially social media provides lots of pundits telling us about what to buy and sell, etc. If you had taken the advice of most of these pundits, the chances are greater that you would have lost money rather than made great returns. Make up your own mind on what to invest in and when to invest. Use a strategy that you are comfortable with.
Selling an asset at below its intrinsic value.
- The example, I gave on Naspers above, is a good example of this. Maybe with a little more homework, or a bit more analysis, I would have not sold. The other side of the coin is that I could have done all the analysis in the world, but still came to the conclusion to sell. In this case, I would need to accept that I could not have made a better decision at that time and ask myself how I would tackle a similar situation in the future. I’ve learnt to hold on to good companies for as long as I can and hence our bias to “invest in great businesses for the long term” at Lunar Capital.

Mistakes of Omission

Not identifying a significant buying opportunity.
- The universe of investing is so large, that it is impossible to cover it entirely. This means that you should identify your investment universe and build your knowledge, skills and strategy for that specific investment universe. It does pay however, to every now and the take a look at other industries or analyse trends that are taking place in other markets. Often, a trend (think biotech; renewable energy; cryptocurrencies) is not sufficiently noticed until there are a few years of significant growth. It helps to keep your eyes and ears open to trends outside your comfort zone. If this trend appears to be quite strong, then try and build some competence in it or tap into other professionals that have a better understanding of that trend/industry.
- Every now and then, significant buying opportunities come about (think after the 2008 global financial crisis). At times like this, one needs to be very aggressive in buying these highly discounted businesses. Unfortunately, market sentiment at that time will not be great. So, again if you’re disciplined in your investment valuation methodology, you would buying when “there is blood on the floor.” Similarly, if there is a business that you would love to own, buy as much of it as you can if and when it shows great value (i.e. is cheap).
Not identifying a significant selling opportunity.
- Another mistake is not to sell in time. In this case, one may be missing a negative industry trend or also a company specific issue. A case in point is the recent results from the fast food industry. All indications were that the consumer is struggling, that fast food businesses were over-paying for franchise licenses from global players, etc. This would have been a good time to have sold some of these businesses, before their results even came out. Many investors who have enjoyed the great returns that Famous Brands (FBR) provided over the years would have assumed that this will carry on forever. They would thus miss important indicators that significant headwinds are facing the industry as a whole. So, they typically hold onto those shares until the results come out, which is often too late.

Some other examples of investing mistakes

Over a period of over 25 years in investing, I can go through many mistakes that I’ve made over the time. Over and above the Naspers example, here are a few others:

Holding onto to Stocks and Stocks (a construction company) until it went bust (100%) loss.
Creating arbitrary buy or sell prices because it sounds or feels good. Example: I’ll sell if I get a 50% return or I’ll sell when the price reaches R100 per share.
Thinking that old sector industries would never make a come-back, thus missing the early stages of the previous Resources boom.

The list can go on and on. I’ve used all of these as learning experiences and fine-tuned our investment methodology as a result of this learning. I’m satisfied that the results of the good decisions far out-weighed the mistakes over this period.

Perhaps my biggest mistake is writing this piece and admitting my Naspers mistake to my wife.

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Interview with Sabir Munshi on what is Bitcoin and what the future may hold for Bitcoin

Archive / By VCS Agency

Sabir Munshi Director at Lunar Capital talks Salaamedias listeners through a number of questions explaining what the bitcoin is all about. Some stores are soon going to trade with bitcoins, hence we need to understand how it all works.

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Second-Level Thinking

Archive / By VCS Agency

The best investors in the world have a great ability to look and think beyond the obvious. This characteristic is referred to as second-level thinking. In second-level thinking, one has to go beyond the obvious cause-and-effect type thinking. It requires one to ask deeper questions, like “So, What?” and “Could there be more complex dynamics or other hidden but more important factors at play?”

Fallacies

Let us look at some recent examples to see how second-level thinking could have helped us in predicting an outcome that was different to the then prevailing analysis:

US Markets

Prior to the US elections last year, many commentators were predicting a major crash in the US stock markets if Donald Trump was elected as US President. These commentators were unable to comprehend beyond the realm that Trump was an egomaniac, prone to irrational outbursts and behaviour, etc. Their argument thus was that if someone of Trump’s character is elected President of the US, then that will be a catalyst for a major market correction. In hindsight however, we know that in fact the market has powered ahead since Trump’s election. Needless to say, he has taken all the credit for the market rally, but that is a different story.

If we applied second-level thinking, we would have also considered that:

His policies would be pro-business, e.g. by reducing taxes (or at least promising to), incentivising American corporates to re-invest their foreign cash hordes in the US; decreasing red-tape, etc.;
The Fed stimulus would still be in play, providing the market with little choice but to keep investing on the stock markets given the poor yields in other asset classes, especially in cash;
Trump’s America First policies and bullying tactics would coerce businesses to invest in the USA, even if they did not like to.

There probably are a number of other factors also at play in driving the US markets higher. The point however, is that too often we as investors do not sufficiently see and understand all the issues at play in investment outcomes. All too often we think too simplistically about these issues and we look for just that one factor that would cause an outcome to occur, not considering that there are many other dynamic factors at play.

SA Macroeconomic environment

Another issue is related to the current South African macroeconomic environment. We have just recently come out of a technical recession. Our macroeconomic picture paints a picture of significant financial distress amongst the poor- and middle-classes. This would imply that banks and retailers should be experiencing incredibly hard trading conditions. In general, this is the case. However, if one looks at the recent results from Capitec, Standard Bank, FirstRand, Shoprite, and Choppies, for example, different pictures emerge for each of these companies.

Shoprite (SHP) is doing pretty well, continuing to gain market share in all market segments. Given Shoprites’s strong competitive positioning, they are able to “invest” by keeping prices low and winning customers over. If you look at the results of Shoprite wannabe Choppies, you can see that they are struggling. So, retailers are experiencing headwinds, but the stronger and more competitive players use their power during difficult market conditions to put further stress on weaker competitors. This often results in the stronger players gaining market share and pricing power and the weaker players losing market share or even going out of business altogether.

Capitec (CPI) has also had spectacular market share gains against the big banks. In this case, the nimble and cost-effective player is taking on the big guys, offering customers a cost-effective and functional service. Cost-conscious clients are thus migrating to Capitec from the other banks. So, not all banks are in fact experiencing difficult trading conditions in current macroeconomic environment in South Africa. Capitec has recently surpassed Nedbank’s market capitalisation, reflecting the very differing outcomes for different players in the same industry and same market.

Unsecured Lending

Another great example of where second-level thinking would have yielded spectacular results was during the African Bank crisis in 2014. During this time, the Capitec share price was also severely knocked down by the market. The market (investors) had incorrectly painted Capitec with the same brush that they had painted African Bank with. In reality, African Bank had a different business model and with African Bank out of the way, Capitec was able to better price their lending products and be more selective in who they lend to. Four years later, the Capitec share price has gained more than 300%, whereas African Bank shareholders lost almost all of their investment in African Bank.

In weak markets, it’s the weaker players that suffer the most, with many in fact withdrawing altogether. The stronger and better competitively placed players increase their market share and ultimately allow them to improve their pricing power. So, simplistically reading that poor market conditions are bad for certain industries as a whole is in fact quite false. One needs to apply second-level thinking which can yield spectacular outperformance.

Howard Marks

Howard Marks, in his book “The Most Important Thing Is …” devotes the first chapter to Second-Level Thinking. He says that very few people have what it takes to be great investors and even the best investors don’t get it right all of the time.

“The reasons are simple. No rule always works. The environment isn’t controllable, and circumstances don’t repeat exactly. Psychology plays a major role in markets, and because it’s highly variable, cause-and-effect relationships aren’t reliable. …” Howard Marks writes.

Market Behaviour

Howard Marks stresses the importance of second-level thinking to outperform the market and highlights a number of examples of second-level thinking and some of the questions one needs to ask to surpass first-level, simplistic cause-and-effect thinking.

One of the points that he stresses is to assess the consensus market psychology, i.e. what is the market’s (general investor’s) view? Is it too bullish or too bearish? What will happen to the asset’s price if the consensus is right or wrong? We saw in the Capitec/African Bank example above that market consensus was way off for Capitec. And this provided a great opportunity to invest in a quality asset at an incredibly low price.

Going against the market consensus is not easy, as the market can over-value or under-value assets for long periods in time. This puts enormous pressure on the investor and investment manager to accept or continuously explain under performance during this period of over- or under-valuation.

Arguably today with the proliferation of social media and the ease with which information flows, market behaviour may be a larger contributor to investment decisions than it ever was. So, the investor needs more so to be able to apply second-level thinking to outperform.

Helpful techniques

Here are some simple questions that you could ask to help develop your second-level thinking:

So, what if an event takes place?
What is the consensus view and how do you differ from it?
What could the range of outcomes be? What is most likely and why? What if a low probability outcome actually occurs?
If most people are thinking similarly, then they are investing similarly. Why should you do the same because the market would reflect the consensus thinking?

The questions may be simple, but getting the right answers may not be so easy. The journey of learning is ongoing and dynamic. Circumstances change, psychology plays an important role, and there are many variables that affect the outcome of markets. This forces us all to think a little harder.

Let us consciously improve how we think when we invest.

Second-Level Thinking Read More »

Thinking about investing in Cryptocurrencies like Bitcoin?

Archive / By VCS Agency

In this blog, we will briefly discuss what are cryptocurrencies, what you should consider before investing in them, and how you could invest in them as a South African investor.

What are cryptocurrencies like Bitcoin?

A cryptocurrency (like Bitcoin) is fundamentally a digital currency. It can be exchanged to or from other currencies like the US Dollar or the South African Rand. It can also be used to buy goods or services, provided that the vendor of those goods or services accepts the cryptocurrency.

Cryptocurrencies utilise encryption technology (i.e. blockchain technology) to:

Regulate the creation of units; and
Securely verify the transfer of funds from one party to another.

So, without the key to the blockchain (encryption) one would not be able to access that unit/s of cryptocurrency.

Cryptocurrencies are decentralised, they operate independently of a central regulator (e.g. Reserve Bank). Cryptocurrency miners (anyone can be a miner) mine for new units of the currency using blockchain technology. They manage the integrity of the system in a decentralised way.

When a new cryptocurrency is created, a cap on the number of units of that cryptocurrency is set. Cryptocurrencies thus have a built in limit of the total number of units that will be created. So, if the demand increases for the cryptocurrency, then the prices of those currencies will rise. In traditional currencies like SA Rand, the central bank can create more units at any point in time. The more they create, the more the currency can devalue (inflation).

Cryptocurrencies can be held in safekeeping in one of two ways:

At the exchange where you trade them; or
In a wallet that is in your safekeeping. The wallet is an electronic wallet, where you keep the keys to the units of the cryptocurrency you own.

What should you consider before investing in Cryptocurrencies?

There are hundreds of cryptocurrencies in issue. The current largest values are in Bitcoin, Etherium and Ripple.

Reasons to invest in Cryptocurrencies

There is a view that cryptocurrencies will replace traditional government issued currencies in the future, i.e. traditional currencies will be disrupted. If this trend continues, then arguably, the value of cryptocurrencies (or at least the accepted ones) will rise relative to traditional currencies.
Supply is limited from the outset. So, as demand for the cryptocurrency increases, the price will rise. This is a phenomenon that we are currently witnessing. From 1 May 2013 to 16 August 2017, Bitcoin has risen from USD117 per unit to USD4178 per unit, a staggering 3,470% return in just over 4 years.
Cryptocurrencies are decentralised, therefore they are beyond the control of governments and government agencies. Its value cannot be changed by ‘printing’ more money.

Reasons not to invest in Cryptocurrencies

If you don’t understand it, you should not invest in it;
The value of a cryptocurrency is hard to determine, so how do you know if you are paying too much or too little? Could the current cryptocurrency prices be in a bubble? Cryptocurrency prices have been quite volatile. Whilst over the long-term, they have grown significantly in price, there have been periods of significant pull-backs (over 30%) in the cryptocurrency prices.
- From 9 June 2017 to 16 July 2017, Bitcoin decreased in value from USD2865 to USD1900, a 34% decline in value in about 6 weeks;
- From 4 January 2017 to 13 January 2017, a decline of 28%, from USD1100 to USD796 per Bitcoin.
A currency is valuable if it can retain or increase its value and it can be easily used to pay for goods or services. If vendors do not accept a cryptocurrency, then its uses are limited, potentially reducing the demand for the cryptocurrency.
Regulators could change the rules, making cryptocurrencies more restricted. This would require quite a concerted effort by all regulators worldwide.
If you keep your cryptocurrencies at an exchange, the exchange could be hacked and potentially you could lose your cryptocurrencies.
If you keep your cryptocurrencies in a wallet and you lose your wallet, you will not be able to redeem the value in the units that you hold – they are lost forever.
How would you determine which cryptocurrency would be the winner? Would it be Bitcoin, Coinbase, Etherium, Ripple, or a new issue? At the moment, Bitcoin is the most popular cryptocurrency, followed by Etherium.

So, there is no clear cut answer on whether one should or should not invest in cryptocurrencies. If you are not experienced and knowledgeable in cryptocurrencies and you do wish to invest in them, then you should consider the following:

Learn about them by reading up and following experts like @farzamehsani (Farzam Ehsani), @naval (Naval Ravikant) and others.
Identify the cryptocurrencies that you want to invest in and where you could invest in those cryptocurrencies safely. Perhaps, you could start with one of the larger and more well-known and traded cryptocurrencies (Bitcoin, Etherium).
Develop a strategy for investing in these currencies – consider investing in small amounts until you get more confident and you are more knowledgeable. Nothing beats experience for learning. Then you can revise your strategy – be more aggressive or reduce/stop your investments in cryptocurrencies based on your learning.

How does one practically invest in cryptocurrencies?

Cryptocurrencies are traded on exchanges. To our knowledge there are two Bitcoin exchanges available to South African investors: www.ice3x.com and www.luno.com. You are required to be FICAed before you can trade. Once your account is opened, you can then deposit the amount you want to trade in and put in an order for the trade on the exchange.

There are many more exchanges offshore, but you would need to use your offshore exchange allowance to be able to access those exchanges. Here you would also be able to trade in cryptocurrencies other than Bitcoin.

You should consider the safety of your cryptocurrencies. Each of these exchanges provide you with options on how you can improve the security of your Bitcoins. You can also consider other alternatives like keeping your Bitcoins in a Wallet. In a wallet, you can keep your Bitcoin keys, which means that it is in your safekeeping and not the exchanges safekeeping. However, if you do lose your keys, you will not be able to get your Bitcoins or exchange them.

Closing

If you have already been trading or investing in cryptocurrencies, then well done and good luck.

If you are considering investing in cryptocurrencies or have very little knowledge of cryptocurrencies then you should consider taking the steps outlined in this write-up.

My overall view is that the underlying technology to cryptocurrencies, i.e. blockchain is going to be a fundamental driver of disruption in financial services. This will thus continue to power the growth and usage of cryptocurrencies. There is also no doubt that there are risks in the cryptocurrency markets (over-valuation, regulatory, other not yet known). But my overwhelming sense is that this is a trend that will continue to grow.

It is thus advisable for all of us to become familiar with this phenomenon and be prepared to take advantage of it.

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Thinking about investing in Cryptocurrencies like Bitcoin? Read More »