Big Cheese's eating big Mac's

This month, I cover two snippets of broad interest, the maximum value for which a cheque can be written and an update on the Big Mac index with a political twist.

According to the Payments Association of South Africa (PASA); yes there is an Association for everything! With effect from 16 July 2012 The South African Reserve Bank has reduced the maximum value for which a cheque can be written. The current maximum value per cheque is R5million. This will be reduced to R500 000. One of the main reasons for the reduction is risk related. Less than 1% of cheques in the industry are for values above R500,000, yet these high value cheques account for more than 40% of the total industry’s fraud losses. By reducing the cheque limit, this will directly curb cheque fraud.

In general, there has been a continuous decrease in cheque volumes (24% per year), which can be attributed to the number of different electronic payment options available. Electronic payments are safer, faster, cheaper and increasingly preferred by banks’ clients. Reducing the cheque limit is not a strategy to do away with cheques. Further analysis by banks is required before any major decision on the future of cheques is taken.

Last year at about this time I wrote about the Economist’s Big Mac Index. Although it seems strange, the index does provide a good indicator of the relative ‘real’ exchange rates of various currencies. One can determine whether a particular currency is under or overvalued by reference to the globally standardised Big Mac hamburger. Surprisingly also, the Big Mac has primary and secondary cost inputs which cover a big spectrum of an economy. This includes the cost of packaging, agricultural products, property rental, labour, and delivery costs. Of course one of the challenges is evaluating how the currency under or over valuation relates to the buying power of individuals in each country. To properly compare, one would need to count how many Big Mac’s a person in a directly comparable job could buy, say, per day with their salary in these various economies. The task becomes more complicated by, for example, different tax rates and in getting some sort of standard job description. I started by looking at secretaries which seemed to be a fairly universal job category, but one quickly gets bogged down in the responsibility scales within a secretarial function. In the financial planning world, planners in highly regulated countries earn more, because of the risk they run, than in less regulated economies, and so on.

The Economist and the International Business Times came to my rescue once again, by comparing the salaries of the leaders of various countries. Given that, at least politically, these leaders are at the top of the food chain (the buck stops there!) the work task is a little more uniform. Arguably, the heads of bigger countries should earn more than smaller countries, but as you will read this is not so. Below for your casual interest is the number of Big Mac’s each leader could buy per day in his home country with his salary.






















There are a huge number of caveats here so be aware, some heads of state don’t pay tax, the published salary is just that, it may not include the cost of perks or the overall cost of running the head of state’s household. The year applicable to the salary may not be consistent. The ability of some of the Heads of state to consume this many burgers a day has not been assessed.

ETF's and Hedges, derivatives with other names

We cannot keep mulling over Europe; will Greece leave the Euro? Will it stay? Can Germany fund all of this? What about the Greek Elections? All that can be said is, as best it can, the market has absorbed all of these questions and the underlying factors. So, as the experts say ‘it is already priced in’.

A lot has been written recently about ETF’s (Exchange Traded Funds) and now about Hedge Funds in an excellent article in the FM by my old friend Stephen Cranston. These are both strong competitors to traditional ‘long only’ equity funds.

In the case of hedge funds as Stephen says, many accuse them of being “a remuneration policy (for fund managers) masquerading as an investment”. Hedging is, in fact, a strategy adopted by managers to limit the downside risk in a conventional portfolio and many would argue that this is where it should stay; Hedging is not an asset class. The questions to ask are; why would you invest in a hedge fund? What are you hedging against? How does one know what the manager of the hedge fund is hedging against? Finally, there are the fees involved, usually 2% per annum and 20% of the profit earned. Are the fees worth the result?

ETF’s have also been in the headlines recently. These are, normally, passive funds which simply follow an index. Put simply, this means that the manager buys the correct percentage of the underlying shares to match the index that it follows. These are a rapidly growing class of funds. Of course, weirdly, these funds could not survive if there were no traditional managers. Take for example an EFT that tracks the ALSI 40 index in South Africa. The components of this index are determined by the consolidated views of active managers and market participants. Their views, in turn, are influenced by the skills of the executives in those listed companies in both enunciating their future prospects and more importantly delivering on them. If the whole market were to consist of ETF’s then the components of these indices would remain static, regardless of the success or otherwise of the underlying company. This status would continue until the underlying company mysteriously disappeared, through delisting, insolvency or a takeover and then another company would mechanically move into the vacant slot. Thankfully, since the market consists of a blend of decision makers; stock brokers, private individuals and other professional managers, it is unlikely that this situation would arise. The ETF therefore ultimately reflects the average views of all these players.

ETF’s have become critical components of what is known a core-and-satellite approach to asset allocation. Sasfin itself uses this model in its retail and retirement fund portfolios. Here the manager uses an ETF as a cheap core portfolio and arranges for high conviction active managers as a high performing satellite which will over time cause the whole fund to outperform the index. The exclusive use of ETF’s as an alternative to active asset management is however questionable. It is the financial equivalent of flying in an aircraft on auto pilot with no pilot! In a case study prepared by Magnus Heystek, three mainstream funds (and I suspect many more) have performed comparatively better than the previously high flying SATRIX40. Whereas the SATRIX40 has returned 27% since June 2007 the Investec Opportunity Fund achieved 57.4% and the Stanlib Balanced and Aggressive Income Funds achieved 24% (with significantly lower volatility) and 58.7% respectively. This is not because SATRIX 40 is worse than these funds, but because the South African Market reflected by the top 40 shares is very exposed to commodities stocks. So understandably, when resources/commodities do well then Satrix 40 will do well, however active managers would never hold the level of commodities in a properly balanced portfolio, this would present too much volatility.

The bottom line is that a portfolio investment in ETF’s has to be as actively managed as any other asset. The truth is, however, that no-one is actively managing exposure to ETF’s. This means over time investors will land up with seriously imbalanced portfolios with an investment result, good or bad, arising out of luck rather than good planning.

Global issues and Domestic Mandates

OK, here we go again! As I am writing this the Greek government is unable to manufacture a coalition and the French have, unsurprisingly, moved to elect a President that has promised no/lower austerity measures. Yesterday the world stock markets trended lower by between 1 and 2% as market traders tried to work out the consequences of these developments.

As an aside, one thing that has not seen a lot of airtime is that the politicians in many of these countries are cutting back on social pension benefits. This is because pensioners are a soft political target. It happened here in South Africa as well, civil servants got an 8,6% increase and social pensioners only 6%.

Amongst all the negative headlines I spotted this one “Warren Buffet says he’s buying stocks amid market dip”. There is a simple rule being followed by Warren Buffet; one must buy assets when they are relatively cheap, not expensive. Although we all know this is true when shopping at a supermarket, it also is true of investment assets like shares, listed and other property, Bonds etc. So any market weakness is a time to be buying not selling. The real skill of Warren Buffet and fund managers in general lies not in whether to buy but in what to buy in times like these.

Research done mainly in America but also in the UK shows that somewhere between 80 and 90% of the performance of one’s investment portfolio whether it is positive or negative is generated by the asset mix of the portfolio. These assets are; Property (usually listed), Bonds, Cash and Equities (other than Property). So if your portfolio falls by, say,10%, somewhere between 80 and 90% (8-9%) of that loss relates to the asset mix that you chose, the rest (1-2%) has to do with market timing (the decision by a fund manager when to buy or sell a particular share) and the shares that a fund manager bought (stock selection).

There is a very big ‘however’ or irony in the statement above. The decision about asset mix (how much in Bonds, Cash, Property and Equities) relates to each individual’s financial lifestyle requirements weighed up against how much volatility he/she can tolerate. No fund manager makes these decisions for you. You decide your lifestyle and our task as your adviser is to select the most appropriate fund manager/s to manage that targeted mix of assets.

A word (or two) about Mandates

One of the overlooked factors in selecting a fund is answering the question; What is the fund’s mandate? The mandate is a statutory and/or contractual requirement that reflects the agreement between the Fund manager and the investor. So for example, a unit trust that has an equity mandate usually may not hold less than, say, 90-95% in listed equities. The important thing to realise is, even if the fund manager of this fund is convinced that the equity market is about to collapse he/she may not disinvest from the Stock Market or he/she will be in breach of his/her contract (Mandate) and have broken the law.

Because of the above facts, a number of fund managers have made funds available with a broader mandate. These are the so-called “flexible” or “managed” funds. In these funds the manager’s mandate allows a shift in the asset mix. The manager can move between property, equities bonds and cash. So these funds are generally less volatile, but they still do not link with your own targeted financial lifestyle and selection of which of these funds to invest in remains your decision.

As a rule of thumb if you have more than 7-10 years to go before you will need to use your invested funds, then you can select a fund with a high equity content/mandate. These funds should generate high returns to compensate for high volatility. On the other extreme if you have less than 3 years to the point where you will need to use the accumulated investment, the fund selected should be a lower volatility which of course means that the returns will be lower.

Inter-generational Wealth

April 2012
Many will know that I serve in a volunteer capacity on the board of the Financial Intermediaries Association (the FIA). I also chair their Financial Planning Sub-committee. The FIA is the trade association which looks after the interests of the financial intermediary community, their interaction with clients, the industry and the authorities in Southern Africa. In this role, the FIA provided contributions to a recent request for input from the Financial Services Board (FSB).
In preparing our input, I was reminded of one of Sir Winston Churchill’s lesser known quotes;

"If I had my way, I would write the word “insure” upon the door of every cottage and upon the blotting book of every public man, because I am convinced, for sacrifices so small, families and estates can be protected against catastrophes which would otherwise smash them up forever. It is the duty to arrest the ghastly waste, not merely of human happiness, but national health and strength, which follows when, through the death of the breadwinner, the frail boat in which the family are embarked, founders and the women and children and the estates are left to struggle in the dark waters of a friendless world.”

The above statement was made by Sir Winston at a time when there were many people returning to the UK after the war and where the infrastructure was in serious need of restoration; I am sure much to the delight of many insurance salesmen at the time!
One wonders whether the current South African circumstance do not carry similarities. Like post war Britain, we suffer a serious structural poverty cycle and a degrading infrastructure. Subsequent generations, inherit this poverty of their forebears with little hope, in the main, of a break in that cycle. Life Insurance and Life Insurers can, as identified by Sir Winston, play an enormous role in the inter-generational wealth creation that is required to break the cycle.
This happens at two levels firstly; In exchange for a relatively modest premium, a breadwinner can ensure that his or her income generating capability is replaced with capital, thus ensuring that dependents are able to complete their education and prepare themselves for life without a financial overhang to contend with. Where a breadwinner has the foresight, or is cajoled, to effect life insurance, the second generation starts out its life better off, even if slightly, than their parents. Thus the cycle of poverty is broken.
The second role that insurers fill is that they invest the premiums, not required for claims settlement into the economy. This activity contributes to the wealth of a broader society in many ways, including market investments, which either directly place capital in the hands of businesses, which in turn grow employment or indirectly assist in access to capital by lowering the cost of capital overall. In the managing the assets emanating from their life book, the insurers are also free to invest outside the areas where investment clients would demand that they invest.
So, using a simple rule of thumb, of securing ten times one’s annual salary in provision for ones loved ones, is an essential component of a well considered financial plan. Of course this amount can be reduced by the actual investible capital that has been accumulated up to that point. For those in the role of an employer, it is important to educate, if not provide, perhaps through Group Life, some of this cover for less fortunate staff members.

Two story's

Last month, I dedicated this one pager to the looming dividend tax. What actually hit us at budget time last month was a tax rate 50% higher than what had originally been expected, 15% instead of the expected 10%. Why then is it that the new dividend withholding tax, introduced at 15% in replacement of STC at 10%, is budgeted, by Treasury, to lose R1,9 billion in revenue?

 Well, the answer lies in the analysis of who will be paying this tax. In the case of STC, the tax was borne by all shareholders of a company. In the case of the new dividends tax, some massive blocks of shareholders are exempt from the tax. If your shareholdings are indirectly held by one or more of;

• a Preservation Fund,
• a Retirement Annuity,
• a Living Annuity or
• an employer sponsored Retirement Fund,

then, all things being equal, the dividends received within those investments will actually go up! The reason for this is that the previous STC applied to all dividends regardless of the nature of the shareholder. Dividends Tax on the other hand is a tax on the shareholder. This means that because the entities listed above are generally exempt from all other taxes, it follows that they will, similarly, be exempt from Dividends Tax. So, if you are invested via one of those vehicles, your investment returns should improve by reason of an increase in dividend yield.

The second source of revenue lost to the fiscus relates to the reason that the new dividend tax was implemented in the first place, that is foreign shareholders are also exempt from the tax or can claim it back if it is withheld. Of course the theory is that replacing STC with dividend withholding tax will encourage inward foreign investors to SA, so one should expect this increased demand for listed shares to ultimately be reflected in the share price, once again benefitting investment returns.

 Market timing

 Many readers will recall the examples, in Sasfin’s standard strategy documents, showing that market timing cannot be relied upon to generate returns, and that lifestyle based asset allocation is the biggest driver of returns. This long-held philosophy of ours has once again been highlighted in an article by Brett Arends, a financial Journalist writing, amongst other publications, for the Wall Street Journal.

In a recent article this time published in Smartmoney.com titled “Main Street's $100 Billion Stock-Market Blunder” and sub-texted “The market may be back to pre-crisis levels, but many regular investors have missed out”, Arends makes the point that Main street (the man-in–the- street) has lost an opportunity by bailing out of the market during the 2008 crisis.

 He makes the point that at 28 February 2012,

 “the Dow Jones index has recovered most of the ground lost from the peak. When you include dividends, someone who invested on the day before Lehman collapsed is now up a remarkable 18%. If they invested at the lows three years ago, they have doubled their money.

But for all the cheering on Wall Street, there's a sorry tale behind the headlines.
While we've seen a stock-market boom that has made plenty of people rich, much of Main Street America has missed out. Instead of buying, they've been selling. The few moments when they've steeled themselves and turned buyers have been, on the whole, the worst times to do so.”

He continues by calculating an arithmetic consequence of this client activity:

“In October 2008, after Lehman, investors panicked and withdrew about $45 billion from their U.S. stock funds. That trade alone has cost them $25 billion in investment profits since, according to MSCI data: On average, the shares they sold for $45 billion would be worth about $70 billion (including dividends) now. In February and March of 2009, as the market slumped to its record lows, mutual fund investors sold another $29 billion worth of U.S. stock funds. That cost them another $26 billion in lost profits.
In total, by my math Main Street investors have missed out on a staggering $106 billion in investment profits over the past five years by selling stocks at the wrong time.”

As I always say, if your circumstances have changed, contact me to reevaluate your risk benefits and overall investment strategy.

Gavin Came
Consultant
Sasfin Financial Services (Pty) Ltd
E-mail: gcame@sasfin.com
Fax: (+27) (86) 520-5055
Cell: (+27) (0) 83 675 3185
Post: P O Box 95104, Grant Park 2051
Web: http://www.sasfin.com/

Dividend Tax

I have been getting feedback from my clients and other enquiries relating to the dividends tax to be introduced on April fool’s day (seriously!). The feedback and queries range from; ‘should I cash in my investments?’ through ‘I thought dividends were tax free’ and ‘not another tax’ to ‘what is this new dividends tax?’

The background to the dividend tax, like much of our law, lays in the fact that prior to 1994 South Africa had limited engagement with the outside world. This meant that we had few updated double tax treaties and very little incoming investments. As a result in 2009 we found ourselves, together with Estonia, (where’s that!) and India as the only countries in the world that taxed dividends internally via a tax called STC (Secondary Tax on Companies). Simplified, this tax required a company to pay over 12,5% (more recently 10%) of the value of the dividend that it declared. There was no direct link to the shareholders. Importantly however companies had to contemplate this tax when declaring the dividend and therefore reduce the dividend to enable them to pay the tax.

From April 1 2012 the STC will be replaced by a withholding tax on dividends. This means that the point at which the tax also 10% is recovered will be the stock broker (in the case of directly held shares) and the unit trust company in the case of unit trusts.

The most important thing to note is that the amount available to the company for its dividend will be bigger, because it does not need to pay STC. So, all things being equal, the net dividend you will receive will be about the same (see technical point below). In fact, in the case of Retirement Annuities, Preservation funds and Living Annuities you will be better off because these entities will be exempt from dividends tax, whereas previously the effect of STC was passed through to these funds.

So if it is the same, or similar, why have we done this? Well, the answer lies in globalisation. In terms of many of the world’s double tax agreements a taxpayer can claim the withholding tax on dividends from his foreign shareholdings against his domestic tax bill. This facility was not available in the case of STC (because it was paid over by the company paying the dividend). So to attract incoming foreign shareholders this change was essential.

To conclude then, all that has changed is the point of payment of the tax. The introduction of the tax should make very little difference to the amount of dividends arriving in your share trading account or appearing on your unit trust statement. Those with RA’s, Preservation Funds and Living Annuities will see an increase in the dividends added to these portfolios.

Technical point (not compulsory reading!)

· For those who administer or impact on a PBO (a registered public benefit organisation), you will need to ensure that they are registered as such with the stockbroking firm or unit trust company that holds their investments.
· The effective rate of dividend tax will be slightly higher than under STC because the dividend is now declared gross i.e. there is no tax on the dividend in the company.
For example: if an amount of R100 000 was available to declare, the STC was calculated over and above the dividend. The calculation was R100 000 x 10/110 which equals STC of R9,090. This left R90,909 to be paid in the dividend. Under the new dividend tax the full R100 000 will attract a dividend tax of 10%, which is R10,000, so the net dividend will be R90 000. The shareholder will receives R909 (about 0.9%)less as a dividend.

January -who is the biggest

I wish all the readers of this monthly note a fulfilled 2012.

Well, can 2012 be a less turbulent year? One of the things I noted in reading the, much diminished, press in December was that Brazil has now overtaken the Brits as the 6th biggest economy in the world, this according to The Centre for Economics and Business Research Ltd, a London based research house. The whole pecking order however makes for really interesting reading and shows how change tends to ‘sneak up’ on us. For example Russia has pushed India down to 10th place:

Ranking
Country (2010 ranking in brackets)
1
US (1)
2
China (2)
3
Japan (3)
4
Germany (4)
5
France (5)
6
Brazil (7)
7
UK (6)
8
Italy (8)
9
Russia (10)
10
India (9)

As the rankings and scale of these mega economies shifts, so too their influence on the broader investment markets. To test thinking, would one naturally regard Brazil as an investment destination? Can we name one listed company in Brazil? Yet, one automatically assumes that an offshore investment should include UK assets. It is for this reason that one gives asset managers the broadest possible mandate within the confines of each investor’s, lifestyle driven, volatility/return profile.

The year ended in a strange, mixed way. Despite Euro turmoil, the JSE ‘only’ ended 0,6% down and the Rand actually strengthened slightly. What remains worrying is that the Euro crisis is now left firmly in the hands of politicians to resolve. One can therefore expect that ordinary economics will be set aside for a while. Inevitably, a political solution involves deferring bad economic consequences for a future generation of Europeans (the cynic will say future voters; not current ones) to pick up. The wonderful thing about openly traded markets is that they continuously adjust. Bright and not-so-bright minds apply themselves at determining which sectors and companies will thrive and prosper in this environment and which won’t. Our task is to make sure the asset allocation (including onshore/offshore balance) correctly reflects lifestyle expectations and then allow these asset class managers the room to invest for best results.