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P C Finance Research Clarifying Complexities
Registration Number: 1985/000022/23
Members: P E Hattingh and C P Hattingh
Tel: 011 476-3626; Fax: 011 476-3627; Email cphat@iafrica.com; Web: www.mafiabuzz.co.za; Add: P O Box 731625 Fairland 2030
SowB Buzz 003
I have compiled bits of information published in Mafia • There is no legal requirement for trustees to develop
Buzz over the years relating to investments in this Buzz for the necessary skills to carry out their responsibilities as
your convenience. I have not quoted the sources, just the they do in the US
knowledge. Good reading! • It recommends that trustees should set investment
objectives for the fund, and not try to outperform other
The following are details of how dot-com companies funds
overstate their revenues because analysts use revenues as • It appears as if funds are paying active fees to
the basis for valuation: managers who are using passive investment techniques
• Showed the gross amount as revenue when the • It appears as if the focus is short-term performance
enterprise only earns a commission thereon, e.g. gross rather than long term performance
ticket sales in a travel agency • It recommends that shareholders become active in the
• Including barter transactions, often overvalued, in affairs of the companies to improve investment
revenue performance
• Treating cash and trade discounts as expenses instead • It recommends that the trustees have an investment
of deductions from revenue plan and that the performance be properly reported
• Treating losses on sales as “loss leaders”, i.e. adding Some interesting lessons to learn from how investors got
the loss to the revenue and calling the loss marketing taken for a ride in the recent US market crash (which,
expenditure within five years will have been forgotten because people
• Treating sales rebates as expenses like to believe in myths!) are:
• Calling operating costs marketing costs to give the
impression that they are really investments in the future • Profits drive prices, not revenue.
• Recognising service revenue at the beginning of the • Actual performance is more reliable than expected
future castles in the sky.
contract instead of spreading it over the period the
service is given • It is not a sound reality check to compare the PE ratio
with expected future growth (the theory of the modern
Benford's law, which is used to detect fraud and error, investor was that one could justify the value of a share
predicts the frequency in which digits occur in certain as long as the PE ratio did not exceed the expected
naturally-occurring numbers, i.e. the probability of d future rate of growth).
appearing as the first significant digit in a number is log10 • Even at today’s prices, over 80% of value is dependent
(1 +1/d), e.g. for 2 it would be log10 (1 + 1/2) = 17,609%. on future unproven growth.
For 3 it is 12,494%. If the numbers in a population do not • Speculators (note, not investors) were buying shares
fit this law, they are probably contrived. because prices were going up whereas the wise
Some wisdom from Christo Wiese: investor buys in the dip.
• The making of money takes time. • One cannot assume that if there is liquidity in the
• To make money you have to take risks. economy that it will automatically end up in equities.
• There are unlimited opportunities but you have to get Restructuring charges should be taken with a pinch of salt.
your priorities right and you have to work. Companies love the one-time restructuring charge as it can
• You don't become wealthy from salaries. hide all sorts of blunders made by managers (plus, in my
Revision of regulation 28 of the pensions funds act opinion, legitimate operating expenses to make the profits
requires: of the company look better than they really are). Investors
• The adoption of an investment strategy should view a pattern of restructuring charges as a red flag.
• The appointment of investment managers Here are the rules for investing in tech stocks that investors
• Investments to be in accordance with the investment forgot about:
strategy • Buy when no one is interested in them and sell when
• Monitoring of the investments everyone is interested in them.
• Review of investment strategy • Buy when the fundamentals are intact and sell when
• Reporting of performance in compliance with the they begin to trade down after large rises.
requirements • Don’t fall in love with tech stocks.
• Not to exceed certain laid down investment
One needs to understand how we behave when undertaking
concentration levels
investments. Here are some problems:
• To account for investment property in terms of AC135
• We do not learn from our mistakes.
The Myners Review of Institutional Investment, published
• We become obsessed about arbitrary rules – classic
in the UK in March, 2001, which includes an analysis of
herd behaviour.
how institutional investment in the UK operates, is relevant
• We become fixated on the price we paid for the stock –
to us in RSA:
we hold onto losers and do not want to sell winners.
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• We like to convince ourselves that our beliefs are • It is critical to understand the fundamentals of each
factual, despite clear evidence to the contrary. stock, the macro and micro-economic variables that
• The more often we check the performance of our drive it, the market’s perceptions of the stock and the
shares, the more likely we will do something foolish underlying risks before taking a decision
like sell good shares in bad times. The mistake investors often make (I am one of them) is not
Analysts are a corrupt, cowardly bunch. They never say knowing when to sell. Here are some pointers:
“sell”. They spend the whole time working on investment- • Forget what you paid for the shares. The question is,
banking deals. (Harsh words these, but even in RSA one would you pay today’s price to buy the shares.
has to look carefully at the motives behind the advice given • Be alert to fundamental shifts; i.e. recognise when the
by analysts to clients.) The article goes on to identify story has changed.
attributes of an all star analyst: • Check the fundamentals. A fall in the price of a share
• A high standard of ethics. does not mean that the share has lost real value.
• Advice based on thorough fundamental research. • Ignore the day to day swings in the share price.
• Makes no distinction between clients and non-clients. Technical analysis should not replace fundamentals if
• Makes money for investors. one is a long-term investor.
• Free from arrogance. • Consider the tax benefits of taking a loss. If you have
• Forecasts based on fundamentals, not on herd built up a tax gain, you could reduce the CGT by
mentality. realising a tax loss (sell at the present price and buy
• Experience. back at the lower price).
• The courage to go against the trend when fundaments • Consider selling down gradually (the opposite of Rand
show this should be done. cost averaging).
The secret to successful fund managers is their fixation on • Don’t look back when you sell a share. You have not
the fundamentals. They go beyond PE ratios. They do not made a loss when then price rises after you have sold
follow the crowd because the crowd, who follow the crowd, the share!
are often wrong. Here are some of the things they do: I have read many a book on personal management but “The
• Focus on the underlying business of the company. power of focus” by Canfield, Hansen and Hewitt must rank
• Find shares that are trading below their business value. in the top best three I have ever read. Here are the ideas I
• Look for companies where the managers have a stake. got from it – to get the full benefit from this book read it!
• Hold investments for long periods. The ideas here are relevant to investing as well.
• Look for solid balance sheets and high returns on • Identify habits that inhibit success, choose to change,
assets. create an action plan (affirmations) and work on
• Look for defendable franchises that will grow despite changing.
the economy. • Focus on what you are brilliant at and dump, delegate
Some basic questions one should ask when preparing a or defer other activities.
retirement plan are: • Develop a clear vision of what you want to achieve –
specific, personal, meaningful, challenging and
• How long will you live? You can’t afford to live too
realistic goals that can be measured – and get your
long or you will become a burden on society!
priorities right.
Smoking, a poor diet and a lack of exercise will come
• Create an optimum balance – make time to think, plan,
in handy here.
act, learn, exercise and relax.
• When will you retire? Can you really afford to take
• Build excellent relationships – avoid toxic people,
early retirement?
focus on core clients and build strategic alliances.
• What investment returns will you generate? Your best
• Develop winning attitudes – a confident belief in
investment is the skills you possess: don’t lose your
yourself.
income earning capacity!
• Ask for help when needed.
• What will inflation be? With the rand deteriorating as
• Consistently and persistently pursue your goal with
it is, what chance have we got?
total integrity.
• What are your expenses? Keep your costs down; you
• Take decisive action – think, get facts, consider
don’t really need that flashy car, do you?
options, priority rate, visualise outcome and focus on
Prudential M&G make the following comments regarding performance.
their investment philosophy: • Create a purpose for being and live that purpose.
• Prices are often driven by people’s emotions The following comments are made regarding the mutual
• Many times the true underlying value of shares is not fund wipe out that has just taken place (2001):
reflected in the share prices
• “Fund managers are supposed to keep your money safe
• Money can be made by unemotionally using rigorous
and make you rich no matter how rough the waters. So
and disciplined approaches to finding value
how does one explain the wipe-out that 2001 is turning
• One should resist the temptation of short-term
out to be?” Big name funds are down by around 20%
forecasting by trying to time the market
in the US this year.
• Analysts typically overestimate earnings by 20% to
• “I have got clients wondering why they should give
30%
money to some portfolio manager who will lose 60%
• Insider trading rules make it difficult to sustain a
when they could do that all on their own and still have
competitive edge
time to mow the lawn.”
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• “Most portfolio managers were in nappies the last time your bank! (That is subject to the rule of disposition
we saw anything like a bear market.” without value.) It has been calculated that dividends have
• “Managers are paid based on the size of their provided 50% of the total returns on equities in the US
portfolios. This creates a clear incentive for them to between 1971 and 2000. It is predicted that dividends will
give investors what they want, i.e. whatever style of make up 60% to 70% of the total returns in the US in the
investing works at the moment.” future. (Welcome back to the humble dividend!) (27 th)
Warren Buffett points out that in 1971 91% of private In 1981 an investor was advised by the Gold and Hard
pension funds were invested in equities. After the market Asset Exchange that a 1953 SA Long proof set would be an
crashed, they took investments out of equities leaving only exciting investment. He paid R665 for it and has, 21 years
13% invested in equities when equities were extremely later, been offered R1 000 for it (a 2% p.a. return). (And
cheap! He makes the point that not even he can predict now for the bad news: SARS!)
what markets are going to do in the short term but in the
long term the markets are predictable. (Remember that he is Index-trackers outperform roughly 60% of active managers,
taking about US conditions.) mainly because of their lower costs. After adjusting for
risk, only a handful of active mangers beat the index. And,
RMB’s Asset Management philosophy is: they do not seem to be able to repeat this feat in the next
• They are disciplined in applying their investment period. For active managers to win:
philosophy and they stick to it. They educate their • Markets need to be inefficient.
clients to have faith in the process and not allow their • They (the managers) need superior skills.
emotions to get in the way of their decisions. • Their fees need to be low.
• A top down asset allocation team makes decisions • There should be little competition for the same
about exposure to different asset classes such as shares, investments.
bonds and properties.
Clearly, active management is a no win situation. So what
• A sector allocation team decides on when there should is the solution? Index tracking! Vanguard, the US index-
be changes in the weightings between different sectors tracking giant, has worked out that its total costs are 3.1%
such as resources, financials industrials and real estate. p.a. (R100 000 invested at 12% p.a. for 30 years = R3,0
• A bottom up team focuses on security selection. million. At 8,9% p.a. it comes to R1,3 million. Who wins
Pension plans can overlay an equity market-neutral fund with tracking? You get 1,3 million and the tracker
with equity index futures to create a synthetic long equity company gets R1,7 million. So what is the solution?
portfolio. To the extent that the hedge-fund component Intelligent DIY!) (Page 61)
outperforms its funding cost, the alphas may be transferred
back to a long-only equity portfolio via derivatives. In Investment ideas:
theory, one can reverse this process to form a pseudo hedge • Remain in tune with your objectives, age and risk
fund; that is, an equity long-only manger’s alpha over an profile.
equity index can be transferred back to an absolute return • Don’t get caught up in short-term cyclical chases –
fund by shorting equity futures. (A bunch of loonies, I tell think long term.
you!) • Maintain realistic expectations.
• Go for value.
Suggestions on how to avoid the next stock bomb:
• Remember the importance of asset allocation.
• Don’t buy serial acquirers. • Select high quality shares and diversify.
• Read the fine print in the company’s report. • Focus on achieving capital appreciation within the
• Don’t feed money to pigs (overpaid managers). context of preserving capital as far as possible.
• Watch the cash flows. • Forget sentiment, go for value.
• Don’t bet on the debtors in a company’s balance sheet • Don’t churn your investments; transaction costs
(we just have to look at Unifer and Saambou for this destroy value.
rule).
Some investment advice from the investment gurus:
• Spread your bets.
• Making wealth is not the answer to human progress or
Formulas doing the rounds: happiness. Spiritual progress is the answer. (John
• EBITDA = Earnings by insiders to deceive analysts Templeton) (An investment or spiritual guru?)
• EBIT= Earnings before irregularities and tampering • The unthinkable can always happen and you have to
• CEO = Chief embezzlement officer run your affairs accordingly. Survival in this game
• CFO = Corporate fraud officer begins with humility. (Peter Bernstein)
I found the following comment in Finance Week, 26 • Look at every stock as part of a business rather than
November 1999, page 44: “PSG Online dealer Willie things that go up and down. Have the right attitude to
Greenen says that now is the time investors should be going fluctuations. Build a margin of safety into what you
for blue chips such as Dimension Data, Datatec, Comparex pay. Prosper from the actions of the business rather
and Old Mutual.” Had “investors” taken this advice they than from the actions of the stock over the short term.
would have lost 90% of their money on the three IT The Investment Professionals Industry is the only
companies recommended! industry I know where the professional’s efforts
subtract value from what the layman can do himself.
The pendulum is swinging back to “dividends count”. In an
(Don’t you just love this man?) (Warren Buffett)
era of questionable income statements, balance sheets and
• Focus on long term investment and not on short-term
cash flow statements, the only thing one can 100% rely on
speculation. Base the assessment on a steady,
is the dividend you get from the company – it goes into
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sophisticated enlightened, analytical approach rather even if it is wrong, than to tell people what they do not
than on the public appraisal of the price of the want to hear, even if it is right.
share.(Jack Bogle)
Investors want to be secure while they aspire to be rich,
• Develop your skill set, work at it, hone it and do not want to save while they are tempted to spend, want to feel
follow the crowd. (Gary Brinson)
joy and pride and avoid the pain of regret, i.e. human nature
• Develop and stick to your own style. (Dean LeBaron) is human nature.
The most common financial shenanigans according to
“How to Detect Accounting Gimmicks and Fraud in In 1990 there were 23 registered asset managers but by last
Financial Reports” are: year that had increased to 301. (All chasing the same
investments and charging for doing so!)
• Recording revenue too soon.
• Recording bogus revenue. Asset managers spend vast sums on creating brand
• Boosting income with one-time gains. awareness to attract investment advisors who feel more
• Shifting current expenses to a later or earlier period. comfortable with being wrong with a big name player than
• Failing to disclose all liabilities. risk being wrong with a small manager.
• Shifting current income to a later period. Graeme Tosen looks at the meaning of VAR (value at risk).
• Shifting future expenses into the current period. From what I can gather from the article (statistics, among
Fund managers can’t make money for unit trust investors other things, has never been my strength) VAR is “the
because of the excessive buying and selling of shares, amount of loss relative to a mean return”. The example
which chops several percents off returns. (Anthony given in the article states that if the expected return (mean)
Ginsberg) (A buy and hold strategy invariably beats a churn is R3m and the standard deviation of this return is R7m,
strategy. Investment managers need to churn to generate then:
fees.) • VAR at 90% confidence level is 3 – (1,28x7) = R6,0m
Sir Isaac Newton said that he could predict the motion of • VAR at 95% confidence level is 3 – (1,65x7) = R8,6m
planets but not the madness of crowds. The market • VAR at 99% confidence level is 3–(2,33x7) = R13,3m
emotion cycle goes something like this: Optimism, Or, to put it another way, there is a 10% chance that you
excitement, thrill, euphoria (peak) anxiety, denial, fear, can make a loss of R6,0 million, a 5% chance that you can
depression, panic, capitulation despondency (trough) make a loss of R8,6 million and a 1% chance that you can
depression, hope, relief, optimism (go to start). make a loss of R13,3 million.
Very skilled, very careful investors can consistently beat Here are seven ways to boost your savings:
the market. They don’t try to hit home runs. They hit lots • Set aside money for your retirement.
of singles. They don’t follow hunches; they follow • Save first and then spend.
computer models. They don’t believe that markets are • Bale out of your poor investments.
efficient but they don’t believe that they are very inefficient • Build a mix of investments (diversify).
either. • Use Rand cost averaging to build your portfolio.
The greatest insight into new finance is that investment • Do not gamble with your savings.
returns are in part a reward for taking risks. Risk means the • Make use of legal tax breaks.
possibility that a share or a portfolio will go down more When it comes to saving for your retirement, it’s not what
than the overall market. If you earn a higher return by you know but rather what you do with what you know.
taking a higher risk than the market risk, you haven’t Retirement planning is an action sport. Your portfolio
necessarily beaten the market. Since the costs of active requires hands-on, disciplined and very regular
trading are more than the cost of the buying and passively maintenance to grow as it is supposed to. The problem is
holding shares, someone who simply buys the market will that most people are either paralysed by the sheer number
invariably do better than the average active investor. of options or too intimidated by the market to engage.
If you don’t read the notes in a company’s financial The questions you should ask before buying equities are:
statements, you are not getting the whole story. Most of the • How does the company REALLY make its money?
critical details are buried in these notes. Examples: • How aggressive is the accounting policy for revenue?
• Growth in earnings may be attributable to acquisitions • How is service revenue recognised?
and not organic growth. Find this clue in the notes. • What is the relationship between cash from customers
• Read the note on related party transactions carefully. and credit sales?
• Study the accounting policy notes carefully, e.g. if a • How is the company doing relative to its competitors?
company recognises revenue when goods are shipped, • Are the post-retirement obligations killing the
there could be a “stuffing of the channel” problem company?
(goods are ending up in stock of the customers and not • What is the impact of interest rates, foreign exchange
being consumed). rates, GDP, etc. on the company?
Maverick risk is the risk of being wrong and alone. When • What could really hurt or kill the company over the
agents work on investing other people’s money, it is more next few years?
acceptable to fail conventionally than to succeed • What is the business of the company?
unconventionally. A contrarian view is not accepted until it • What is the financial strength (liquidity and solvency)?
has been shown to be correct and has, therefore lost its • Are management sweeping expenses under the carpet?
relevance. It is easier to tell people what they want to hear, • Do restructuring charges occur regularly?
• Are expenses capitalised to assets?
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• Do irregular costs occurring regularly? market value of $12 trillion. So the mutual fund industry
• Are stock options issued regularly? confiscates nearly 50% of the historical real rate of return
• Is the company living within its means? earned on the market. (It would be interesting to compare
• Is the debt/equity ratio within norms? this in RSA were we do not have the same economy of
• Who is running the company? scale as in the US.)
• Does management change its policies regularly? Burton Malkiel of A Random Walk Down Wall Street fame
• Does management have stock excuses for poor results? says that 66% of professionally managed portfolios are
• Does the company sport spanking new offices with lifts beaten by low-cost index funds. The third that beat the
going through fishponds? index in some particular period are not the same as those
• What is the stock really worth? that beat the index the next period.
• Do you really need to own this stock?
Here are some ideas on behavioural aspects of investing: The following terms are used in describing the shenanigans
that go on in fund management:
• Keynes said that picking stocks is like a beauty contest
– the judges must decide on not only who is the most Market timing: Trading in and out of mutual funds to
beautiful but whom everyone else will think is most make a quick profit.
beautiful. Late trading: Buying or selling shares of a fund at a given
• Cognitive bias is the tendency of intelligent, well- day’s price after the usual close to enable to allow investors
informed people to do the wrong thing. to act on after hours developments that could move prices.
• Attention grabbing stocks do not outperform the
market. Front-running: Trading stocks or bonds ahead of a mutual
• Know the intrinsic value of a share. This way one can fund when you have information that the fund is about to
determine to what extent behavioural factors are built buy or sell a particular counter.
into its price. Scalping: When a portfolio manager uses mutual fund
• There is no evidence that behavioural finance assets to buy a stock to jack up its price when he already
techniques can enable an investor to make money on owns it in his personal account.
stocks. (But I believe that a knowledge of this
Cloning: Setting up a special brokerage account to conceal
technique can reduce the risks of losses.)
an investor’s identity thus helping him avoid detection by
• A stock is not necessarily a good buy just because the
mutual funds that are trying to prevent market timing
company is sound. The price of the stock may be
activity.
inflated.
• Just because you know that the market is undervalued Charles Booth says that RMB Asset Managers use a
you can’t make money on it right away – you can’t dividend discount model, which has introduced a lot of
trade against sentiment. (Ever tried waiting?) discipline and has made it different from others. They use
• Familiarity bias is where we believe that things that are the model to determine whether a share is over or under
familiar to us are better and less risky – this is why so valued. [You cannot believe how I have been abused over
many people put so much of their money into the stock my lifetime trying to promote such simple common sense!]
of the company they work for, e.g. the poor staff of Americans are spending between 98% and 99% of their
Enron. earnings and then are shocked to find that they cannot pay
• The brain uses shortcut methods to make financial for their retirement! The question the US is trying to
decisions without having to do the full analysis. answer is: “How do we encourage savings?” The problem
• We tend to hold onto loss making shares as we do not is that in the modern culture people only see the here and
want to admit that we made a mistake. now. They cannot see into the long term. Maybe, when the
• We tend not to like boring companies when they can next generation sees the results of this attitude, they may go
make sound investments. back to the old fashioned habit of saving for a rainy day.
• We tend to be overconfident in our decisions
(overconfident bias). Tiger 21 is a fascinating idea! A group called The
• We focus on information that confirms our beliefs and Investment Group for Enhanced Results was formed. They
ignore inconsistent information (confirmation bias). meet periodically to dissect and deconstruct the investment
• We tend to place too much emphasis on similarities portfolios of the members of the group. They are highly
(representative bias). critical of each other, have fun but importantly pool
• We tend to anchor estimates to salient numbers even if knowledge for enhancing their investments. Some of the
the figures have little or no relevance to the estimates ideas that were thrown about when Fortune attended one of
(anchoring bias). the meetings were:
One of the most effective means of dealing with poor • Why is your portfolio so complicated? Get rid of the
behaviour patterns is to write out a thorough investment small stuff.
policy statement and stick to it. The statement should be • Are you trying to be a portfolio equity manager?
specific, i.e.: Why are you saving this money? What do you • Why don’t you have any real estate in your portfolio?
want to buy? When do you want to acquire it? • Why don’t you think about opening your own
business?
The total sum of all the advisory fees, marketing
• What are you really looking for in life?
expenditures, sales commissions, brokerage commissions,
transaction costs, custody and legal fees and securities This is not an investment club where each person puts in
processing expenses (and audit fees?) come to $300 billion money and watches ten other clowns vote to invest it in
a year in the US. This is nearly 3% of the total capitalised rubbish. It is also not handing your investments over to
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someone who has their own interests at heart, e.g. churn to “The odds in Las Vegas and the odds of making money by
generate brokerage income. It is a pooling of knowledge to investing in companies have two major differences. In Las
help each other make better investment decisions. Vegas, one can compute the odds of winning or losing.
These days, the way publicly traded companies are
Fortune explains how to find your “number”, i.e. how much
behaving, you cannot. The dealers usually do not insert or
you need when you retire. Remember that this is a US
scenario. I have translated the amounts into rand using an remove a couple of aces during the game, but on Wall
exchange rate of R6,50. If you are a 45 year-old making Street and among many of the publicly traded companies,
they do.”
R650 000 p.a. and you plan to retire at age 65 your number
will depend on your lifestyle in retirement, e.g. if you need “Managed mendacity, systematically applied to the
x% of your income in retirement your number is: investing public, has become the new science of publicly
• If x = 60% will need R12,7 million traded corporations.”
• If x = 80% will need R17,0 million Examples given in this book are:
• If x = 100% will need R21,3 million • Cendant allegedly booked $500m in fake revenue over
[These figures are really scary. Do not get too depressed. three years
Remember that there are always ways of making ends meet • Waste Management became the most frequently sued
such as selling your posh house in your home town, company in 1998 due to accounting scandals
investing the proceeds in bonds and buying a home in • Sunbeam shifted $231m from reserves to income
Pofadder.] • Global Crossing used Enron-like accounting fraud and
Mr Strephen Mulholland discovered that he was paying inflated revenue
fees of R394 to his financial advisor on income of R957 • Tyco International was investigated for hiding debt to
from an annuity earned from a certain financial institution, make revenues look better
i.e. 40% of the income. He says that he has not heard from • The Korean unit of Lernout & Hauspie Speech
his financial advisor in years. The investment in question is Products funnelled bank loans through third parties to
an equity linked life annuity invested 50/50 in equities and make it look like customers were paying for sales that
the money market. [I wonder if he ever did a proper due never took place
diligence on this investment before making it. I also If investors cannot validate the factual basis of revenue
wonder what kind of return it is earning after all the hidden reporting, return on capital and reports of cash flows,
fees. If R394 is only the advisor’s fee, what about all the logically they should not invest. But with all this deception
other fees? I wonder?] and deliberate concealment, there is no way to validate all
Evidence has come to light that high portfolio turnover is the reporting. This is the investors’ “catch-22”.
detrimental to after tax returns. [Wow – the Americans are Warren Buffett commented that if he could not understand
at last waking up to the fact that one should look to after tax an annual report, perhaps the company did not intend for
returns!] It is contended that a long term strategy is more him to understand it.
suited to taxable investors [are there any other types?].
Companies that lie are the equivalent of economic terrorists
Disciplined investing and maintaining a strategy during
in our midst.
adverse times are the challenges to be faced.
78% of corporate financial executives said that they had
Here are explanations of some items used in the game:
been asked to use accounting rules to cast reporting in a
Soft Dollar Commissions: Fund managers receive better light and 38% had complied – from a KPMG report.
securities research, trading screens, dedicated telephone
It takes moral courage to tell it like it is.
lines and other goods and services from brokers who charge
higher execution costs on the purchase or sale of securities. Something that I picked up in the book that I did not know
Because of the conflicts of interests caused by such was that in The Continental Vending case in the US (1968)
arrangements, the UK Financial Services Authority has the judge ruled that adherence to GAAP did not exempt
introduced a rule restricting the use of this form of auditors from liability if the court found that there was a
compensation. need for further disclosures. This ruling opened the door to
further litigation against auditors (71 cases in 1970, 140 in
A chugger is someone who collects for charities in the
1971 and 200 by 1972).
street (a charity mugger).
Stephen Cranston listed these problems with retirement
The Sharpe Ratio is (the return of a share or portfolio
fund management:
minus the risk free rate) divided by the standard deviation
of the returns, e.g.: • Because consultants are paid by the hour, they have an
incentive to make things complicated rather than to
Portfolio A B keep things simple.
Return 12% 15%
• Consultants often get commission from insurance
Risk-free rate (after tax!) 5% 5%
companies so will push funds into these products.
Excess return 7% 10%
• Many funds have no formal evaluation process to asses
Standard deviation 4% 8%
the effectiveness of their investment consultants.
Sharpe ratio 1,8 1,3
• Many trustees do not know whether the benchmarks
Therefore, portfolio A wins the competition! Do you agree they are using are appropriate.
with this thinking? I would rather earn 15% than 12%. He goes on to give some sound advice on investing:
Here are some extracts from “How Companies Lie” by A
Larry Elliot and Richard J Schroth
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• Have a strategy that considers your time horizon, risk One can reduce mistakes, which are inevitable in the
tolerance and amounts to be invested. investment game, by:
• Build a diversified portfolio – do not invest in • Researching before deciding.
individual stocks (Warren Buffett would disagree with • Understanding the risks and your risk tolerance.
this). • Timing your deals.
• Do fundamental analysis to support your investment • Avoiding high flyers.
decisions. • Sticking to a well designed investment strategy.
• Don’t buy when the market is high. (And don’t sell • Investing for the long term.
when the markets go to h…!)
45% of South Africans have no money left to save after
• Don’t take tax driven decisions.
they have paid their monthly expenses (49% blacks and
• Understand your risk tolerance – distinguish between coloureds, 37% Asians and 20% whites). Those who do
your attitude toward and your capacity to take on risk.
save are setting aside money for big ticket items, funeral
Pension funds are resisting moves by the government to costs, school fees, and food! Few are saving for long term
invest 5% of their assets in socially responsible financial security.
investments. So it might be necessary for Government to
compel them to do so. [All the more reason to set up a DIY Tobin’s quotient is the capitalised value of a company
pension plan.] based on its market price per share divided by the net
replacement cost of its assets. The theory is that you should
According to the communication manager of the Life only buy shares in a company when there is a reasonable
Office’s Association, financial intermediaries have a legal discount between the two. The problem is that balance
obligation under FAIS to: sheets do not give enough information to calculate the net
• Introduce themselves and explain how they operate and replacement cost of its assets (use the historical cost basis
the fees they charge. for PPE and most intangible assets are excluded from the
• Collect and assess all your financial data (assets, balance sheet). [Besides, I am of the view that a share can
liabilities, tax returns, share transactions, insurance have a value in excess of its net asset value, so the concept
policies, wills and pension plans). of Mr. Tobin’s ratio is suspect.]
• Help develop strategy necessary to achieve your The Pension Funds’ Adjudicator, Mr Vuyani Ngalwana
personal goals. lists ten dirty little pension fund tricks that undermine
• Identify problems that could impede achievement of pensions:
your goals, e.g. tax, cash flows, responsibilities, etc.
• Provide a written financial plan. • Poor investment decisions resulting in poor returns.
• Periodically review your progress. • Hidden costs.
• Sneaky interest charges.
Wealth is often destroyed when the investor becomes
• Incestuous relationships.
impatient and/or has tried to take a short cut.
• Funds not sticking to the spirit of the law.
Here is an all too familiar story of a miner who handed over • Trustees who don’t use their brains.
his pension payout of R613 000 to a large insurance • Trustees who surrender their fiduciary duties to service
company to invest. After three years he needed to access providers.
his investment because he broke his marriage vows. He • Penalties charged for pulling out.
discovered that his investment had fallen to R217 000. On • Plundering the funds.
enquiry, the insurance company could not find his file and • Employers pocketing savings for themselves.
his advisor had disappeared. He appointed a forensic [If you are forced to join a pension fund as part of your
investigator to investigate. To cut a long story short he employment contract, see the contributions as an expense
found that there had been constant switches of investments and not as an investment. Make your own provisions for
(up to four in one month) with all the related costs of your retirement, if that is your goal.]
switching based on fraudulent authorisations. Eventually
after much perseverance, the insurance company promised Modigliani and Miller received the Nobel Prize for their
to investigate. assertion that the split between equity and different forms
of debt and its dividend policy make no difference to the
Old Mutual gives these excellent seven rules for sound total value of the entity. [I have battled with this idea for
investing: the past 30 years! I fought many a student in the past who
• A well diversified portfolio to diversify risk. had this rule drilled into them by their lecturers.] The
• It is time in the market that counts, not timing (invest Economist says that this principle is not wrong but is only
long term). true in circumstances so rare that it is the exception rather
• Cash is unlikely to deliver inflation beating returns in than the rule and says that structure does affect the value of
the long term. the firm. [Thank you, thank you, thank you! When I was
• Invest consistently for the best returns, even when the in merchant banking, we used to structure companies to
market falls. increase wealth.] The Economist says that this idea set
• Avoid decisions based on greed and fear. back the study by economists of corporate finance for a
• Invest according to a sound financial plan and in generation. Have you noticed the recent trend of saying:
accordance with your risk profile. “The company is not maximising shareholder wealth as
• Start early and you will have more chance of reaching they are not utilising gearing properly.”?
your goals. Mr Laurie Dippenaar, gives us some of his precious
wisdom regarding investments:
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• Think long term, not short term one fund to another and changing one investment for
• Buy and hold – churning undermines wealth another. A massive amount of wealth is destroyed for
• Do not hold poor assets for the sake of diversification investors because of this churning process.]
(did you hear that you SATRIX fans?) Shaun Harris writes that feedback from retirement fund
• Invest in what you understand – a solid Warren Buffett managers is that presentations made to boards of trustees
principle are often suffered in open boredom. Some trustees couldn’t
• The market does not talk, it is there to serve us, not to care less about the performance of the fund and matching
instruct us assets and liabilities. [When it is not your money, no one
• Avoid investing in companies if you do not trust the cares. That is why you should take responsibility for your
management – watch for creative accounting tricks own wealth development.]
• Invest in companies that are owner managed where the
management is passionate about the business Mr Rhys Summerton of Citi Group had the pleasure of
• Value the shares as you would value a business – my going to Omaha to meet with Mr Warren Buffett and Mr
valuation models are based on this philosophy Charlie Munger in 2004 and summarised some of the words
• Buy on fundamentals, not on technical movements – of wisdom he picked up at the conference:
act rationally • Try to buy businesses that do not require huge capex
• Avoid investments that don’t pay dividends and can price in inflationary increases.
• Focus on a few good ideas, do not spread yourself too • It is dangerous to project high growth rates. Not many
thinly companies can exceed 10% p.a. for any length of time.
• Ridicule fads • The problem with derivatives is that people do not
Michel Pireu points out the errors that we, as investors think of the consequences of the consequences.
make: • Investing does not require enormous intellect. It
• We overrate our skills, e.g. seeing order in information requires enormous discipline.
where none really exits and making predictions based • Diversification is madness. The best way to minimise
on skimpy evidence. risk is to think.
• We use bias to support an investment we favour. • Using brokers to advise you today is equivalent to
• When our predictions do not materialise, we are not kings in ancient times using fortune tellers. You will
prepared to accept that we made a mistake. We hang get the same result.
onto investments too long. • They do not believe that EVA does anything for a
• We avoid taking risk when there is a good chance of company’s profitability. EVA is one of many fads
gain but become risk takers in the face of certain loss. used by companies (as an excuse for thinking!).
• We tend to sell a good investment too quickly. • They calculate all variables fairly conservatively and
• We feel a loss to a greater extent than we enjoy a gain. then make a provision for a margin of safety.
• We focus too much on the short term. • Some people are very stupid when they know
• We tend to be influenced by the herd. something is wrong but do it anyway. [Like straight
• We become obsessed with prices and trends ignoring lining leases!]
solid information. • Stock buy backs are often motivated by management
wanting to increase the price of the shares.
Some pearls of wisdom from Mr Warren Buffett:
• Investing is a life-long game. You keep learning. The
• When being presented with growth rates achieved, be two most important ingredients are temperament and
wary of the start point and the terminal points for common sense.
calculating the growth. Spectacular growth can be Noah Greenhill (JSE GM) says that the problem with the
achieved if the start points and terminal points are retail investor is that they tend to be last in and last out.
carefully chosen. Richard Sneddon, head of Online Share Trading at Standard
• When a company issues its own shares to acquire Bank, says that investors are starting to become aware of
assets what it is really doing is to give away part of the costs associated with investment products and are
what the existing shareholders own. turning to DIY investing.
• Be nervous about derivatives: they are little understood
and pose a serious threat to the global financial system. The Joint Municipal Pension Fund, which lost R1,4bn from
• Buy companies that have as their goal customer speculating on maize futures, [what is a pension fund doing
satisfaction rather than shareholder satisfaction. If you speculating with pensioners’ money???] is suing the JSE,
treat your customers with indifference your business the Financial Services Board, Deloitte, PwC and 21 others
will wither. for the loss. Russell Loubser, the CEO of the JSE, said that
• Do not take decisions merely to meet short term he found the lawsuit “amaizing” [sorry, could not resist
targets. this]. [I really feel sorry for the pensioners of this fund.
Don’t hand over your hard earned cash to others to invest. They worked all their lives, thinking that they were saving
The layers of costs going to the intermediaries between you for their retirement only to find that the people to whom
and your assets eat into your returns thereby undermining they entrusted their investments were a bunch of fools. If
your wealth. you are forced to contribute to a retirement fund, see your
contributions as an expense and take responsibility for your
Mr Vuyani Ngalwana, the Pension Fund’s Adjudicator, has own financial security in your old age.]
warned trustees to stop the process of churning, i.e.
changing one policy for another purely to generate fee The regulators are, quite rightly, looking into two practices
income. [He should look into the process of changing from used by asset managers to generate income for themselves.
They are scrip lending and softing. The former is where
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shares owned by the investors are lent to third parties. A
commission is earned on the value of the shares lent. The
latter is the practice of passing part of the brokerage
charged on transactions back to the asset managers in a
form other than cash. The practice of softing encourages
asset managers to churn portfolios under management
which has the effect of reducing returns on the investments.
Nobody spends somebody else’s money as carefully as he
spends his own. Nobody uses somebody else’s resources as
carefully as he uses his own. So if you want efficiency and
effectiveness, if you want the knowledge to be properly
utilised, you have to do it though the means of private
property. (Milton Friedman, who died recently at the age of
94)
Want a quick way to find out how long it will take to
double your money? Divide 72 by the rate.
How the JSE has changed:
Apr 2003 Nov 2006
Alsi index 7 361 23 950
Companies listed 457 394
Market cap R1 303bn R4 866bn
Here is an interesting comparison of PE ratios and dividend
yields (Feb 2006):
Index PE Ratio D.Y.
SA’s Alsi 16,6 2,3%
SA’s Indi 25 15,6 2,0%
SA’s Fini 15 15,9 3.2%
US’s S&P500 17,8 2,3%
US’s Nasdaq 35,3 0,6%
UK’s FTSE100 15,6 3,5%
Australia 16,8 3,8%
Kind regards,
Charles Hattingh
May 2007
CPD points 60 minutes
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