south african fund

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.

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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.

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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:

$\"\"$ 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.

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.

Six Months Read More »

Forecasting

Six Months