“We can’t solve problems by using the same kind of thinking we used when we created them.”
Albert Einstein
The quote above summarises the theme of this newsletter – change! As our seasons change, so do our markets, both locally and offshore. It is always important to differentiate between the REAL news and the BIG news brought about by these changes in our markets. It seems that the general public and the investment world alike, are always searching for BIG news and once a few changes take place, what was BIG news is actually no longer news at all.
The build up to elections was quite exciting for many South Africans especially for those voting for the first time in our 20th year of democracy. Many of us would have felt proud making our mark and although there weren’t too many changes (as referred to in the February 2014 quarterly newsletter) there seems to be a slight shift in the minds of many South Africans. The lack of change, which may have been disappointing for some, was relatively good for our markets and hence we saw no major disruptions or changes in our markets, over this last quarter. The ZAR has strengthened slightly against the US Dollar over the last quarter. The closing price at the end of February 2014 was R10.75 to the US$ and the closing price at the end of May 2014 was R10.58.
There are still many key fundamental problems in the SA economy including, inter alia, continued strikes in the platinum sector (the strike started on 23 January 2014!); extremely high real inflation, coupled with high consumer debt levels; a large trade deficit and an uncertain political and economic environment.For these reasons, we’re not convinced that the ZAR has any reason to strengthen from a fundamental perspective, in the medium to longer term. The ZAR may be ‘oversold’ but without any improvement in some of the fundamentals mentioned above; it is very difficult to believe that the ZAR will strengthen to where it was before the 2008 crash. It seems that the long term trend of the ZAR is to weaken against the USD and although during the short to medium-term there has been little or no change, it is very likely that the long-term trend will continue as the USA economy starts to show signs of recovery.
Passive versus Active Management:
One of the BIG and REAL news headlines over the last year involves making an investment decision between passive and active management styles. Active management involves a fund which is actively managed by an individual manager, co-managers or a team of managers. Passive management includes index funds where their portfolios mirror the components of a market index. The take-up of passive investing in South Africa is relatively low as investors have been in an environment where returns of 15% and more, seem normal and costs are not as much of a deciding factor when choosing a unit trust fund. For markets where returns are more in the range of 6% to 8% (like the USA), however, smaller differences in fees have more of an impact. The need to find cheaper alternatives has not been as pressing in South Africa but the investment landscape is changing. Accordingly, the debate around the effect of fees on returns locally will become a bigger issue.
It is important to stress that both these investment styles have merit and don’t need to be mutually exclusive. Passive investment styles have brought to book some of the so-called active managers, who are not truly active. This can be measured by referring to a fund’s ‘active share’. This term measures the extent to which active managers’ portfolios differ from their benchmarks (usually an index tracker). It is reported on a scale of 0-100, where a score of 100 reflects a portfolio that mirrors its benchmark (i.e. no active share at all) while a score of 0 indicates that the portfolio is completely different to its benchmark (i.e. a very active share of 100%). 
This tool does give advisors and investors an opportunity to measure the extent to which their managers’ portfolios are closet index trackers and those which are truly active. It is important that Active managers are assessed over a reasonable time period. Ideally, one should look at returns over 10 years but no less than 5 years, to ensure that luck as well as market conditions, are eliminated. Over the last 20 years the average actively managed general equity unit trust produced an annualised return of 17.3% after fees, while the JSE All Share Index returned an annualised 16.6% over the same period. While passive investing can be a great low-cost way to gain market exposure, costs should never be the only factor. Passive and Active management styles can be complementary. Passive styles of investing will differentiate the active managers from the truly active managers – perhaps the perfect time for active managers to make a change.
Retirement Reform Update:
Continuing with my theme of change in this newsletter, there have been some changes within retirement annuities; the tax break on contributions to retirement funds will be harmonised across different fund types and capped at the lower of 27.5% (previously 15%) of taxable income, or R350 000 from 1 March 2015. The requirement to annuitise at least two-thirds of retirement capital will now also apply to all new contributions made to provident funds by members younger than 55 years old as at 1 March 2015. The tax-free lump sum that can be taken at retirement has been increased to R500 000 (previously R315 000), while all retirement funds less than R150 000 can be taken in full effective 1 March 2014. There are other changes which are still in discussion and we will inform you about those as soon as there is some finality.
Conclusion:
So the search for a new story continues… As Summer gives way to Autumn – not overnight but in a smooth kind of a way – we hope that changes in our markets are the same. Although we may be faced with some bad news at some point this year, news always brings about change and change is sometimes exactly what we need in order to find the solution.
As always please don’t hesitate to contact us for assistance.
Kind regards
Stacey Lancaster – end May 2014.
Finlaw Consulting