Investing

We prune roses to maintain the shape of the bush, to keep the main branches to a manageable height, and to eliminate unsightly, superfluous deadwood. Pruning encourages strong new growth and reduces the number of flowering stems, resulting in an increase in eventual flower size.

Similarly, in nature most fynbos species are fire-dependent, in that they require bush fires to complete their life cycle. Bush fires are incredibly complex and are affected by a large number of factors, such as how land is used and managed; the introduction of unnatural fuels like invasive alien species; and urbanisation that is altering the land cover. In a perfect world – one without humans, perhaps – bush fires are a wonderful thing. They clear out the old, bring in the new, and create space for fresh growth.

Human nature is equally complex and dynamic, causing valuations of financial products to be unpredictable and volatile over the shorter term. Just like in nature, we need periodic adjustments that can be severe and painful, but necessary to get valuations back in line. Most people expected shares and bonds to lose some steam after the exceptional year they had in 2021, but the consensus expectation was not for markets to go down between 20% and 30%. Although it hurts, we have to remember that we are merely back to levels we were at about twelve months ago.

The longer-term thesis still stands: that shares in quality companies will outperform any other asset class over time; and that is why you should simply continue your regular equity investments. Most market commentators are not worth listening to, because they simply repeat whatever happens to be the prevailing market narrative at the time.

Like all really knowledgeable investors, Warren Buffett is buying billions of dollars’ worth of shares at the moment because he has seen these deep drawdowns before. It is true that the current market decline is worse that expected and we do not know when it will stop, but we have seen this before and we will see it again. This is a time where you have to accept that some of the money you made last year has been lost, but if you are patient you will see it return in years to come.

We all know the world is changing and our children and grandchildren will live in a world completely different from the one we grew up in. We all know that technology companies have replaced the old oil and resources companies as the most valuable in the world and names like Apple, Amazon, Google, Netflix and Facebook dominate the way we live today. But there are many companies currently still flying somewhat under the radar which will have a profound impact on our lives in the years to come. If you bother to look more intently, you might see the following names:

Transport

• Virgin Galactic is a British space flight company within the Virgin Group. It is developing commercial spacecraft and aims to provide suborbital space flights to space tourists and suborbital launches for space science missions. The one-year share movement was 80%.
• Tesla Inc is an American electric vehicle and clean energy company based in Palo Alto, California. The company specializes in electric vehicle manufacturing;  battery energy storage, from home to grid scale; and, through its acquisition of SolarCity, solar panel and solar roof tile manufacturing. The share has increased in value 483% over the last 12 months.

Payment

• PayPal Holdings Inc is an American company operating a worldwide online payments system that supports online money transfers and serves as an electronic alternative to traditional paper payment methods like cheques and money orders. The one-year share movement has been up 53%.
• Bitcoin we all know as the very controversial virtual money, loved by some and hated by others. The value movement over one year has been -24%.

Healthcare

• Seattle Genetics is a biotechnology company focused on developing and commercializing innovative, empowered monoclonal antibody-based therapies for the treatment of cancer. The one-year share movement has been up 173%.
• Illumina Inc is an American company. Incorporated in April 1998, Illumina develops, manufactures, and markets integrated systems for the analysis of genetic variation and biological function. The one-year share movement has been 0%.
• Cerner Corporation is an American supplier of health information technology solutions, services, devices, and hardware. As of February 2018, its products were in use at more than 27 000 facilities around the world. The one-year share movement has been -8%.

We chose these three themes specifically because we believe that consumers are turning to transportation that will be environmentally friendly, self-driving and with the development of the Hyperloop, much faster; that space tourism is on the verge of becoming commercial; that people will move away from cash and embrace online payments as well as virtual money; and, lastly, that not only living longer but with continued good health, is becoming an obsession.

There are other areas that will dominate the way we live in future, like the need for faster computer chips for online gaming, which is overtaking actual sport in spectator numbers. Here Nvidia is a market leader with a share price up 162% over the last 12 months. Cloud storage is also big, for all the data we gather and want to save, and Microsoft, Amazon and Google remain big players there.

As you can see, owning these new generation shares can be somewhat hit and miss, but some of them will make it and may become the new Apple, Amazon or Facebook.

Popular wisdom has it that one should just buy a share, or the share index, and hold on to it. That over the longer term you will make your money. That paying an active fund manager is not worth the money because over time they do not beat the market. The problem with these statements is that they could be misleading and one should dig a little deeper.

If you look at the graph above depicting the American share market over the last 100 years, it is easy to see that if you invested money in 1920, you would have made a lot of money if you cashed out today. But what if you invested in the early 1960s? You would have had to wait until the early 1980s to start making money. That is a 20-year wait. There are other statistics that show that over the last 125 years or so, you always had to wait on average 20 years to have a 100% guarantee of a rolling positive return from American stock markets.

The statement that active fund managers do not beat the index over time, is only partly true. There are some fund managers that beat the index over a 5- to 10-year period after costs but they are few and far between. The question is what can you do about it? The answer, unfortunately, is not that simple. One of the golden rules of investing is that one should not try to time the market, but rather look at valuations.

When you invest in the index, you have to make sure that the general market is not overpriced at that time. Theoretically, this problem should not occur when investing with a fund manager because they should evaluate the shares they buy on a continuous basis. If you did get the valuation right at time of investing and the market goes up, one should rebalance the investment and take some profits as the market becomes more expensive. This should once again be the responsibility of the fund manager if you are using one.

So the best option is to find fund managers who can invest in undervalued shares without having to worry about the overall level of the market and monitor these managers to make sure that they do not become passive. Together with this, it is advisable to diversify your investments between different asset classes and geographical areas even if you have a 20-year investment time horizon because there will be surprises which you can benefit from if you pay attention. Unfortunately, there will always be some investments made at the wrong time which will take a very long time to turn a profit.

If you have owned a Ferrari for the past decade, there is a good chance that its increase in value has outperformed even the S&P500. And that in spite of the fact that the S&P500 has been trading at record highs.

Unfortunately, we never advised our clients to buy a Ferrari, but over the past ten years or so we have repeatedly advised them to take a healthy portion of their assets offshore. So, even though Ferrari prices have tripled over the last decade, the S&P has given you a good 158% return. The Ferrari price increase is based on the Hagerty index and most probably excludes the steep costs involved in owning such a car, so the difference in return is probably much lower.

Some good news is that the Zondo Commission of Inquiry into State Capture is proceeding well and hopefully we will see some people going to jail for a long time.
And it seems the UK is planning to invest R146 billion in Africa over the next four years, with Theresa May courting Africa because she may have to accept a hard Brexit and lose some old trading partners in the process.

We have talked about the difference between investing directly in shares versus investing via a unit trust fund before, but there is still a lot of confusion out there. So let us summarize the differences between the two as follows:

Direct share investment

This type of investment is ideal for traders who want to buy and sell shares on a regular basis; or investors who have a specific interest in a particular company and want to hold the shares for the longer term. There is a third group of investors, who use a direct share portfolio to increase the possibility of higher returns on their overall equity investments by investing in smaller, higher-risk companies. This naturally also increases the risk of getting it wrong and losing money.

Unit trust investments

This type of investment is ideal for people who do not want to be actively buying and selling shares.

Using your own stockbroker vs unit trusts

There are thousands of companies to invest in worldwide; some of these companies will thrive over time and some will go bust. When you decide to buy and sell shares directly, you have to do a lot of research to understand the company you want to invest in and then continuously monitor that company to know when you have to sell again. Some people might argue that they would ask a stockbroking company to make these decisions for them but that would mean they are simply creating their own unit trust fund. Asking an investment professional to buy and sell shares on your behalf is exactly what you do when you invest in a unit trust fund.

We have also noticed that very few stockbroking companies actively buy and sell shares in the discretionary portfolios they manage for clients. They adhere to a buy-and-hold philosophy and only buy when there is a new cash inflow. Unit trust managers are much more focused on actively managing the collective funds under their care and have to make daily decisions on which new shares to buy and which to sell because there is a constant inflow of new cash and outflow of old cash. We have also found that the amount of expertise in the fund management houses exceeds those of the general stockbroker and depending on the size of your direct equity portfolio you might get a stockbroker who lacks the proper experience.

Cost is another issue people raise when comparing the two. It has to be understood that if you ask a stockbroker to manage a direct portfolio for you, he will charge you a fee which is often not much less than the fees charged for investing in an equity unit trust fund. At JWR we do offer a service managing direct share portfolios for clients but we make it clear that we do not actively trade these portfolios, but rather engage with the client who has an interest in owning direct shares. Because we have regular interaction with the fund managers of the unit trusts we invest in, we tend to buy or sell shares on their recommendation.

In conclusion

At JWR we prefer to manage our clients’ portfolios by investing in unit trusts. We feel comfortable with their expertise and their dedication to managing the funds for the benefit of their investors and we encourage clients to have direct share portfolios only if they fall into one of the categories described at the beginning of this letter.

When investing in shares, a lot of people believe that you only need to buy those of a big blue-chip company and hold on to them for ever. This might have been a good investment philosophy a few decades ago but things have changed in the investment world. Back then you were limited to a few investment instruments like policies, retirement annuities, and of course a direct holding in shares. Buying shares was a cumbersome process and you ended up holding a piece of paper called a share certificate. If you wanted to sell the shares again, you had to mail back the certificate and a sales order before you could receive your money. Subjected to this unsophisticated process a lot of people believed it was just too much of a hassle to sell shares so they simply held on to them.

Today shares can be bought and sold online in a matter of seconds and we have instruments like ETFs and unit trusts which make the process of investing very fast and efficient. With access to the internet we receive information about changes in the economy and developments at companies instantly, making it much easier for investors to decide whether to buy or sell shares.

This new trading environment does not necessarily mean that the old buy-and-hold philosophy can no longer be used to great effect, but we have to at least monitor the shares we hold to make sure they are still relevant. Take, for example, an old favourite called British American Tobacco (BAT). If you bought BAT about 9 years ago, your return would have been 217% (24% per annum) plus you would have received good dividends. If you bought BAT 4 years ago, your return would have been 0%, but you would still have received the dividend. If, however, you bought Anglo American 9 years ago, your return would have been between 0% and 79% (9% per annum) – with wild swings – over the 9 years.

So, it becomes clear that the new environment created by the internet and the advances in the IT sector has changed the general investment philosophy of buy-and-hold to one of buy-and-monitor.

We will keep this newsletter before the long weekend short and hopefully sweet.
Everywhere we go, we hear investors complain about the bad returns on their portfolios and their consequent anxiety. When we engage in conversation, it usually becomes clear that they do one of two things to cause their anxiety, namely:

• They compare their returns to a specific other investment that is doing very well at the moment; or
• They look only at their returns over the last three months; ignoring the longer term and the performance of the various components of their portfolios.

Fact is, there will always be some investment that does well at any given time. Do not consider only the current return on that investment, but also the risk you would be taking if all your money were invested in that one investment. It is only natural to feel nervous when some of your investments are not performing well, but there will always be good times and bad times.

One of the most important aspects of constructing and managing a successful long-term investment portfolio is called Strategic Asset Allocation (SAA). SAA is the strategy for matching your cash flow requirements to the appropriate asset class. Money you will need in the next year or two will be placed in cash and money you will need in 10 years’ time should be invested in shares. So, when you evaluate investment performance, always look at the performance of each of the building blocks of your investment individually.

Cash has been king over the past three months, so if you have had some bills to pay, you should have used the cash to pay the bills and left the shares alone. But, when you have to replace your car in 5 years’ time, the shares that are showing a negative return now should provide you with an inflation-beating return then.

• They compare their returns to a specific other investment that is doing very well at the moment; or
• They look only at their returns over the last three months; ignoring the longer term and the performance of the various components of their portfolios.

Fact is, there will always be some investment that does well at any given time. Do not consider only the current return on that investment, but also the risk you would be taking if all your money were invested in that one investment. It is only natural to feel nervous when some of your investments are not performing well, but there will always be good times and bad times.

One of the most important aspects of constructing and managing a successful long-term investment portfolio is called Strategic Asset Allocation (SAA). SAA is the strategy for matching your cash flow requirements to the appropriate asset class. Money you will need in the next year or two will be placed in cash and money you will need in 10 years’ time should be invested in shares. So, when you evaluate investment performance, always look at the performance of each of the building blocks of your investment individually.

Cash has been king over the past three months, so if you have had some bills to pay, you should have used the cash to pay the bills and left the shares alone. But, when you have to replace your car in 5 years’ time, the shares that are showing a negative return now should provide you with an inflation-beating return then.

These are volatile times and a lot of skeletons are tumbling out of closets. It is a time of reckoning for overconfident investors, fund managers and companies that laid big bets on a few assets or strategies and are now losing more money than they will be able to recoup for a long time, if at all. Just take a moment to mourn the Bitcoin bulls, the Steinhoff disciples, the Resilient ravers and the Brexit punters. If you invested heavily in any of those assets – or assets linked to them – you would have lost at least 50% of your investment over the past few months. Which means you would now have to earn a 100% return just to get back to where you were.

 

There may have been times these past years when you thought the wheels were turning very slowly for you and you were being left behind. Your neighbours may have bought Bitcoin and doubled their money within a few months; or your friend may have invested in a property syndication and received a 10% return per month. Meanwhile your money was invested in a balanced portfolio of shares, bonds, property and cash and you received a return of only 9,22% per year for the past 7 years. You may have thought that this was just not good enough.

 

But, what you need to keep in mind is that there are two very important advantages that come with this prudent approach to investing: namely beating the cost of living, or inflation; and being able to sleep at night. If we look at the returns generated by various asset classes over the last 7 years, we see the following:

SA General Equities	9,44%
SA Resources	0%
SA Industrials	14%
SA Financials	15,45%
SA Property	12,55%
Cash	6,3%
SA Bonds	9,12%
Global General Equities	15,18%
SA Inflation	5,59%

So, if you invested R1 million 7 years ago, you would now have R1 854 023 in your balanced portfolio. R1 463 000 of this amount would cover only the increased price of goods and services caused by inflation, but you would still have a clean profit of R391 000. If you were very conservative and preferred to leave your money in a Money Market account, your clean profit would be only R70 673 and most of this would go to the taxman if not properly structured. The moral of the story is that you can generate proper returns without taking a lot of risk if you are a longer-term investor.

 

At the end of the day it is your mindset that will determine your financial well-being. Chances are that the person who bought Bitcoin or property syndications might have made it big the first time around, and even the second time – provided they got out in time – but their mindset is that of a gambler and we all know the casino always wins in the end.

We have been advising clients for more than 22 years and the saddest stories we encounter time and time again are the ones we call “riches to rags”. BizNews recently carried a very informative article by Mike Fannin, a financial advisor, in which he explains why being rich and being wealthy are two different things. He highlights the fact that a study conducted by the Williams Group wealth consultancy in the US shows that 70% of wealthy families lose their wealth by the second generation, and an even more astounding 90% by the third. We are of the old-school opinion that if you have not worked hard for every rand you’ve earned, you will not understand the value of money and squander it quickly and easily. Mike Fannin goes on to say that research done by Forbes has shown that only 22% of millennials demonstrate basic financial knowledge.

To illustrate the point, Mike gives the following examples: The rapper 50 Cent quickly earned a fortune of $155 million, but by July 2015 it was gone and he was bankrupt. Another young rap artist, MC Hammer, earned a $30 million fortune with his chart-topping hit songs in the 90s, but filed for bankruptcy six years later with debts of more than $13 million. Even Michael Jackson was in debt to the tune of $500 million when he died.

It all boils down to understanding value; whether of money, water, electricity, food, income security, or anything else. If a parent becomes very successful financially, it is his or her responsibility to educate the children about the value of that money. Warren Buffett once wrote that every time he was about to take a dollar out of his wallet, he understood that if he chose not to spend it at that moment, he could have two dollars in a very short period of time. So he always made sure that whatever he was going to spend his dollar on, would provide him with actual value.

People always say there is no such thing as a free lunch, but in investments there are two:

• the power of compound interest; and
• the benefits of diversification.

 

Compound interest is the central pillar of investment. It is why investment grows so well over the long term. Look at it this way: if you save R10 000 at a return of 6% and withdraw nothing, you start the second year with R10 600 and you earn interest on both your original R10 000 and on the interest earned in the previous year. In short, you earn more interest each year because your investment amount increases every year even though you do not make any additional investments. The compound interest gained on the initial amount of R10 000 may not seem significant, but when applied to larger figures the effect is substantial.

A good way to accumulate savings, is to sign a monthly debit order towards an investment when you start your first job. That way you become used to not having the money available to spend on other things. Even if you are already in your 30’s or 40’s, it is never too late to start saving for your retirement, but the younger you are when you start, the more you stand to benefit from compound interest and the less money you need to put away each month, compared to somebody starting to save in later years. It is all about allowing time for compound interest to make your money grow.