We attended a global investment conference in Cape Town last week and experienced varied views on global risk assets by the asset managers presenting. One can easily be influenced by some of the negative global challenges: unprecedented Central Bank balance sheet expansion, a potential US corporate debt bubble, descending US corporate gross profit margins, high government debt to GDP ratios in many countries, developed market bond yields below zero and slowing global economic growth – just to name a few! One can easily lose faith and hope for your investment strategy when focusing on all the potentially negative impacts on your portfolios. Many of us will agree that global equity markets are also positively influenced by any news or ‘hope’ of an end to the US-Sino Trade War rhetoric.

Most of our readers are residents in the UK or South Africa. It is fair to assume that the negative political rhetoric of Brexit in the UK and structural economic and social political headwinds in SA could influence local investors in each jurisdiction to externalize their assets and diversify away from local investment/currency risks. It is so easy to be critical of local conditions and be influenced negatively.

But events can change the destiny of your investment strategy very quickly. To illustrate my point, I must use the opportunity of recent events to debate how emotions can whipsaw due to events.

It is fair to say that over the past week South Africans’ emotions varied between the fear of a SA Debt downgrade to junk by the Rating Agency Moody’s, coupled with the fear of a loss to a rampant English rugby side in the World Cup Rugby Final! Today we all know that Moody’s only shifted their outlook from stable to negative and the Springboks surprised even their most loyal supporters with a 32-12 win over England! An example of how quickly one’s attitude can shift from fear, to hype and potentially a new destiny. From a SA risk asset price perspective, prices may have looked very different from one week to another; with dire consequences to the SA economy if Moody’s downgraded SA Debt.

When it comes to an investment strategy it is important to focus on the facts. But how do you contribute to the destiny of your portfolio (and maybe your country?) while short term hype influences our emotions to such an extent?

For the benefit of UK and SA readers, I address both local issues in this overview, starting with fiscal proceedings in SA: 

Last week, Tito Mboweni – SA Minister of Finance – delivered the Medium-Term Budget Policy Statement (MTBPS). Moody’s reported that ‘the combination of low potential growth and high and inexorably rising debt as outlined by the MTBPS would not be consistent with SA’s current rating. The current rating rests on the government’s ability to quickly develop a credible strategy to halt and ultimately reverse the rise in debt’. They continue by concluding that ‘such a strategy has not been forthcoming to date and that the MTBPS does not identify what the cost-saving measures will be, other than that they will focus on the public sector wage bill. The MTBPS also reiterates that additional operational and financial reforms will be needed to curb the drain on public finances from Eskom and SOE’s in general. In short, last week’s MTBPS does not yet represent a developed, credible fiscal strategy.

It remains easy for us to demand action from our SA Government to provide an action plan to avoid economic disaster. But what can we do? More about that in the conclusion below…

And what’s next for Brexit proceedings? 

The bill to hold a general election on 12 December has now received Royal Assent which means it is law. It follows the confirmation of a Brexit delay until 31 January 2020 after the EU agreed to the UK’s extension request.

Prime Minister Boris Johnson had previously said the UK would leave by 31 October 2019 “do or die”. He has agreed a deal with the EU but the bill implementing it has been put on hold. It will now not progress before the general election.

So how can we improve the destiny of our respective country’s (and perhaps the destiny of our portfolios)?

People like stories; we all respond to something that is worth celebrating, especially when we witness believable actions. This weekend we all witnessed the underdogs beat the favourites in the Rugby World Cup. When Rassie Erasmus, the award-winning coach of the winning SA team, was asked whether he and the team believed that they could win the Tournament, he answered as follows:

‘We believed in 3 things:

• Hard work (they had the players, resources and a leadership team – but hard work would make a difference)
• Needed luck (sometimes the bounce of the ball or a bad referee decision determines a result)
• To give destiny a go! (believe in the chance to succeed)’

Certainly, a story to celebrate for South Africans – a divided nation, but with renewed hope to stand together after a story book display of belief and commitment by a diverse SA rugby team.

A question to myself, all readers (UK, Global and SA), political leaders, business leaders, the people from SA and the UK:

• What are you doing to communicate positive messages?
• Are we stuck in hopelessness and a focus on the negatives?

Hope is no investment strategy, but we all can make a difference to renew our loyalty toward unity in our respective countries. Let’s vote for the appropriate leadership team (every vote makes a difference as witnessed by the results of Brexit and the US Election outcome) – those that demonstrate a clear strategy and work hard toward a collaborative goal to improve our destiny.

Instead of waiting on a clear action plan from our respective governments investment professionals in SA / UK, business leaders and large influential corporates should become more involved at government level to assist them in strategic direction. If not dialogue, some contribution to support the economy via investment in the local economy is also a contribution to our respective destinies.

By each making our contributions – even if it’s just a positive message – we can renew government ideologies and thereby revive hope for all citizens.

Hope can drive our new destiny, but investment strategies should remain focused on the facts and until we witness a more collaborative global, domestic leadership exhibition, a managed diversified asset class portfolio remains the best message we can give to ensure you preserve your portfolio against the volatility of irrational local or global political/central bank behavior!

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors,  officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) is registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal Portfolio Management (UK) Ltd is part of the MitonOptimal group of companies. Authorised and regulated by the Financial  Conduct  Authority No. 770509.  Registered in  England and Wales No. 10524374. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial  Services Provider’s  (FSP’s).  MitonOptimal  South  Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242). Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).

In previous weekly comments and numerous alternate financial commentaries alike, the perceived correlation between an inversion of a country’s sovereign yield curve and the prospect of an imminent recession have been highlighted. In this weekly comment I want to avoid making judgments based on this indicator alone, as its reliability in isolation has been questioned and instead look at additional signals that may be evident.

Historically, manufacturing has been an important bellwether of the health of a country’s economy and one way in which this is measured is through the Manufacturing Purchasing Managers’ Index (PMI}. Compiled by the Institute for Supply Management, this expresses the output from a monthly survey of a country’s manufacturing firms in numerical form, with a reading above 50 indicating growth and below 50 indicating contraction within the sector.

As a consequence of US policies on trade and subsequent responses from Chinese authorities, global manufacturing readings are showing signs of a widespread downturn. In the US, the PMI is at its lowest levels in over a decade at 47.8, the Eurozone readings having shown contraction since February of this year (current 45.7}, the UK is just coming off of a six-and-a-half year low rising from 47.4 to 48.3. Among the major economies, the only bright spot is that Chinese data has surprised on the upside in August with a reading of 51.4, after readings of 49.4 in June and 49.7 in July. Based on these figures, it could be argued that manufacturing data points to the potential of a forthcoming global recession.

However, the manufacturing component of the largest global economies is far less significant than has historically been the case, particularly within the developed market world, where the service sector now contributes the majority of most countries’ GDP. Taking the US as an (albeit extreme) example, manufacturing contributed only 12% to GDP in 2018; moreover, even China’s GDP composition is now more reliant on services than manufacturing, with the services sector contributing 52.2% of GDP.

Whilst services remain resilient, a global contraction and subsequent recession is unlikely. The US continues to expand its service sector, with the latest reading of the Services PMI confirmed at 50.9 and along with China, whose reading also indicated expansion, at 51.3 (the weakest reading since February however), meaning the world’s two largest economies should stimulate growth in the broader global economy.

Other data also suggests that US economy remains, arguably, in a relatively healthy state, particularly in respect of consumer activity and GDP is forecast to increase (consumer spending makes up 70% of the US’s GDP print). Commentators point to the latest jobs and wage data as further evidence, with the headline unemployment rate falling to 3.5% and incomes modestly rising. On the flip side of that, others would contend the rate of consumer spending is slowing, climbing only 0.1% in August, its weakest increase in 6 months, and companies are spending less on capital equipment.

Elsewhere, the latest UK services PMI of 49.5 indicated the sector is in decline, which, when combined with the manufacturing Index release indicates the economy contracted 0.1% over the 3rd quarter after shrinking 0.2% in Q2. Elsewhere, the Flash Eurozone Services PMI Activity Index came in at 52, coupled with the manufacturing equivalent this leaves the Eurozone Composite PMI on the brink of falling below 50, currently at 50.4: a 75-month low. The region’s largest economy, Germany, after shrinking 0.1% in Q2, will hope the increase in industrial production in August will alleviate fears of falling into recession.

As the foregoing comments suggest, the global economy is in a precarious position and a lot, as ever, is reliant on the US and China to provide the engine for growth and stimulate demand. Meanwhile, the likes  of the UK, Germany, Italy, parts of Latin America, South Korea and Russia, amongst others are in, or on the verge of, recession. The credit rating agency, Fitch, is predicting global growth to fall to 8-year lows in 2020 citing the US-China trade tensions as the main catalyst. The PMI data would perhaps support this forecast.

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors,  officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) is registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal Portfolio Management (UK) Ltd is part of the MitonOptimal group of companies. Authorised and regulated by the Financial  Conduct  Authority No. 770509.  Registered in  England and Wales No. 10524374. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial  Services Provider’s  (FSP’s).  MitonOptimal  South  Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242). Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).

Ever since the ANC announced in its 2019 manifesto that it would “Investigate the introduction of prescribed assets on financial institutions’ funds to unlock resources for investments in social and economic development”, there has been a broad swathe of irresponsible hype and sensationalism in the press, sometimes written and said by people who should know better.

It is instructive to look at the facts:

Fact 1

Since the quiet inclusion of the above comment in the manifesto, the ANC itself has hardly mentioned it.

Fact 2

The comment is extremely vague, in the party’s manifesto document, and has gone nowhere near parliament where such a decision would have to be made.

Fact 3

The historical prescribed assets regime did NOT require all retirement funds to invest 53% of their assets in government bonds, as is frequently reported. It required 53% of all NEW cash flows to be invested in a list of prescribed assets which included government bonds, fixed deposits, cash and Krugerrands.

Fact 4

As equities far outperformed bonds in the 1980’s, the split between equities and bonds by MARKET VALUE was closer to 60/40 in favour of equities for funds with a longer history.

Fact 5

As most funds in the late 1980s were defined benefit funds, any opportunity cost of being forced into investing in a possibly underperforming asset was actually a “tax” on the employer who had to ensure the soundness of the fund.

Fact 6

There has been absolutely no mention of the proposed level of prescribed assets, how broad the list of prescribed assets might be, the “grandfathering” of existing assets, the timing of the introduction of prescribed assets or the implementation of any such policy.

Fact 7

If some form of prescribed assets had been in place for the last 3 years, the All Bond Index would have produced an aggregate return of 26%, Money Market 24%, the JSE All Share Index (total return) 12% and listed Property -13%!

Fact 8

Since most retirement funds are now defined contribution funds an obligation to invest in assets that may underperform is now a direct tax on the members of those funds in the form of reduced long-term returns.

Fact 9

Prescribed assets are a blunt way of raising funds for government as most government bonds are traded on the secondary market between third party investors and not on the primary market where the capital raising happens.

Fact 10

Approximately 50% of South African government bonds are held by foreigners which means, at least from their perspective, they are attractive and safe investments.

Fact 11

The Chief Executive of the Eskom Pension and Provident Funds has come out against prescribed assets.

So, until, the issue of prescribed assets, with some of the above-mentioned lacking detail clarified, is introduced to Parliament where it is likely to be met with vehement opposition by lobby groups from the industry, organised labour and business, probably matched with legal challenges all the way up to the Constitutional Court, it is pointless and possibly irresponsible to create worry and tension about something that may never actually happen.

Opinion 1

Is it possible that the whole issue was included in the manifesto simply to snatch it away from any other more populist parties who might have used it as an electoral weapon?

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors,  officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) is registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal Portfolio Management (UK) Ltd is part of the MitonOptimal group of companies. Authorised and regulated by the Financial  Conduct  Authority No. 770509.  Registered in  England and Wales No. 10524374. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial  Services Provider’s  (FSP’s).  MitonOptimal  South  Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242). Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).

With the World’s monetary policy makers all congregating last week at Jackson Hole, Wyoming for the annual summer gathering at the economic policy symposium; it was interesting to read that the title of this year’s event was; Challenges for Monetary policy. I’d suggest that most policy makers have been thinking long and hard about two main problems which sing true to the event’s title. The first being, despite dropping interest rates, in some cases below zero, central banks in developed economies still cannot meet their inflation targets. The second problem is a more recent encounter, that being, the uncertainty created by trade disputes and the negative consequence it is having on global growth, even in America! Central banks are now becoming progressively more uncertain about the tools at their disposal, as they may need to use them sooner than they had first anticipated with the current economic backdrop being its most interesting since the global financial crisis (‘GFC’).

All ears were on the early scheduled keynote speaker Jay Powell, US Federal Reserve Chairman, who commented on such matters:

“The current era has been characterized by much lower neutral interest rates, disinflationary pressures, and slower growth. We face heightened risks of lengthy, difficult-to-escape periods in which our policy interest rate is pinned near zero. To address this new normal, we are conducting a public review of our monetary policy strategy, tools, and communications-the first of its kind for the Federal Reserve. We are evaluating the pros and cons of strategies that aim to reverse past misses of our inflation objective. We are examining the monetary policy tools we have used both in calm times and in crisis, and we are asking whether we should expand our toolkit. In addition, we are looking at how we might improve the communication of our policy framework.”

This follows Mr Powell’s comments in June, where he pointed out that the Fed’s rate, then at 2.5%, was already close to zero, leaving little room to make a difference in the next economic down-turn. Having said that, the Fed is not alone. Since the GFC, central banks in other developed countries have dropped short-term rates; many are now below zero. They have also been buying bonds to try to drag long-term rates down, a tactic that was once considered a heresy, with the Japanese central bank going one step further and buying equities to prop-up risk assets.

But after a decade of accommodative policies, central banks have been unsuccessful in meeting their inflation targets and now are left with low or negative rates; as a result, economists are on the pursuit for alternative measures.

In the past, some former policymakers have proposed that governments of developed economies should have clearly defined fiscal spending projects ready for a downturn, paid for with debt bought by their central bank. The reason for such radical measures is simple – it is very difficult to envisage stimulus in the next recession coming from pushing rates lower than they already are and having the same effect as they have done in the past, especially in light of the recent path change and sentiment, with quite a few central banks already having eased in the last six months on the back of slowing growth especially in China and Germany.

Unfortunately for Mr Powell, the dilemma is that the US data points are not as bad as that for other countries: industrial output has slowed but is not shrinking, while unemployment remains at levels not seen since the late 60s. Meanwhile, the US ‘power-house’ consumer is continuing to spend.

As a result, it will be interesting to see what new ‘radical’ policies are put forward and whether fiscal policies will have a greater role to play in the next recession – all of which we are keeping a close eye on.

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors,  officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) is registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal Portfolio Management (UK) Ltd is part of the MitonOptimal group of companies. Authorised and regulated by the Financial  Conduct  Authority No. 770509.  Registered in  England and Wales No. 10524374. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial  Services Provider’s  (FSP’s).  MitonOptimal  South  Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey

Financial Services Commission (Company No. 97242). Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).

Click here to view the report

By Richard Harwood CFA

Managing Director (Jersey) and Fund Manager

Investing, like many other aspects of the modern world, is changing rapidly to include softer considerations which would previously have been ignored, and the integrity of the senior management team is rapidly becoming an important factor for investors to consider. Corporate history has been full of powerful leaders whose power and influence has been largely unchecked by their Boards and fellow Directors and whilst some of these characters have been immensely successful, the drive necessary to achieve that often comes with less positive personal characteristics.

It is impossible to read any biography of the late Steve Jobs and not admire his vision and determination, but also to realise that his drive left a wake of carnage in both his personal and professional relationships and that some of his behaviour would not be tolerated in today’s society. More recently, Steve Wynn and Sir Phillip Green have been subject to public damnation which, in the case of Steve Wynn, resulted in his being ousted as CEO of the Company bearing his name, as well as being forced to sell his shares in that Company. The consequences have not been solely reserved for the individuals involved, with many of the Board Members who oversaw Steve Wynn’s tenure as CEO having stepped down under shareholder pressure as it became apparent that they had not fulfilling their duty in monitoring the activities of their CEO.

Whilst these instances are disappointing, is it really a matter of concern for investors?Unfortunately, the answer is very much yes. When the allegations against Steve Wynn surfaced, the Wynn share price stood at $200, whilst it now trades at $117 with question marks still hanging over whether the company will be stripped of its license to run the $2.5bn Boston Encore casino. In the four days after the news broke, investors lost around $4.2bn of value.

Consumers are also becoming increasingly intolerant of poor public behaviour, with certain consumers boycotting brands which fall below acceptable standards. Companies are now having to become much more aware of their public image than at any time in the past. There are still plenty of PR tricks which can change the public’s perception of a company’s brand, but in today’s increasingly transparent society, they are short term solutions to a long term problem.

The role of the Board, which was perhaps once seen as a reward for a lifetime of service, is changing. It is now incumbent upon Board Members to monitor and review the behaviour of overly powerful CEOs, not only for their own protection but to prevent potentially permanent damage to their company. The world is changing very rapidly, and it is important not to be on the wrong side of that changing trend. Thinking about the integrity of a company and its senior management is an important step for investors, in avoiding what can be very expensive mistakes.

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors, officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) and MitonOptimal Guernsey Limited (Registration No. 40985) are both registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial Services Provider’s (FSP’s). MitonOptimal South Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242). Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).

Click here to see Richard Harwood’s weekly comment

By Blair Campbell Chartered MCSI, Portfolio Manager (Guernsey) 

Rewind to the 4th Quarter of last year when numerous commentators and analysts were calling an end to arguably the longest bull market in history – certainly since World War II – with major indices, such as the S&P quadrupling since the lows of 2009. Since the end of Q4, and as we approach the end of 2019’s 1st quarter, equity markets have shrugged off the various concerns felt by investors, of which, the reversal of tightening monetary policy by the Federal Reserve has appeared to be the main catalyst behind this V shaped recovery.

The speed of recovery in investor sentiment and subsequent snap back of markets coupled with the reduction in the VIX index (the markets expectation of future volatility) has caused us to question the validity of this resumption of the bull run. Namely, complacency of market participants and their confidence in central banks to support equity markets is, for us, a cause for apprehension. The concerns investors held at the end of 2018 remain (the Federal Reserve’s hawkish stance excluded) and as one of the fixed income managers we invest in reminds us; the dynamics of the bond market is telling us the state of the economic landscape is different than that of the equity market’s narrative – the US yield curve inverted on Friday 22nd March with the yield on the 10-year note falling below that of 3 month paper – as widely publicised, a recession indicator.

Notwithstanding the above, equities are still our favoured asset class, however, we have been exploring ways of gaining equity exposure whilst decreasing the risk within portfolios and maintaining a level of capital preservation. One way of achieving this is by introducing Convertible Bonds into our asset mix. In simplistic terms, a convertible bond behaves like any other bond in that it pays the investor a regular coupon and at maturity will pay out the par value of the bond, however, it differs from vanilla bonds due to an embedded option in the security which allows an investor to participate in the growth of a company by converting the bond into the equity of the company at a pre-determined stock price level. The price paid for this option is a lower coupon on the security than would be received in the typical bonds of the company.

As described above, the structure of the bond allows for partial participation in a rise in the stock price, while limiting the depreciation in the value of the convertible bond when stock prices fall, due to a bond floor offering a level of capital preservation. This performance profile is referred to as “convexity” and it is this convexity that convertible bond managers look to exploit when building a portfolio of convertible bonds.

The graph replicated overleaf of the environment encountered in 2018 highlights this asymmetric return profile where the total return of a convertible bond is skewed, where it’s upside capture of equities is more than that of the downside capture in falling equity markets. Though, it should however be emphasised that convertible bonds will underperform in steadily climbing markets.

Performance of the Global Convertibles Index versus the World Equity Index

Source: Financial Express 29.12.17-31.12.18

We are currently in the process of considering the inclusion of a convertible bond manager and whether a convertible bond strategy would fit within model portfolios. We’ve conducted a number of manager meetings, conference calls, watched webcasts and gone through various sources of research material in order to develop a list of prospective candidates that exhibit the attributes we look for in manager selection. Watch this space!

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors, officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) and MitonOptimal Guernsey Limited (Registration No. 40985) are both registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial Services Provider’s (FSP’s). MitonOptimal South Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242). Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).

Click here to see Blair Campbell ‘s weekly comment

By Scott Campbell Group MD and Chief Investment Officer

Since 2011, Emerging Markets (EM) have significantly underperformed the US market. As the following chart of the MSCI EM Index in US Dollar terms shows, however, we may have seen a technical breakout on the price action of EM equities. Having said that, a broad based benchmark may not be the best way of looking at the argument, since, as we are frequently reminded, not all EM equities are created equally: while the Brazilian, Russian and South African economies are dominated by mining and energy stocks, for example; India and many Asian countries are looking to the technology and tourism sectors to drive growth forward.

Source: Bloomberg

Moreover, valuation may not necessarily be the best short-term indicator of market direction as it usually is over the medium to long term. So where do we sit today?

A first important valuation criteria is price-to-book ratio. According to research from JP Morgan, the MSCI EM Index’s price-to-book ratio at the end of last year was 1.5x, which, although some way above the 2015 low of 1.23x, is meaningfully below the long-term average of 1.8x and thus represents good value in historic terms. The second part of the chart overleaf highlights the subsequent 10 year returns from various starting price-to-book levels. This clearly shows a wide dispersion of 10 year returns (scatter points on the chart) but much higher overall returns from current 1.5x levels, than much more lofty valuations. Interestingly, at lower price-to-book levels, the next 10 years haven’t increased as incrementally.

Emerging Markets equity valuations and subsequent returns

The second important valuation criteria (and some may argue even more important) for Emerging Markets is currency value. Many fundamentalists have attempted to use Purchasing Power Parity and the simpler Big Mac Index as an indicator, but a simple look at the relative movement of a basket of EM currencies versus the US Dollar has generally shown good under and over valuation points.

EM currencies vs US Dollar

Taking the foregoing factors into account, our conclusion is that Emerging Market equity valuations are, on the whole, attractive value; currencies are cheap relative to the USD and investor flows into EM assets (a useful gauge of investor sentiment) are starting to pick up. While our view is that this is not the time to be underweight in this asset class, a careful selection of countries and sectors within the universe will always be important as the wide range of returns will undoubtedly be the same for the next 10 years.

Click here to see Scott Campbell’s weekly comment

It is in times like these that ‘new’ products appear with the messianic promise of being able to deliver amazing returns through their unique ‘angles’ of approach.

Private Equity has been one such solution. Private Equity has been around since before listed companies and clients have invested in tranches offered by a number of investment managers, both here and in the UK, that have delivered good results, but quite a number of funds are experiencing slow-downs in expectations. The reasons for this are simple. Investors make money when Private Equity entities list. In difficult economic environments, Private Equity companies prefer to defer an intended listing and thus the accelerated returns expected towards the end of a tranche are postponed and an investor is either disappointed or needs to wait longer than the targeted investment period of up to 12 years.

Managing a Private Equity solution is a huge undertaking, involving a specialised team, working long hours, attending numerous Board meetings, sifting through financials which do not necessarily follow rules applicable to listed companies, and analysing possible competitor or technological changes which could influence the profitability of the underlying companies aggregated in the solution. Gaining an understanding of the ventures, inside and out, while remaining part of all decisions and management activities as well as being aware of changes and the significance of these, all forms very much part of the process. A Private Equity team needs to understand the total risk involved and often facilitates the process to get the venture to the listing stage. It is a costly exercise and there is a charge that these specialists extract for the value they add.

We have analysed some of the structures currently on offer, and their underlying holdings, and we need to caution investors against a wave of interest that often ends in tears and/or disappointment, especially where it involves a tax loophole. Ask, does the analysis work properly? Obtain more than one view and understand the investment thoroughly. A thorough understanding of the involvement of the Private Equity team is critical. Are they merely doing a ‘due process’ on the underlying funds, or are they intricately involved in the inner workings to ensure that the diversification is real and that the value they add is more than superficial.

The Section 12J

In South Africa it has recently become fashionable to hold Private Equity in a portfolio and the section 12J tax beneficial structure has contributed to this current popularity. The s12J structure allows the investor to deduct the total amount invested from their taxable income, but the investor must keep the funds invested in the structure for at least five years otherwise the tax benefit received will immediately become taxable.

Most Private Equity products offer an inflation + 9% to 10% return, albeit few have delivered this of late. But what is more concerning than the possible (probable?) underperformance is that at presentations the tax saving aspect takes up most of the content and is explained in glorious detail, whilst the underlying instruments are not treated with the same level of diligence or understanding. The message out there often is: Investors save 45% at the marginal tax rate, so even if they get only their original money back, they win. Or the ‘risk premium’ is only 55% of the investment.

The problem is this: At inception investors get the 45% (only if this is their marginal tax rate) rebate, but their original capital amount for Capital Gains Tax (CGT) purposes is zero. Once the investment pays out, investors will be taxed (CGT) fully on the pay-out. Paying 18% (effective rate for individuals and special trusts in South Africa) on the total amount is a painful reduction in the final proceeds.

Thus, a fair comparison of the hypothetical returns and tax efficiency of all specialist and non-conventional investment instruments requires thorough and specialist analysis and comparisons on a like-for-like basis with more conventional and less subject-to-change investments such as retirement annuities, pension funds and mutual funds all of which have substantial protection for the investor written into legislation and are overseen by management boards of trustees or similar custodians.

Also be aware that Private Equity solutions carry substantially more risk than conventional investments and the investment team’s involvement, diversification of the underlying instruments, both by business sector and geography, should be present to alleviate this risk. Legal opinions on the soundness of the offering should be available as well.

We have seen presentations on numerous s12J fund-of–funds offerings and while some of these are managed by experienced people, one has to question that at the minimum amount required for investment (often substantial), annual administrative costs that can amount to 5% or more on top of the underlying investment fund’s costs. How an investor can hope to get a net return of inflation + 9%/10% is optimistic. With those costs, the manager is more assured of a return than the investor!

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors, officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) and MitonOptimal Guernsey Limited (Registration No. 40985) are both registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal Portfolio Management (IOM) Limited is licensed and regulated by the Isle of Man Financial Services Authority (Registration No. 103941C). MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial Services Provider’s (FSP’s). MitonOptimal South Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242). Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).

By Roeloff Horne | Director and Head of Portfolio Management (SA)

At MitonOptimal, we subscribe to a dynamic strategic asset allocation process and debate the real/absolute return prospects for each investable asset class in our regulated universe. Each member of the team makes a contribution per asset class which is followed by a debate and a team decision. The results are used to run our optimization process for the ZAR/USD/GBP portfolios. Part of the process is to gather views from our underlying managers to complement our own process and debate. To illustrate our challenges, I will share some of my preparation for medium term (4-5 years) global listed real estate projections.

We approach the process by debating the fundamentals of each asset class within the business cycle, understanding the current yield and earnings projections and looking to the past for guidance on performance in all business cycles.

Firstly, we will look at the projections of STANLIB – a large South African Asset Manager. Their total return expectations are divided into a bull, bear and base case scenario’s where they make assumptions on the US 10-year bond yield, the expected exit yield and expected earnings growth over 1- and 4-year periods.

Total return expectations – Global Property ($)

At first sight, their base case scenario of 13.46% over a one-year period appears very bullish. However, when one considers a base ‘date’-in this case, early January 2019 -it is fair to reason that after a poor 2018, where US REITs returned -4.55% and non-US REITs returned -6.7%, a 13% absolute return in the following 12 months is not inconceivable. When one considers the January 2019 performance, nearly 10%, it feels as if most of the returns for the year are in the bag! However, using 1 January 2018 as your base, one immediately realises that this was merely a recovery rally from a low base (US REITs up 5.8% and non-US REITs up 2.1% over 13 months) and that the 11-12-month projections remain realistic.

We also consider Marriott’s, one of the oldest financial services businesses in South Africa, forward-looking expectations which are assumed to be a longer-term absolute return expectation for the Global REIT Index, yielding between 4.5% and 6.5% p.a. This return is made up of a yield of 4.5% with an annual property rental growth of 1% to 2% over time. If a US Dollar Cash rate of 2% p.a. is assumed, this expectation would reflect a Cash plus return of between 2.5% and 4.5% p.a.

We also pay attention to long-term returns in bear and bull markets to remain in-check with reality. When using December 2007 as a base for longer term past performance, it is clear that US REIT’s experienced a long-term bull market post the credit crisis (Cash plus 5% p.a.), while non-US REITs simply recovered to their starting value pre-global credit crisis. This pattern is very much the same for US equities versus the European/UK and Emerging Market equities.

US REITs vs non-US REIT’s

An analysis on any asset class must address current fundamental risks and realities. Presently, one of our preferred global real estate managers is Catalyst. We have summarised the Catalyst fundamental outlook (not withstanding all the known risks such as higher US interest rates, global political instability, etc.) as follows:

• Global real estate operating fundamentals, although moderating, remain healthy overall. Positive GDP growth, low unemployment, wage growth, and moderate inflation all contribute towards a healthy economic backdrop.
• On the whole, supply of new real estate remains manageable relative to demand. However, there are certain sectors in specific geographies that face some excess supply over the next few years. The most notable cases of markets with significant supply are offices in New York and Singapore, and apartments in certain US Sun Belt markets. However, markets where excess supply is expected remain limited to a handful of instances. New supply has been curtailed in this cycle by increasing construction costs and tighter development financing underwriting standards.
• REITs generally own higher quality portfolios today compared to a decade ago.
• Balance sheets are, on average, a lot healthier today than they were towards the end of the previous cycle. For example, in the US, the REIT sector loan-to-value (LTV) ratio was approximately 40% ten years ago, whilst it is currently around 30%. Debt-to-EBITDA has come down from 7.5x to 5.5x over the past decade. Not only is leverage overall lower, but in terms of debt, it is longer, expirations are staggered over multiple years and a high proportion of debt cost is fixed for the long term. In addition, most REITs have diversified their sources of funding to include not only bank financing, but also access to capital markets, private placements, preference shares and securitized markets.
• Over the last year we have seen a pick-up in REIT privatizations as investors took advantage of the disconnect between pricing in the public (listed) and private markets.
• Finally, valuations of the global listed real estate sector currently seem fair. The current estimated Funds Available for Distribution (FAD) yield of 5.25% is attractive, especially when taking into account that the growth in this yield over the medium term is forecast to be well ahead of expected inflation.

Considering these views, my expectation for a medium term (4-5 years) US$ cash plus return for global real estate lies between 3.5% and 4% p.a. Let’s see if the rest of the team agrees!

Click here to view the powerpoint presentation

This document has been issued by the MitonOptimal Group of companies. The content of this document is for information purposes only and does not constitute an offer or invitation to any person. The opinions contained in this document are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. MitonOptimal‘s prior written consent must be obtained before the contents of this document are reproduced or communicated to any third party. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness. MitonOptimal’s respective directors, officers, employees and associates may have an interest in the products, services or service providers occasionally referred to herein. The value of investments and the income from them may vary, and you may realise less than the sum invested. Past performance is not necessarily a guide to future performance and no guarantees are offered in respect of investment returns and/or capital invested. MitonOptimal Portfolio Management (CI) Limited (Registration No. 36763) and MitonOptimal Guernsey Limited (Registration No. 40985) are both registered in the Bailiwick of Guernsey and licensed and regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987, as amended. MitonOptimal Portfolio Management (IOM) Limited is licensed and regulated by the Isle of Man Financial Services Authority (Registration No. 103941C). MitonOptimal UK Limited is registered in England and Wales (Company No. 09138865). Authorised and regulated by the Financial Conduct Authority. MitonOptimal South Africa (Pty) Ltd (Registration No. 2005/032750/07) & MitonOptimal Portfolio Management (Pty) Limited (Registration No. 2000/000717/07) are regulated in South Africa by the Financial Sector Conduct Authority (FSCA). MitonOptimal South Africa (Pty) Limited (FSP No. 28160) and MitonOptimal Portfolio Management (Pty) Limited (FSP No. 734) are authorised Financial Services Provider’s (FSP’s). MitonOptimal South Africa (Pty) Ltd and MitonOptimal Portfolio Management (Pty) Limited comply with all the requirements of the Financial Advisory and Intermediary Services (FAIS) Act (Act 37 of 2002). MitonOptimal Jersey Limited is regulated by the Jersey Financial Services Commission (Company No. 97242) Full details on all companies within the MitonOptimal Group are available on our website (www.mitonoptimal.com).