Thursday, 29 January 2009

A very different atmosphere at Davos...

What the really smart people have to say at this year's World Economic Forum:

The World Economic Forum, which in past years featured glitzy receptions and boasted an attendee list including high-flying hedge fund managers, bankers and private equity moguls, has turned sombre.
This year, gloom is everywhere, with the global economic downturn at the centre of every conversation. World Bank managing director Ngozi Okonjo-Iweala observed: 'I think every expert that has spoken in Davos has said that this is much worse than they had thought.'
Fabled hedge fund manager George Soros also fears that the slump will continue to worsen. 'The size of the problem confronting us today is significantly larger than in the 1930s,' he said. 'The situation will continue to deteriorate.'
But despite all the gloom and doom, Davos remains one of the biggest networking events for a who's who of the world's political, economic and financial elite. And despite high-profile cancellations like that of Barclays investment banking boss Bob Diamond, there are still plenty of eminent and influential people in Switzerland this week.Is the forum actually useful?
Its unique asset is its ability to bring together so many of the world's key decision-makers in one place. It may offer the best opportunity for the great and the good to discuss and devise solutions to the global crisis. If the Davos participants can't come up with some bright ideas for saving the world's economy, who can?
Quoted from: Comments,

The unbearable truth of investment product fees...

Well, during the good times most investors do not worry too much about product fees - who will complain about investment charges of 2.5-3% if your returns are well in excess of 20%. But anyone with a bit of investment experience and a lot of common sense will know those kind of returns are not sustainable over longer investment periods. In fact, you should realise that you cannot control investment returns; you can only control the cost thereof. The choice is ultimately yours.

Marc Ashton published the following article on

Retail investors could cut their costs significantly by looking at passive index tracking products as opposed to the high fees attached to actively managed portfolios - but don't expect your financial adviser to push these products.

This is according to Craig Chambers, the deputy managing editor at Umbono Fund Managers. He argues that independent financial advisers (IFAs) continue to push traditional active management unit trust products as opposed to lower cost index tracking products, which yield lower commissions.
Chambers points out that in the bull market experienced in SA markets from 2003 to early 2008, 20% returns tended to mask the fees charged by active portfolio managers. However, with markets turning down, investors will take a closer look at fees and ask some tough questions.

He points to a recent survey conducted by Alexander Forbes. This shows that for an average R100m pension fund, fees for an actively managed portfolio are 390% higher relative to equivalent tracker fees.

"It's fair to assume that equity returns will revert to their long-term rolling real average of 8% per year to prior to 2003. As a result, we estimate that active fund management fees, plus trading costs as a percentage of the expected 8% return (on a R100m fund) come in at 14% per year, while index tracking fees on the same basis come in at 2.8% per year.

Traditionally, there are two main forms of retail investment product for investors not directly investing in the market - either an actively managed portfolio which includes a fund manager supported by a research and investment team and an index tracking fund (for example, the Satrix 40) which mechanically tracks an index.

When looking at the South African market, Chambers points out that 80 stocks make up 96% of the top 11 managers' aggregated holdings in 2008. This, he argues, creates a "de-facto passive core" tracking an index, which you are paying active management fees on.

"Consumers need to start asking their IFAs to show the total expense ratio of different products in the portfolio," said Chambers. He believes retail investors need to specifically ask their IFAs to investigate passive asset management products.

Mahesh Cooper, who heads up the institutional client offering for leading active manager Allan Gray, believes local investors need to take a hard look at their active managers. Cooper said: "Relative to average active manager performance, retail investors could be better off in tracking products paying tracker fees."

He questions whether active managers in South Africa are really "active", pointing out that many include certain blue-chip shares in their portfolio, simply because they are afraid to underperform the index. "We don't start with a benchmark and then build a portfolio."

Neville Chester, a senior portfolio manager at asset manager Coronation, agrees that while the universe of shares to invest in on the JSE remains relatively small, an active manager can add value.

Chester said: "The point of an active manager is to pick the correct weighting of the right shares in a portfolio."

He points to 2008, when companies like Billiton and Anglo American were "patently overvalued" and yet index funds continued to put money into these shares due to their weighting in the index.

"This is an area where an active manager can deliver significant outperformance," said Chester.

Despite perceived high costs, index tracking products have been slow to take off in South Africa, says Chambers. He recommends that investors develop a mix of active and passive assets in their portfolios. "It's no longer simply a question of active versus passive management."

However, in the last few years, the South African market has begun to look at index tracking products as a component of investment portfolios that allow investors greater access to index tracking products.

The NewGold ETF proved very popular with investors in 2008, as investors sought to hedge their portfolios by investing in the underlying gold price.

Apart from various Satrix indexes, Deutsche Bank introduced their X-Tracker product which allows SA investors the ability to track the MSCI World, US, UK or Japanese indexes. Investec added a product to track the underlying performance of the SA bond market.

Thursday, 22 January 2009

The global economic crisis and the prospects for SA's economy

Kevin Lings, economist at Stanlib, one of SA's leading asset managers, argues there are some specific positives which will lessen the impact of the global economic crisis on the country's economic performance in the next couple of years:
A rapid fall in inflation
The sharp drop in the oil price, together with the slowdown in domestic demand, has significantly eased domestic inflationary concerns in South Africa. The 12-month CPIX inflation rate fell from a peak of 13.6% in August 2008 to 12.1% in November and is set to fall sharply over the coming months as base effects, a lower petrol price and the reweighting of the CPI basket take effect.
The recent depreciation of the rand (which declined by 28.5% against the Dollar during 2008) will push up the cost of some imported goods, partly counterbalancing the downward trend in inflation, but we still expect inflation to enter the target range of 3% to 6% before the middle of 2009.

Currently the consumer remains under enormous pressure from a cash flow perspective. However, the recent declines in the petrol price (which has now fallen by 44% since the peak in mid-2008), as well as the expected further easing of interest rates should start to provide some relief. In addition, as inflation falls further in 2009, salaries and wage increases should start to rise in real terms. This will add to the consumer’s ability to weather the current economic storm. Importantly, these benefits are rapidly eroded if unemployment rises dramatically.

Significant monetary and fiscal stimulus
The SA Reserve Bank opted to cut the Repo rate by 50bps to 11.50% with effect from 12 December 2008. This was the first cut in rates since April 2005.

The interest rate reduction in December 2008 sets the tone for successive interest rate cuts of 50bps in each MPC meeting this year, as long as it does not result in undue volatility in the financial markets. While we expect the repo rate to bottom out at a higher level than in the previous cycle, the reduction should ensure at least a modest recovery in consumer demand during 2010.

Fiscal policy should also support economic growth through an ongoing improvement in infrastructure spending. The Medium Term Budget Policy Statement published in October 2008 projected that the budget deficit will widen to 2.0% of GDP in fiscal year 2009/10, however, it is possible that some extra spending initiatives could be introduced in February’s budget to stimulate activity further. Nevertheless, we do not anticipate the deficit widening beyond about 3% of GDP unless the slowdown in activity becomes more pronounced, reducing tax revenue by more than anticipated.

Fortunately, over the past few years the Minister of Finance has substantially curtailed the build-up of Government’s debt, as well as generating a fiscal surplus. While it is unlikely that the Minister will greatly reduce taxes in this year’s budget; the generally healthy fiscal position should ensure that government will not have to increase taxes in the face of a revenue slowdown.

A sound banking sector
At a time when the global banking system is under enormous pressure, South Africa’s banking system remains incredibly sound, having had almost no exposure to subprime debt, or other ‘toxic’ assets. This is simply not the type of business SA banks would typically get involved in; which is partly due to prudent management, but also a general avoidance of derivate structures.

The local interbank market has been functioning normally throughout the crisis. The SA Reserve Bank has not had to supply any additional liquidity to SA Banks. In fact, no action by the Reserve Bank has been needed to specifically support the banking system.

The banking system’s exposure to external liquidity pressures is extremely limited. Total liabilities to the public amounted to R2 357 billion at the end of June 2008, of which foreign currency deposits were a mere R69 billion (2.9% of total), foreign loans received under repurchase agreements were R31 billion (1.3%) and foreign currency funding to the domestic and foreign sector R60 billion (2.6%).

Overall, the SA banking sector is well placed to cope with the current global financial market crisis. Obviously, given the current state of the domestic economy, the provisions for bad debts are on the rise, while at the same time higher costs and lower revenue implies lower profitability. However, these trends are not expected to become alarming or detrimental to an economic recovery.

Well advanced infrastructural development programme
Unlike many of the developed countries in the world, South Africa already has a well advanced infrastructural developments programme, with major projects that are currently well underway. This is evident in the incredible 28% quarter-on-quarter growth in public sector fixed investment spending during Q3 2008. This growth contributed around 80% of the total quarterly increase South Africa’s in fixed investment activity.

The public sector’s investment spending is obviously coming off a very low base, but nevertheless the rate of increase since the end of 2006 has been spectacular and is clearly providing a very significant offset to the general economic slowdown in South Africa. In fact, the increase in public investment spending in 2008, up until end Q3 2008, accounted for around 60% of the overall GDP performance in 2008.

According to the latest Medium Term Budget Policy Statement, the solid growth in public sector fixed investment spending, especially by public corporations is expected to be maintained over the next few years. This is reflected in the budgeted increases in public sector investment activity across a broad range of infrastructural activity including electricity, roads, harbours, airports, stadium, rail and water.

Impending 2010 World Cup Soccer Tournament
Hosting the Soccer World Cup represents a major focal point for economic activity. The financial impact of the event is substantial, both in terms of the cost of hosting the event as well as in terms of the potential revenue earned. The benefits of hosting the 2010 FIFA World Cup lie less in the event itself than in the long-term benefits of transport, sports and other infrastructure investment. Exposure from the event will hopefully benefit the economy for years to follow. Furthermore, it provides a vital catalyst to fast track urban development, to improve the basic infrastructure and to broadly promote economic development.

This process to host the event is well advanced with government and private business having established multi-billion Rand capital projects in order to finance the necessary infrastructural development. These projects are centered on the building of stadiums, the improvement of transport infrastructure and the enhancement of telecommunications. As many as three-million tourists are expected during the World Cup. That's 40% more than the average annual number of tourists. With this, the World Cup is expected to directly create 159 000 new jobs and provide a welcome boost to the economy at a critical time.

Wednesday, 21 January 2009

Beyond zero interest rates...

Central banks around the globe have made their intentions clear: Interest rates will be cut -even to zero - to revive their economies after perhaps the worst financial and economic crisis since WWII.

The Federal Reserve slashed the Fed funds rate to a range of 0% and 0.25%; not too long ago (August 2007) it was still at 5.25%. The ECB cut their rate from 4.25% to 2.5%. The Bank of England reduced rates to 1.50% - the lowest level of interest rates ever recorded in the UK - from a peak of 5.75%. The Bank of Japan reduced interest rates to 0.1%.

Thus, in the major economies of the world interest rates have been cut for all practical purposes to zero (and negative, if considered on a real basis).

But what if the extreme loose monetary policies do not work, i.e. kick start the economy? After all, interest rates can be dropped only to zero. The next best thing is Quantitative Easing (QE) which unlike interest rates is a limitless monetary tool.

Basically, QE does not focus on the price of money, i.e. interest rates, but its quantity. This is accomplished by issuing money from the printing press to purchase securities - anything from government bonds to corporate debt, even equities.

One significant indicator of QE is seen by the rapid expansion of the central bank's balance sheet. In this respect the Fed's balance sheet has tripled in the past year as they swapped US Treasuries for securities held by struggling banks to provide them with liquidity. Furthermore, they announced their intent to buy $500bn mortgage-backed securities.

Such monetary policies should be inflationary. But for now that is not the worry - deflation poses a much bigger threat and QE should counter the risks of a prolonged deflation outlook. When Japan used QE, it was too late. Deflation by then was very well entrenched. At least for now, it seems that the Fed is acting swiftly to prevent a similar economic environment that plagued Japan in previous decades.

Tuesday, 13 January 2009

Changing investment preferences

At the end of November 2008 , ETFs (exchange traded funds) posted net buying, or inflows, of $138 billion for 2008, while long-term mutual funds saw an exodus of $185 billion, according to consultants Financial Research Corp,

John Spence of The Wall Street Journal writes:

In recent months, investors have been moving into index funds managed by Vanguard Group, Fidelity Investments and other fund giants, experts say. What is behind the trend?
Firstly, many financial advisers and investors use passive funds and indexed ETFs as part of a conservative asset-allocation plan. In general, they have a long-term perspective and haven't been selling during the market downturn. "These investors haven't been panicking," said Scott Burns, Morningstar's director of ETF analysis.
Secondly, short-term traders have been driving trading volume to ETFs, which are baskets of securities that can be bought and sold during the day. For example, overall ETF trading volume spiked this fall along with market volatility. "When markets are this volatile, investors tend to trade whole sectors with ETFs rather than individual stocks," Mr. Burns said.
Finally, in bear markets, many investors go back to basics and focus more on tax efficiency and the fees they are paying, which matter even more in low-return environments. "The same thing happened after the dot-com bust, and snake-bitten investors went into index funds and focused more on asset allocation," Mr. Burns said.