FEBRUARY / MARCH 2018
PROFICIO NFB FINANCIAL UPDATE FROM THE CEO’s DESK
W
ell, anybody who says 2017 was a quiet year has certainly been out of touch. Markets, politics, economic and social change have abounded and interesting outcomes and changes have resulted. Much has been said about moral bankruptcy, state capture, South Africa being a lost cause and more. In typical SA fashion, we once again might have brought it back from the brink. Cyril's 'victory' is important. No matter what the naysayers have to say, and given that his victory might right now seem hollow given the makeup of the ANC's top structure and the NEC, I am of the opinion that once in office he will have both the executive power and leverage to effect change. I am also convinced that this change represents a moment in time of great importance to us all. If you don't agree, pause for a second and look at what JZ got done with the exact same structures and controls around! Slightly, but not much further afield, changes in Zimbabwe and other neighbouring states signal further change. Whilst not quite done and dusted, these conspire to allow a thought of reversal of trends in the short term, and revival in the long. A country's share price is well represented by its currency. The Rand has shown great levels of volatility of late, but post the ANC elections, investors, here and abroad, have reacted positively. This needs to be watched and if sustainable considered carefully as SA, which is a reasonably important Emerging Market (EM), has to a large degree missed out on the recent re-rating of EM's by investors,
given politics and a lacklustre economy. On to business, which has historically held the moral high ground, dishing out criticism and condemnation to politicians regarding theft, fraud and corruption. Whilst most investment houses have always avoided material exposure for clients to any single event, company or entity, using diversification as the primary tool, pain was and is being taken by stakeholders in Steinhoff. The extent of this event has brought significant focus to bear on those involved. The impact sadly will be more regulation, more rules and more watchdogs being appointed. I wonder where the good old adage of 'What would a reasonable man do?” has gone. I watched with great glee the Indian Supremos of cricket being humbled by a South African rookie. Given the trouncing, the program producers were scrambling for content and switched to the U19 competition. One of our next generation talents played a ball and then passed it back to the opposing wicket keeper. This young fellow, clearly having studied the rules of the game, appealed. The umpires considered the appeal, consulted the rule book and proceeded to give young Moodley his marching orders! The condemnation and fuss this caused is amazing. In essence, cricketing greats were uniform in asking one question, i.e. What is the right thing to do? And more importantly, without lambasting the young captain who appealed, or the umpire who simply interpreted the rule book (written in some boardroom, somewhere), was to coach and engage, making the outcome fairness and enjoyment. The term “Spirit of the Game” has been bandied about and whilst business and investment aren't a “game”, they have several things in common. They have the interests of
I am of the opinion that once in office he [Cyril] will have both the executive power and leverage to effect change.
participants, players, commentators, regulators and importantly future players to consider. Very often good and bad habits are adopted, making the current 'players' roles even more important. Two things strike me as important before we, as the investing public or spectating enthusiasts wade in with condemnation and advice. Firstly, what is our role in changing the game? And secondly, if we allow the regulators oversight and rights of censure or perhaps even the rights to overlook issues, have we not just now realised that the watchdogs appear to need watchdogs? Enough of theory and on to the facts: we have a tough budget around the corner. We also have a stronger Rand, mostly the result of the 'Cyril Halo'. Often, we are too busy to take stock of these facts. I would urge our readers to consider the likely changes to income and other taxes in a few weeks' time. Perhaps CGT will be revised - probably not downward! With regard the Rand, offshore investments, both via Foreign Allowance and Asset Swap, might make sense on either a tactical or strategic basis. Whilst recent relative strength in the Rand has those of us who took funds offshore at weaker rates wishing we had a crystal ball, there is an equal chance that SA gets a downgrade, or the Cyril effect wanes and we miss an opportunity to diversify. The Steinhoff saga has reaffirmed one important lesson for me: that being, our market is ridiculously concentrated, making diversification that much more important. In conclusion, may I, on behalf of all of us at NFB and NVest thank you for being a client or service provider to us and wish you well in the exciting year ahead. We do indeed live in interesting times.
Mike Estment CFP® BA / Chief Executive Officer NFB Private Wealth Management JHB
ACTIVE AND PASSIVE FUNDS
BOTH ADD VALUE
I
nvestors generally follow two main investment strategies when looking to invest their money: active fund management or passive fund management. Each of these strategies has their own approach in trying to achieve returns, and have their own strengths and weaknesses. It is important to understand how they are constructed and what actions are allowed to be taken by the fund manager on behalf of the investor.
ACTIVE FUND MANAGEMENT APPROACH Active fund management involves a fund manager, or a team of managers together with a group of analysts, who actively make decisions on the asset allocation and/or the investment instrument selection within their fund which will have a predefined mandate (such as local equity; multi asset class; bonds; flexible, etc.). The fund manager then has the discretion to take positions within that mandate, based on their views, which are informed by some form of qualitative and/or quantitative research process. Let's consider an equity mandate. Active fund managers can pick which stocks they would like to own within their fund, the weighting of these stocks, and could add to or reduce their holdings when they deem appropriate. Generally, active managers are not obliged to hold any specific stock in any specific weighting unless their mandate is to be highly benchmark cognisant. In theory, their decision to hold (or not hold) a stock is purely based on their view on its value and prospects, as opposed to any rule that obliges them to hold that stock. The decision to buy or sell a share is made on the back of a comprehensive and thorough research process that involves the development and use of sophisticated quantitative and qualitative analysis. To execute this analysis, active managers typically invest significant amounts of money in buying research and employing investment professionals.
STRENGTHS OF ACTIVE FUND MANAGEMENT Flexibility – as the fund manager is not obliged to replicate any particular index, they can invest where they believe the investment case provides the most inherent, often risk-adjusted value (taking their mandate into account). = Excess returns – active mangers aim to outperform their benchmarks by generating “alpha”. The aim of an active fund is to generate higher levels of returns than their chosen benchmark without taking on excess levels of additional risk. In theory, they aim to lose less and gain more than their comparative benchmarks over time. = Risk Management – the fund manager will have specific strategies in place to avoid excessive overweight positions in his portfolio. This may be defined as overweight to a specific investment instrument, a group of instruments or even to a specific theme (e.g. aging demographics). =
WEAKNESSES OF ACTIVE FUND MANAGEMENT Fees - fees are generally higher than fees seen in passive strategies. The fees are typically higher as investors are paying for IT, research, investment professionals, and operations whereas in a passive fund investors are paying for the implementation of a rule based strategy which is often a cheaper exercise. Active fees can also be performance based which sometimes aligns portfolio managers with their investors, but sometimes can also be misaligned and can be more expensive than a flat active fee. = Manager selection - the active management approach requires investors to assess the skill of the manager, as different managers have different approaches, resources, experience, and will consequently have different outcomes. = Active management risk – by its nature, active managers attempt to outperform specific benchmarks or indices by making investment decisions based on their views. While this may result in outperformance when these views prove to be correct, there is the risk that their investment thesis is wrong and that the fund underperforms its benchmark as a result. Thus, while active management introduces the possibility of “alpha” (excess returns), it also introduces the risk of underperformance. =
PASSIVE FUND MANAGEMENT APPROACH Passive fund management or index investing is the strategy of investing based on specific rules that are aimed at replicating the returns of a specified index. Passive management is a style historically associated with Exchange Traded Funds (ETF's), but this is rapidly evolving. Passive managers do not have the ability to choose between what investment instruments or asset classes they would hold. They attempt to, as closely as possible, follow an approach that replicates the characteristics of the selected index. There is little to no discretion in what is held in the fund, and there is little use of research beyond that which advances their understanding of optimal replication strategies. No views are used in arriving at portfolio holdings. Passive investors largely believe in the Efficient Market Hypotheses (“EMH”). The EMH, in short, is an investment theory that states it is impossible to “beat the market” because prices always immediately adjust to incorporate and reflect all known information.
STRENGTHS OF PASSIVE FUND MANAGEMENT Low fees – passive funds involve the implementation of defined rules, as opposed to any research-based process and its associated cost. As a result, passive funds are typically cheaper than that of actively managed funds. = Transparency – it's always clear which assets are in an index fund =
and their exact weighting as opposed to an active fund that may not fully disclose its current holdings and weightings. It's also clear which assets are likely to be in a fund or be excluded from a fund in future.
WEAKNESSES OF PASSIVE FUND MANAGEMENT Limitations – passive funds are limited to a specific index or predetermined set of investments with little to no variance; thus, investors are locked into those holdings, no matter what happens in the market. = Zero Excess Returns – by definition, passive funds will more often than not provide a lower return than the benchmarks they track due to the frictional costs they incur to track those indices. = Tracking Error – is the difference between the return an investor receives and that of the benchmark the fund was attempting to replicate. Since portfolio risk is often measured against a benchmark, tracking error is a commonly used metric to gauge how much risk a portfolio is taking on in chasing performance. Tracking error shows an investment's consistency relative to a benchmark over a given period of time. Even portfolios that are perfectly indexed against a benchmark behave differently to the benchmark, even though this difference on a day-to-day, quarterto-quarter or year-to-year basis may be ever so slight. The risk here is that it is possible for a passive portfolio to deliver a different outcome to the index if the strategy is not well executed. = Inflexibility – the rules-based nature of a passive fund means that there is no consideration given to any other factor outside of the weighting that an investment instrument holds in a chosen index. Thus, irrespective of whether a security or sector is potentially over or undervalued; whether the security represents a disproportionately high percentage of the index; whether there are factors that would otherwise make an investor want to hold more or less of the security, the passive fund has no discretion as to whether that security is held or in what weighting it is held. =
A PRACTICAL EXAMPLE: NASPERS Founded in 1915, Naspers is a global internet and entertainment group and one of the largest technology investors in the world. With a market capitalization of R1.61trn it represents more than 20% of the JSE's Top 40 market value. At its peak in November it was up by 88%, before finishing the year at 68% up. The graph below, which is very relevant to this discussion, is that of the JSE Top 40 index itself. The index was up by 23% for the year.
What is very important to understand is that given that Naspers makes up >20% of the index weight and that it saw a return of 68% for the 2017 year, it contributed roughly 17% of the total index return. There are a couple of issues that come from this when considering the
The age old debate of active vs passive fund management and which strategy is best for client returns is one that will most likely continue until the end of time.
active vs passive debate. It is unlikely that any active fund manager would hold such a big position in their fund as it would represent a significant risk (even if they felt that Naspers was attractive). Over the 2017 year, the JSE Top 40 would have outperformed most active funds as a result of Naspers' weighting in the index. So, things have worked well for the passive fund tracking the Top 40 in this case as a result of a remarkable return by a share that has a disproportionately high weighting in the index. The challenge comes when one starts to consider risk and valuations. In this example, the passive fund has no choice, but to hold this weighting in Naspers. The fact that Naspers has had a terrific run and may be closer to a full valuation (or overvalued) is not something that the passive fund can consider. Furthermore, the passive fund is unable to lock in any profits by reducing its exposure to Naspers. A PRACTICAL EXAMPLE: STEINHOFF The recent collapse of the Steinhoff (SHF) share price has once again fuelled the debate as some passive management proponents (potentially opportunistically) jumped on the issue that many active managers were invested in Steinhoff, despite warning signs. Their argument is that the research processes of the active managers should have picked up the issues and thus active managers should not have been invested in Steinhoff, and thus the fees paid for active management are unjustified. It is a simplistic argument for the following reasons: =
Not all active managers held SHF so to say the whole industry failed would not be accurate = Many managers were underweight their position in SHF for a number of reasons = Managers attempt to generate Alpha by taking on risk and may have felt that the risk of holding SHF was worth the potential reward. = Notwithstanding the SHF issue, some of the funds that held SHF are still ahead of their benchmarks over time. This is to say that one shouldn't judge them purely on one specific share, but the overall result of the approach to managing money. Active management by nature involves risk taking, and mangers will get some things right and some things wrong. The passive argument doesn't address the inflexibility of index-based investing. SHF made up 3.5% of the JSE Top 40 Index and thus despite the problems in SHF that some passive managers are so eagerly pointing at (in hindsight), the passive funds were obliged to hold SHF at these levels. Thus, despite the warning signs (once again, with a healthy dose of hind sight), many passive funds had no option, but to hold much higher levels of SHF than their active counterparts. If one now considers Naspers as an example here, the problem becomes evident. What would happen if there were warning signs for a share that held a massively overweight position like Naspers at (>20%) in an index like the JSE Top 40? The passive fund would be obliged to hold (>20%) of its value in this share. The age old debate of active vs passive fund management and which strategy is best for client returns is one that will most likely continue until the end of time. Both have strengths and weaknesses and as such it is not possible to categorically state that one is better than the other. NFB has always advocated diversification within client portfolios and as such various investment strategies are used when constructing portfolios. We believe that every investor is unique and therefore their portfolios will be aligned to specific investment objectives. Should you have any questions kindly contact your NFB Private Wealth Manager. Jaco Van Zyl Higher Certificate in Financial Planning Private Wealth Manager NFB Private Wealth Management JHB
UPDATING YOUR LAST WILL AND TESTAMENT
A
friend of mine got divorced in August 2017 and after the divorce she updated her life insurance policy and pension fund beneficiary and her will. She only managed to go to home affairs for a new ID reflecting her maiden surname in November. When she informed me that she now has a new ID with her maiden surname, I couldn't help but wonder how many people who have recently married or divorced, or have given birth, have changed their life cover beneficiaries and have updated their wills? As obvious as it might seem that at divorce you should change your will, adapting to your new life might make you forget to update your will - it's understandable - but how will this impact your estate should you pass away? The law of testate succession in South Africa is governed by the Wills Act 7 of 1953. Section 2B of the Act states that: 'if any person dies within three months after his marriage was dissolved by a divorce or annulment by a competent court and that person executed a will before the date of such dissolution, that will shall be implemented in the same manner as it would have been implemented if his previous spouse had died before the date of the dissolution concerned, unless it appears from the will
that the testator intended to benefit his previous spouse notwithstanding the dissolution of his marriage'. The Western Cape high court in October 2016 delivered a judgement that pertained to this section. The brief facts of this case are: Anna Kock (ex-wife) and Pierre Koekemoer (ex-husband/deceased) executed a joint will in 2004 which nominated the surviving spouse of the two as the sole and universal heir; should both of them pass away, the deceased's father would inherit, failing which the Society for the Prevention of Cruelty to Animals (SPCA) was to inherit. The couple divorced on the 17th of October 2014 and a settlement agreement was concluded. On the 7th of January 2015, the husband passed away (within 3 months of the divorce). Prior to the deceased's death, the wife had remarried. Citing the disqualification afforded by section 2B, the Master was to devolve the estate to the SPCA, as the deceased's father had passed away. The ex-wife instituted a claim against the decision stating that no other person is nominated as heir to the deceased regardless of their divorce and the deceased did not intend to benefit any other person apart from her upon his death. In the
As obvious as it might seem that at divorce you should change your will,
judgment, the presiding judge Meer found that the ex-wife can only inherit if it appears from the will that the deceased intended her to inherit notwithstanding the dissolution of the marriage and such intention does not appear from the will. Furthermore, if the deceased had intended the ex-wife to inherit after divorce, the will would have explicitly stated so or he would have made a new will indicating such. As such the interpretation of the will and the wording of the section excluded her from inheriting. The Wills Act does afford some protection should one pass away within 3 months of the divorce order being granted; the same cannot be said should one pass away post the grace period, and as such the ex-wife in the case mentioned above could have inherited from the estate. It is thus important to update your will regularly and most importantly when there are changes in your life. In the same light, if you are not sure who you nominated as beneficiary in your investment portfolio, please check with your financial advisor. Sources used: Louw No v Kock and another 2017 (3) SA 61 (WCC); www.fisa.net.za/louw-no-v-kock-another-2017-3-sa-62-wcc/; www.cliffedekkerhofmeyr.com/en/news/publications/2017/trusts/trustsand-estates-alert-3-february-2b-or-not-2b-will-your-exspouse-inherit-from-your-estate.html
Phomolo Moreng B.Juris (Financial Planning), PGDFP
adapting to your new life might make you forget to update your will - it's
Financial Paraplanner
understandable - but how will this impact your estate should you pass away?
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