Investments in the year that was 2010 and the year that will be 2011

Looking back at 2010 we can see that investments made so far favoured the brave, with year to date returns (30/9/2010) as follows:

· SA Equities 8.7% (13% end October)
· SA Bonds 14%
· SA listed property 25.68%
· Rand/Dollar 5.4% stronger
· Foreign Equities 0.92% in US$
· Emerging market equities 8.7% in US$
· SA Cash 5.28% (3.17% after 40% tax)
· Inflation 2.84%

At the beginning of 2010 I expected equities to outperform Cash and inflation and hoped that the JSE All Share would reach 31 815 points (15% for the year). These expectations were based on the state of the world economy at that time and the fundamental valuations for the different asset classes.

I knew that interest rates had to come down and that holding money in cash could not be seen as an investment. I believed that the South African Rand should be above R8 to the Dollar and that where you had very little or no international equity exposure you should make use of the strong Rand to invest in those markets. Here I have been a tad premature and the Rand surprised.

I advised clients to remain true to strategic asset allocation principals when investing money and to follow the following specific guidelines:

· For money required in the next 3 years: Invest in cash
· For money required in 4 years from now: Invest in Preference Shares
· For money required 5 to 9 years from now: Invest in Balanced Funds
· For money required only in 10 years and later: Invest in Equity Funds

This strategy would have ensured sufficient cash for short term expenses and would have ensured participation in any growth in equities. The following example demonstrates the outcome:

For a 60 year old client investing R2.5mil, needing R10 000pm after tax to spend, the following investments with allocations and returns materialised year to date 31 October 2010:

· SA Cash 15% allocation 5.76%
· SA Preference Shares 5% allocation 12.96%
· Balanced Funds 28% allocation 11.90%
· SA Equity Funds 31% allocation 16.05%
· International Equity 21% allocation 1.51%

This portfolio provided a 10.15% average return for the year till 31 October 2010 (7.22% real).

At the beginning of 2010 there was still a lot of uncertainty as to the sustainability of the world recovery. The SA equity market has performed well during 2009 and the big question was whether the companies would be able to support the inflated share prices by generating higher earnings. This proved to be the case. The JSE lived up to my prediction of being very volatile and bounced between 26 500 and 28 500 points until October.

Then the US decided to approve the second Quantitive Easing Package (QE2) worth US$600bil, and people started investing in shares and bonds again. Year to date we have seen R60bil flowing to SA bonds and 20bil to SA shares.

The problem for 2011 and beyond

In short we can say that the developed world (USA and Europe), still experience a lot of problems. The US is printing $ to get the economy going which in turn weakens the $ and makes the US exports cheap but also strengthen the currencies of developing countries like SA, making our Rand too strong and thus our exports very expensive.

The low interest rates in the US (0.25%) combined with the massive amount of money the government is printing motivates investors to look for places to invest. In SA they can get 6-7% on bonds and up to 5% dividends in some blue chip shares. The result is international investors buying SA shares at rather expensive valuations.

The problem is that one day, in a couple of years from now, the abundance of money is going to give rise to inflation which will in turn see US interest rates rise. That will spark a sudden and severe turnaround of capital flows, seeing international investors selling their expensive SA shares and bonds and relocating the money to the US.

The Rand will fall out of the sky like a rock and probably overshoot any rational level against the $, spiking SA inflation with the resulting rising of interest rates and eventually company earnings coming under pressure and any overvalued shares taking a nosedive.

When all of this might play out I don’t know. The only thing we can do now is to make rational decisions based on fundamental valuations using information of the day. I would therefore recommend the following investment approach based on asset allocation:

·Cash: only hold cash where you will need to spend it over the next 3 years.
·Preference Shares: Margins on these shares have fallen away and should be replaced by balanced funds.
·Balanced funds: The managers of these funds should be in a good position to manage funds for the medium term return.
·SA equity funds: It will be risky to invest in a SA share index like the JSE All Share. The selection of individual shares will be crucial to ensure that only cheap (value for money) shares are held in the portfolio.
·International equity: There are many international companies that are still very good value for money. One should utilise the strong Rand to invest in these companies. This will also protect against a weakening of the Rand.

Selecting specific shares

As I have predicted in 2009, shares were priced very attractively after the 2008 selloff and a general re-rating was a big probability. Investing in an index fund with the low cost advantage would have been a good choice. Going into 2011 things are very different. Most fund managers agree that shares in general might disappoint and the selection of specific companies will be very important.

The following two areas are highlighted as good potential:

Established international companies with a big part of their earnings being generated in the BRIC countries and
Companies with an established infrastructure in Africa.

Conclusion
It seems as if most investment professionals agree that although shares are not cheap, sitting in cash will produce no return, and that whilst the US keeps on printing money, and developed countries keep interest rates low, the place to be will still be shares, specifically those companies with close ties to the BRIC countries and Africa, as well as undervalued Blue Chip US shares.

We know that this is a party that will continue for a while longer and that the hangover is going to be severe one day, but over the longer term those investors attending the party with a good supply of headache tablets will have the benefit of good memories one day, although having to have stayed in bed for a day or two at one point.

Reply on comment received regarding Satrix posting

I would like to reply to a comment received on my Jan 2009 Blog regarding investing in Satrix.

If you make any comments and would like me to reply to them, please share your e-mail address.

My reply:

If you consider the time my blog was posted you will notice that it was the 12 Jan 2009. The 2008 Market Crash was very fresh in our minds and nobody had any idea where the bottom of the market was going to be. If you invested your R20 000 all at once on the 12th, you would have had -18% return 2.5 months later. JSE All Share went from 22 183 to 18 120! That would have destroyed the confidence of already shattered investors.

It would have taken 6 months to get back to your R20 000 investment.
So, the reason the “Rand Cost Averaging” principal (phasing in) was more important than the “economies of scale” principal was due to the uncertainty in the market at that stage.

Congrats to all equity investors!

This will not take a lot of time. I want to take you back to my blog posted on 28/4/2009. Just a short re-con:

Cash then at prime interest rates, 13%, cash now 9.5%, that is a 27% drop!

Shares then 20 000 points on JSE, now 30 500, that is a 53% climb!

The combined difference of investing in shares rather than cash over the last 17 months was 80%!!

For those of you who used the opportunity to invest in shares, well done! This will not happen again soon.

The strategy going forward should be:

• Don't panic when the shares drop back a bit, it has to happen!
• Continue investing on a monthly basis rather than big lump sums if you can.
• The next few years should see the Rand weaken and inflation picking up, investing in international shares now should benefit from the weaker Rand.
• SA Bullion sells Kruger Rands at round 5.5% cost. Gold will do well when Rand weakens against the $ and if the Gold price remains high. I am not a keen buyer of Gold but if you are then you might get something back in a few years from now.

It is almost end of the year. We will reflect on the past 12 months and look at 2011 in a month or two.

Remember Zimbabwe!

It is a Sunday afternoon, 16 April 2000. A white farmer lies dead on his farm in the district of Macheke, Zimbabwe. His name was David Stevens.

In 1980 Zimbabwe gained its independence and Mugabe became the leader of the country. Every white person feared the worst and many left the country but for 20 years the country prospered. Then it all imploded and lives, families and fortunes were wiped out.

September 2010, Durban, South Africa. The ANC Youth League screams for Nationalization of mines. The implementation of a Media Tribunal is imminent and the redistribution of wealth is not "satisfactory". It is 16 prosperous years since the ANC came into power. Unemployment is rife and only the selected few ANC top brass became obscenely rich since transformation began. Government officials are living like kings and family members of the President became multi millionaires over night.

Why am I telling you this? Not because I believe that South Africa is going to implode soon or on the other hand that that South Africa is not a Zimbabwe, but for one reason only:

The future is uncertain; you have to put your eggs in different baskets!

In 2006 the Zimbabwe Dollar (Z$) was pegged at Z$101 000 for 1US$. On the black market however, the exchange rate was Z$300 000 for 1US$. This rate, as we all know, deteriorated 100 fold over the last couple of years. The irony in it all is that the Zim fat cats and ruling party officials made millions of US$ with the weakening of the Z$ because only they were allowed to buy US$ at the official rate. This is how it worked:

FAT CAT takes Z$10.1mil and buys US$100 (using official exchange rate)
FAT CAT goes to black market and exchanges US$100 for Z$30mil (using black market rate)
FAT CAT goes back to Reserve Bank and buys US$297 with his Z$30mil again.
FAT CAT made 200% profit without doing anything and continues doing this until he can buy a brand new Mercedes-Benz for US$100!

The question you should ask yourself is why are there still people outside of government prospering in Zimbabwe? The answer is simple, they repatriate foreign currency as and when they need it.

I probably need not say anything more to drive home my point. Anything can happen in the word. If you were an investor in American shares over the last 10 years, you made NO money! Would you have believed me if I told you this 10 years ago?

An investment in South African shares gave you a fantastic return over the last 10 years. Once again hard to believe! The Rand is strong at R7 to the US$. There are international shares that are trading at very favourable valuations currently.

My message is thus:

If you haven't got money invested outside of South Africa, doing so with a strong Rand, a fairly priced International share market and a knowledge that it is always prudent to "spread your bets", might come in handy one day when President MALEMA, calls the shots!

Death, Taxes and Financial Advice

Unavoidable, all of them are unavoidable! My client was sitting across the table, sipping a coffee and listening intently. We were talking about opportunities in the property market for people with ready cash at the moment. He is a wealthy man and clued up when it comes to financial matters.

Why then is he at my office, paying me an annual fee to manage a Preservation Fund for him? He is relatively young and there is not much we can or should do to his current investments so one could argue that we are not adding any value!

Now the short answer is that a trusted financial advisor is like a toilet, you can go without one for quite a while but when you need one, you really need one!! The most important word in the previous sentence is "TRUSTED". Trust can only be established over time by proving that your best interests are taken into consideration and that advice received over an extended period of time proved to be to your advantage.

There are too many people that will sell you something either for their own benefit or because they believe that it is a good product but have no solid evidence that it is.

When it comes to financial matters everybody have advice to give, your parents, your brothers and sisters, your friends, your priest, husband, wife, grocer and off course your "advisor". Unfortunately it only takes one misguided or bad piece of advice to destroy years or even a lifetime's worth of savings

Here are a couple of things to remember:

• Always get a second and third opinion.
• Establish a relationship with a licensed financial advisor early on in your life.
• Test their advice with small investments over time.
• Do not make big investment decisions on your own. Emotions are the prime destroyers of wealth.
• Never get into a position where you have to make a huge decision without someone you have trusted for years.
• Get involved with your investments and even if you have very little invested, use the opportunities offered to you to discuss it with your advisor.

So perhaps now it makes sense that my client is prepared to pay me to manage his portfolio. He has been with us for over 6 years, his investments have performed well, he can always phone and ask my opinion, he does not have to make emotional decisions and he knows that in 10 years when he retires, trusting our advice will not be an issue.

Banish Negativity!

I once saw a movie where a device discovered under the ocean gave people the ability to replicate in real life what they dreamt. They were unaware of this ability and did not know what the device was for. Unfortunately things started going wrong and all sorts of horrible things happened to the crew of this underwater salvage operation, directly as a result of fellow crew members dreaming these horrors into life.

Almost every Holy scripture on earth alludes to the fact that your wishes /prayers/thoughts will become reality and all the motivational and spiritual literature that I have ever read mentioned the fact that your conscious thoughts will determine your future.

Why then do we default to being negative rather than being positive?!

Why do newspapers and magazines sell more copies when there is a war to write about or some disaster with blood, guts and despair than when there is something beautiful and positive going on?

Why do we get consumed by headlines that deal with bad stuff rather than good stuff? Why do we insist on elaborating on sad stories rather than good stories when we know that those things that we talk about most of the time will determine the things that we think about most of the time which will then ultimately become our reality?

What has this got to do with investments you must be screaming by now?

Well, I wish I could say "nothing" and that I am just sick of people being so negative (including myself), but unfortunately 50% or more of the decisions we make in our lives are made based on how we feel, rather than what we know.

So if you hear about the recessions, Greece going under, Railway strikes, FIFA failure, blackouts and generally the end of the word in 2012, you might just become so negative that you sell your house, cash in your share portfolio or liquidate your investment policy to enable you to move into a bunker south of Hot as Hell and stock up on Bully Beef and Beans.

That is why little gems like these I found in the Business Day of 20 May are so precious:

• "Recovery hopes soar as retail sales turn the corner"
• "IMF lifts SA growth forecast to 3%"
• "SA edges up in global competitive index for second year in a row"

All I can say is that everything I really wished for in life became a reality.

We have to understand the power of positive thinking. We have to understand that we were given the ability to choose and participate in the creation of our future. We have to realise that even if something bad happens, you can choose for the negativity to consume you or you can evaluate it, accept it and then move on, taking it as a lesson learned or at least not something personal that life has against you.

My advice is:

• Stop reading sad sensationalism.
• Start reading uplifting stories of achievement.
• Stop watching violent movies.
• Start watching the beauty in people and places around you.
• Stop taking life personally.
• Start accepting that life is a balance between suffering and joy.

And lastly, if everybody can start thinking the share market up our collective consciousness can perhaps give me an early retirement!

It makes my head spin!

Sunday afternoon I settled down behind my computer, sipping a steaming cup of coffee and watching the rain pelting down outside. The Atlantic was chasing enormous waves onto the beach at Bloubergstrand and looked as turbulent as the equity markets during the last couple of days.

My aim for the afternoon was to select a couple of shares to buy the following day on the back of a huge pullback of +/- 11% on the JSE All Share index. The problems in Europe and specifically Greece caused investors to panic and I was hoping to find some companies that offered good value after being treated unfairly by the markets.

After doing some comparisons I ended up with about 15 shares that experienced a pullback of between 7% and 17% over the last 30 days. After a while I chose only 2 which I wanted to buy at the current levels and for the balance I would wait for another 5% pullback before I would venture into buying.

Monday morning saw me sharpening my pencil to write the cheques for the acquisition of the 2 shares only to see them opening about 5% higher than my buying level! I waited for a "dead cat bounce" pullback but that never happened and the market ended 4% higher at the end of the day.

Market movements we experienced over the last 14 days can only make you gasp and feel dizzy. The JSE had 2 record setting trading days in its 123 year history last week alone!

Now this is not a good thing. I believe in the gradual unlocking of value from a share based on fundamental good management, earnings and prospects.

We are seeing something never seen before in the world economies. The 2008 credit crisis caused governments to print billions of $ to save the financial systems as we know it and now The EU and IMF are doing the same to prevent a small bankrupt country(Greece) to die. The next in line are Ireland, Portugal and Italy.

I do understand that during 2008 governments printed money to save companies affected by bad investments. So the problem moved from companies to the Government. Who is going to save the Government when they go bankrupt? In the case of Greece it is the EU and IMF but what if the UK or USA go belly up?

At the end of the day I suppose that the problem started with man made cyber assets and will be solved with cyber assets. In the interim all I can say is that people lost all sense of value for money.

Important for me and you is to always understand the value we get when we pay for something.

What market crash?

The JSE All Share Index took aerial photographs of the 29 000 level as it flew over it! In March 2009 the market was at 18 000 points and now it is at 29 245 point. This is a 62% increase! (an investment in cash gave you about 7.5% taxable).

Lessons to be learnt.
13 months ago when things were at it's darkest and the ashes of Armageddon were raining down on the world, a small group of us were huddled round a boardroom table at the company I work for and we were asking the question " what now?"

We made one very important decision namely: "We are not clever enough to know what the market will do, so stick to the fundamentals of investing".

These fundamentals can be summed up as follows:

• Shares will outperform cash over the longer term (10 years +).
• Cash will provide stability over the shorter term (0-3 years).
• Asset classes will revert to their longer term average valuations.
• Timing the market is more about luck than skill.
• Base your investment decisions on your projected need for expenditure.

Based on these fundamentals we took the following decisions:

• Shares are very cheap compared to their longer term average valuations.
• Interest rates on cash investments will come down to stimulate growth. Bad for cash.
• When the recovery will take place is impossible to predict but when it starts you will not have time to get into shares, you have to be in already.
• Perform cash flows on our client's portfolios and ensure that they have enough cash for any expenditure over the next 3 years and make sure that the balance of their money is invested in shares.

Currently we are in the same situation of uncertainty. We are asking the question "what now?" again.

We go to the presentations of some of the best investment professionals in South Africa on a weekly basis and study all the investment and market analysis available. They have been predicting a market pullback since the JSE All Share was on 26 000 points and that the Rand against the $ should be at R8.70 but things are exactly the opposite.

The moral of the story is that somehow the predictions of people can be very wrong and that the market will continue doing what it did in the past. I therefore invest according to proven investment fundamentals and adjust my portfolio only slightly as things become obviously out of sync.

I can only say the following:

• Don't be greedy, stay in cash where you might need the cash over the next 3 years.
• Don't be fearful, stay in shares where you will not need the cash for the next 10 years.
• Re-calculate your cash flow every year and make adjustments to your investment portfolio where necessary.

There are two things I do indulge in that deviates from the pure investment fundamentals and they are:

• I keep the equivalent of 1 extra years expenses in cash based on my cash flow projection. This provides me with some additional cash to buy shares with should there be a substantial correction in the markets.
• I believe that the Rand will go back to R8.50+ against the US$ and focus on Rand hedge shares/financial instruments.

Don't try to predict what the market will do!! Have both cash and shares in your portfolio. Cash for short term expenditure and Shares for growth.

Remember: You only need to beat Inflation after costs and taxes to move forward in life.

Cutting Costs in 2010

If you still have a job, car and house you made it through the recession! If you only have your job, you will be okay.

A lot of people earn only enough money to cover their expenses. They have nothing to save for the day they can no longer work, not to mention luxuries. Both these issues are problematic for the following reasons:

• If you last longer than your job, you will have nothing to live with if you didn't save during your working life.
• If you can't buy something small but very special every now and then, life becomes gray.

The only way out is to force yourself to save something every month!

I have been researching ways to save money every month without changing anything except my habits. I forced myself to do the following 3 things and these were the results:

1. Never exceed the speed limit on the road. Save 10% on petrol (R150pm)
2. Buy the "no name" brands and "advertised specials" in supermarkets. Save (R100)
3. Switch of lights in the house and overall electricity conscious. Save (R120)

This is a monthly saving of R370.

NOW this might seem like a lot of effort for very little benefit but consider this:

For every R150 you can save per month at 7.5% return (Money Market rate), you will have R26 700 in 10 years from now.

If I invest my R370 per month in an Equity Unit Trust I believe I will get at least 10% growth which will give me an investment of R75 800 in 10 years time!

The point is that by just thinking about saving I can have something I never would have had.

None of us have enough self discipline to save and then not spend it again so to make this work you have to SIGN A DEBIT ORDER!!! Never accumulate the saving in a tin on the fridge or in your savings account at the bank.

Some other things I do:

• Only drink coffee at a place where I can read the morning newspaper for free (save R6.20 per visit)
• Never park where I have to pay (save R7.50 per parking)
• Invest in a Retirement Annuity at end of the tax year (save up to 40% on the investment). If you earn R100 000 taxable income per year you can contribute R15 000 to an R/A and save up to R6 000 in Tax.
• Adjust my short term insurance values every year (save R100pm)
• Take lunch to work instead of buying takeaways (save R20 per lunch)
• I eat what I buy. You will only eat an over ripe banana once. Next time you will buy one less!

What I am going to start doing:

• Grow my own herbs and greens (save R100pm)

There are many more things you can save on without doing anything except changing your behaviour. We live in a world where we waist way too much. You can actually contribute to saving the Planet!!

2010!!

Good Luck for 2010, this will be a defining year as far as the sustainability of the economic recovery goes. One of 3 things can happen:

• Everybody can sit and wait to see what will happen resulting in the market moving sideways.
• The predictions of a double dip recession will materialise and we will see another 40% fall.
• The work done by governments in 2008/2009 to stimulate the economies will work and we will see markets grow at a moderate pace.

If you read the newspapers, experts are divided 50/50 between points 2 and 3, in other words, nobody has a clue!

2009 was easier to predict the direction of the markets. After a 40% drop the next direction would be up, the timing was uncertain. Evidence of this can be seen in the 10 shares I chose in April 2009 and discussed in my June Blog. I chose 10 shares based on their NAV valuation and reputation of the companies, the result was a 42% average return.

For 2010 I would play the game as follows:

• Interest rates would remain stable in SA.
• Only the companies with solid earnings growth will reap the benefit of higher share prices.
• Small marginal companies will suffer.
• The Rand will weaken, if not in 2010, then in 2011!

Based on the points mentioned, I would follow the following investment strategy:

• Stay in cash for any short term requirements (3-4 years worth).
• Invest 80% of your longer term money in bigger, solid companies. Unit Trusts can be used with such a mandate if you don't buy direct shares yourself. SATRIX DIVI and RAFI still offer a well diversified, low cost investment.
• Keep the remaining 20% in cash and wait for dips in the market to invest or invest this amount over a 12 month period using a monthly debit order.
• Make sure you invest half of this amount in international markets to protect yourself against the weakening of the Rand.
• If you have money that you can save on a monthly basis, get the debit order going and forget about it!

At the end of the day you have to remember:

• Investing in cash over the longer term is a dead investment.
• Never be impatient with the return on a share investment. If you can't wait for the return, don't do the investment.
• If you invest in a company that has been going for 20 years, chances are that even if the market drops by 40%, it will bounce back as before.
• Never compare your returns with that of your neighbour. Only focus on getting an after tax and cost return that outperforms Inflation.
• Spend less than you earn!
• Get rid of debt!

Some of us have to work harder for our money than others. Some are lucky and they get a couple of good breaks in life. Some inherit wealth and they have no financial concerns and others had financial peace of mind and lost it. At the end of the day none of this will matter if your mindset is one of making the best with what you have got, contributing to society where you can and taking pride in what you do. We need not eat the best food every day or live in the biggest house or drive the smartest car to experience contentment in life. The secret is in appreciating the small things like watching the sun set over the Atlantic or watching a bird building its nest in the garden.

Nothing is permanent, everything changes. If you can prepare for these changes in any manner, you will stay ahead of the game!