Element Investment Managers; A return to normality; November 2013

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  • Almost looking as expensive relative to history as the ALSI was in May of 2008. Note however that the ALSI did not mean revert by itself, i.e. the movement was not only a function of valuation, but needed a catalyst in the form of a deflating US housing bubble. It is therefore difficult to say with conviction that this series will correct significantly only as a result of valuations.
  • “Probably the biggest unknown is what happens when interest rates normalize… bond markets are so finely priced that the fallout could be very violent for equities.”~ Ian MacFarlane – BCA Global Asset Allocation – CFA Institute – March 2013
  • Element Investment Managers; A return to normality; November 2013

    1. 1. Senate Group A Return to Normality Jeléze Hattingh – Portfolio Manager René Prinsloo – Portfolio Manager 14 November 2013
    2. 2. René Prinsloo Portfolio Manager B Sc Hons (Act Sci) FFA – Qualified Actuary CFA 8 years’ industry experience Joined Element in November 2007 Appointed Portfolio Manager in June 2012 Stellenbosch University - Lecturer Glacier - Investment Analyst 2
    3. 3. Overview of Element Investment Managers Independent investment manager established in 1998 Track record > 15 Years Rebranded from Frater Asset Management in 2009 Long-term contrarian value investors Material focus on downside risk We define risk as the possibility of permanent capital loss Leaders in Responsible Investment and ESG analysis Enhances our analysis of risk >115 years’ experience in Investment Team - qualifications include: 8 CFAs (80% of Investment team), 4 CA (SA)s, 3 Masters, 1 Actuary No performance fees charged on Element Unit Trusts 3
    4. 4. Agenda Backdrop to the Return to Normality Extremely stretched markets globally Warning signs Element Unit Trusts How are we positioned for the Return to Normality? Element Real Income Fund Conclusion 4
    5. 5. Market movements since we last met… Asset Class 2013/03/14 2013/11/12 Move % Move ALSI 40 908 45 220 4 312 11% ALSI - EY 5.9% 5.4% -50bp -8% Property - DY 6.0% 6.5% 50bp 9% 10y Gov Bond 6.9% 8.0% 110bp 16% 10y ILB 0.9% 1.7% 80bp 92% 3y NCD 6.2% 7.2% 100bp 17% Repo 5.0% 5.0% - 0% CPI 5.9% 6.0% 10bp 1% USDZAR 9.16 10.34 1.18 13% S&P500 1 563 1 768 205 13% 10y UST 2.0% 2.8% 70bp 36% Green: increased, more expensive. Red: sold off, cheaper. Source: Element Investment Managers, I-Net, 12 November 2013 5
    6. 6. QE is clearly driving all markets Correlation Coefficient: 56% Source: Element Investment Managers, I-Net Bridge, 30 September 2013 6
    7. 7. More loose monetary policies to follow? What do the following 3 scholars have in common? The portfolio-balance theory found that policy makers had the ability to affect the James Tobin Koichi Hamada Janet Yellen prices of individual assets by altering their supply and demand in theTobin at Yale Professor at Yale Did Ph.D. under Tobin Did Ph.D. under financial Nobel Prize Winner markets. at Yale (1967) (1971) Economic Advisor to Professor at Yale Economic Advisor to Pres. Bill Clinton “Do J.F. Kennedy Pres. policy makers have the knowledge and ability to improve macroeconomic Economic Advisor to P.M. than Abe Next Credited with “Tobinoutcomes rather Shinzomake matters worse? Fed Chair Tax” and “Operation Twist” “BrainsYes…” behind” ~ Janet Yellen, 1999 “Abenomics” “Force behind” … QE infinity starting Sep’12 7
    8. 8. Is the FED losing control of the markets? In June and September, changes in perceived tapering scenarios led to large movements in key financial market variables. Moves were significant and in the conventional direction. Changes in the perceived pace of asset purchases have a very similar financial market effect as changes in the policy rate during more “normal times.” Real 5y interest rates: Equity markets: Source: James Bullard, St. Louis Fed, 1 November 2013 8 http://research.stlouisfed.org/econ/bullard/pdf/BullardStLRegChamberFinancialForum1November2013Final.pdf
    9. 9. This phenomenon’s latest example US Non-farm payrolls for October were released on Fri 8 Nov The number came in at 204 000 compared to market expectations of 120 000 i.e. 204k jobs were created over October, more than expected This is good news! The markets sold off on this news SA bonds weakened by 10 points, US bonds by 14 points Gold sold off by 1.7% The ALSI closed down 1.2% Why? Good news => economic recovery => Fed more likely to taper Insanity or markets becoming too addicted to stimulus? 9
    10. 10. US Bonds still have a long way to go… End of multi-decade bull market? Average yield Current yield 10
    11. 11. US Equity market looks expensive… Source: dshort.com, October 2013 11
    12. 12. US Equities’ expected returns are very poor! Source: Butler, Philbrick, Gordillo & Associates, 31 July 2013 12
    13. 13. US’s margin debt above dot-com levels… Source: Motley Fool, 26 October 2013 13
    14. 14. And high margin debt is negative for US equities… ? Source: GaveKal, August 2013 14
    15. 15. SA Asset classes - 15 year bull markets! Bond yields still down 47%! ALSI up 13 times! Source: I-Net, 31 October 2013 15
    16. 16. SA bonds move in lock-step with US bonds The end of a 15y bull run? Source: Element Investment Managers, I-Net Bridge, 31 October 2013 16
    17. 17. The ALSI PE is currently very high Market currently trading on 21.4x trend-earnings And 18.8x actual past 12m earnings Both average around 11.9x Source: Element Investment Managers, 31 October 2013 17
    18. 18. Returns from this starting point should be poor Expected 5 year return from current PE Source: Element Investment Managers, I-Net Bridge, 31 October 2013 18
    19. 19. INDI only this stretched twice before The INDI is currently on a similar valuation as the ALSI was in May 2008, just before the correction Source: Element Investment Managers, 31 October 2013 19
    20. 20. ALSI in US$ vs World Index ALSI in $ has rolled over – time for caution A great time to buy SA market Source: Element Investment Managers, I-Net, 31 October2013 A decade of material Outperformance (5 x) 20
    21. 21. All Share Breadth – June 2008 ALSI returned 10% over the previous year Without these five you would have lagged the index by 24% It was difficult to beat the index by omitting a few key shares (i.e. one-sided breadth) The situation was exceptional relative to history BHP Billiton, Anglo, Sasol, Implats and MTN skewing the ALSI’s performance Source: Element Investment Managers, 30 September 2013 21
    22. 22. All Share Breadth – September 2013 Richemont, Naspers and SAB Miller skewing the ALSI’s performance Breadth not as stretched or one-sided as in 2008 However, in the past year half of ALSI’s return came from 3 shares Source: Element Investment Managers, 30 September 2013 22
    23. 23. Foreigners: Buying BRICS to selling BIITS*? “What you will see is a lot more differentiation - what’s important is to distinguish between one emerging market and another.” Marco Annunziata, chief economist General Electric Co, Oct 2013 Foreigners hold > 38% of SA Government Bonds 7 Bonds > 45% foreign owned, SA’s 10y bond (R2023) is 60% foreign owned Cumulative Foreign Flows since Jan 2012 (R'm) vs ALBI YTM 130 000 8.90 120 000 8.70 110 000 8.50 100 000 8.30 90 000 8.10 80 000 70 000 7.90 60 000 7.70 50 000 7.50 40 000 7.30 30 000 7.10 20 000 6.90 10 000 6.70 Cumulative Foreign Equity Flows Source: Element Investment Managers, I-Net Bridge, 11 November 2013 *BITTS = Brazil, India, Indonesia, Turkey, South Africa 22Oct13 06Nov13 07Oct13 22Sep13 07Sep13 23Aug13 24Jul13 08Aug13 09Jul13 24Jun13 09Jun13 25May13 10May13 25Apr13 10Apr13 26Mar13 24Feb13 11Mar13 25Jan13 09Feb13 10Jan13 26Dec12 11Dec12 26Nov12 27Oct12 11Nov12 12Oct12 27Sep12 12Sep12 28Aug12 29Jul12 Cumulative Foreign Bond Flows 13Aug12 14Jul12 29Jun12 14Jun12 30May12 30Apr12 15May12 15Apr12 31Mar12 16Mar12 01Mar12 31Jan12 15Feb12 16Jan12 -10 000 01Jan12 - 6.50 ALBI YTM 23
    24. 24. Warning signs of the end of the “New Normal” aka bubble territory
    25. 25. Anatomy of a bubble… 25
    26. 26. Party like it’s 1999… Comparing Nasdaq (rebased to 1990) to the SA Retailers (based to 2002) Source: Element Investment Managers, Bloomberg, November 2013 26
    27. 27. Exponential bubbles: Bonds and Farmlands Source: Mauldin Economics, 3 November 2013 27
    28. 28. Caution warranted: Bearish sentiment at 20 year low… 30 October 2013 28
    29. 29. Jeléze Hattingh Portfolio Manager M Sc (Cum Laude), CFA, CMT Business Mathematics and Information Quantitative Risk Management 8 years’ industry experience Joined Element in May 2010 Appointed Portfolio Manager in June 2012 Allan Gray Ltd – Fixed Interest Credit Suisse and Deloitte Consulting (UK) – Risk Management Standard Bank (SA) – Risk Management 29
    30. 30. Element Unit Trust Overview and focus on Element Real Income Fund 30
    31. 31. Element: Unit Trust Fund Profile 2% - 4% long term outperformance with lower than market risk Lower risk than the market Reduce risk with combination of asset classes Real return with material reduction in risk Reg 28 Balanced Fund – expected position Size of bubble = maximum drawdown Offer investors a choice along a risk/return frontier Data: Fund inception to Oct 2013 31
    32. 32. Element Unit Trust Performance Overview Element Global Equity Fund Element Earth Equity Fund Element Flexible Fund Element Balanced Fund* Element Real Income Fund* Inception Date Feb 2011 Oct 2001 Oct 2001 Nov 2009 Oct 2002 ASISA Category Global Equity General South African Equity General Multi Asset Flexible Multi Asset High Equity Multi Asset Low Equity Maximum Equity 100% 100% 100% 75% 40% MSCI World Index ALSI CPI + 5% Average of the Multi Asset – High Equity Group CPI + 3% Benchmark Performance at 31 October 2013 Fund Benchmark Fund Benchmark Fund Benchmark Fund Benchmark Fund Benchmark Annualised since Inception 24.8% 25.2% 17.4% 18.5% 15.5% 11.0% 9.0% 13.3% 11.8% 8.4% Annualised 10 Year 16.6% 20.0% 14.1% 10.8% 11.2% 8.8% Annualised 5 Year 12.1% 20.2% 10.8% 10.4% 10.2% 8.4% Annualised 3 Year 7.1% 17.9% 10.4% 10.8% 10.6% 14.2% 11.3% 8.8% 7.6% 26.2% 13.6% 10.9% 14.4% 19.2% 13.7% 8.9% 1 Year 45.9% 46.6% * Regulation 28 Compliant First Quartile over 1y and since inception Poor Equity Performance Absolute AA Funds outperforming 32
    33. 33. Equity performance impacts all our Funds We manage and engage across “one” equity portfolio EQUITY FUNDS EARTH EQUITY FUND FLEXIBLE FUND EQUITY ENGAGEMENT ASSET ALLOCATION FUNDS REAL INCOME FUND BALANCED FUND SCREENED FUNDS ISLAMIC EQUITY FUND ISLAMIC BALANCED FUND When equity performance turns – will boost all our Funds Asset Allocation calls have been good 33
    34. 34. Our Asset Allocation calls have been good… Above average despite poor Equity performance Source: Element Investment Managers, MoneyMate, October 2013 * For internal presentations only 34
    35. 35. Asset Allocation and Positioning for a Return to Normality
    36. 36. Asset Allocation Investment Process Balanced Funds Asset Allocation Equity Income Foreign Income Allocation Implementation FRNs/ Cash Bonds ILBs Property Prefs Security Selection Duration Credit Curve Shape Liquidity 36
    37. 37. Cautioned against capital loss on “risk-free” assets Source: Element Investment Managers, I-Net Bridge, 31 October 2013 37
    38. 38. There is no substitute for due diligence… Mail & Guardian, August 2 to 7 2013 R925m corporate bond default – Element had zero exposure Some of SA’s largest asset managers were caught – searching for higher yields “We don’t know what happened here…Due diligence is only as good as the financials that are presented to you.” Leon Campher, CEO of ASISA, 26 July 2013 We disagree as there were numerous red flags raised! Our credit process involves rigorous analysis of issuers Detailed research on alternative investments Including ESG research – particularly corporate governance 38
    39. 39. Investment in Renewable Energy Bond Detailed research Use alternative asset classes to enhance our risk-return profile Actively manage our income positions Invest in CPV bond …and kick the tyres! 39
    40. 40. ILBs: What did we say in April 2013? Impact of Real Yield Change for 10 SA Government ILB 10% Apr’13 10y Real Yield of 0.62% 5% 0% 8% Capital Loss in 6 months! Capital Return -5% Real GDP expectations: 2013: 2.7% 2014: 3.5% 2015: 3.8% Historical ILB Real Yield = 3.4% -10% -15% -20% -25% Oct’13 10y Real Yield of 1.65% -30% -35% -40% -45% 0% 1% 2% 3% 4% 5% 6% 7% Exit Real Yield Source: Element Investment Managers, I-Net Bridge, April 2013 40
    41. 41. African Bank Prefs are an attractive alternative New Basel rules mean that preference share capital loses its recognition over time African Bank Preference Shares effectively paying cash plus 7.2% after tax Reversion to historical norms implies price of R81: 21% upside Prospect of company buy-back at price of R100: 49% upside Even if this event only happens 5y from now, return earned is still 19% p.a. Rights issue of R5.5bn is positive for pref shareholders and bond investors Source: Element Investment Managers, I-Net Bridge, 31 October 2013 41
    42. 42. Active management of Foreign Cash Leverage knowledge of domestic companies that issue offshore. Hedge out currency risk. Issuer YTM Exposure Currency TRR* TRR* of ALBI Relative TRR* TRR of USDZAR Old Mutual 5.2% USD 57% 15% 42% 33% 14.9% USD 71% 4% 66% 19% 6.2% USD 40% 4% 35% 15% DY: 7% USD 108% 4% 104% 19% Aquarius Platinum Edcon Holdings Redefine International * TRR in ZAR, since date of first purchase (not annualised) At 31 October 2013 42
    43. 43. Peer Group Performance: Epoch Global Choice Fund The Epoch Global Choice fund’s reached its eight year track record in September 2013 For comparison, it outperformed all other funds in the ASISA Global - General - Equity fund category since its inception. Source: Epoch Investment Partners, Moneymate, 31 October 2013 43
    44. 44. Asset Allocation Investment Process Balanced Funds Asset Allocation Equity Income Foreign Income Allocation Implementation FRNs/ Cash Bonds ILBs Property Prefs Security Selection Duration Credit Curve Shape Liquidity 44
    45. 45. The cyclicality of investor emotions… Richemont Naspers Retailers Platinum/Gold shares Resources 45
    46. 46. Why have our equity funds underperformed? There is a material divergence between: Low PE (Value) shares and High PE (Momentum) Shares Resources (unloved) and Industrials (favourites) Cyclicals (unloved) and Defensives (favourites) Expensive shares have re-rated further Cheap shares have de-rated further Value managers are underperforming momentum managers This is unsustainable and will change as it always has 46
    47. 47. Bottom 20 CTAR & Share Positions 6 shares account for 76% of underperformance Positions taken Benchmark Earth Equity: Average relative weights of the latest 12 months ending 31 Oct 2013 ALSI 47
    48. 48. All Share Index: Industrials at all-time high Oct 95: INDI 52% of ALSI Mar 98: RESI 21% of ALSI Source: I-NET Bridge, Element Investment Managers, 31 October 2013 Sep 13: INDI 55% of ALSI Jun 13: RESI 25% of ALSI 48
    49. 49. Resources look cheap, Industrials expensive… As stretched as ever Buy Resources Sell Industrials Series always reverts, only timing is uncertain Source: I-Net Bridge, 31 October 2013 Sell Resources Buy Industrials 49
    50. 50. Sector Allocation Holdings as per Element Earth Equity Fund, 31 October 2013 50
    51. 51. Top 10 Overweights % of Earth Equity Fund % of ALSI RELATIVE 6.7% 1.0% 5.7% 10.2% 4.7% 5.5% NG PLATINUM ETF* 4.7% 0.0% 4.7% MURRAY & ROBERTS 4.1% 0.2% 3.9% TONGAAT 4.1% 0.2% 3.9% TSOGO-SUN HOLDINGS 3.5% 0.0% 3.5% GOLD FIELDS 3.8% 0.6% 3.2% SUN INTERNATIONAL 3.3% 0.2% 3.1% REINET 3.6% 0.5% 3.1% HCI 2.9% 0.1% 2.8% SHARE ANGLOGOLD SASOL * Alternate to Platinum shares Holdings as per Element Earth Equity Fund, 31 October 2013 51
    52. 52. Murray & Roberts: Long Term Sheets MUR trading at R102, a 564% premium to model fair value Source: Element Investment Managers, 31 October 2013 52
    53. 53. History tends to repeat itself… MUR market capitalisation Rm FY08-FY12 Market cap -69% 30 000 25 000 MUR shareholder’s equity 6 000 5 000 20 000 FY96-FY00 Ordinary shareholder's equity -48% 4 000 FY95-FY99 Market cap -84% 15 000 FY10-FY12 Ordinary shareholder's equity -36% 7 000 3 000 10 000 2 000 5 000 1 000 - FY12 FY11 FY10 FY09 FY08 FY07 FY06 FY05 FY04 FY03 FY02 FY01 FY00 FY99 FY98 FY97 FY96 FY95 FY12 FY11 FY10 FY09 FY08 FY07 FY06 FY05 FY04 FY03 FY02 FY01 FY00 FY99 FY98 FY97 FY96 FY95 - Similarities between changes incorporated in 2001 & 2011: Divisional structures removed Leadership team strengthened Corporate office consolidated Non-core businesses disposed Remuneration restructured Gearing reduced Source: Company data, Element Investment Managers, I-Net Bridge to 30 June 2013 * Equity in FY12 adj for R2bn rights offer 53
    54. 54. Central bank balance sheet expansion and gold… Impact on gold as fiat currency => Gresham's law: “Bad money drives out good…if they exchange for the same price.“ When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear, while the overvalued money will flood into circulation. ? Source: Sharelynx.com, September 2013, BCA Research, 3 November 2013 54
    55. 55. Anglos vs SAB: Cheapest in over 70 years… 0.48 At 30 September 2013 55
    56. 56. Bottom 10 Underweights % of Earth Equity Fund % of ALSI RELATIVE SABMILLER 0.0% 8.6% -8.6% CF RICHEMONT 0.0% 8.6% -8.6% BHP BILLITON 2.6% 11.1% -8.5% NASPERS 0.0% 6.2% -6.2% MTN 1.8% 6.0% -4.2% BA TOBACCO 0.0% 2.6% -2.6% FIRSTRAND 0.0% 1.8% -1.8% SANLAM 0.0% 1.7% -1.7% REMGRO 0.0% 1.7% -1.7% SHOPRITE 0.0% 1.3% -1.3% SHARE Holdings as per Element Earth Equity Fund, 31 October 2013 56
    57. 57. Naspers: Long Term Sheet - EPS Naspers Expensive Naspers Cheap Source: Element Investment Managers, 31 October 2013 57
    58. 58. Naspers now a bigger company than Sasol… Sasol Market Cap Naspers Market Cap Source: I-NET Bridge, 31 October 2013 58
    59. 59. …despite Sasol earnings almost 5 times higher! Sasol Earnings Naspers Earnings Source: I-NET Bridge, 31 October 2013 * HEPS per IFRS 59
    60. 60. Tech icons often fall to future competitors… -94% down from peak 60
    61. 61. Conclusion on Element Fund positioning Asset allocation - critical investment decision Global and local markets do not look cheap Diversify by asset class, geography and currency SA Equities look expensive on a relative basis We remain cautiously positioned Material relative valuation differentials = opportunity Capital preservation, dividend yield (rather than growth) key focus areas in equity markets over the medium term “… but if you tell me that QE is going to be removed over 9 or 12 months, that’s a big deal, because it’s my belief that QE has subsidised all asset prices and when you remove that subsidisation the market will go down.” ~ Stanley Druckenmiller, Sept 2013
    62. 62. Who should invest in the Real Income Fund? Investors looking for a real return on their money Target to outperform CPI + 3% over all periods Have beaten its benchmark since inception 11 years ago. A turnaround in equity performance will filter through in the Asset Allocation Funds first Investors who are more risk* averse – either older demographic or cautious of the current environment Low (<40%) exposure to equity Well diversified portfolio across Asset Classes and Geographies * We define risk as the possibility of permanent capital loss 62
    63. 63. Asset Allocation – Element Real Income Fund At 31 October 2013 Holdings for Element Real Income Fund 63
    64. 64. Performance – Element Real Income Fund Element Real Income Fund CPI + 3% RELATIVE Annualised Since Inception 11.8% 8.4% 3.4% Annualised 10 Year 11.2% 8.8% 2.4% Annualised 5 Year 10.2% 8.4% 1.8% Annualised 3 Year 11.3% 8.8% 2.5% 1 Year 13.7% 8.9% 4.8% As at 31 October 2013 64
    65. 65. Conclusion on Element Investment Managers We have a proven philosophy, process and track record Restructuring of staff completed, lessons learnt Should lead to improved equity performance going forward We have a well qualified, experienced and hard-working team focused on ensuring our portfolios outperform our benchmarks, cash and inflation on a long-term view Strong Responsible Investment credentials Our defensively positioned portfolios should hold up well in the current environment of heightened uncertainty and overvalued markets 65
    66. 66. Yellen and screamin’ into 2014… For: Justin Wolfers Univ of Michigan Public Policy & Economics Professor 9 October 2013 “She’s an imaginative and technically adept economist possessed of a brilliant and precise mind.” Against: 28 October 2013 66
    67. 67. Disclaimer Element Investment Managers claims compliance with the Global Investment Performance Standards (GIPS®). The firm includes all portfolios managed by Element Investment Managers. Element Investment Managers is an independent, owner-managed company. It provides discretionary investment management services to retail and institutional clients. Element Investment Managers has been verified for the period: 1 January 2003 to 31 December 2012 Copies of our verification reports are available on request. A complete list and description of our composites is available by contacting Brenda Lambrick at: +27 21 426 1313 or at brenda@elementim.co.za 67
    68. 68. CONTACT DETAILS: • René Prinsloo rene@elementim.co.za • Jeléze Hattingh jeleze@elementim.co.za Thank you www.elementim.co.za
    69. 69. Element - LISP Platforms LISP Earth Equity Flexible Balanced Real Income Islamic Equity Islamic Balanced Global Equity Fund Momentum Fund Shop Fund Shop Fund Shop Fund Shop Fund Shop Fund Shop Open Glacier Open Fusion/ Open Open Fusion/ Open Open Open Open AIMS Yes Yes Yes Yes Yes - - Investec Fund Choice Fund Choice - Fund Choice Fund Choice Fund Choice Old Mutual Galaxy Galaxy/ Max - Galaxy - - - Sanlam Stratus/ Topaz Stratus/ Topaz - - Stratus/ Topaz Stratus/ Topaz - Stanlib Classic Classic - - - - - BoE - - - - Yes Yes - 69

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