04/2015
ANGLE
Keep it. Simple.
Message from the CEO
We have a packed edition for you this month.
We are often asked by our clients when is a good time to take South African Rands offshore. Andrew Flavell considers
this question in depth in his story about the volatility of the Rand. Our Chief Investment Officer, Jacques du Plessis, a
hedge funds specialist, looks at why this asset class is gaining more mainstream acceptance. Chris Ball, our investment
analyst, shares with you why now is a good time to enter the European stock market and where the opportunities lie.
Keith McLachlan, fund manager for AlphaWealth’s small caps fund explains why exceptional companies make exceptional
stocks.
Wealth manager, Chris Pretorius, tries to figure out whether he should get a new cellphone contract or just get prepaid
(pay as you go). In his case, he definitely saves with pay as you go on MTN. Finally, we are all familiar with the issues
related to inflation, but what is the problem with deflation? John Haslett, portfolio manager explores the downside and
whether there’s a place for inflation linked bonds.
Enjoy!
@kerrywestfynn
Kerry
JOHANNESBURG |
CAPE TOWN |
DURBAN |
LONDON |
GENEVA |
[email protected]
MAURITIUS |
MALTA |
HONG KONG
03 2015
1
How volatile is the ZAR actually?
ANGLE
Andrew Flavell, Wealth Manager
CUMULATIVE FOREIGN PURCHASES
OF SOUTH AFRICAN ASSETS
Billion U $
There are many aspects which influence the strength of the rand but the rand’s
depreciation has been consistent with two economic theories: The interest rate
differential and the inflation rate differential. Since 1997 South Africa’s inflation has
averaged 6%. US inflation has been 2.25% which makes the average differential over the
period 3.78%. According to this theory, the Rand should depreciate at 3.78% annually.
Billion U $
Tracking intra day volatility, the ZAR is the second most volatile emerging market currency, but overtime it has been depreciating in
a consistent fashion. I tracked the US dollar and the Rand exchange rates since January 1997 when it was R4.39. The current exchange
rate is R11.78 to the dollar which means the annual exchange rate depreciation has averaged 5.3% per year.
According to the interest rate differential, using the ten year bond yield, South Africa has
on average been borrowing at 10.1% and the US has been borrowing at 4.05% which
means the Rand should have depreciated around 6% to the US dollar each year.So the
value of the rand should be at R9.27 based on the inflation differential and at R13.74
according to the interest rate differential. When we combine the two, the average
differential of inflation and the interest rate, the average annual depreciation should be
4.9%. So the Rand should currently be R11.50 but it is currently trading around R11.78
which is only a 2.4% discount.
40
40
35
35
30
30
25
25
20
20
15
15
Flavell suggests that this discount exists for five main reasons.
10
10
5
5
0
0
11. Capital flows: A big driver is when rates normalise in developed economies,
the flow of capital from emerging markets is significant and money managers
are able to achieve real returns in hard currency and not have to take on the
liquidity and sovereign risk that comes with emerging markets.
Foreigners were buying South African bonds and equities since 2003. This
peaked in 2011 and since then, foreigners have been net sellers of South African
equities and bonds.
2003
2005 2007 2009 2011 2013 2015
CUMULATIVE SINCE JANUARY 2002
EQUITIES
LOCAL CURRENCY GOVERNMENT BONDS
04/2015
2
How volatile is the ZAR actually? continued
ANGLE
Andrew Flavell, Wealth Manager
1.
2 Market sentiment: Business confidence is low due to
power, labour and policy uncertainty.
SOUTH AFRICAN BUSINESS CONFIDENCE INDEX (June 2010=100)
120
100
80
60
40
0
2008
2009
2010
2011
2012
2013
2014
2015 (Jan)
SOUTH AFRICAN BUSINESS CONFIDENCE INDEX (JUNE 2010=100)
POLY (SOUTH AFRICAN BUSINESS CONFIDENCE INDEX, JUNE 2010=100)
1.
3 Poor fundamentals in the local economy: South
Africa’s GDP growth has lagged behind its peers. When
real GDP growth is compared in key emerging markets
such as Brazil, India, Mexico, Morocco, Thailand and
Turkey, South Africa has come in well below par.
REAL GDP GROWTH IN KEY EMERGING MARKETS, 2006=100
210
200
190
180
170
160
150
140
130
120
110
100
90
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
INDIA
THAILAND
SOUTH AFRICA
BRAZIL
MOROCCO
TURKEY
MEXICO
4 Low productivity: To remain
1.
globally competitive as a
manufacturer, either the South
African work force needs to
become more efficient, or the
currency needs to depreciate
to compensate for the lack of
productivity. In reviewing the
productivity chart below, it is
clear that we are going through
a period of inefficiency and
to combat this, the Rand has
depreciated. Ideally a country’s
output should be 50% or above.
South Africa is currently around
45% which indicates weakness in
output production – this may be
on account of slow growth, lower
demand, higher wages, strikes,
an inconsistent power supply and
variable input costs for importers.
%
SIGNS OF RENEWED
MANUFACTURING WEAKNESS
%
70
SOUTH AFRICAN KAGISO MANUFACTURING PMI*
70
65
OUTPUT (PRODUCTION)
65
60
60
55
55
50
50
45
45
40
40
35
35
30
30
04/2015
3
How volatile is the ZAR actually? continued
ANGLE
Andrew Flavell, Wealth Manager
5 Credit outlook: In general, a credit rating is used by
1.
sovereign wealth funds, pension funds and other investors
to gauge the credit worthiness of South Africa thus having
a big impact on the country’s borrowing costs. Standard &
Poor’s credit rating for South Africa stands at BBB. Moody’s
rating for South Africa’s sovereign debt is Baa1. Fitch’s credit
rating for South Africa is BBB+. The ratings agencies have
indicated that GDP growth is the main driver for a potential
downgrade. With an unreliable power supply, the imminent
‘strike season’ and widespread corruption, the GDP growth
rate may continue to come under pressure. On the back of
a repeat of low GDP figures and a contingent liability due to
Eskom, another downgrade would see the Rand once more
sell off against hard currencies.
S&P
SOUTH AFRICA
BBB-
ESKOM IS SOUTH AFRICA’S SINGLE MOST SIGNIFICANT CONTINGENT
LIABILITY
ESKOM IN SOUTH AFRICA’S FISCAL CONTEXT (%GDP)
60
12
50
10
40
8
30
6
20
4
10
2
0
2009
Baa2
2011
NET GENERAL GOVERMENT DEBT
UNDRAWN ESKON GUARANTEES
2012
stable
BBB
2013
2014
2015
0
NET PUBLIC SECTOR DEBT
Source: Standard & Poor’s
Fitch
Moody’s
stable
2010
TE
negative
52
stable
So what to do? Keep your Rands in South Africa, or take them offshore?
In the light of SA’s fundamentals, 2.4% is not a bad discount, to be externalising capital, especially given the
potential headwinds. So taking money offshore should be considered. Flavell advises taking money offshore as
strategic geographic diversification, rather than allocating offshore as a rand trading position. After all South
Africa makes up less than 3% of global capital markets and therfor other capital markets, globally, should be
considered.
Whilst the rand is currently trading at a 2.4% discount, factor in the five reasons for the decline of the currency.
If you believe that these issues will be resolved or turned around, then it may not make sense for you to transfer
your investments offshore.
If on the other hand, you believe that capital flows are more likely to exit rather than enter the country, that
market sentiment will remain depressed, that GDP growth is unlikely, that productivity will remain low – now
would be a good time to discuss these issues with your wealth manager and to evaluate offshore investment
opportunities.
04/2015
4
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RANMORE GLOBAL EQUITY FUND
Jacques du Plessis , Chief Investment Officer
The AlphaWealth team met with the managers of the Ranmore Global Equity Fund in our Johannesburg offices
recently. The fund has been managed by Sean Peche since inception in 2008 and Sean has recently been joined
by Tim Allsop, who managed the Nedgroup Rainmaker Fund. Together they bring over 40 years of investment
experience. The fund forms an integral part of our equity allocation in our Iconic range of offshore multi
manager funds. The investment manager’s approach is a bottom up, “value based” research-driven, stockpicking methodology. The fund comprises around 40 - 45 equities at any point in time, primarily in large and
mid-sized companies from a range of industry sectors. This relatively concentrated approach means that the
position size of the average holding is greater than that of a broadly diversified portfolio. This is to ensure that the
return from investment opportunities are maximised and not diluted by an over-diversified portfolio. Investment
in emerging markets equities is limited to no more than 20% of the fund’s net assets.
KEY FINDINGS FROM THE MEETING
GLOBAL BACKDROP
CURRENT ENVIRONMENT
Inability of central banks to raise interest rates
Swiss recently issued 10yr bonds at negative yields
¼ of European Government debt is trading at negative yields Cost deflation due to fall in energy & commodities
Currency headwinds facing large US domiciled companies
Currency tailwinds facing European and Japanese exports
Strong USD & low cost of finance supports M&A in midcap space
MSCI has been driven by the strong
out-performnce of the US markets,
mainly due to Mega Cap stocks.
Significant under-performance of
global currencies against the USD
given divergent monetary policies.
13,8%
annum
ANNUALISED RETURN
pe r
WHY WE LIKE THE FUND
Excellent ACCESS to management and transparency of positions
as at 31.03.15 since the funds inception in 2008
6,5
YEAR TRACK RECORD
2.6%
Excess return over the benchmark MSCI World Index of
per annum (as at 31/03/15) since inception.
MORNINGSTAR CATEGORY RANK: Top quartile of peer funds over the latest 2 years and since inception
& second quartile over the last 1, 3 and 5 years (as at 28/02/15).
Management invested alongside shareholders of the fund.
Non benchmark with a focused portfolio of high conviction stocks in order to maximize alpha
Smaller fund with a more flexible mandate provides the manager with a better ability to deal with market changes
Lower correlation to index than most funds , assists in diversification of our equity allocation.
04/2015
5
European opportunities and strategy
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Chris Ball, Investment Analyst
Earlier this month, the AlphaWealth team met with BCA Research Inc. (BCA) to discuss the macroeconomic environment in Europe
and to strategise regarding opportunities in that investment market. Dhaval Joshi, a chief strategist at BCA hosted the evening and
presented on the topic, “Is there life after debt?”; a discussion on what will happen post the debt super cycle.
The dangers of inductive reasoning and life time bias. Inductive reasoning is the thinking that what has happened will naturally follow
- like the chicken believing that the farmer’s arrival will always result in food, but one day finding that the farmer has come to wring
his neck. Relating this to the real world, Dhaval noted the following: Since WWII the UK and other European countries have seen a
rapid growth in their respective Consumer Price Index (CPI)¹. Looking back on this trend, one would have expected inflation to rise and
economies to start to grow. However, if one looks far enough back in history, evidence presents that the CPI growth was flat until WWI
with shock effects occurring during the Napoleonic Wars. The team at BCA do not believe that inflationary targets will easily be met.
Hence, they draw a comparison between Europe and Switzerland. Over the past 20 years, with low interest rates, low inflation, and low
growth, Switzerland has still been able to be a competitive economy.
Previously, monetary policy has been used effectively and has been seen
as the saviour post the 2008 financial crisis when governments lowered
interest rates through increasing money supply and thereby helping to
stabilise the global economy. Central banks’ debt as a percentage of GDP
has reached all-time highs over the past year¹ - this in turn has diminished
the effectiveness of monetary policy. Post the crisis, several central banks
have tried to increase interest rates, mostly unsuccessfully, before having
to lower interest rates to re-stimulate growth.
ECB INTEREST RATE
4.5
4.0
3.5
INTEREST RATE %
What should one expect to follow? With the expectancy of the
normalisation of the inflation rate, one will most likely see a fall in the
price of commodities. Tracking the US CPI and the oil price since 1990,
one is able to find a strong relationship between the two, with shock
variability mainly to do with the industrialisation of China¹. Therefore,
the BCA team expect that the oil price will not rise significantly over
the coming period, and may correct to match the level of CPI in the US.
3.0
2.5
2.0
1.5
1.0
0.5
0
SEPT 04
SEPT 06
SEPT 08
SEPT 10
SEPT 12
SEPT 14
Annie Gilroy “Interest Rates” Market realists 2014
04/2015
6
European opportunities and strategy continued
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Chris Ball, Investment Analyst
Although the European Central bank has been injecting cash into the system, the pass-on effect has not been as efficient as previously
anticipated. In the past six months, the Euro area banks have extended about € 75 billion of new lending to households and firms, which
is a strong contrast to the net zero lending of the previous six months¹. Credit impulse is often used as a leading indicator for growth in
the economy as evidenced in the graph below.
CREDIT: A CYCLICAL UPTURN IN A STRUCTURAL DOWNTURN
AS GOOD AS IT GETS
MONTHLY FLOW OF BANK LENDING TO EURO AREA HOUSEHOLDS & FIRMS* (LS)
EURO AREA GDP (EX GERMANY)** (RS)
Sources: ECB, STATISTISCHES BUNDESAMT, EUROSTAT
* Adjusted for sales and securitisation
** Germany is highly sensitive to global growth, so stripping it out gives a useful gauge of the Euro
area’s underlying performance
BCA still believes that there are numerous political risks that should
be considered when looking to invest in Europe. With the UK elections
just around the corner, the financial market is concerned about the
different outcome scenarios, each of which has different economic and
European policies that will be implemented. The other, is the possibility
of Greece exiting the Euro Zone, as to date they have not reached an
agreement with the European Union. Currently the market is pricing
the Greek exit at a 45% likelihood¹. This is derived by an analysis of
Greece and Euro area 5-year yield spreads. A Greek exit would mean
an imminent default of the payments to the European Central Bank,
resulting in a break down in the Greek banking system. Further, a
positive outcome for Greece after exiting the European zone, would
set a bad tone for countries like Ireland and Portugal moving forward.
Taking all of this into account, BCA still believe that European equities
are trading at a good discount to US equities.
¹D. Joshi “Is there life after debt” BCA Research 2015
²Annie Gilroy “ECB interest rates” Market realists 2014
An additional point made by BCA was the opportunity in antibubbles. For example, pre-crisis, the Spanish real estate equity
market was trading at a premium to the rest of the world. However,
now in 2015 the Spanish real estate property market is still trading at
a strong discount in relation to global real estate equities.
BCA advise therefore that it would be a good time to enter the European stock market with an emphasis on the
German consumer play and the embattled Spanish real estate equity market and other anti-bubbles that may exist.
04/2015
7
Hedge funds poised to take on unit trusts in SA
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Jacques du Plessis, Chief Investment Officer
From April, hedge funds in South Africa were classed as collective investment schemes in terms of the Collective Investment Schemes
Control Act. The change paves the way for SA to abandon its existing model of unregulated hedge funds and in this way attract large
retail interest. Jacques du Plessis, chief investment officer at AlphaWealth, who has 15 years of experience in the hedge fund space,
believes that hedge funds will transition from the exclusive investment arena of a select few to an attractive investment option for the
broader investment community.
The shift occurs against a backdrop of a well-established hedge fund industry in South Africa. The first fund started over 10 years
ago and the industry now stewards in excess of R53 billion. “Local hedge fund managers have thrived and produced world-beating risk
adjusted returns, but the majority of inflows come from a select group of pension funds and high net worth individuals,” says du Plessis.
The HedgeNews Africa Long/Short Equity Index produced a return of +14.03% in 2014, outperforming the All Share (+10.88%), average
South African Equity General Unit Trust (+10.4%) and the All Bond Composite Index (ALBI) (+ 10.15%).
Two classes of funds will be distinguished in South Africa: retail hedge funds available to the public, which will be allowed to solicit
investments from all investors as do unit trusts; and qualified hedge funds, which are only available to investors who meet certain
qualifying criteria. Given their retail focus, the highest investor protection has been applied to retail hedge funds. Qualified hedge funds
are less restrictive, but there are a number of requirements. “With the JSE ALSI at a precarious level and many pundits believing that a
pull back is long overdue, the opportunity for hedge funds to showcase some of their famed downside protection and reduced volatility
might be just around the corner,” predicts du Plessis.
AlphaWealth has been involved in the hedge fund space for almost 18 years and has funds with ten year track records. Its flagship
hedge fund of funds, Alpha Equity Hedge, was recently ranked first over 12 months from a risk adjusted perspective in the Alexander
Forbes hedge funds survey. This fund has seen R50 million in inflows over the last three months. This fund aims to participate in 2/3 of
the market upside and limit the downside to 1/3. It has a more than seven year track record and has achieved 12.4% annualised return
since inception versus the JSE All Share of 11.7%. These higher returns were achieved while taking on only one third of the volatility. Du
Plessis says that South Africa is not the first market to undergo this type of regulatory change. “The European equivalent Undertaking
for Collective Investment in Transferrable Securities (UCITS) was originally designed to provide a set of European Union directives aimed
at creating funds that could be marketed freely across the region, but it provided the opportunity for many hedge funds to convert into
a retail collective investment scheme.
04/2015
8
Hedge funds poised to take on unit trusts in SA continued
ANGLE
Jacques du Plessis, Chief Investment Officer
“Credit Suisse studied the hedge funds that made use of these changes and found no significant decrease in performance when
compared to a manager’s original offshore fund. In general, there was lower volatility and therefore better risk adjusted returns,” says
du Plessis. The Alternative UCITS market has experienced tremendous growth with assets under management increasing by over 40%
in 2014 to $225bn. There were 53 new alternative funds launched in 2014 despite the very modest returns produced. “This reflects the
healthy interest from investors and managers to make use of the UCITS structure, which bodes well for the local hedge fund industry,”
says du Plessis. The table below shows the main differences between the types of hedge funds being adopted in South Africa.
INVESTORS
RETAIL HEDGE FUNDS
QUALIFIED HEDGE FUNDS
Need to be invited by managers to invest.
Minimum investment is R1 million.
Investors need to supply declaration of their eligibility.
Investor must have the ability to assess risks and merits.
Must appoint a qualified advisor.
FUND
MANAGERS
Manager may borrow up to 10% for liquidity purposes.
Annexure lists permitted securities that may be held and
exposure limits.
Manager may only include investments in other retail
hedge funds or in collective investment schemes.
The investment in any one portfolio may not exceed 75% of
the market value of the portfolio.
Specific requirements for investments in trade derivatives.
Manager reports monthly to registrar on positioning, value
at risk and liquidity.
Meet redemptions within one month of an investor
instruction to repurchase.
Managers may only invite or permit qualified investors to
invest.
Leverage and liquidity must be addressed in the founding
documents.
Founding documents need to stipulate either level of
exposure or value at risk.
Meet redemptions within three months of an investor
instruction to repurchase.
Provide for pricing frequency that is at least equal to the
purchase and repurchase date.
Monthly valuation.
Maximum level of all fees charged by the manager must
be specified.
Provide for pricing frequency that is at least equal to the
purchase and repurchase date.
Daily valuation.
04/2015
9
ANGLE
AlphaWealth’s Small Cap Fund offers superior quality
Keith Mclachlan, Fund Manager
A number of well-respected stock market experts, recently published a recent rather unfortunately-named paper, “Size Matters, If
You Control Your Junk”. The paper comes to an intuitive conclusion regarding small caps. Basically, if you had wanted to beat the stock
market over time, all you had to do was buy small caps that were selected with a quality-bias when measured by financial aspects like
balance sheet strength, profitability, stability and growth.
Quality is intuitive in the sense that you are buying a best-of-breed business.
Best-of-breed companies not only thrive during the good times when they grow quickly, gain aggressive market share and generate
fantastic returns, but they are also in a much better position to survive the bad times. Thus, they give you greater upside and less
downside than the lower quality companies in the stock market.
In essence, that is the art of stock picking: finding, buying and holding stocks with more upside and less downside risk than other
stocks.
In our AlphaWealth Prime Small & Mid Cap Fund (Small Cap Fund) we are growth and value agnostic (we pick companies, not
methodologies), we have a definite quality bias in our stock selection.
While management and the business model are the key differentiators in a quality small cap, ultimately these qualitative factors will be
reflected financially in stronger balance sheets, higher profitability and faster and more stable growth rates.
Hence, by measuring our Small Cap Fund’s financial ratios against the broader market, we can determine if our quality bias philosophy
has come out in practice and we are executing it correctly.
04/2015
10
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AlphaWealth’s Small Cap Fund offers superior quality continued
Keith Mclachlan, Fund Manager
The graph compares our Small Cap Fund against the entire JSE
market (based on the AllShare Index) and concludes:
25,0%
Our Small Cap Fund’s average company has less debt than
the average company on the JSE ALSI (Small Cap Fund’s Net
: Debt ratio < ALSI’s Net : Debt ratio),
Our Small Cap Fund’s average company is more profitable
than the average company on the JSE ALSI (Small Cap
Fund’s Return on Equity < ALSI’s Return on Equity), and
Our Small Cap Fund’s average company is growing faster
than the average company on the JSE ALSI (Small Cap
Fund’s growth in earnings < ALSI’s growth in earnings).
20,0%
A number of assumptions, details and other aspects naturally
lead the above numbers to being imprecise. However, the
margin of difference is sufficiently large that we can safely
conclude that we are indeed successfully executing on the
quality bias of our small cap stock picking philosophy.
15,0%
10,0%
5,0%
0,0%
NET DEBT: EQUITY
RETURN ON EQUITY
GROWTH IN EARNINGS
AWSM FUND
15.6%
17.9%
17.0%
JSE ALSI
23,0%
12,7%
10.0%
Sources: Bloomberg, AlphaWealth workings, calculations and assumptions; * Partially
excludes banks and REITs as they distort the D:E and ROE ratios.
The above mentioned paper also implies that we should comfortably beat the market with this approach (at least in the long-term).
After all, who doesn’t want greater upside with less downside risk? We definitely do.
04/2015
11
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Contract vs. prepaid
Chris Pretorius, Wealth Manager
?
My contract recently expired and I was confronted whether to upgrade my handset. After going through the options, I couldn’t decide
which handset I should get. My Samsung Galaxy S3, is in my opinion, exactly the same as the new S6 and Note. After discussing the issue
with some colleagues who have upgraded their iPhone, they weren’t able to clearly articulate noticeable differences in their devices.
So I thought about why I was upgrading, when the functionality of the new phones are virtually the same as the one I currently have.
I concluded that upgrading is a waste of time, so I started to consider whether I should be on contract or prepaid.
My clear conclusion is that on a per minute basis, contract customers are getting ripped off. I only considered MTN and Vodacom,
as based on customer feedback, the Cell C network is not of a high enough quality to be a viable alternative. The average per minute
saving you get from being on prepaid versus contract is 57c which represents a 36% discount to contract rates.
I was aware of the big difference between prepaid and contract rates, but there are other issues I have not accounted for and could not
qualify:
Both
MTN and Vodacom offer per second billing on prepaid;
and
You only pay for the first three minute of your call on prepaid on both networks, the remaining 57 minutes are free.
So prepaid rates are considerably cheaper than contract rates, but the allure of contract is that you are given a ‘free’ phone as part of
the package which needs to be accounted for.
04/2015
12
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Contract vs. prepaid continued
Chris Pretorius, Wealth Manager
In doing this analysis, I made the following assumptions:
You are only looking at an iPhone 6 plus 16GB;
You do not exceed your monthly package cost (on contract);
I have assumed that you your do not send SMS’s, as most people these days make use of Whatsapp and iPhone’s iMessage;
All data costs are in bundle;
A new iPhone 6 plus 16GB cost R12,216; and
I used packages ranging from R829 to R1,169 offering minutes from 120 to 400;
I have not accounted for the following prepaid benefits:
Calls on networks are free after the first three minutes;
Per second billing.
I averaged the packages and reached the following conclusion.
Applying the above methodology the conclusion is that on Vodacom you are paying R97 per month too much by being on contract and
on MTN you are saving R38 per month.
Fixed
price
Voice
cost /
minute
In
bundle
data
cost
SMS
cost
Package voice
minutes and
prepaid equivalent
value
Package data
and prepaid
equivalent
value
994
1.67
0.15
0.35
256.67
533.33
1.2
0.15
0.58
308
80
1.47
0.15
0.5
350
350
0.79
0.15
0.5
276.5
52.15
SMS
iPhone
6 cost
per
month
Total
cost
VODACOM AVERAGE
Contract
Prepaid
MTN AVERAGE
Contract
Prepaid
799
-
350
-
509
509
994
897
799
04/2015
13
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What’s so bad about deflation?
John Haslett, Portfolio Manager
It’s hard to pick up a financial publication that doesn’t make reference to the labours of developed market central banks to stave off
deflation and stimulate growth within their respective economies. The United States only recently ended its third round of Quantitative
Easing while Japan and more recently Europe are well underway with their stimulatory efforts. In addition, interest rates across the
board are at all time lows with very little indication of a change in landscape anytime soon. While there are rumblings from the US
of an intention to normalise rates, this is likely to be gradual given the recent strength of the US dollar, weaker oil price and historic
tendency of the US Federal Reserve to be behind the curve when it comes to raising rates. So why all the fuss and trillions of USD/EUR/
JPY forked out by central banks to fight off this nemesis that is deflation, surely things getting cheaper is a good thing?
Prime examples of the dire consequences of deflation can be found during the Great Depression and more recently the two decade
deflationary spiral in Japan. Remember deflation usually means wages are reducing or at least stagnating, so while prices are falling
you also have less cash to spend. In addition, as things are likely to be cheaper in the future, there is a tendency to save more and
spend less causing economies to stagnate and these are often characterised by high unemployment. Deflation can also increase debt
burdens, reducing the spending power of firms and consumers. This doesn’t mean that significant inflation or hyperinflation is ideal,
rather a low to moderate amount of inflation. This is because if consumers believe prices will rise, they will purchase now rather than
wait and pay more in the future. Therefore inflation helps keep the economy ticking over.
The goal for central banks is to achieve a happy medium of not too much and not too little and in the case of the developed world, that
elusive figure currently stands at an annualised rate of inflation rate of around 2%. Despite the US’s best efforts, its recent key gauge of
US consumer prices sank in January 2015 due partly to cheaper oil and a stronger dollar, thereby undershooting the Fed’s goal for the
33rd consecutive month. It is for that reason, that many believe rates will stay lower for longer and until the whites of inflation’s eyes
are visible, the US and other central banks will likely maintain their unprecedented accommodative monetary policy.
So in a world where financial media and markets are concerned about deflation does it make sense to consider an instrument that
is meant to provide protection against inflation?
Inflation Linked Bonds (ILBs) are securities designed to help protect investors from inflation. Primarily issued by sovereign governments,
such as the US and the UK, ILBs are indexed to inflation so that the principal and interest payments rise and fall with the rate of inflation.
Inflation can significantly erode investors’ purchasing power, and ILBs can potentially provide protection from inflation’s effects. ILBs
may also offer additional diversification benefits in a broader portfolio context as historically they had no or negative correlation over
an extended period of time to major asset classes, including equities, government bonds and corporate bonds.
04/2015
14
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What’s so bad about deflation? continued
John Haslett, Portfolio Manager
Despite the obvious benefits for inclusion given the low correlation and corresponding reduced volatility for a well diversified
portfolio, most global ILBs currently trade at significantly depressed levels on the back of market expectations for inflation. History
has shown that building exposure to this asset class during these periods has tended to yield positive portfolio effects given the reduced
downside risk for the asset class and hedge offered for any inflation surprises. In the past, inflation has surprised to the upside relative
to what breakeven inflation (inflation priced into ILBs) suggests.
According to PIMCO, one of the leading players in the ILB space, inflation surprised to the upside in 69% of 141 rolling 5-year observations
and expects inflation in developed countries to remain subdued, but believe that in many regions inflation has bottomed.
NUMBER OF OCCURENCES: REALISED FIVE YEAR INFLATION MINUS FIVE YEAR BEI*
25
DOWNSIDE SURPRISE
UPSIDE SURPRISE
Average negative
surprise: -0.4%
Average positive
surprise: 0.9%
FREQUENCY
20
15
10
5
0
-1.3 -1.0 -0.8 -0.5 -0.3 0.0 0.3 0.5 0.8 1.0 1.3 1.5 1.8 2.0 2.3
INFLATION SURPRISE %
Source: PIMCO
INFLATION PRICED IN INFLATION-LINKED BONDS vs MARKET EXPECTATIONS & CENTRAL BANK TARGETS
3,0%
US HISTORICAL AVERAGE
2,5%
EU HISTORICAL AVERAGE
2,0%
1,5%
1,0%
0,5%
0,0%
UNITED STATES
INFLATION PRICED IN 5YR INFLATION-LINKED BONDS
MARKET CONSENSUS 2014 INFLATION
EUROPEAN UNION
CENTRAL BANK INFLATION TARGET
If you take the US as an example, current inflation
expectations priced into 5 year ILBs is 1.64%, this is
below the 2% actual inflation average for last 40 years.
With central banks this determined to achieve their
goals for inflation and continuing with easy monetary
policy, one has to think that risks for inflation are
skewed to the up from these levels.
Finally, some of the factors that may have been
keeping investors away from the ILBs are beginning
to dissipate. The drag from energy prices on headline
inflation is likely past the worst. Since it is the rate of
change in oil prices, and not the level, that impacts
headline inflation, we have likely already seen the
lows in energy inflation and ILBs warrant careful
consideration.
ALPHAWEALTH LAUNCHES ICONIC DEFENSIVE
FUND
Alpha Wealth recently launched an Iconic Defensive
Fund which employs a multi-strategy approach
with the aim of investing across asset classes and
investment styles. Based on a comprehensive
quantitative and qualitative analysis of global
mutual fund managers and assets classes, the
benefits of including ILBs were clear. AlphaWealth
has allocated a portion of our capital to one of the
most respected names in the ILB market, the PIMCO
Global Real Return Fund. The fund has over 10
years in track record and consistently outperformed
its respective benchmark and peers. PIMCO was
founded in 1971 and is a leading global investment
management firm, with offices in 12 countries
throughout the Americas Europe and Asia.
04/2015
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Stock News
Andrew Flavell, Wealth Manager & Chris Ball, Investment Analyst
Short news snippets from some of the local and global stocks we monitor. If you’d like to discuss any in more depth, please contact your
wealth manager.
Firestone Diamonds
“FDI has reached agreement with Resource Capital Fund VI, one of FDI’s two largest shareholders (with
~23% currently), for the latter to provide a US$15m standby debt facility to support the construction of FDI’s
Liqhobong diamond project in Lesotho. The standby facility is designed to cover any overruns but, based on
progress to date, FDI does not expect to need to draw down on the standby facility.” Mirabaud Securities
This pending standby facility was the most significant piece outstanding for FDI to draw down from the
USD82.4m facility provided by Absa Bank. With this having been achieved, the project finance risk has
been removed materially and there is now is execution risk. CEO Stuart Brown and his team are the
correct operators for the roll out. They have a proven track record and the construction to date has been
in line with budget. With a stress tested fair value of 60p on the stock and the company trading at 27p, we
are continuing to prudently add to the position. AlphaWealth
Twitter
“The stock plunged 6% before it was halted. Twitter (TWTR, Tech30) shares plummeted as much as 20%
once the stock resumed trading before bouncing back a bit. In afterhours trading, the stock slipped 2%.” CNN
Money
Twitter is a hard business to value given the negative cash-flows from operations and the general hype
around the business. We have steered clear of the company despite analyst consensus indicating that it
offers 26% upside on the back of the recent sell off. AlphaWealth
Brait
“A sizeable war chest from the sale of Pepkor enabled investment company Brait to clinch a last-minute
deal to buy 80% of the Virgin Active health club chain for £682-million. The nature of the business is a high
predictability of profit generation given the nature of the consumer and the contracts people enter into. It’s
a defensive asset but shows very good growth features and it’s highly cash generative.” Brait
The announcement of the deal saw the share price pop nine per cent over the week. Although we believe
that the team at Brait has the ability and clout to pull off another sensational deal, our analysts are
retaining their hold consensus until more information is available on Virgin Active as an investment.
AlphaWealth
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Stock News continued
Andrew Flavell, Wealth Manager & Chris Ball, Investment Analyst
Rocket Internet
“Rocket Internet AG today announces the successful pricing of its initial public offering at EUR42.50 per
share. At the issue price of EUR42.50 per share, and assuming the full exercise of the underwriting banks’
option in connection with the over-allotment, Rocket has a market capitalization of approximately EUR6.7
billion. The offering was over-subscribed well in excess of ten times at the top end of the price range.” Rocket
Internet
Rocket Internet offers normal investors direct exposure to a large portfolio of start-ups. Founded by the
charismatic leader Oliver Samwer, Rocket Internet has successfully copied some of the most successful
start-ups and placed them into new markets such as Eastern Europe, Africa, South America and Indonesia.
Previously the company had positive exits to Facebook, E-bay, Groupon and Zynga. The war chest provided
by the listing will allow the company to roll out more start-ups in new regions as well as hold onto their top
assets. Currently the share price is sitting just above the IPO. Our view is that for investors who are happy
to ride a turbulent wave, there is a lot of scope for growth with the benefit of investing in a diversified
portfolio of start-ups. AlphaWealth
Santova
“Shares of South African small-cap logistics firm Santova Logistics [JSE:SNV] rose 2.4% to 84 cents after the
company said it was in talks that could impact its share price.”
Santova Limited provides logistics services. The company, with its offices throughout South Africa, China,
the UK and North West nontinent, as well as strategic partners throughout the world, provides supply
chain optimisation solutions to international and domestic clients.
This is a quality company that deserves to be watched. It is well placed in a growth industry, with quality
leadership to execute expansionary plans. With a well-developed technological platform and a global
footprint, we believe this company is well placed to take advantage of coming opportunities and should
show strong growth. AlphaWealth
04/2015
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Disclaimer
This document is intended to provide general information regarding AlphaWealth, its affiliates and Group companies (“AW”) and its
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consult your professional advisor before you make any decision, or take any action which might affect your personal finances or business.
Please be advised that this is not a full disclosure of the risks involved in making an investment in any financial solution, product, stock
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applicable. Certain strategies employed may include unregulated investments. All information as set out in this document is provided
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