sabir munshi - Lunar Capital

Delaying Gratification

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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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The ‘Biggest’ Risk in Investing

Archive / By VCS Agency

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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.

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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.

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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.

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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:

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$\"\"$ 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:

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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.

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:

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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.

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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

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 great opportunities for us.

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.

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