Archive - Lunar Capital

The ‘Biggest’ Risk in Investing

[fusion_builder_container hundred_percent=\”no\” equal_height_columns=\”no\” hide_on_mobile=\”small-visibility,medium-visibility,large-visibility\” background_position=\”center center\” background_repeat=\”no-repeat\” fade=\”no\” background_parallax=\”none\” parallax_speed=\”0.3\” video_aspect_ratio=\”16:9\” video_loop=\”yes\” video_mute=\”yes\” overlay_opacity=\”0.5\” border_style=\”solid\”][fusion_builder_row][fusion_builder_column type=\”1_1\” layout=\”1_1\” background_position=\”left top\” background_color=\”\” border_size=\”\” border_color=\”\” border_style=\”solid\” border_position=\”all\” spacing=\”yes\” background_image=\”\” background_repeat=\”no-repeat\” padding=\”\” margin_top=\”0px\” margin_bottom=\”0px\” class=\”\” id=\”\” animation_type=\”\” animation_speed=\”0.3\” animation_direction=\”left\” hide_on_mobile=\”small-visibility,medium-visibility,large-visibility\” center_content=\”no\” last=\”no\” min_height=\”\” hover_type=\”none\” link=\”\”][fusion_text]

Two sides of the same coin

Whenever the subject of investing or investments is brought up, the immediate thought that would come to mind for most people is risk. This is quite appropriate and understandable as investing and risk are two sides of the same coin.

However, the problem is that most of us fail to truly understand what the real risks are in investing. In this post, I want to argue that the biggest risk in any investment is in fact the investor her/himself.

Let’s talk about Risk

In any investment, risk can rear its ugly head in many different forms:

The investment thesis could be flawed, e.g. the growth projections overestimated;
Market sentiment could be negative, leading to prolonged depressed prices, severely testing your conviction;
External events could create a shock that could lead to a devaluation of the investment, e.g. war or unanticipated policy changes;
Mismanagement – i.e. management could make mistakes resulting in the loss of value, e.g. poor controls resulting in fraud; or bad publicity resulting in a destruction of a brand and ultimately loss of revenue;
Disruption – the business could be disrupted by new upstarts using improvements in technology for example.

These are merely examples of the kinds of risks in any investment. It is not a comprehensive list. There are many textbooks written on risk. These risks are typically managed by the Investment Manager. They are typically trained to understand risk and how to mitigate these risks. But inevitably, some of these risks may be realised causing temporary or permanent losses. Good returns in other parts of the portfolio may or may not offset some of these losses.

However, there is a risk that is not sufficiently thought through and written about. And that is YOU!

YOU are the ‘biggest’ risk

As an investor you are in the driving seat of making decisions on what to invest in, who to consult or invest with, when to invest, how much to invest, when to liquidate an investment, etc. These are all big decisions that you need to make so that you can establish your financial security and grow your wealth. But how often do you spend time to think through these issues and establish strategies and plans that allow you to improve your decision making and reduce this risk? How do you mitigate the risks of your own poor decisions (or no decisions)? How do you mitigate against taking decisions based on emotions rather than a well thought out strategy or plan?

When an investment goes wrong, it’s easy to blame the markets or the fund manager or your investment advisor for the poor performance. But how often have you considered that perhaps you are as culpable or maybe even more culpable for the poor performance of your investments?

Let’s paint a few scenarios and I want you to seriously ask yourself, whether you are guilty of any of these:

Inertia – Are you guilty of non-action? How often have you delayed in taking action on an investment decision? With regulations like FICA, the account opening process is quite tedious. How often does this stop you or delay you in getting your paperwork done to start a new investment? If you are serious about your financial security and building wealth for you and your family, then perhaps you would consider what this inertia has cost you. You may not only be missing opportunities in the market as a result of this inaction, but you are also losing time, which is by far the greatest contributor to building wealth.

Waiting for the Bell to ring? I wrote about this in a previous post. People often ask me whether there will be a market crash or not. And my answer is always the same: yes there will be one, but I don’t know when it will happen. The idea of waiting for the market to crash so that you can buy assets cheaply is excellent in theory but very hard (and probably impossible) to actually implement successfully. During a market crash or a bear-market, the market sentiment is very negative. The mainstream media will be full of horror stories about how much was wiped off the stock market. It will also profile high net worth individuals who have lost a substantial part of their wealth. Market commentators will be talking gloom and doom. No-one will be able to give a clear view of when the carnage will stop. But you have been waiting for this, and needless to say most of you will not go on a buying spree during this time. When sentiment is low, it is very difficult for most of us to actually take a contrarian view and begin buying.

Not Understanding your Risk Tolerance – If you don’t understand your Risk Tolerance and how you will behave in different market conditions, this may also be a big risk for you as an investor. If you do not have the patience or stomach to wait through a bear market, then you may in fact be selling at a very wrong time. Bear markets can last for any number of periods, but often can last a few years. If you have negative returns in your portfolio for two years say, then you may be inclined to sell your investments. This may be one of the worst times to be selling and in fact may be a very good time to be investing a little more aggressively. But, in this case your risk tolerance or patience may be low – leading you to make a decision to either cash up so that you avoid more losses or possibly invest somewhere else where the returns were much better in the last few years. Again, there is a good chance that you are making the wrong decision. You would be inclined to blame the investment manager for not performing over the last few years. To be fair, there will be times when you do need to cut your losses and move on. The point however, is that you need to be clear (and honest enough) as to why you are making the decision that you are. It is important that you understand the Investment Manager’s investment style and it must also be aligned with your own risk tolerance.

Driven by Sentiment. In this scenario – you invest when you look at past performance – it’s been great over the last few years and good returns have been made, so you begin investing. Or, you invest in the best performing fund over the past few years. Conversely, you sell because the last few years’ performance has been bad. The problem is that whilst equity markets go up in the long-term, the trend is not a straight line. Look at the graph below to see the annual returns on the Johannesburg Stock exchange (All Share Index) since 1996.

$\"annual$

You can observe that returns range from -25.72% to +66.62%, an incredibly wide range. One can observe periods of low returns (e.g. 1996 to 1998) or extended periods of very high returns (2004 to 2007). However, R100 invested at the beginning of 1996 would be worth R905 at the end of 2016 plus any dividends paid out. If you stopped investing in 1997/1998, you would likely have missed the big run in 1999. Or, if you started investing in 2006/2007, you would have had a big loss in 2008. So, you should be cautious of being taken in by the sentiment in the market.

Not Understanding performance. Many investors do not understand performance calculations. A common mistake monthly investors make is that they look at the value of their portfolio say after 5 years of investing, they assume that the return on the total amount they invested should be for the whole 5 year period. The correct way to look at it is that only the first payment is invested for the full 5 years, the second would be for 4 years and 11 months, the third for 4 years 10 months, etc. Needless to say, they get disappointed with their returns because they have incorrectly calculated performance. Sometimes this disappointment is justified because the fund has actually underperformed. But, it is important to correctly calculate performance so that you can make the right comparisons and the right decisions. Another common mistake in calculating performance is not including costs. This is typical in property investments, the investor takes the gross rental received and divides by the capital invested to calculate a return. However, some or all costs are excluded like levies, municipal taxes, maintenance, etc. This gives a false view of performance.

What can you do to mitigate against yourself?

Understand your Risk Profile and Investing Temperament

Firstly, it is important to understand your own risk profile and temperament. If you would not be able to live through big downturns in the market, then it is important that you choose a fund that would be less volatile and provide more stable returns. In this case, you should accept that you will most likely have lower returns over a long period. If you do select a higher risk fund or investment and you make decisions based on sentiment, it is again likely that you will be entering the market when the last few years provided good returns (which you missed) and exiting the investment when the last few years’ returns were low, locking in your losses. Ensure that you understand the investment manager’s strategy and style and that you are comfortable with it so that you can stay invested over a long period and get the benefit of time in the market.

Develop a Strategy and Stick to it

I have also previously written about developing an Investment Strategy. If you develop a strategy and you stick to it, you give yourself a better chance of reducing the emotional decisions. A good strategy to avoid trying to time the market, is a regular (say monthly) investment. In this way, you set up a debit order and you invest in one or a number of investments on a monthly basis. This is called rand cost averaging. It takes away the decisions on when to invest. Most importantly, it reduces the risk of emotional decisions.

Just Do IT.

Take action. Open up the account, sign the debit order increase, list your assets and liabilities (#MyFamilyBalanceSheet), set a goal to achieving your retirement savings and actively work to achieve that. In other words, don’t let inertia set in. If you don’t take action, you will forever regret lost opportunities.

LEARN

Those of you who have been reading my posts, will know what I’m going to recommend now: LEARN! It is important to develop your investment knowledge. Whether it is trying to understand the mechanics of the market, how businesses make their money, understanding risk, understanding your own balance sheet and risk profile, your investment philosophy or simply calculating the actual performance in your investments. Investing is an ongoing learning journey and it is very difficult to build financial security and wealth without investing. You owe it to yourself to learn about investing because you deserve it.

[/fusion_text][/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

The ‘Biggest’ Risk in Investing Read More »

One Year On …

Archive / By VCS Agency

Market Context

We launched the Lunar BCI Worldwide Flexible Fund (LBWFA) on 1 June 2016. In our first year to 31 May 2017, several significant events have been playing out locally and globally, which impacted the investment markets:

Political events in South Africa have not only impacted investment sentiment negatively, but also led to a ratings downgrade, historically high unemployment levels, very little trust between government and business and a decline in investments;
A weakening South African macro-economic environment;
Allegations and counter-allegations of corruption within state-owned enterprises and government departments;
A significant reduction in the ANC’s majority and a loss of major metropolitans to opposition parties in the recent local government elections;
British voters voting to leave the European Union and American voters voting Donald Trump as their 45^th president and the potential uncertainty his presidency may bring to the world;
The S&P 500 and the Nasdaq reaching historical highs;
Rate increases by the US Federal Reserve and speculation on how much more can be done to normalise US and European interest rates.

This has created a lot of turbulence in the investment markets during this period. The USD/ZAR exchange rate reacted to these factors and was a significant driver of equity market valuations.

We have been of the view that valuation levels (reflected in the Price Earnings Ratio (PE)) on the JSE has been quite high. This has reduced somewhat, and if you exclude some of the heavyweights like Naspers, BAT, Richemont, AB Inbev; PE ratios look somewhat better. However, we still hold the view that there’s still a lot of risk in the market, particularly as rates start increasing in the US and other developed markets, and as political events play out in SA. We anticipate that the turbulence will continue in the equity, bond and exchange rate markets. However, we think that certain assets are looking better in value.

The Nasdaq market is also near all-time highs and there has been a weakening of technology stock prices recently. Regulatory issues such as fines for anti-competitive practices have been a factor influencing share prices.

How have we positioned our fund?

Our strategy of phasing in our foreign allocation paid off somewhat but as expected, not perfectly. The Rand strengthened during the period from 15.71 to approximately 13.11 to the US Dollar. We had very good dollar returns on our foreign holdings (Amazon, FaceBook, AliBaba, Amgen, Nvdia). The small loss that we made in foreign exchange translation was more than offset by the returns we achieved in our foreign holdings.

In the local market, we had excellent returns from PSG, Shoprite and FirstRand; satisfactory returns from Aspen, Discovery, Omnia, and Capital and Counties; and negative returns from Ethos Capital, Rhodes Food Group, Consolidated Infrastructure Limited and AdapIT of the holdings we still have in the portfolio. Small cap shares have been under pressure since the beginning of the year, in our opinion largely due to the negative sentiment in the market.

We also sold off Woolworths at a small loss, Telkom at a good profit, Balwin at a loss and Alphabet (Google) at a small profit. These were sold either because we changed our minds about the investment thesis, or we had better opportunities elsewhere, or they were tactical investments.

Our overall holdings are reflected in the charts below:

$\"asset_allocation\"$

Figure 1: Asset Allocation

$\"Sector_alocation\"$

Figure 2: Sector Allocation

Our total equity position is now at 87% in equities, which is an increase through the period.

Our Top 10 Equity Holdings as at the end of May 2017 was as follows:

$\"\"$

Figure 3: Top 10 Holdings

Ideally, we would be more fully invested in equities. However, in the current market, we believe retaining some cash is prudent and provides an option to acquire assets that become available at good prices.

In the businesses that we own, most have great long-term potential, i.e. they have and continually seek to gain competitive advantage through innovation. They support key investment themes. We are also satisfied that our positions (and size of positions) reflect our view of the valuations and risks in these businesses.

We believe that the structure and shape of the portfolio will change as the market changes. We have a number of other great businesses that we would like to own. At the appropriate time, we will buy into those businesses. We do prefer to hold onto businesses for the long-term, and also prefer to have concentrated positions in those businesses.

The table below provides a synopsis of our likes and dislikes of our Top 6 equity holdings at this time. It is not a comprehensive analysis, but rather a quick view of how we are thinking about these businesses:

Business

Likes

Dislikes

Investment Themes Supported

PSG

– Diversified business

– Owner managers

– Disruptors

– Focussed on solving SA problems

– Private Equity potential upside

– Underlying businesses pricey

– Growing Emerging Markets Middle Class

– Innovative

– Exponential growth in Technology

– Changing preferences of millennials

Aspen

– Global generics and OTC business

– Owner Managers

– Strategic positioning in geographies and product portfolio

– more attractive at these valuations

– Risks in some markets (e.g. Venezuela)

– Regulatory

– Aging populations

– Growth in Emerging Markets Middle Class

– Exponential growth in Technology

Discovery

– Innovative

– Owner Manager

– Upside from global initiatives

– Behavioural driven business model

– Big data driven business model

– Valuation, especially price to Embedded Value

– Banking foray

– Initiatives need to start delivering

– Aging populations

– Growth in Emerging Markets Middle Class

– Exponential growth in technology

– Changing preferences of millennials

Omnia

– Innovative technology

– Scalable

– Back-door entry into resource sector revival

– Valuation

– Agriculture

– Liquidity

– May take a while for resources to recover

– May experience margin pressure due to droughts

– Manufacturing sector in SA under pressure

– Innovation

– Growing Emerging Markets Middle Class

FirstRand

– Great franchises

– Owner manager driven culture

– Innovative

– Valuation (especially ROE)

– Higher funding costs due to ratings downgrade

– SA Macroeconomic fundamentals poor

– Changing preferences of millennials

– Growth in Emerging Markets Middle Class

Shoprite

– Rest of Africa strategy

– Positioned for the cost conscious shopper

– Owner Manager

– Innovative arrangements with property owners

– SA Consumer struggling

– Ability to remit cash from some countries

– Growth in Emerging Markets Middle Class

Table 1

How have we performed since inception?

We are satisfied with our performance to date of 0.99% after fees and expenses, despite a real negative return during the period. We are mindful that it is still very early days in the fund. The fund ranks 10^th out of 55 funds in the Worldwide Flexible category. The average performance of the Worldwide Flexible category was -2.78%.

Figure 4 below shows the fund’s performance against the market benchmarks we measure ourselves against. Our weighted benchmark is 75% of the ALSI and 25% of the NASDAQ, converted to Rands.

$\"\"$

Figure 4: Cumulative Performance

As can be seen we are marginally outperforming our benchmark, we returned a 0.99% versus the benchmark (Weighted line (yellow) in the figure above) of 0.79%. Twelve months is a very short period in which to assess our performance.

Strategy

In our investment strategy over the next quarter, we will:

Continue to be patient in our investment approach, waiting for prices to better reflect value before we invest more funds in great companies for the long-term; and
Slightly reduce the number of counters we hold to increase the concentration in the fund.

Conclusion

Despite the turbulence in the market, we are pleased with our start and our performance. We have no doubt that we will continue to face headwinds along the way and that the markets will also provide great opportunities for investing. Whilst we will be patient in investing our funds, we will also not hesitate to be more aggressive if the market conditions provide better investment opportunities.

May we take this opportunity of thanking our clients and co-investors; our partners and all our followers and readers for helping us get off the ground. We will continue to learn and hone our investing skills. We will continue to share our learning and encourage more people to invest, especially those from previously disadvantaged communities.

We believe that an investment culture will not only positively impact individuals and their families but also our communities and the country as a whole.

One Year On … Read More »

#MyFamilyBalanceSheet

Archive / By VCS Agency

Click here for spreadsheet

https://lunarcapital.co.za/wp-content/uploads/Lunar-Capital-MyFamilyBalanceSheet.pdf

[/fusion_text][/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

#MyFamilyBalanceSheet Read More »

The Robots are Coming!

Archive / By VCS Agency

Artificial Intelligence

One of the most rapidly advancing technologies today, and perhaps scariest, is in the field of artificial intelligence (AI).

I’ll attempt a layperson’s explanation of AI:

AI is the ability of a machine or computer to have human-like thinking (or cognitive) capabilities. The computer is programmed in a way that allows it to:

apply certain rules on inputs that it receives,
use previous experience, and
improve its learning as it gains more experience

so that a goal or certain goals are met.

You can deduce that this is very similar to human-like thinking and learning.

Examples of Artificial Intelligence systems

There are quite a few examples of AI systems that are already available today:

Self-driving vehicles

This is probably one of the best examples of very advanced artificial intelligence. There are many inputs one has to consider when driving a car safely, such as the rules of the road, objects, other road traffic, pedestrians, animals, traffic rules, road conditions, etc. One then has to use that information to make decisions like is it safe to proceed or turn, how fast should you drive, how hard should you brake, is it safe to change lanes or overtake, what action should be taken to avoid a collision, what route should you take, etc.

Despite the complexity of designing self-driving vehicles, this technology already exists today. The Google self-driving car project, also called Waymo is probably the most advanced project in this space, recording significantly fewer accidents over many kilometres of testing than human drivers. Take a look at the Waymo website.

As an aside, it would be fascinating to have the Waymo tested on South African roads. There may be a real risk that it learns all of our bad driving habits.

Siri

If you are an Apple iPhone user, you may already have encountered Siri. Siri acts like a personal assistant and is able to interact with you in a natural language like English. You can ask Siri for directions or search for some information or even send a message or book a calendar event for you. Siri improves itself by accessing more and more information databases, building its own intelligence as it learns from its successes and failures.

Siri has gone through several iterations or versions and has improved over every iteration. One can expect that as this technology develops, it will become more user-friendly and valuable. What excites me about this technology is the natural language capabilities. This will get better over time and I look forward to a time when we’re not all hunched over our mobile phones for fear of missing some breaking news or that all important email. Siri (or equivalent) will take care of that for us, and only call our attention if it thinks that the issue is important enough.

COIN

JP Morgan process approximately 12,000 new commercial loans annually. Each of these has an associated loan agreement. COIN is an AI system developed by JP Morgan to parse these commercial loan agreements and to interpret these agreements. This used to take over 360,000 hours per annum to do by lawyers and loan officers. Now, it is done within seconds. COIN also helped JP Morgan to reduce errors in loan processing.

COIN started with parsing and interpreting commercial loans and they intend to extend this to other types of loans that they conclude with their customers and counterparts.

Amazon Go

Watch the YouTube video on Amazon Go. Amazon Go is a new concept self-service store. You walk into a store which allows you access into the store because you have signed on at Amazon Go and the App on your smartphone connects to the store’s access control system. Whatever, you choose to add to your shopping basket and walk out of the store with, immediately gets charged to your Amazon account.

There are no security staff or cashiers at the store. You don’t need to stand in a queue, no need to swipe a card.

Amazon Go concept stores have already been opened and currently they have a limited set of product that you can purchase. Watch this space, as the technology improves and the stores stock more products.

Again, sensor and AI technologies are used to determine that you have entered the store, what products you have put into your shopping basket, which ones you have taken but then decided not to take and ultimately what you have walked out of the store with.

Cancer Detection

Google and other AI companies have developed technologies for detecting and diagnosing certain types of cancer. In some cases, these AI systems can detect certain cancers faster and more accurately than even the most trained pathologists.

Due to the number of slides of tissue samples, as well as the complexity of these images, even trained eyes can make mistakes and it can also take a long time to review and make a diagnosis.

AI technology is helping to analyse these samples much quicker and with better accuracy. Whilst limited at this stage to certain types of cancer, again one can expect that this technology will only improve. In time, it will be standard equipment in all pathology labs.

Should we embrace these developments?

Safer roads, better and quicker medical diagnosis, no queues at shops, ability to talk in a natural language with your smart phone or robot assistant. Surely, these are all welcome in our lives as it can only make life better? Imagine the improvement in productivity if you didn’t have to concentrate on driving to and from work every day. Or, Siri doing some research for you for a project that you are working on.

BUT. Let’s, consider how many people earn a living driving vehicles. Truck drivers, taxi drivers, couriers, delivery agents, …. The list goes on. What happens to them? What about other consequences: if you don’t drive the car, why should you want to own one? Would this decrease the demand for cars on the road, if you can just call up a cab on your app to take you to wherever you need to go to? Does this mean fewer cars been produced and fewer available jobs at motor manufacturers?

How many people earn a living as cashiers, packing assistants, security at a supermarket or store? What happens to them when one has fully automated stores?

Lawyers, pathologists, personal assistants. These are just from the few examples I have referred to above. What about other jobs: doctors, accountants, miners, farmers, fashion designers, bankers, engineers, computer programmers? Again, the list can go on.

Technological developments occur throughout history. In fact, humankind continuously looks for ways to make life safer, easier and of a higher quality. The Luddites were textile workers during the industrial revolution who refused to embrace machination. History has shown that they failed to stop this revolution. The destruction of factory and white collar jobs has also continued apace. Arguably, AI is targeting the next set of jobs and it is hard to tell where this will end up. If history is any indication, then certainly we will see those jobs been decimated.

History also shows that in the longer term, jobs moved from farms to mines and factories, from mine factories to service sectors like banks, insurance companies and retail, and also more people in professional careers. Will we see another migration of work during the second machine age?

Needless to say, without an appropriate response from policy makers and a clearer view of what new jobs there would be in future, so that people can be trained in them; we run a significant risk of more social upheavals. Some analysts have mooted the idea of a universal basic income for all.

A universal basic income will provide each citizen with a monthly stipend to provide for basic needs such as food, shelter and education. Some will rise above this mere existence through entrepreneurship, endeavour or other means. Don’t ask me how we fund this or whether it would in fact allay any social issues?

What can you do?

Very simplistically, you can do certain things that are in your control to try and soften the blow that will likely come as the robots start taking more of our jobs.

Here are some of the things I am doing? There is no guarantee that it will work, but for me it is much better than doing nothing:

Invest in some of these businesses that are leading the way in developing these technologies. If they are successful in killing your job, then the impact may be countered if you earn a decent return from your investment.
Continue your journey of learning. This will give you a better chance of adapting in this rapidly changing environment.
Pressurise policy makers (governments) to develop appropriate policies to cope with this.
Lastly, try to be part of the change, i.e. make the change rather than be changed or be a victim of change. Think about how you can work together with technology to do better, whether it’s in your career or to solve challenges facing the world. In this way the change can be very beneficial to you and to society.

[/fusion_text][/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

The Robots are Coming! Read More »

Risk

Archive / By VCS Agency

“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1” Warren Buffett

What does Buffett mean when he says that the first rule of investing is never to lose money, and the second rule is to never forget the first rule? Has Buffett never lost money?

To answer the second question first: over his investing career and his portfolio as a total, Buffett has not lost money. In fact as we all know, he has had spectacular gains. However, there have been periods when he has lost money and he has also invested in some companies that had to be sold at a loss.

So, to get back to the first question: what does Buffett mean when he says don’t lose money? What he means is that one should not approach investing in a frivolous way. Investing is not like gambling, it requires a systematic approach, careful analysis and an expectation that one’s analysis could be wrong or that unforeseen risks may be lurking in the future. One of his investing guidelines is to try and identify a margin of safety in any investment that he makes. The margin of safety is one way of trying to manage the risk in any investment.

Investing and risk management are two sides of the same coin – they go together.

Risk is not binary

Many investors think about risk in a binary manner, i.e. either something will happen or it won’t. For example, you will buy a listed company because you think that the share price will rise. But, after you do your analysis and you assess that the price that the share is trading at offers good value, a number of scenarios can play out:

The share goes up exactly as you analysed. However, this is not how it pans out most times;
The share could go up more than what you thought. This is a positive risk and is sometime termed as an upside risk;
The share could go up by less than what you thought;
The share could stay more or less the same;
The share could go down;
Etc.

Any number of factors could cause any of the above scenarios:

Unanticipated risks could have materialised;
Other investors either correctly or incorrectly may have an opposite view to you and this impacts the share price;
Your analysis may have been flawed;
Regulatory changes;
Etc.

So, when one thinks about risk in a binary way, this is really very flawed way of thinking. Risk is in fact a range of probabilities that different outcomes may occur. Your analysis suggests the most likely (i.e. highest probability) outcome, which may or may not occur. Even lower probability outcomes may occur. And, these may occur for rational or irrational reasons.

One of the key tenets then of risk management is to assess how different scenarios may or may not play out over time in your portfolio. Rather than betting that an event will occur, assess the different scenarios and position your portfolio in a way that reflects the different probable outcomes. A good example would be in the South African context: assume that you are thinking that the Rand will weaken against major currencies over a 2-3 year period by 20% to 25%. In this case, if you were 100% sure that this will occur, then arguably you should have all your investments in Rand hedge shares.

Now let’s play out the above position, assuming everything else stays the same:

If the Rand does weaken then arguably you should get the benefit in your portfolio of whatever the Rand has declined by. In fact, you wish that the Rand can weaken a lot, so that you can get the benefit (in Rands) in your portfolio. In this case, you are a hero! Crazily, poor risk management resulted in a good outcome!
Let’s take the opposite scenario: the rand actually strengthens. In this case your portfolio loses by the value of the rand strengthening. The more the Rand strengthens, the more you lose in your portfolio. In this case, you are an idiot! You have broken Rule No. 1.

Remember, that even a small probability of an event happening could occur.

Arguably then, if you thought that the Rand was going to weaken, but if your conviction was not 100%, say 70% chance of weakening and 30% chance of strengthening, then perhaps you should have some (approximately 30%) of your portfolio in shares that would benefit if the Rand strengthened.

In this case, you would be neither hero nor idiot; maybe a little better off if the Rand weakened, and a little less well off if the Rand strengthened relative to the market. But, arguably you would have better managed your risk, i.e. following Buffett’s rules of investing.

Risk is not volatility

Many investment professionals make the mistake of defining risk as volatility. Volatility is rapid and unpredictable change. Volatility may be due to several factors: lack of liquidity in a share, derivative traders hedging positions, many or large uninformed investors in the market, sentiment, etc.

True, if a company’s business is prone to many unpredictable factors, then it is a risky company to be invested in. But, if you have the ability to predict the performance of a company with relative accuracy, but its shares trade in a volatile manner, then this can in fact give you a great advantage. You can buy at much lower prices than the underlying value of the business.

Many great investors talk about buying when there is blood on the streets. Risk analysts and volatility indicators will in fact say that the market is very volatile and thus very risky. But for the greats like Buffett and Templeton, these volatile times are likely to be great times to be investing. They provide an opportunity to pick up good businesses or assets at great prices (when price is below intrinsic value).

Risk is not volatility, it is in fact paying more for an asset than it is worth. Even great businesses can be over-priced, leading to poor investments if they are bought at over-priced levels.

If you are geared either through loans or derivatives (both not recommended), and you are required to make interest or margin calls, then in this case volatility is a risk for your portfolio.

Sentiment and Risk Appetite

There’s another factor that should be considered and that is your ability to stomach volatility. If you constantly watch the stock prices and are jittery to sell when share prices come down, then in fact YOU may well be the risk in your portfolio, i.e. you panic and sell at the wrong time.

You are required to be quite rational and not driven by sentiment when making investment decisions. Most people in fact are not geared this way. They are affected by sentiment, selling when everyone else is also selling thus forcing prices down, or buying after large returns have already been made.

If you are prone to sentiment in your investment decisions, then you should rather let a professional invest your money for you, whether it is through low cost index trackers or through actively managed funds or a combination of those.

Do your homework

Risk management is thus as much about understanding the potential hazards and unknowns in an investment, as it is about understanding the businesses that you are invested in. It is also about understanding yourself and how you may behave under volatile market conditions.

It is thus important that you do as much homework as possible and develop a risk management strategy that suits your risk appetite.

Similarly, invest only in businesses that you understand and that you have a high conviction in.

If you do not have the time and/or inclination to do proper analysis, then select an investment strategy, possibly with the assistance of a qualified financial advisor and rather let professionals manage your investments.

First prize is always that you are able to manage your own investments.

* * * * *

Buffett’s rules of investing therefore is that you should aim to protect your capital or permanent losses as a fundamental rule. Only swing to the fences when you are certain that you will be able to do so, otherwise balance your portfolio accordingly. This could mean sitting on a bit more cash until the better opportunities come along.

Risk Read More »

Ring the Bell

Archive / By VCS Agency

Ring the Bell

Please let me know when market guru of the Johannesburg and/or the Nasdaq Stock Exchange rings the bell to tell us that we are at the top of the market cycle. Similarly, let me know when our market guru declares that we have reached the bottom of the next bear cycle.

You know that I am been facetious about the market guru. Nobody rings the bell or for that matter can reliably predict the top or the bottom of a bull (rising market) or bear (falling market) cycle. There are far too many factors that influence the markets. Behavioural economics also teaches us that investors can display huge doses of irrationality – pushing stock prices higher in an already overheated market or pushing them lower in an already under-priced market.

So, anyone that can claim to predict the top or bottom of a market is simply lying. But, we as investors can also get caught in this same lie. Amongst us, we often hear someone saying that they are waiting for a crash in the market, so that they can then enter the market, only to watch the market go higher.

What alternatives do we have if we cannot predict when to enter or exit the market?

When we’re around a braai and I inevitably get the question is it the right time to invest or do I think that the market is in for a crash or something along those lines, then my response is generally what most non-professional investors don’t want to hear:

It is very difficult to predict the markets, especially in the short-term. An over-valued market can remain over-valued or even get more over-valued in the short-term. However, at some point in the future, it will correct itself. But when and how this correction will take place is very difficult to predict;
Similarly, an under-valued market can remain so for a long-time and even get more undervalued. Again, it will correct itself but how and when this will take place is difficult to predict;
Another response, maybe yes, the markets are over-valued in general, but we may be of the view that there are opportunities in certain sectors or shares;
Lastly, our responses may not be what is generally perceived, i.e. the general sentiment may be down but we may be seeing opportunities or vice versa.

Generally, most people don’t like to hear these less definitive answers. They want a high degree of certainty: it’s a great time to buy or the market is due for a correction soon and then it will be a great time to buy. To try and help things along, I suggest to non-professional investors that they develop an investment strategy and stick with it.

Given the uncertainties, risks, knowledge, skills as well as the opportunity to build wealth over the long-term; the non-professional investor could consider two very simple strategies for investing in the equities (stock) markets:

Invest by Debit Order

In this strategy, you take it as granted that it is very difficult to predict the top or the bottom of the market; so you invest a fixed amount every month. Ideally, it is automatically debited from your bank account, so you don’t have the administrative hassle every month and you don’t get cold feet. The advantage of this approach is that as the market rises, the funds that you have already invested benefit from the rising market. However, when the market declines, then you get the benefit of getting more units for the money that you now put in, i.e. you get more units for each rand that you invest. This method is called rand-cost averaging.

Your biggest advantage is that you are not trying to time the market, which you know is a futile exercise. By investing over the long-term, you have a much better chance of building real wealth over this period as you stay the course.

By not investing a lump sum at a point in time, you take away the timing risk, i.e. that soon after you have invested there is a crash in the market and you lose a big percentage of that lump sum early on, which impacts your lifetime returns, i.e. it takes you longer to achieve your target.

Another huge advantage is that you take the emotions out of investing. You have a strategy, you stick to it, irrespective of what the sentiments in the market are.

One of my favourite reasons for investing in a debit order approach, is that you are paying yourself first, as Warren Buffett likes to put it. By paying yourself first, you are putting away money for a rainy day and giving yourself a great chance of actually building wealth. After you’ve paid yourself, then you can look at spending in other areas.

Invest Monthly, but adjust according to market conditions

In this approach, you really just make a variation of the above strategy. You choose a minimum monthly investment by debit order, but you increase the amount as market conditions look better for investing. In this approach, you must have a methodology of assessing whether conditions are good or bad for investing. For example, you may apply a simple analysis of the current market valuation (say price to earnings ratio) to the long-term historical average price to earnings ratio.

If the current price earnings ratio is lower than the historical average, you may choose to put more money in every month; but if it is higher, you can choose to lower the monthly payment.

Perhaps the biggest challenge that you will face is that you will likely be going against the general market sentiment, i.e. when all is doom and gloom, you will be investing more; and when everyone is wanting to buy, you will be reducing your buying. If you have the emotional discipline to be able to do this, there’s a good chance that you will do better than most. Remember the saying: Buy when there’s blood on the street (i.e. the market has crashed), and sell when the man-in-the-street is talking about buying in the stock market.

This is also more difficult to execute, as you need to make a decision each month whether you will add to the debit order or not, and if you do think you will add, how much will you add.

* * * * *

Unless, you really are very close to the investment markets, a good strategy is to invest in the market on a monthly basis, preferably by debit order, i.e. pay yourself first. You can vary it a little. Perhaps after you’ve received a bonus, you can put a portion of your bonus into your investment portfolio if the market conditions are good for investing. Alternatively, you can take that portion and invest it temporarily into a money market account or a call account until such time that market conditions are good for investment. When market conditions are good for investing, you can then transfer from your money market or call account into your investment portfolio.

The worst thing that you can do is to wait for someone to “ring the bell” to signal that you need to start investing. You will watch the market go by and lose a real opportunity to build some wealth for you and your family. Over the past 25 years, equities have returned 9.7% in real terms per annum, bonds 6.6% and cash approximately 0.9%.

What are you waiting for? Nobody is going to ring the bell for you to start investing.

Ring the Bell Read More »

Read to Learn

Archive / By VCS Agency

Read to Learn

“If I have seen further, it is by standing on the shoulders of giants”

This quotation is attributed to Sir Isaac Newton. Newton was making the point that had he not learnt from other great scientists, he would not have been able achieve what he did.

In the investment world, there are a number of great investors who are eager to share their investment philosophies and strategies. This is a great source of learning. The internet also has an abundance of people (and maybe some bots) sharing their ideas and views. However, I have found that books written by the masters have provided the deepest learnings, especially when one tries to practically implement those learnings. To be able to write a book well, one must be able to think through the subject matter deeply and be able to communicate this so that the readers are able to understand the complex analysis and messages that one is trying to convey. Hence, in my opinion books provide the best means from which to learn complex subjects.

In this blog, I’ll briefly discuss five books that have had a major impact on my investment philosophy, strategy and approach. This is by no means the best five books but merely those that I can trace back from our current investment philosophy and approach. There are many other books from which we have learnt and these learnings are perhaps more implicitly used in our investment philosophy and approach.

Benjamin Graham – The Intelligent Investor

One of the highlights of most investor’s year is Warren Buffett’s annual shareholder’s letter to Berkshire Hathaway’s shareholders. In many of these letters as well as in interviews, he has recommended reading Benjamin Graham’s The Intelligent Investor. Buffett calls it the best book on investments ever written.

This book is full of practical advice on investing, valuing companies, managing risk; broadly providing a framework that anyone can apply in their investment journey. The advice that Graham provides, if applied correctly can significantly reduce the emotional aspects of investing. In other words, he provides one with quantitative tools that you can use to make investment decisions and reduce the impact of emotions in these decisions.

One of the tools that we use in our investment approach is a set of quantitative and qualitative valuation criteria that we directly applied from The Intelligent Investor. Over time, we have added to this valuation criteria, but the core aspects of deciding how to determine the value in a given business comes from our learnings from this seminal work.

Perhaps the best take-out from this book is that it allows you to think independently about the market and whether a share is over- or under-priced. This is particularly important when one considers that the market and particular stocks too, can be significantly over- or under-valued at any point in time. If one has the emotional discipline to apply Graham’s advice in your investment decisions, there is a very good chance that you will outperform the market over time.

Graham is considered as the godfather of value investing and the father of security analysis.

Alice Schroeder – The Snowball

The Snowball is sub-titled “Warren Buffett and the Business of Life” written by Alice Schroeder on the life of Warren Buffett. This book would be as close to a book written by Buffett himself on his life if he had done so (He has decided not to write his autobiography).

It traces his life both personally as well as professionally and provides an incredible insight into his wisdom, frugality and quirkiness.

Some of Buffett’s quirkiness are his love for drinking cherry flavoured coke and eating burgers, replacing his car with a used vehicle, because he hates paying a full price and living in the same house for the most part of his adult life. His simple philosophy is that if he saves a dollar today, it will be a thousand dollars one day in the future. Isn’t there a wonderful lesson on what we can do to save a little today so that we can invest to get more in the future?

The book also shows his deep respect for Benjamin Graham and how Buffett adopted Graham’s teachings into his own investment style. Importantly, it also shows how Buffett “stood on Graham’s” shoulders by adapting his own investment philosophy. Graham espoused the idea of buying cheap stocks, i.e. stocks that are priced cheaper than its intrinsic value. Whilst this is still a core component of Buffett’s approach, it is his learning from his long-time partner and friend Charlie Munger that Buffett adapted his style to not only focussing on a cheap price but also on the quality of the business.

The argument that if you can get a quality business at a cheap price (even maybe not so cheap, but at least cheaper than its intrinsic value), then you are into superior investment performance. It certainly shows in Berkshire Hathaway’s performance over the very long term.

One of the other profound learnings from The Snowball for me was that Buffett only invests in businesses that he understands. During the dotcom boom of the late nineties and early noughties, Buffett famously did not invest in any IT businesses. For a while, Berkshire Hathaway underperformed the market, but this was quickly reversed subsequently. The pressure to invest in the latest craze and the “next big thing” will always be there. If you do not understand these crazes, then it is better not to invest in them.

The book also covers Buffett’s philanthropy and his approach to how he will donate his fortune. It covers how he and Bill Gates, the founder of Microsoft have become friends, and how Buffett has pledged most of his fortune to the Bill & Melinda Gates Foundation, a philanthropic organisation trying to solve some of the world’s greatest problems, including for example finding a vaccine or cure for malaria, one of Africa’s greatest killers.

Howard Marks – The Most Important Thing

Howard Marks is the Chairman and founder of Oaktree Capital Management. His investor memos are also legendary and always provide great insight and very deep thinking. He used the material from some of his memos to compile The Most Important Thing.

He starts of by saying that it was his discussion with Charlie Munger (Buffett’s partner) that led him to conclude that investing is not easy. Sarcastically, he in fact lists twenty issues that are the most important thing when it comes to investing: from second level thinking (i.e. not simple cause and effect thinking), to understanding market in/efficiencies, value, understanding risk, controlling risk, being attentive to cycles, appreciating the role of luck, etc.

Marks is no doubt a deep thinker and a very experienced and successful investor. Arguably, he can be considered as a contrarian investor. In this book, he provided a checklist to gauge whether it is a good time to invest or not. It is not surprising that the best investment opportunities are more likely to come during economic downturns and when the mood is really grim. This is when most investors are in fact staying out of the market.

We have adapted this checklist to gauge the mood in the market. We use this as an additional input in deciding how aggressive or defensive we will be. As an aside: Our assessment using this tool, is that the market is lukewarm at the moment, i.e. neither a great nor a terrible time to be investing. So, we approach the market with an element of caution. Another section that we found useful is understanding and controlling risk, and in particular the dangers of betting on a single outcome. We often mistake risk as volatility, or we look back and say that a particular event caused the risk to be realised. But risk is in fact a range of scenarios that can possibly play out, some scenarios beneficial, and some costly. At the outset, it is hard to assess the exact scenario that will play out.

The Most Important Thing highlights the difficulty in investing. There are many moving parts, many risks, and many hidden factors influencing the markets. It is a continuously surprising and learning experience.

Peter Lynch – One up on Wall Street

One Up on Wall Street was written by Peter Lynch who managed the Magellan Fund at Fidelity from 1977 to 1990. The Magellan Fund was the best performing fund over that period. This book, written in 1989, shares some of Lynch’s insights and investment techniques. It is written with a view that the person in the street has a better chance of outperforming the market than Wall Street (i.e. the professionals).

How can the layperson beat Wall Street, especially after we heard Marks’s view that investing is not easy? The layperson, has a better chance of spotting emerging trends that can lead to great investment decisions, than the professionals. An emerging company will be too small for professional investors and will not even make their radar initially. In all likelihood, this is when this emerging company is not over-priced and can likely result in a ten-bagger (i.e. an investment that yields ten times its original investment).

These trends are often observed in the consumer sectors, notice a trendy product, chain store or franchise that everyone is raving about. Are they listed? Is the new store or product part of a listed company? How big is that store or product of the listed company? If it is significant, then maybe you have spotted a potential ten-bagger.

Lynch also identifies different types of investment opportunities: is it a stalwart, i.e. a profitable but slow growing company; is it a fast grower; is it a turnaround; is it an asset play; is it a cyclical business? We find this a very helpful way of providing a clear reason for why we may be investing in a particular business.

I also found the section of when to sell a share very helpful. Warren Buffett is famously a collector of businesses, i.e. he likes to invest in businesses forever. However, I found Lynch’s indicators of when to sell a share as particularly insightful and pointed. Has inventory levels being building up? Is the business requiring more and more cash to stay competitive.

Even though this book was written in 1989, it is as helpful today as when it was written, to both the professional and more so the individual investor.

Martin Ford – The Rise of the Robots

Finally, Martin Ford’s analysis of technology trends and its impact on jobs in The Rise of the Robots is a scary book. It shows the decimation of jobs as a result of automation and the reducing share of income of the average working person over the last twenty-odd years. I wrote about this in a previous blog: Making sense.

He paints a picture that if we see this trend of job decimation and lower or stagnant wages continuing, then we will not have a market for the goods that we produce. The general public will not be able to afford the goods that are produced – i.e. demand will die. Arguably, the rise in populism is a reflection of this trend, people are unable to afford what they believe that they should be able to afford.

Ford also argues that with Artificial Intelligence, even good jobs like office workers, programmers, journalists, paralegals will be taken over by computers (robots). This book makes one think very poignantly about the future. What economic prospects will we have? Will inequality continue to widen? Will this result in social upheaval? What policy responses could we have to be able to either counter this trend or be able to better cope with these trends?

Whilst this book is not directly about investing, it does provide one provide a glimpse of what the future may look like, which industries may benefit and where the risks may lie. As citizens, the book provides a better insight to the problems that we are facing and allows us to engage with leaders and policy makers more meaningfully. It also allows us to take individual actions so that we can learn new skills and build up reserves to cope in this rapidly changing world.

* * * * *

Read to Learn

In summary then, by reading we can learn from the masters and avoid the pitfalls that they encountered. We can share in their wisdom and put this into our practice. Books are by far the best way to learn quickly, but it is only through practice that one will know how well you have learnt.

Read to Learn Read More »

Forecasting

Archive / By VCS Agency

Time to forecast?

It’s that time of the year when many pundits provide an opinion on what they forecast for the year ahead. Some even go so far as to predict what the exchange rates or market indices will be as at the end of the year. A good way to check out how good these forecasters are is to look at their previous forecasts and check how well their predictions panned out. Inevitably, these forecasts are more wrong than right.

If 2016 has thought us anything, then it is that we are poor at forecasting and predicting outcomes. There are far too many variables, including behaviours and emotions that influence what happens in the social, political and economic environments and they all influence each other as well. Thus, to be able to predict outcomes with high levels of certainty is an impossible task.

At Lunar Capital, even though we make decisions about the future, we do not forecast or predict what the future will bring. We analyse the current landscape, try and understand the risks in the market (expecting also that there may be risks unbeknown to us) and make investment decisions based on this assessment. Typically it means that we do not invest on the basis of a single outcome. Similarly, we have a longer term horizon in our investment decisions.

In a previous blog, Growth at a Fair Price, we outlined how we make investment decisions. In this blog, we will use this methodology to re-assess our decisions.

Reviewing our Investment Themes

At the outset, it is important to note that we are primarily a South African based fund. Our mandate limits us to have a maximum of 25% in offshore assets. In the offshore portion of our fund, we have a bias towards technology and pharmaceutical/biotechnology businesses.

In the table below, we relook at the key investment themes we identified when we launched our fund last year. We assess whether the investment theme is still valid or not and what are the possible investments we could make to take advantage of that theme.

[fusion_builder_container hundred_percent=\”yes\” overflow=\”visible\”][fusion_builder_row][fusion_builder_column type=\”1_1\” background_position=\”left top\” background_color=\”\” border_size=\”\” border_color=\”\” border_style=\”solid\” spacing=\”yes\” background_image=\”\” background_repeat=\”no-repeat\” padding=\”\” margin_top=\”0px\” margin_bottom=\”0px\” class=\”\” id=\”\” animation_type=\”\” animation_speed=\”0.3\” animation_direction=\”left\” hide_on_mobile=\”no\” center_content=\”no\” min_height=\”none\”]https://lunarcapital.co.za/wp-content/uploads/frecasting.pdf

$\"\"$

Figure 1 – Reducing costs of Wind and Solar

Valuation and Investment Strategy

The next step that we take is to value these businesses to determine if they meet our investment criteria. We typically look at price earnings ratios, cash flows, return on equity, net asset value, debt to equity ratios, etc. We also assess other qualitative measures like management, industry dynamics as well.

From this we determine the businesses we want to invest in and how much we want to invest. We then construct a portfolio that we are comfortable with under the circumstances and given our assessment of the value and the risk.

This is by no means a guarantee of success, and we are sure that we will make some decisions that will turn out unfavourably. But at an overall portfolio level, we think an approach like this has a better chance for success than if we tried to forecast say the Rand/Dollar exchange rate and bet on that outcome.

Warning

There are no guarantees in the investment world. Similarly, whilst we share our investment philosophy and strategy with you, we are by no means suggesting or recommending that you follow our advice and buy into the companies that we mention. We hope however, that it helps you in choosing an appropriate investment strategy for yourself.

[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

Forecasting Read More »

Six Months

Archive / By VCS Agency

Our first six months review

Market Context

The Lunar BCI Worldwide Flexible Fund (LBWFA) was launched on 1 June 2016. In our first six months to 30 November 2016, several significant events have been playing out locally and globally, which impact the investment markets:

The ongoing political wars within the ruling African National Congress in South Africa;
A slowing macro-economic environment in SA;
SA dodging an investment ratings downgrade bullet;
Allegations and counter-allegations of corruption within state-owned enterprises and government departments;
A significant reduction in the ANC’s majority and a loss of major metropolitans to opposition parties in the recent local government elections;
British voters voting to leave the European Union;
American voters voting Donald Trump as their 45^th president and the potential uncertainty his presidency may bring to the world;
Speculation on pace of rate increases by the US Federal Reserve.

This has created a lot of turbulence in the investment markets during this period. Our observations in the local investment markets over the last 6 months is that the USD/ZAR exchange rate reacted to these factors and was a significant driver of equity market valuations. With the USD/ZAR rate been as volatile as it has been, equity market valuations have also being quite volatile.

Three months ago, we reflected that valuation levels (reflected in the Price Earnings Ratio (PE)) on the JSE was quite high. This has reduced somewhat, but we do however still hold the view that there’s still a lot of risk in the market, particularly as rates start increasing in the US and other developed markets. We anticipate that the turbulence will continue in the equity, bond and exchange rate markets. However, we think that certain assets are looking better in value.

How have we positioned the fund in this context?

In the second quarter, we have taken advantage of starting to build up our foreign equity holdings. In particular, we have started acquiring Facebook, Amazon and Alphabet (Google). We also reduced our property holdings in South Africa and have been acquiring our preferred businesses in instances when prices have come down.

Our overall holdings are reflected in the chart below:

$\"\"$

$\"\"$ Figure 2

We have marginally increased our total equity position during the quarter from 63% to 67% in equities. Our Top 10 Equity Holdings as at the end of August was as follows:

$\"\"$ Figure 3

Ideally, we would be more aggressive in our investments, i.e. having a larger equity holding than we currently have. However, we are quite happy to have some ammo that we would be able to use if there is a correction in the markets, hence a higher than ideal cash position.

$\"\"$
Table 1

How have we performed since inception?

We are satisfied with our performance to date, despite a negative return of -1.56%. We are mindful that it is still very early days in the fund. Figure 4 below shows the fund’s performance against the market benchmarks we measure ourselves against. Our weighted benchmark is 75% of the ALSI and 25% of the NASDAQ, converted to Rands.

$\"\"$

Figure 4

As can be seen we are outperforming our benchmark, we returned a -1.56% versus the benchmark (Weighted line in the figure above) of -6.07%. We outperformed our benchmark by 4.52%. We ranked 7^th out of 55 funds in the South African unit trust Worldwide Flexible fund category for the six months. Six months is a very short period in which to assess our performance.

Strategy

In our investment strategy over the next quarter, we will:

Continue to be patient in our investment approach, waiting for prices to better reflect value before we invest more funds in great companies for the long-term; and
Continue investing our offshore cash, again on a patient and steady approach. We are allowed to hold a maximum of 25% of our funds offshore.

Conclusion

May we take this opportunity of wishing all our co-investors and our readers a safe and restful festive period. This is a wonderful time to clear your mind, re-energise and refocus yourself. Here’s to a prosperous 2017 for you and all your loved ones.

Six Months Read More »

Making Sense

Archive / By VCS Agency

Seminal changes

When the British voted marginally in favour of leaving the European Union (Brexit as it was popularly known as); many, including me and even Brexit supporters were surprised. Even more surprising was Donald Trump’s stunning victory in the US presidential elections. We were all led to believe by the mainstream media, as well as most pollsters, that Hillary Clinton would win the election. In the recent local government elections in South Africa, we witnessed similar changes in voting behavior. Most of the major metropolitans are now run by parties in opposition to the ANC.

If you include in the mix the #FeesMustFall movement, the public service delivery demonstrations and other similar protests; it is becoming evident that there is a growing level of discontent with the current status quo in South Africa as well as in many other countries.

As citizens as well as investors, we try to understand what is happening and how this may affect us.

What is happening?

I would like to posit a theory that suggests that these changes in voting and the protests that are taking place reflect a deepening dissatisfaction by the majority of citizens on the current status quo:

Unemployment – unemployment levels are high, traditional long-term employment is being replaced by short-term contract type assignments. In South Africa, unemployment levels stand officially at 26.6% but does not take into account many who are in the informal sector who barely make ends meet.

Increasing levels of Inequality – a study by Anna Orthofer from Stellenbosch University, finds that 95% of the wealth in the country is owned by only 10% of the population. Interestingly, Orthofer also finds that there is a growing Black middle class which makes up approximately 40% of the population and that there is less disparity in incomes between top earners and the middle class. This Black middle class however, has very little assets (only 5% to 10% of the total wealth).

Poor policy choices – policy choices made those in power have not had the expected impact on unemployment and / or inequality. One can argue that these policies have exacerbated these issues. Low interest rates by central bankers have increased asset prices (stocks, bonds, property, etc.) widening the inequality gap. Where businesses have invested, these have been typically in capital intensive, labour saving machinery instead.

Disconnected elite – Elites (i.e. those in government, business and professionals) are disconnected and thus unable to understand and / or respond appropriately to the growing angst and dissatisfaction of the majority of the population.

The result is Brexit, Trump, Vuyani, #FeesMustFall, #RhodesMustFall, etc. Citizens are rejecting the status quo and are looking for alternatives. You may not agree with any or all of these movements, but they are capturing voters by understanding their fears and voicing these. Some of the words and actions may be racist or violent in nature, but this does not deter people from supporting them.

My view is that the underlying causes of the issues are not well understood and hence we find ourselves in this situation.

Some of the Underlying reasons for the issues

Several underlying issues are playing out causing the current dissatisfaction. I highlight two of these:

Technological Change – Technology innovations are increasingly decimating jobs. Most modern factories are highly automated. Similarly clerical or white collar jobs are also rapidly been replaced by automation. Recent developments in artificial intelligence are also beginning to impact on knowledge based professions (automated trading; robot advisors, medical diagnosis, legal research, language translation, etc.). Imagine the impact that driverless vehicles will have by thinking about how many earn their living by driving.

Globalisation – Globalisation also plays a significant role in the destruction of jobs. Offshoring, cheap manufacturing countries, low tax jurisdictions, all vie for more capital and / or jobs to move to their countries. The movement of people from countries with potentially lower economic prospects to countries with higher economic prospects (e.g. Mexico to USA; Zimbabwe to South Africa; Eastern Europeans to United Kingdom) also plays a role in employment changes.

But the world has gone through technological as well as globalisation changes before and by-and-large mankind has benefited from this. What is wrong this time?

Benefits not equally shared

Take a look at the graph below:

$\"lunar-capital-graph\"$

Source: Lawrence Mishel, The Wedges Between Productivity and Median Compensation Growth, Economic Policy Institute. http://www.epi.org/publication/ib330-productivity-vs-compensation/

What this graph shows is that the economic benefits of productivity gains has by-and-large only gone to others (shareholders, maybe tax authorities) and not to the workforce. This is perhaps the most telling picture of why we have the level to inequality that we have right now.

Jobs have been displaced from blue and white collar workers to technologists and from high cost countries to low cost countries. New jobs created have been insufficient in addressing the tide of unemployment or real wage growth. Further, the benefits of productivity improvements from 1975 onwards has not gone towards compensation (salaries and wages). Hence this growing inequality and unrest on the status quo.

South African specifics

In South Africa, with the challenges that we face in our education sector, we are not creating near enough new economy jobs or onshoring jobs to take advantage of these trends. Many of our school leavers and even university graduates are ill-equipped to cope with the demands of the new economy. We score poorly in Mathematics and Science when we benchmark our students against global peers. Many of our brightest minds are been lured to work overseas taking with them their skills and the opportunity to create jobs in South Africa.

Because our economy is not growing, those that are in employment, protect their jobs at every cost. Whether it is through subtle racism in the corporate world or by killing rival political candidates in government elections. All these actions reflect a fear of losing one’s income. [fusion_builder_container hundred_percent=\”yes\” overflow=\”visible\”][fusion_builder_row][fusion_builder_column type=\”1_1\” background_position=\”left top\” background_color=\”\” border_size=\”\” border_color=\”\” border_style=\”solid\” spacing=\”yes\” background_image=\”\” background_repeat=\”no-repeat\” padding=\”\” margin_top=\”0px\” margin_bottom=\”0px\” class=\”\” id=\”\” animation_type=\”\” animation_speed=\”0.3\” animation_direction=\”left\” hide_on_mobile=\”no\” center_content=\”no\” min_height=\”none\”][To be clear, I’m neither an apologist for racists nor murderers.]

Arguably, even the Black Economic Empowerment (BEE) policies create an unintended consequence of white people desperately (yet subtly) hanging on to their jobs for fear of losing their incomes or protecting their lifestyles or fearful that their children will not be able to have a future in this country.

Policy Response

So what have the responses been from policy makers?

Central bankers have tried to stimulate the economy through low interest rates and quantitative easing programmes. However, this has not created the demand from consumers or stimulated investments that have created jobs in a sustainable manner. If anything, consumers have used lower interest rates to reduce debt levels. Asset prices (property, stock, bonds) have increased in value, benefiting the already wealthy and possibly creating an asset bubble.

In South Africa, government jobs have ballooned which has helped employment figures and in increasing the size of the Black middle class. But, this has not created a sustainable, structural change in the economy that creates jobs in a sustainable way. Fearful that these jobs are not sustainable, we have high levels of corruption and protectionism in our economy. This makes South Africa less attractive as an investment destination.

Business leadership is not playing its role in creating a more inclusive economy. Earlier, I talked about the wealth differentials between the richest (mostly White) and the rest (mostly Black). This is a sad indictment after 23 years of our democracy which has been a relatively peaceful transition. Given the atrocities of Apartheid and the privilege that this has afforded White communities and businesses, I do believe that White businesses can be more forthcoming on alleviating the discrepancies between Whites and Blacks in the country and redressing the ravages of Apartheid.

Earlier I also talked about BEE not having the impact that it was intended to have and in fact possibly also creating unintended consequences. Shouldn’t we take a cold look at this without the emotions that it evokes and ask ourselves how can this be improved?

Some thoughts on possible policy changes

Here are some of my thoughts on what we could do in South Africa:

Incentivise investments in new growth industries – we should be incentivising investments in growth industries like renewable energy, information technology; space exploration, driverless and electric motor vehicles; etc.
Fix the Basic education System – upscale teachers, provide high tech learning and teaching in our schools. Break the concept that all schools must have the same facilities – this is a noble objective but idealistic. Rather create champion schools initially and roll out the champion models to other schools on a phased approach as resources become available. Create a globally competitive mindset.
Revisit BEE – the current BEE model creates a mindset of limited resources rather than one of abundance. A few have benefited but we need to rethink how we can create access for the many who are left out in the cold. We need to rethink how we develop and retain critical skills and investments; and how we create more opportunities rather than trying to share from a shrinking pie.
Encourage entrepreneurship – make artisanal skills development a priority. Develop a plan to increase the quality and quantity of our STEM (Science, Technology, Engineering, and Mathematics) graduates. Incentivise them to stay in the country. Develop a plan to encourage entrepreneurs.

Investor responses

As investors, we understand that certain realities are here to stay: you cannot reverse the trends of technological advancements and globalisation. Similarly, you cannot miss out on the opportunities to create wealth that will not only benefit you and your family, but also the community at large. It is important to understand that you need to have a clear plan to build wealth for you and your family. You cannot rely only on your income to improve your standard of living. If you do have wealth, you will be able to influence where your investments go.

A philosophy that we follow is to invest in innovative businesses, because these businesses are generally more sustainable in the long-term. A strategy that we follow is to try and identify those companies that take advantage of trends such as technological innovation and if their valuations are reasonable, we invest in them. In this way, we participate in earning from productivity gains.

Lastly, we do not ignore the potential social implications of these irreversible trends and hence we play an active role as citizens in influencing policy debates and changes so that ultimately we can have a more inclusive economy. A more inclusive economy by definition is beneficial to all and certainly more sustainable. Ultimately, we all aim to improve our quality of life. Building wealth goes a long way in helping us improve our quality of life.[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

Making Sense Read More »