Investing

It feels as if life is more intense now than twenty years ago. There are more people, more traffic, more events and more news. A constant stream of information flows through our mobile phones and every time we buy something, it is more expensive than the previous time. There might be an element of age involved. The older we get, the broader the spectrum of responsibilities. Another potential reason for our increased anxiety is social media. It is almost impossible to relax when your phone constantly updates you on the news around the world. Inevitably, the majority of the news is negative, and although it does not necessarily have a direct impact on your life, it still makes you worry.

The good news is that although we may think otherwise, people’s lives are actually getting better on average. Owing to advancements in medical technology, child mortality is much lower than just a few decades ago (see graph); your children will live to be a hundred years old, never develop cancer, and previously irreversible conditions like blindness will be cured. It is also a fact that many more people now live above the poverty line than a few decades ago.

Two of the most talked-about worrying factors currently are climate change and market volatility. Consider the fact, however, that the earth is actually overdue for another ice age; but thanks to the amount of carbon dioxide mankind’s activities have pumped into the atmosphere, we have actually avoided being frozen by now. Unfortunately, the fact that we are so good at causing global warming does upset our weather systems a bit. So perhaps we should do what we can to live in harmony with nature; but the future of our climate is determined by way bigger cosmic cycles than our human activity.

If we consider the much more manageable problem of market volatility, we have to take some comfort from the fact that what we are witnessing now, is not unusual. If we look at the S&P500 Index in the USA since 1928, we can see that there has been a period of negative returns (drawdowns) in every single year, but we have still had a positive close for the majority of them. The thing to do, is to stay calm. Take precautions and implement a plan. Then test your plan by going away for a couple of weeks to a place where you have no internet signal and little interaction with other people. If you come back relaxed and people tell you about the storms that washed away bridges and the markets that fell by 7%, but your house is still standing and your investments are still positive – stop worrying. If you have been affected by the chaos, then work on your plan.

Late one night, on August 15th, 1977, the Big Ear radio telescope in the USA picked up a strong narrowband radio signal on the frequency of 1420 megahertz. Astronomer Jerry R. Ehman discovered the anomaly a few days later while reviewing the recorded data. He was so impressed by the result that he circled on the computer printout the reading of the signal’s intensity, “6EQUJ5”, and wrote the comment “Wow!” beside it, leading to the event’s widely used name. The signal appeared to come from the direction of the constellation Sagittarius and bore the expected hallmarks of extraterrestrial origin.

The two most common instincts for humans and most animals when they encounter something unusual are to fight or to run away. It turned out that the “Wow!” signal made people run away and buy extra toilet paper.

It was a calm night on October 19th, 2017, when Robert Weryk, using the Pan-STARRS telescope at Haleakalā Observatory, Hawaii, observed a small object estimated to be between 100 and 1 000 metres long, with its width and thickness both estimated between 35 and 167 metres, enter our solar system from beyond the stars. It was the first interstellar object ever detected passing through the Solar System, and when the news exploded on the airwaves, people rushed out to buy extra toilet paper. This object was later called “Oumuamua”.

On 5th March 2020, it was reported in South African news that a traveller returning from Italy tested positive for Covid-19. Within a space of 18 days, 402 cases were detected among people with no travel history. So naturally people rushed out to buy extra toilet paper.

The moral of these stories is that when something unusual happens, human beings tend to panic first and then ask some questions later. It is very important for us as investors to know this, because in most cases, when people panic and sell every single share they own, it creates a buying opportunity for those people who choose to stand and fight rather than run away!

We are often told that when you buy a share, or some other investment that invests in shares, you have to just forget about it and let it grow over time. There is a lot of truth in this advice because shares as an asset class do increase in value over a longer period of time. There are, however, three very important points to consider with a view to reducing your risk and enhancing your returns over time.

The first point to consider is the concentration of your share investment. If you or your fund manager invests in only one or two shares, and one of those shares underperforms for whatever reason, you will have a very unfavourable return on your portfolio. So, if you bought these shares while they were doing well and locked them away, you would not notice a change in the environment that could potentially have a negative impact on your shares, and a share that once was a star, might turn into a dog. We have seen numerous examples of this, and just looking at the list of companies that currently dominate the world stage, compared to the companies that dominated twenty years ago, tells you this story. If, on the other hand, you have a portfolio or fund in which you have a variety of shares, the impact of one or two negative performances will not be so severe. The lesson to take away from this is that the more concentrated your investment, the more you need to pay attention.

The second point to consider is the impact of better returns on your portfolio over time. This is a point that invites a lot of argument in the “active versus passive” debate. If you decide to just invest in the broader market like the JSE All Share Index, the main driver of your investment performance will be the asset class as a whole, and not much thought has to go into the quality of the individual companies that make up that asset class. So if one or three of the companies in the Index should go out of business, you will still earn the average return of the remaining companies. If, however, you take a more active approach to the management of your portfolio, and not just invest in the Index, you can theoretically avoid those bad companies and concentrate more on the winners, resulting in a better return over time. It has been proven that it is not easy to outperform the Index over time and that is why a lot of investors decide to just invest in the Index; which will require no work from their side and also costs less when they use fund managers. But there are some fund managers that do outperform the Index over time, and the result can be quite profound. If, for example, you manage to outperform the Index by 1% over time, the compounding effect of this outperformance will be as follows, simplified to make it easy to understand: in the case of an investment of R1 million, your outperformance will be R101 000 after ten years; R249 000 after twenty years; and R441 000 after thirty years.

The third point we need to understand, is that combining the two previous points can result in a “Goldilocks portfolio”; where the number of shares are just right. If we have a portfolio where there are just the right number of shares to decrease the risk of a bad one impacting the returns too much; but time and compounding will do its work with a good one big enough to have a noticeable impact on the performance. Thus, at the end of the day, it is worth your while to pay attention to your investments. If you have a longer-term portfolio where you see a 1% or 2% average outperformance, in the good years and the bad years, remember that underneath it all your portfolio risk is less over the shorter term and over the longer term these small gains will pack a big punch.

Your personality plays a big role when it comes to how you invest your money, but when it comes to how you manage your investment risk, age should play that big role. Understanding the longer-term nature of the various assets you can invest in, is important when you construct your investment plan. As a general rule, investing in cash will provide you with a lower, yet stable return, and investing in equities will provide you with a higher, yet volatile return. The obvious result is that a more risk-averse person will prefer to invest in cash and a person that is more risk-tolerant will choose equities. These personality-driven investment choices can, however, have a dramatic impact on your investment performance over time.

When you are young and just starting out on your investment journey, you have very little. If you are a risk-averse investor, it will be very tempting to invest the little you have in cash, because losing it will be painful. But that will be the wrong choice. If the money you are putting away is truly for retirement purposes, you should invest it in something that will give you the highest return, and risk should play second fiddle. Let us, for the sake of argument, consider only equities as our high-risk investment option; and leave out the other high-risk options like investing in your education, your own business or property. The argument for investing in equities when you are young – even while accepting the possibility that you can lose it all – stems from the fact that even if you do lose it all, time is on your side to make it all back. It is also highly unlikely that you will lose it all permanently in a well-diversified equity portfolio. The upside of investing in a portfolio of equities, is the likelihood that over time, the compounding effect of the higher return you get, will obliterate any return you would have received in cash.

However, when you reach the age where your high-earning years are behind you and your investment portfolio becomes your main provider of monthly income, you have to make the switch to wealth preservation, rather than wealth creation. Chasing the highest return at any cost during this stage of your life can undo all the good you and your investments have done over your life and leave you destitute. Equities are unpredictable and even fantastic companies can stay depressed for long periods of time. The best thing to do during the time of your life when you rely on your investments for income, is to increase your diversification and provide cash liquidity for longer periods, so that shocks in the equity markets can be tolerated.

In summary, we can say that there are life stages to investing. You have to start early, and focus on getting rid of any debt. You have to concentrate on equities in your high-earning years and gradually increase the cash or cash equivalent portion of your portfolio as you grow older. Once you rely completely on your investments for your income needs, your portfolio should be well-diversified and sufficient cash should be available for long periods of market instability.

In a recent tweet by Karin Richards, she had this interesting wealth comparison graph (see below), showing how much you would need in net wealth to be among South Africa’s richest 1%. Knight Frank’s current model estimates this at $109 000. At today’s exchange rate, that would be R2,14 million. In 2021 this amount in SA stood at $180 000, or three times that of India, then at $60 000. India is now at $175 000. You can interpret these statistics any way you want to, but what stands out is that the average wealth base in South Africa is very low relative to some other countries, and that the base continues to drop. These figures are very selective and might even be inaccurate, but the comparison still makes for an interesting discussion.

Money does not automatically translate to happiness, of course. Every person living in Monaco is a dollar millionaire, but imagine the pressure of always having to live up to the neighbours’ latest extravagance!

What is of concern, however, is that money is the primary incentive in a capitalist system. Any hard worker who knows there is an opportunity to earn a very large bonus, will try to do just that little bit more. Capitalism is designed to reward overachievers and eliminate mediocrity.

So, when we look at the small amount of money you need to feature in the top 1% of South Africa’s richest, and the fact that the amount continues to drop, everything indicates that the average South African is not generating anything valuable enough to warrant a larger monetary reward than the previous year. In fact, they continue to offer society less than the previous year! The other rather obvious reason why the wealth base in South Africa continues to drop, is that large numbers of wealthy people emigrate.

So, once again we can turn this negative into a positive. Let all of us who remain in South Africa while the competition is emigrating, step up to the plate and become an overachiever!

After a very strong start to the year, with the JSE All Share Index outpacing even the strong US market, things have been going south for South African equities over the last few months. It is a situation where you just want to put your head in your hands to smother a scream. The problem with investing in domestic stocks is that, although the general sentiment towards equities is negative all over the world, we add to that our ability to score own goals every opportunity we get. We cannot judge the performance of some of the companies listed on our stock exchange against things that are happening in the rest of the world, or for the specific negative conditions in their business cycle; but when the local consumer-driven stocks are washed out, we know it is an internal problem.

Borrowing a graph from Traders Corner, we can see that assuming a $10,000 investment in each of a variety of domestic-focused stocks, we get the illustrated outcome (in USD). Only the Clicks group is close to giving you your money back. And if you were a foreign investor who converted your dollars into rands five years ago to buy into one of these companies on the JSE, you would have suffered a substantial currency loss. The problems we face in South Africa are numerous. We have to take into consideration that the cost of living and the cost of borrowing will rise because the country has been mismanaged for decades and a potential coalition government in 2024 will have a negative impact.

Companies operating in South Africa have seen their profits being negatively affected by the cost of diesel for their generators; the reality of South Africans dying from cholera because municipalities do not maintain the water infrastructure; and a potential stage 8 load shedding causing a loss of 50% of operating hours over any four-day period. Add to this the fact that the most important rail network running between Durban and Gauteng operates at only 25% of capacity; and the fact that we get our money from the USA and Europe but prefer to cosy up with Russia and China; and the outlook becomes pretty grim.

The questions we have to ask ourselves as investors are: can our government change; can Eskom be fixed; can the intervention of the private sector save us? The answer can never be an absolute “no”, so that brings us to the next question: have domestic-facing shares priced in all the bad news yet? The answer has to be that they probably have not, but we are closer to the bottom than the top unless we do become a Zimbabwe or a Sudan. I think most investors today are of the opinion that holding a bit more cash than necessary is prudent, and when the currency opportunities arise, rather invest the surplus cash into international equities than local.

When we look at investment opportunities at any given time, we have to stay flexible. If you take the property market as an example, you will find that trying to sell a property at the moment is difficult but renting it out is much easier. We all have our preferences when it comes to investments, and many of these preferences are the result of past experience. If you had made a good property investment in the past, you would probably prefer that as an asset class going forward. The same can be said for equities. Perhaps you once bought a share in a company and sold it a year later for a handsome profit. These preferences can also stem from negative experiences. If you decided to start investing in international equities at the end of 2021, you would probably hate shares now because share prices dropped so much in 2022.

It is, however, wrong to stick to such a firm opinion about any single asset class, owing to the fact that asset classes are dynamic and impacted by so many fundamental as well as sentimental factors. If we look at the valuations of equities in the USA at the moment, you will see that certain sectors are expensive and others are fair value:

The FANG+ shares have had a spectacular bounce since the beginning of the year, making them a bit pricey now; but the S&P500 excluding the FANG shares is still good value for money.

Investment opportunities are not limited to specific asset classes, the choice is much wider than that. You have to consider different geographical regions, countries, industries and, of course, political interference. Staying on top of the game and being able to identify the best investment opportunities cannot be done as a hobby. Like anything else in life that you want to excel in, you have to gain experience; practise; stay focused; and learn from your mistakes. The building blocks of being a successful investor is the ability to identify something that is unique and has scale. If you can buy into something like that and have patience, you will be rewarded in the end.

As investors we have to believe that, when one door closes, another one opens. We can all attest to the fact that many doors are closing at the moment, but this is not something new. History has proven that we can open new doors of opportunity and in most cases these new opportunities provide us with an even better situation than before.

Let us start this letter on a positive note, shall we? On a recent trip overseas I was seated next to a Kuwaiti girl in her early 20s who had just qualified as an accountant and loved travelling. She did not know who I was, or where I was from. I was contemplating the recent bout of stage-6 load shedding back in South Africa and as one does, getting myself all worked up about our failed government. However, I could not help overhearing her conversation with a Norwegian guy on her other side, about their favourite holiday destinations. To my surprise, hers was Cape Town, South Africa.

There is no arguing the fact that South Africa has some very serious basic problems, starting with electricity and its possible domino effect into sewerage, water and general infrastructure. It is a fact that corruption takes a huge chunk of the taxes you pay every day and that things will probably not get better soon. But, we are not the only country with big problems. Now I know what you are going to say: that only losers compare themselves to still bigger losers and that one should always strive to become better – and I agree one hundred percent.

But, before you pack your bags for another country, just do some research. You may just decide to rather stay here and tackle the problems that impact your life directly. As an example, let us take a look at what life in Norway is like. We may be under the impressions that only the rand can depreciate against the dollar, but over the last five years the Norwegian krone (NK) has lost 34% of its value against the dollar. Okay, if I compare that to the rand, we have lost 54%, so I have at least some egg on my face – but there is a principle here. If we take it a step further, you will pay R462 for a cheeseburger and chips in Norway, R190 for a 500 ml draught beer and R88 for a coffee. If you want to eat something fancy like a pork shank, you will pay R586.

Your counter argument will be that wages in Norway are higher than here and you will be right, but perhaps not enough to disprove the fact that living in Norway is expensive, even for a Norwegian. So let us agree that in Norway you have a fantastically well-run public services office; that you either get eaten by mosquitoes in summer or freeze to death in winter; and that you get paid well to endure the expensive lifestyle and adverse climate. Then let us compare that to South Africa where you have to pay for your own “public services”; but you have a wonderfully temperate climate and a relatively cheap lifestyle.

The one piece of investment advice we can share with you regarding the above, is that much of your anxiety regarding the impact of the weakening rand on future lifestyle expenses and the affordability of travelling locally and abroad, can be negated by having some investments in US$. Most of us cannot simply emigrate or change our government, but we can all invest a substantial portion of our assets and income in diversified international markets and currencies. So your current mantra must be: shorter-term assets in SA; longer-term assets in the USA.

We do not all have the same ideas about the future. Some of us believe that the South African economy is on the brink of a collapse and you have to externalize all your assets, and others believe that the United States faces an imminent meltdown and that you have to sell all your dollar-based investments. Some people believe that the dominance of the West will soon be overtaken by the rising of the East. Many people have a glass-half-empty attitude, but then again you get the eternal optimists who believe that we are destined for better times.

Whatever your view of the future is, you will probably be wrong; but one thing you can take to the bank: human beings are tenacious, adventurous, ingenious and adaptable. We have survived so many setbacks and battled so many obstacles over thousands of years that we have become problem-solvers and survivors.

As investors we have to realize that almost everything we invest in is man-made, and has as its foundation the unpredictability of our very nature. The entire financial system consists of counterparty transactions with very little collateral as support. If you go back to every single financial meltdown we have had, you will find that human engineering played a big role.

There is a quote from Sue Orman that goes something like this: “A big part of financial freedom is having your heart and mind free from worry about the what-ifs of life”. The only way to do this is to approach investing the same way you approach a relationship. There has to be some very strong fundamental reason you enter into the relationship, knowing that there will be ups and downs and loads of uncertainties, but that the foundation will be strong and that you do not have to sweat the small stuff.

In essence, investing in equities is an investment in human nature, warts and all. If you decide to make that commitment, you will have to sometimes just keep quiet and keep your eyes on the horizon, knowing that one day the sunset will be glorious.

I have been told that those who eat Fruit Loops for breakfast, often have a favourite colour and would even avoid eating some of the other colours because they “do not like the taste”. Fact is, all the colours taste exactly the same. If you are older than five, you will probably have to take my word for it or visit the shops to buy Fruit Loops if you need to find out for yourself.

In the case of investments, it is important to get these types of preconceived ideas out of your head and focus on the facts. Equally important, is understanding that investment opportunities change over time, and that we have to adjust our portfolios accordingly.

Currently, shares on our own JSE are performing well. This is counter to many things you hear, see and even experience as a citizen. But we have to remember that only around 30% of companies listed on the JSE derive the majority of their income from South African sources, which will be impacted by our country-specific challenges. The rest of the companies are multinationals and more dependent on international markets, especially on what happens in China.

Currently the consensus view of fund managers for the future is as follows:

• South African shares are still better value than most USA shares.
• European shares are better value than USA shares.
• Any shares linked to China offer good value owing to the re-opening of that country.
• Our commodity shares will benefit from China’s re-opening.
• Companies that are able to pass on inflationary costs to clients will perform well.
• Future company earnings will impact the price of shares heavily.
• Local and USA bonds offer value.
• Current higher interest rates on cash provide you with some time to phase in your investment plan.
• Listed property must be treated with caution.

As always, there will be surprises and challenges going forward but one thing you do not have to worry about is the longer-term performance of your investments managed by JWR. We do not have a favourite colour Fruit Loop. As a matter of fact, we never eat them because they are simply unhealthy. We would much rather start our day with organically grown fresh fruit!

Most people are familiar with the following prayer: “God, grant me the serenity to accept the things I cannot change; the courage to change the things I can; and the wisdom to tell the difference”.

There are lots of lessons we can take away from the last three years. 2020 taught us that things can happen on a global scale and impact our lives and livelihoods materially, without our having any control over them whatsoever. 2021 showed us that we humans have the capacity to turn a calamity that threatened to drag us down a deep black hole, into an opportunity for innovation, adaptation and positivity to lift us up on a cloud of exuberance. And 2022 showed us that civilization is built on an intricate system which, if disturbed, can have a dramatic effect on how we live our lives.

One of the most important lessons we have learned here at JWR, is that we should help our clients neutralise investment volatility – over which we have no control – by assisting them in executing their own investment plan to the letter. As individuals, or even a small collective, we have no control over the price of a share. There are market forces far greater than us that determine market movements. As investors, we have to focus on the quality of a business and not purely on the price of its share, because while the price of the share can be manipulated by a single transaction, the quality of the business is something far more permanent.

As investors, we have to understand that there is a difference between the price of (the shares of) a company, and the value of a company. We have to also acknowledge that there will be times when the share price of a company is not in line with its value. In times like these, you need to have the courage to make changes to your portfolio in order to bring it in line with your original investment plan. At JWR we follow an investment approach called Strategic Asset Allocation where we match your expected expenses to the asset classes you invest in. We recommend that you keep enough cash to cover expenses for three to four years and invest all the money you will only require after seven years in equities. The rest then goes to balanced funds.

As an example, we can look at the past three years and apply this approach to the volatility in equity markets. At the end of 2020 equity markets were all positive for the year and you were able to top up the cash you had drawn during the year by selling some of your equity or balanced funds. At the end of 2021 equity markets were up substantially (JSE +24% and S&P500 +28%). This skewed your portfolio to be overweight in equities and you were able to top up your balanced and cash pools. Then came 2022 and equities lost a lot of value, especially overseas (JSE -1% S&P500 -19%). This should not be a problem for you, because you still have enough cash and balanced funds to wait for equities to bounce back.

We are inclined to become emotional about things we cannot change. These emotions often result in bad decisions, whether personal or in our investments. It is essential for us to distinguish between those things we can change – and those we cannot. In the case of investments, the wise choice will always be to implement and follow your Strategic Asset Allocation framework.

At least 2023 has started on a very positive note and we can only hope that this will continue throughout the year.