VCS Agency - Lunar Capital

Hubris

Investors are faced with a multitude of risks in any investment decision that they take. With the recent results from Famous Brands, Mediclinic, Taste Holdings and also not so recently Woolies and Old Mutual; one can’t help wondering if executive hubris^* is not one of the bigger risks that investors face.

Offshore Expansion

In the name of offshore expansion, too many South African companies have lost significant shareholder value:

Woolies was forced to write off R6.7bn after their disastrous acquisition of the David Jones business in Australia;
Old Mutual finally through in the towel in their London listing and foreign acquisition spree that began in the mid-1990’s. They significantly overpaid for foreign acquisitions. Just compare Old Mutual and Sanlam since they demutualised: shareholders who re-invested their dividends would have received a 553% gain if they invested in Old Mutual versus a 2,822% gain if they invested in Sanlam^**. Old Mutual went on an aggressive international expansion, somewhat neglecting its home market; whereas Sanlam stayed at home built its base and cautiously expanded into niche overseas markets;
Famous Brands, once a darling of investors is now struggling with its acquisition of UK’s Gourmet Burger Kitchen and closing some of the brands that it acquired offshore;
Taste Holdings, similarly is in a dire financial position as result largely for over-paying to bring big-name franchise brands like Starbucks into South Africa.

It is not only South African companies venturing offshore that get it wrong:

Massmart has struggled since it was acquired by the giant Walmart group. So much for bringing international best practice and significant buying power to a previously well-performing business.

The list can go on and on. Too often expansion plans don’t pan out how management paint the picture. Some records also show that most acquisitions don’t meet the original return criteria. One has to question why management do those deals in the first place. Does management overrate their own importance, or do they want to have their names emblazoned on iconic deals, or are they driven by perverse incentive schemes? Executive hubris?

Beware the trophy head office

Hubris takes another form in fancy new head offices. I’m certain there is a study somewhere that shows companies beginning to underperform after they move into fancy new head offices.

In the name of productivity, attracting top human capital, or branding; substantial amounts of money is spent building or leasing new offices, but it is never clear that the required return on investment is actually achieved.

It must be a great kick and boost to self-importance to drive into the fanciest offices in town.

Should we paint all with the same brush?

We know however that not all acquisitions or expansions are bad and that it does make economic sense at times to upgrade to newer, more efficient business premises. We argue that investors should be sceptical of acquisitions, international forays and trophy business premises. Too often, these in fact tell you more about executive hubris than about business strategy.

A good indicator of money well invested is Return on Capital Invested (ROIC) and ultimately also Return on Equity (ROE). Businesses that are able to allocate capital efficiently significantly outperform those that follow some grand footprint or flag planting strategy over time. We gave the example of Sanlam versus Old Mutual earlier. Another great example is FirstRand versus Standard Bank. FirstRand has been much better at capital allocation than Standard Bank and this is reflected in their comparative share price performance over the long-term.

Both Sanlam and FirstRand have also acquired businesses, expanded offshore and moved into new buildings. Arguably, they have been more selective and disciplined about the investments that they made and how much they paid for them. Their shareholders have benefitted substantially more than those invested in their competitors, and who may have not been as selective and disciplined in their investment decisions.

Beware executive hubris!

^* hubris = excessive pride or self-confidence; arrogance; feeling of superiority

^** Source: Business Day 18 March 2018; https://www.businesslive.co.za/bd/companies/2018-03-16-returning-old-mutual-will-find-sanlam-ahead/

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Seeking Growth Markets

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At Lunar Capital, we are continuously on the look-out for long-term investments that can benefit investors in our fund (and ourselves as we are also significantly invested in the fund that we manage).

Ideally, we would allocate a portion of our fund to a large growth market (country, industry or other) that we think offers good growth potential and is trading at reasonable levels.

One of the markets that we regularly look at is the Indian market.

India

India is the second most populous country in the world. At current population growth rates, it could overtake China by around 2024 as the most populous country in the world.

Here are some statistics about India:

Population = 1.34 billion 2^nd Most Populous Country

Population Growth Rate = 1.2%pa

Gross Domestic Product = USD 2,611 Billion 6^th Largest economy in the World

GDP Per Capita = USD 1,983 Ranked 139^thin the World

GDP Growth 2017 = 7.1%

India is a large economy, growing at a very fast rate, but by-and-large the majority of the population is still poor by global standards.

Most foreigners and business people who visit India are intrigued by the country. It has a highly developed service sector, and a workforce that is skilled and relatively cheap. It is ranked as one of the Top 10 foreign direct investment countries in the world.

Services make up approximately 54% of the Indian market, with Industry making up 29% and Agriculture 17%.

Indian Stock Market

The Bombay Stock Exchange (BSE) has a market capitalisation of approximately $2,120 billion and is the 11^th largest stock market in the world. It has over 5,700 companies listed on the exchange. It is currently trading at a Price Earnings Ratio of approximately 23.

With the large number of companies listed on the BSE, it is very difficult for an outsider to successfully pick the right stocks to invest in. India also has its fair share of corruption. Government and corporate scandals are a regular feature of the market.

The current price earnings ratio on the BSE also appears expensive by historical and global standards.

Factors contributing to growth

There has been significant infrastructure spending in India, from new and improved airports and roads to power plants and hospitals. Government has also committed to obtaining 40% of energy requirements through renewables by 2030.

India also has a growing middle-class, that is skilled, ambitious and entrepreneurial. This will likely continue to propel consumer spending.

Indians are also obliged to register their identities through the Adhaar programme. This records all citizens digitally using biometric data. The benefits to financial institutions and other businesses and agencies who require proof of identity are enormous with the Adhaar initiative.

India has also become a tech start-up hub (3^rd or 4^th largest in the world) and some very successful start-ups like Flipkart, Ola and Snapdeal have been established in India.

Impediments to growth

All is not rosy however:

There is a huge infrastructure backlog. This issue is magnified given the size of the population and cities;
Pollution levels is some cities like Delhi are at dangerous levels;
Poverty is still a large feature of the country;
Corruption still exists in both the public and private sectors;
India has a grindingly slow judicial system;
There is always a risk of social and/or religious uprisings, especially given that 2019 will be an election year;
Too few contribute to the tax base, especially compared to the size of the economy; but this has been steadily increasing.

These are some of the hurdles that the country faces to potential prosperity.

How to get exposure to the Indian market?

The Indian market should however be on investor’s radar screens. The demographic changes in this market will likely be a tailwind behind this economy. Whilst corruption is rife, this appears to be reducing. The economy is also becoming more open. Government appears to be tackling the major issues, but success rates will vary.

Stock-picking in a market like India would be very difficult for outsiders. Arguably, a good strategy would be to invest via a low-cost index tracker option. Unfortunately, this is not available directly in South Africa. South African investors would need to use their foreign exchange allowance and invest directly through the Indian market or via one of the developed market exchanges (e.g. Nasdaq).

Another alternative would be through some local unit trusts that have direct or indirect exposure to the Indian market.

A regular (say monthly) investment subscription rather than a large lump sum investment is also probably a good strategy for the individual investor.

Lunar Capital Strategy

We know that many South Africans are keen to have exposure to the Indian stock market. Our approach is to try and minimise the risks to our investors, whether it is understanding the dynamics of a particular company or determining whether a particular investment is priced appropriately or not.

To date, Lunar Capital has not invested in the Indian stock market, but we do follow the market and, in all likelihood, would invest in this market at some time in the future, either directly in certain stocks or via a low-cost exchange traded fund.

At this stage, we continue to monitor the Indian market. If and when the correct opportunity presents itself, we will allocate an appropriate quantum of funds to the Indian market.

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Share Focus: EPE Capital Partners (EPE)

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Ethos Capital (EPE) invests directly and indirectly in a diversified portfolio of unlisted investments, which are managed by Ethos Private Equity, the largest private equity firm in sub-Saharan Africa.

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Inflation and its impact on stock prices

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What is Inflation?

Inflation is when the prices of goods or services rises sustainably. This is when we as consumers pay more for our goods and services. To put it differently, it means that our money is worth less. We get fewer goods or services for the same amount of Rands or Dollars. In South Africa and many other countries, we use the Consumer Price Index (CPI) to measure inflation.

Inflation can be caused by several factors. Here are some of the causes of inflation:

When the economy is doing well and people have more money, they may be willing to spend more on goods and services. This higher demand leads to increased prices.
When commodity prices such as oil goes up, it increases not only the cost of fuel that we use for travelling, but also the cost of transporting goods and services. This translates into higher costs, thus leading to inflation.
Exchange rates also play a role in inflation. If the South African Rand weakens against other major currencies, then this too causes rising inflation, because the cost of imported goods is more expensive in Rand terms.

Moderate levels of inflation generally imply a good economy, i.e. one that is growing healthily. High levels of inflation imply an overheated economy which will likely result in an economic crash. Very low levels of inflation imply a subdued economy.

It is the role of central bankers like the South African Reserve Bank (SARB) to try and manage inflation. They typically do this through monetary policy, i.e. by raising or lowering the interest rates that they charge to commercial banks. If they wish to reduce inflation, they raise interest rates. This leads to consumers having less money to spend on goods and services, as they have higher interest payments on the debt that they owe to banks and other lenders. In this way, the central bank tries to manage the economy so that it does not overheat. Vice versa, when they want to give the economy a push.

Inflation versus Returns

Inflation is a stealth threat to any returns. If your returns are below the rate of inflation, then you are in fact earning a negative return, i.e. you are losing money in real terms. So, when looking for where to invest in, one should always be mindful of the impact of inflation on one’s investment.

Where an investment pays a fixed rate like a bond, then the impact of inflation on returns is easily understood. As inflation rises, the value of the bond drops and vice versa.

The impact for companies, however is not so simple.

Inflation versus Stock Price Returns

There are several conflicting factors at play here:

As inflation increases, the returns on your investments should be lower in real terms, so arguably the share price should reduce.
However, inflation also implies that companies can charge higher prices for their goods or services. In this way they will earn higher revenues. So, this should negate the impact of lower real returns discussed the above.
Factoring in higher inflation rates into valuation models should also have a negative impact on share valuations, which could lead to lower prices.
Markets also operate in complex ways – from exuberance to pessimism, from forward looking to backward looking. So, at any point in time these factors may overshadow whatever inflation may or may not be doing.

It is thus not entirely obvious how inflation impacts stock prices. However, what one should look out for is any significant shifts in inflation. When South Africa broke the back of double digit inflation in the 1990’s, share prices and price earnings multiples increased commensurately. It is thus advisable to look out for any significant and sustainable shifts in inflation.

What are we looking at in terms of Inflation?

In the two markets in which Lunar Capital mostly operates; South Africa and the USA, we could possibly see some interesting developments from an inflation perspective:

In South Africa, the last CPI figures indicated a year-on-year increase of 4% per annum. According to Investec, inflation should increase to between 4.7% to 5.3%, given the VAT and fuel price increases. This is still below the 6% that is imprinted in most people’s minds as to where inflation is. In our opinion, this will have a moderately positive impact on stock prices (price earnings multiples) of companies that have a strong market position.
In the USA, inflation and interest rates are on the rise. In our view, this would likely put the brakes on any significant stock market rallies in the near-term. If anything, there may well be a further correction in the market.

S&P 500 Annual Averages per Decade

The following table shows average annual results for each decade:

	Price Change	Dividend Dist. Rate	Total Return	Inflation	Real Price Change	Real Total Return
1950\’s	13.2 %	5.4 %	19.3 %	2.2 %	10.7 %	16.7 %
1960\’s	4.4 %	3.3 %	7.8 %	2.5 %	1.8 %	5.2 %
1970\’s	1.6 %	4.3 %	5.8 %	7.4 %	-5.4 %	-1.4 %
1980\’s	12.6 %	4.6 %	17.3 %	5.1 %	7.1 %	11.6 %
1990\’s	15.3 %	2.7 %	18.1 %	2.9 %	12.0 %	14.7 %
2000\’s	-2.7 %	1.8 %	-1.0 %	2.5 %	-5.1 %	-3.4 %
1950-2009	7.2 %	3.6 %	11.0 %	3.8 %	3.3 %	7.0 %

Source: http://www.simplestockinvesting.com/SP500-historical-real-total-returns.htm

The table above shows that investing in the equities markets has been a good hedge against inflation in the long-term. Interestingly though, this is not true for two out of six decades in the table shown above. The negative return in the 2000’s reflects the impact of the global financial crisis of 2008-2009; and the negative return of the 1970’s reflects high inflation in the USA. However, over the 6 decades, real returns have been excellent (7.0%).

Our approach to investing is to acquire great businesses at good prices and to hold them for as long as possible. The macro-economic environment is additional input into our decision making, but we rely much more on individual business analysis in our decision making. Ultimately, we aim to have real (i.e. above inflation) growth in the investments we make over the long-term.

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The Land Question?

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In my opinion, the Land Question in South Africa raises a broader issue. It is the question of retribution for the crimes of colonialism and Apartheid. The Black Economic Empowerment policies attempted to address these issues but these have fallen short of meaningful empowerment of the previously disenfranchised. It has also had unintended consequences – fronting, favouring those close to the ruling elite, a laager mentality amongst many whites, etc. Add high levels of poverty and inequality, little access for many people to be able to earn a meaningful living; and this creates a ripe environment for a major social backlash. This backlash can take many different forms, from widespread civil unrest to xenophobic attacks, tribalism, racism, land seizures, etc.

What can government, citizens, activists, businesses, organised labour and the person in the street do to address this issue for an outcome that is likely not going to be satisfactory for most?

The ANC December Congress passed a resolution to adopt a policy of land expropriation without compensation. The Economic Freedom Fighters (EFF) is ensuring that this issue stays at the forefront of the national agenda. Rightfully so. It is unfortunate that since the dawn of democracy in the country, not much has been done by the elite (political and economic) to address this issue in a more wide-reaching and meaningful way. Having access to power and the ability to influence decisions, allowed these elites and their cronies to benefit greatly. It is not in their interest to rock the boat too much.

Now however, it is too difficult to sweep this issue under the carpet or pay mere lip service to how it will be addressed.

Irrespective of what the outcome/s will be and how it is addressed, it can be guaranteed that there will not be a satisfactory outcome for all. In fact, many may get little satisfaction. So, it is imperative that this issue is dealt with the utmost care and with an execution strategy that ensures that in fact as a whole we are better off as a country.

Perhaps, the starting point would be to develop a set of principles that cover the following key questions, amongst others:

Is it about Land reform or more broadly about economic reform?
Do we deal with the broader issue of reparation for the evils of Apartheid and colonialism or only about restoring rights where there is clear evidence ofdispossession and forced removal?
Under what conditions will expropriation without compensation take place?
What should be done about other policies (BEE for example) that haveattempted to redress past issues? Should these continue, be scrapped or changed
to get better outcomes?
How will potential beneficiaries be assisted to lay claims and how can they beset up to get the best for themselves and the country?
How will we deal with potential capital flight and its cousin, lack of newinvestments?

These are complex issues to solve, so setting up a set of principles upfront with the right set of stakeholders will be an essential and critical first step. It should also guide how trade-off decisions will be made.

Our clients at Lunar Capital ask us what the impact on one’s investments is, in this scenario?

At this stage, it is very difficult to predict exactly what will happen and who would be the winners and losers. It depends on what kinds of redress will be sought, and how it could be affected. To what extent will government first redistribute the land/properties in its own portfolio? Are there some cut-and-dried cases that could be resolved quickly, and what are these? If properties that are expropriated without compensation are bonded by banks, will the banks have to carry costs of the default? If not the banks, then whom?

We would be cautious of companies that own large tracts of land in rural, peri-urban and possibly even urban environments. Largely for now, we would not panic. The state has many options to address the issue of land reform before it needs to use the “expropriation without compensation” tool. We are also of the view that the current administration will deal with this issue sensibly, but it will likely face lots of criticism from both the left and right. The country has sufficient intellectual capacity to execute on this properly. It is up to government to ensure that it resources this task team appropriately.

A very good outcome can come from this for the long-term benefit of the country if dealt with from a point of principle and executed with an intention of properly empowering those who have been marginalised in the past and continue to be impeded by a lack of access to earn a decent living. This will be good for the country and for long-term investors.

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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

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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

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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.

View our Summary

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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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