- 2017 WHERE TO FOR INVESTORS?
- REALISING THE POTENTIAL OF AFRICA’S ECONOMIES
- HEDGE FUNDS: FRIEND OR FOE?
- WHY BUY ART?
In today’s interconnected, fast-changing world, you need deep investment insights to make the connections between many seemingly unconnected factors. Kevin Lings and Vaughan Henkel takes a look at a range of factors to help you make better investment decisions in 2017
Since 2009 investors have witnessed one of the longest periods of global economic expansion in history. It may not seem like it though. Expansion has been weak and well below long-term average, but it has been expansion.
Between 1995 and 2005, the US economy produced an average rate of annual gross domestic product (GDP) growth of around 3,5%, regularly reaching over 4%. Since 2009, US GDP growth has averaged 1,5% per annum. This is despite significant stimulus from the US Federal Reserve through low interest rates and quantitative easing (QE). Other central banks, most notably the Bank of England, European Central Bank and Bank of Japan, have also pumped money into their economic systems.
South Africa’s economy has averaged growth of only 1,2% over the past three years, while the growth forecast for South Africa during 2016 remains modest at a mere 0,3%.
The question this raises is what happens next?
To understand where the markets may be headed, it’s worth reflecting on the current scenario. Market volatility, low global economic growth and global political uncertainty – from the US elections to Brexit – have made 2016 a rough and interesting ride.
In 2017 we can expect more of the same. But amid the volatility, there are signs of some stability and sustained growth.
THE BIG FIVE
The extensive and prolonged monetary policy response has not produced the rebound in global economic growth most analysts and central bankers anticipated, mainly due to five major factors.
First is increasing protectionism as a result of a backlash against the perceived negative effects of globalisation. Many countries have adopted more right-wing policies including protectionist measures to protect their trade.
G20 countries have more than tripled their number of trade restrictions since the global financial crisis, according to the World Trade Organisation. As there is a strong link between world trade and world growth, this has dampened economic growth.
Second, the cost of capital is at a historical low in developed markets, yet fixed investment activity has dwindled. Before the global financial crisis, fixed investment activity amounted to an average of 23,3% of GDP (from 1990 to 2008). Since then, the ratio has dropped to 20,3%, which equates to a significant USD1,3 trillion less spent on fixed investment.
Without sustained fixed investment expenditure, which includes infrastructure development, it is hard for most economies to gain traction in stimulating the economy through creating new jobs.
The third factor is the ageing population in the developed world. The average life expectancy was recently recorded as just over 70, whereas after the Second World War it was around 45 years. This in itself is not an issue, but having more people over the age of 65 dependent on others for an income is not ideal. This changes an economy’s growth outlook as more resources are diverted into supporting an elderly population.
This is not the case in South Africa, where we have a young, growing population.
Meanwhile, China is in the process of rebalancing its economy from predominantly fixed investment activity towards greater consumer household consumption. As a result, China’s demand for commodities is slowing, which has a negative knock-on effect on emerging commodity-producing countries.
If China is able to transition from an investment-based economy into one with a healthy mix of consumption and investment, it will easily become the largest economy in the world. In the meantime, it is undermining world economic growth in the short term.
Finally, on a global basis, the level of economic confidence is significantly lower now than before the global financial crisis. This is due to a combination of low economic growth, underpinned by a crisis of leadership in key Western countries, a growing wealth divide and rising levels of corruption.
THE SOUTH AFRICAN STORY
It is concerning that since the global financial market crisis in 2009, the rate of economic growth in South African has not been robust enough to lead to widespread job creation in the formal private sector.
Over the past year, the South African economy lost 112 000 jobs, mostly among lower-income groups. At the same time the official rate of unemployment has remained exceedingly high at 26,6%. The high rate of unemployment contributes to much of the country’s social tension, especially among the youth.
The current state of government finances includes higher levels of debt, a weakening tax base, the risk of a further credit rating downgrade, and the increasing demands for financial support from state-owned enterprises.
It seems clear that the public sector is unable to provide a significant additional economic stimulus in the form of government spending to boost the economy.
Instead, South Africa’s economic policy officials need to find a way to lift business confidence and encourage the private sector to play a bigger role in growing the economy. This is most likely to be achieved through targeted infrastructure development using private/public partnerships, as outlined by the Minister of Finance in 2016.
WHERE DOES THIS LEAVE INVESTORS FOR 2017?
The economic backdrop locally and globally is not conducive to a strong earnings environment for equities while global bond yields are at 30-year lows. This limits the outlook for asset class returns, particularly when the past six years have delivered solid returns, in particular for rand-based investors.
With this in mind, it is worth highlighting that the most important goal of investing is to beat inflation. This is how you create real wealth.
The second most important consideration is time in the market. The power of compounding is best espoused by Albert Einstein (and although no one is quite sure if he said this, it is certainly good advice): ‘Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t … pays it.’
So how do you choose how to allocate your investments between asset classes such as bonds, equities, property or cash in 2017?
Start by considering the key factors that drive markets.
South Africa’s economic outlook continues to be lower than average, coupled with lower levels of business and consumer confidence.
Investors may not agree on the best way to value asset classes, but it is worth considering that 90% of the expected returns in the S&P 500 (the proxy for global equity) on a 10-year view can be explained by the starting valuation level, that is the price to earnings ratio now. This ratio is used for valuing a company by measuring its current share price relative to its per-share earnings.
On a one-year view, the starting price to earnings ratio explains only 5% of the expected return and highlights the uncertainty inherent in a one-year forecast for 2017.
Other measures we look at indicate that we can expect lower returns on our investments than we have become used to. Consensus forecasts indicate company earnings will be in single digits while bond yields are already at 30-year lows.
For South African investors, the rand is an additional factor that has the potential to affect returns, as we have seen from the weakening in 2015 and strengthening in 2016. In a low-return world, currency forecasts become crucial.
Given this combination of factors, we think the most prudent strategy for 2017 is to adopt a cautious outlook.
Short-term forecasts contain a very high level of uncertainty. We prefer investing for the long term where our process and strategy offers a higher level of certainty on an expected outcome.
Our final point is that an investor’s risk profile, which is most easily explained by their age, will impact on the basic level of risk they are comfortable with.
AUTHORS | Kevin Lings, STANLIB Chief Economist and Vaughan Henkel, STANLIB Investment Strategist
Africa’s economic fundamentals remain strong but governments and companies will need to work even harder to keep the region’s economies moving forward. From McKinsey & Co
Many observers are questioning whether Africa’s economic advances are running out of steam. Five years ago, growth was accelerating in almost all of the region’s 30 largest economies, but the recent picture has been more mixed: while growth has sped up in about half of Africa’s economies, it has slowed in the rest.
Between 2010 and 2015, Africa’s overall GDP growth averaged just 3,3%, considerably weaker than 4,9% a year between 2000 and 2008. But average growth hides a marked divergence, finds a new McKinsey Global Institute report1 Lions on the move II: realizing the potential of Africa’s economies. A much less robust economic performance by two groups of African economies dragged that average down – oil exporters hit by the decline in oil prices and countries affected by the political turmoil of the Arab Spring (Egypt, Libya and Tunisia). For the rest of Africa, growth actually accelerated to 4,4% in 2010 to 2015, from 4,1% in 2000–2010. (In addition, long-term fundamentals are strong and there are substantial market and investment opportunities on the table.
Future growth is likely to be underpinned by factors including the most rapid urbanisation rate in the world and, by 2034, a larger working-age population than either China or India. Accelerating technological change is helping to unlock new opportunities for consumers and businesses, and Africa still has abundant resources. The International Monetary Fund projects that Africa will be the world’s second-fastest-growing region in the period to 2020.
Despite recent shocks and challenges, spending by Africa’s consumers and businesses already totals $4 trillion annually and is growing rapidly. Household consumption is expected to grow at 3,8% a year to total $2,1 trillion by 2025. African businesses are an even larger spender. From $2,6 trillion in 2015, business spending is expected to increase to $3,5 trillion by 2025.
Africa could nearly double its manufacturing output to $930 billion in 2025, from $500 billion today, provided countries take decisive action to create an improved environment for manufacturers. Three-quarters of that potential could come from Africa-based companies meeting domestic demand; today, Africa imports one-third of the food, beverages, and other similar processed goods it consumes. The other one-quarter could come from more exports. The rewards of accelerated industrialisation would include a step change in productivity and the creation of up to 14 million stable jobs over the next decade.
While the potential that Africa offers is undoubted, the question remains: will it be achieved? Businesses and governments will need to work harder to capture the opportunity. Africa is home to 700 companies with annual revenue of more than $500 million, including 400 with annual revenue above $1 billion, and these companies are growing faster and are more profitable than their global peers. But Africa needs more of them. It has a lower number of large companies – and they are smaller on average than one would expect given the corporate landscapes of other emerging regions. Corporate Africa needs to step up its performance to make the most of these opportunities. The top 100 African companies have forged their success by building a strong position in their home market before diversifying geographically, adopting a long-term perspective, integrating what they would usually outsource, targeting high-potential sectors with low levels of consolidation, and investing in building and retaining talent.
Governments will need to address the continent’s productivity and drive growth by focusing on six priorities emerging from this research: mobilise more domestic resources; aggressively diversify economies; accelerate infrastructure development; deepen regional integration; create tomorrow’s talent; and ensure healthy urbanisation.
Delivering on these six priorities will require a transformation in the quality of Africa’s public leadership and institutions, as well as governance. All these imperatives require the vision and determination to drive far-reaching reforms in many areas of public life, and they require capable public administration with the skill and commitment to implement such reforms. What the past five years have shown is that Africa’s diverse economies – its economic lions – now need to improve their fitness in order to make the most of their undoubted long-term growth potential and to continue their march toward prosperity.
1 Authored by Jacques Bughin, a director of the McKinsey Global Institute, where Susan Lund is a partner; Mutsa Chironga, a partner in McKinsey’s Johannesburg office, where Georges Desvaux, Acha Leke, and Arend Van Wamelen are senior partners and Paul Jacobson is a consultant; Tenbite Ermias and Omid Kassiri, partners in the Nairobi office; and Yassir Zouaoui, a partner in the Casablanca office.
In South Africa, many hedge funds manage to deliver excellent risk-adjusted returns after all fees. Over the past year, amidst significant market volatility, many added significant diversification to their traditional alternatives, which resulted in strong inflation-beating returns for their investors. By Elmien Wagenaar
Popular international media is rife with despairing headlines relating to hedge funds like ‘Hedge funds haven’t delivered on their promise’,1 ‘Will hedge funds be around in 10 years?’ 2 and ‘Buffett says hedge funds get “unbelievable” fees for bad results’.3
Not making headlines are articles like ‘Hedge fund AUM on the rise’,4 which quotes the latest Credit Suisse Annual Hedge Fund Investor Survey saying that despite several years of lacklustre aggregate returns, hedge fund assets under management are expected to climb 3,5% in 2016.
It also quotes Robert Leonard, global head of capital services at Credit Suisse, who said that ‘Institutional investors remain committed to their hedge fund allocations and are optimistic for further growth in the industry during the upcoming year.’ He added that ‘Increased interest in strategies such as equity market neutral, global macro and equity long/short trading-oriented appears to indicate that investors are anticipating another challenging environment for 2016. Key factors noted in making new allocations were net returns, pedigree of investment team and lack of correlation with other investments.’
SOUTH AFRICAN LEGISLATION ‒ NEW OPPORTUNITY FOR THE GENERAL PUBLIC TO INVEST IN HEDGE FUNDS
In South Africa many hedge funds are now regulated under the Collective Investment Schemes Control Act 45 of 2002 (CISCA) and are available as unit trust funds to the general public.
Many South African investors ask whether they should excitedly welcome this investment opportunity or with trepidation steer well clear. The trusted financial advisor owes his client clarity that will result in an informed investment decision.
‘AVERAGE’ RETURNS AND ‘RELATIVE’ EXPECTATIONS
The root of much confusion lies in the fact that hedge funds don’t have a set definition or standard approach and thus any generalised media statement or investment decision around hedge funds could greatly mislead.
The Securities and Exchange Commission in the United States says the term ‘hedge fund’ first popped up in 1949, but that ‘it is not statutorily defined’. The Financial Services Authority in the United Kingdom admits to ‘no universally accepted meaning’. The International Monetary Fund argues that hedge fund-style instruments have been around for 2 500 years and defines them by four attributes: focus on absolute (rather than relative) returns, plus the uses of hedging, arbitrage and leverage.
Also in South Africa, the Financial Services Board under the new CISCA regulation for hedge funds will appropriately govern risk-taking of these funds but does not prescribe the strict classifications of mandates prescribed by the Association for Savings and Investment South Africa for traditional assets.
The differences in hedge funds are not only conceptual. They also translate into large differences in returns which have vital implications for decision-making.
A Blackrock study shows that the spread between the highest and lowest returning US hedge funds are far larger than that of traditional stock and bond investments. For the period from 2005 to 2014, the spread between the top and bottom decile hedge funds was 37,8%, compared to only 10,1% for large cap core funds and 5,4% for US government bond funds.
Locally, the Novare Hedge Fund Survey for 2015 evidenced a differential of 48,9% for the best and worst performing funds classified under the largest hedge fund strategy.
MISLEADING TERMINOLOGY ‒ ‘AVERAGE’ HEDGE FUND RETURNS
Large variations in any set of investment returns reduce the usefulness of a reference to its average (like asking the shop attendant how sweet the average fruit on the supermarket shelf is this week). Similarly, this holds true for the usefulness of average hedge fund returns when making investment decisions. Where popular media articles quote the average statistics in support of statements that hedge funds have not delivered on their promise5 – the statistics are actually of limited use to make rational investment decisions.
For example, the statement: ’In the first quarter of the year the average fund lost 0,8% after fees, according to Hedge Fund Research, an index provider. That follows a loss of 1,1% for the average fund in 2015, and a gain of just 3% in 2014. In other words, ‘the average investor has earned a cumulative 1% since the start of 2014’ is factually correct, but can only be used to make an informed investment decision if all funds delivered more or less similar outcomes, which Blackrock’s study shows is not the case.
RELATIVE RETURN EXPECTATION
Also, if Warren Buffett’s complete statement at his most recent annual conference is considered, and not just the catchy headline quote, it becomes clear that his comment is not as such a condemnation of hedge funds in isolation, but rather on their returns and fees in comparison to his suggested investment solution – an equity index: ‘Just buy an S&P index fund and sit for the next 50 years,’ Buffett said.
For some investors that may be easier said than done, as not everyone has:
- 50 years to wait it out, and/or
- The risk profile to ignore the fluctuations that coincide with being invested in equities only, and/or
- An unconstrained prerogative from a regulatory perspective to invest in equities only.
Most hedge funds do not aim to outperform equities but rather to outperform bonds as a risk reduction tool in a portfolio where diversification and risk reduction away from the medium-term fluctuations of equity risk is needed. Such an investment profile clearly does not fit the investment needs of Warren Buffett.
On this point THINK.CAPITAL acknowledges that not all investors require risk reduction as their main mandated aim, but many do have a need for risk diversification.
- Some investors with a higher tolerance for risk are reluctant to invest in hedge funds as many of these funds lag equities in an up market – the reason for this lag is that upside is sacrificed in hedge funds in favour of consistent, positive returns.
- These investors then stay invested in equities rather than considering an investment in hedge funds. However, this decision may be to their detriment as their risk exposure remains largely to the direction of equity markets and the investment portfolios cannot gain from any decline in the share prices of equities.
- In contrast, if the portfolio included some investment in specific hedge fund mandates that did not lag equities significantly, the portfolio could also have profited from falling share prices and improved risk diversification significantly.
MANAGER SELECTION AND THE OPPORTUNITY OF DISPERSION
A research paper by Girish Reddy, Peter Brady and Kartik Patel6 quotes a number of studies that have shown that for traditional asset classes, the vast majority of investment performance is driven by asset allocation decisions and that manager selection is far less important.
For example, the decision of how much capital to allocate to domestic equity, fixed income, emerging markets, commodities, etc, is likely to have a much greater impact on the performance of a portfolio than the decision about which international equity or fixed income managers are chosen.
This insight is true because the difference in performance between asset classes tends to be much greater than the difference between managers within a particular asset class. For example, the performance of most fund managers will not stray very far from their benchmark, so the decision to invest with any one of them is far less important than the decision of how much to invest in one asset class versus another.
HEDGE FUNDS ARE UNIQUE IN THIS REGARD
A key finding of their research is that the relative importance of strategy allocation and manager selection in hedge funds is the opposite of traditional investments.
With hedge fund strategies, manager selection has a greater potential impact on performance than strategy allocation. This is primarily due to dispersion of returns between hedge fund managers pursuing the same strategy, combined with the relatively low dispersion of returns between different hedge fund strategies.
The facts presented a unique opportunity for THINK.CAPITAL to combine hedge fund skills to provide a solution for the needs of investors – not to create a different risk profile, but to rather deliver a differentiated risk exposure as an alternative source of returns.
FRIEND OR FOE?
Run away from general statements and averages. They can only misconstrue. But ignoring the benefit of a finely selected portfolio of hedge fund strategies can be equally irresponsible.
1 Buttonwood, A losing bet: hedge funds haven’t delivered on their promise, 2 The Economist, 7 May 2016.
2 Sean Ross, Will hedge funds be around in 10 years? Investopedia, 10 April 2016.
3Sonali Basak and Noah Buhayar, Buffett says hedge funds get ‘unbelievable’ fees for bad results, Bloomberg, 30 April 2016.
4 John D’Antona, Hedge fund AUM on the rise, Markets Media, 10 March 2016..
5 Buttonwood, ibid.
6 Are fund of funds simply multi-strategy managers with extra fees? The Journal of Alternative Investments, 10(3), pp 49‒61 (Winter 2007).
AUTHOR | Elmien Wagenaar CFA is the founder of and fund manager at THINK.CAPITAL, a specialist fund of hedge fund provider
South African art has enjoyed very high media exposure in recent years with record prices being achieved for a number of our acclaimed artists. This begs the question: is this the time when one should be buying South African art? By Frank Kilbourn
A positive answer would require three pre-conditions to be met: South African artists must continue producing high-quality artworks; they must be professionaly supported by art institutions such as galleries, museums, art fairs, academics and the media; and the demand for and supply of art must be accommodated by an effective art market.
South African art is at a critical and very exciting juncture. The two leading art fairs in Johannesburg and Cape Town are very well established and of an international standard from a content and presentation point of view, showcasing African and local artists of a very high calibre to collectors from all over the world.
South African galleries, in turn, have succeeded in not only developing and nurturing our artists’ creative talent but also in participating in leading art fairs all over the world, generating much-needed exposure for local artists.
After a period of some stagnation, the South African museum scene is being given a life-changing injection by the establishment of the Zeitz MOCAA museum in the V&A Waterfront in Cape Town, as well as two private art museums being built in Cape Town and Pretoria.
Wheras art galleries focus primarily on comtemporary living artists (the primary market) auction houses provide a market for well-established artists, recent and deceased, whose works are being re-sold. It is critical for the wellbeing of the art market that auction houses act with credibility and transparency in their market making as they often set the value, through estimates and valuations as well as actual prices achieved on auction, of the art inventory in South Africa.
South African artists have established themselves internationally in recent years and artists such as William Kentridge, Penny Siopis, Mary Sibande, Nicholas Hlobo, Willem Boshoff, Karel Nel and Robin Rohde, among many others, are presented and exhibited by major galleries and museums worldwide.
So, we have a vibrant and well-established art scene in South Africa and an established and fast-growing international audience.
This trend has manifested itself in ever-increasing prices being achieved in the primary market for contemporary and emerging artists, rapidly closing the enormous gap that existed between the local and international contempory art market.
In the secondary market, Strauss & Co, the local market leader, has sold more than R1,36 billion in art over the last seven years, demonstrating the increased demand for quality South African art by establishing 49 new South African records in the process. This phenomenal increase in the interest and valuation of South African art was initially driven by the recognised masters such as Irma Stern, Pieter Wenning, J H Pierneef, Maggie Laubser, Walter Battiss, Anton van Wouw and Alexis Preller.
The emergence of leading black artists such as Gerard Sekoto, Sydney Kumalo, Dumile Feni, Ephraim Ngatane, Ezrom Legae, Lucas Sithole and, lately, Peter Clarke and George Pemba as top performers in the secondary market hints at a welcome broadening of the art appreciation and investor base.
The strong performance of the art market was supported by the re-appreciation of recently deceased artists such as Stanley Pinker, Robert Hodgins, Erik Laubscher, Eduardo Villa and Cecil Skotnes, among others, with new records being set on a regular basis. It is, however, very exciting that contempory artists are making a discernable impact on auction inventories and values. The works of William Kentridge, Deborah Bell, Karel Nel, Penny Siopis, Willem Boshoff, Nelson Makamo, Sam Nhlengethwa, Kagiso Pat Mautloa and Georgina Gratrix have become regular features on auctions and have been selling extremely well to local and international buyers.
It is important to note that the comments above relate primarily to the secondary market and that different dynamics are at work in the primary market. It would be fair to say, however, that the increased international exposure of contempory South African artists has definitely led to a sharp increase in the prices of artworks enjoying an international market. In addition to the names above, artists such as Moshekwa Langa, Zander Blom, Wim Botha, Pieter Hugo, Mikhael Subotsky, Frances Goodman, Mohau Modisakeng and Claudette Schreuders have become very collectible internationally.
After several years of strong growth, the international art market took a bit of a pause in 2015, primarily because of a slowdown in Chinese art sales. The TEFAF Art Market Report 2016, which is widely regarded as the most comprehensive summary of the art market available, had some amazing statistics:
- It estimated the size of the art market in 2015 to have been US$63,8 billion (a mere R900 billion), which is a truly astonishing number, although down 7% on 2014.
- US sales constituted 43% of the market and sales were up by 4% on 2014 to US$27,3 billion.
- The UK, with sales of US$13,4 billion, was in the second place with 21% market share while the Chinese market cooled down significantly (23% down on 2014) with sales of US$11,8 billion, an 18% share of the total market.
Sadly, similar statistics are not available for the South African art market, but having regard to the total turnover achieved on auctions per year and following recent discussions with a number of gallerists my sense is that the South African art market generates sales of up to R2 billion per annum.
It would be fair to say that it is a big, big world one is playing in once you become involved in the art market and with less than 1% market share, South African art has a lot of room for growth.
So, is it the time to buy South African art?
Having regard to world trends as well as the exciting dynamics pertaining to the art market in South Africa particularly, as highlighted above, I would argue that it is an excellent time to do so. Selecting a well-executed and fairly priced work of any of the artists mentioned in this article should reward the investor over time.
Unlike picking shares to invest in, selecting an artwork for purchase should in my mind always have an emotional side to it. Art has an amazing ability to change its audience – every artwork is both a self-portrait of the artist and the viewer, a mirror of our individual and collective likes and dislikes, prejudices and preferences. It can be an incredibly rewarding experience living with quality art and that alone makes it an investment worth considering.
Just like picking shares, it pays to do research into the artist, his or her track record, output to date and prospects for the future before investing a sizeable sum. In this regard, finding a reputable gallerist or auction house to assist can be invaluable in enhancing the chances of securing the magical triple bottom line, a total return – financially, intellectually and emotionally.
AUTHOR | Frank Kilbourn is Executive Chairperson at Strauss & Co