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21 October 2016
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The Importance of Diversification

21 October 2016

The flare-up of local political risk and uncertainties in global markets (monetary policy, economy, politics, etc.) continue to drive markets with no clear trend appearing.  We therefore maintain our view that diversification across assets class, asset manager and investment styles is necessary to protect client capital through these volatile times.

As mentioned previously our South African Unit Trust fund of funds have the maximum 25% offshore exposure mainly in the Sanlam India Opportunity fund, which has outperformed all the other Rand denominated South African offshore funds.

We have 37% in four equity funds namely Anchor Capital, Autus, Bateleur and Baobab, the four top South African equity funds which gave us 17% growth during 2015 up to 9 December 2016.  We also have 12% in Absa property equity which has been the no. 1 property fund in SA over the past 3 years and 25% in the two top South African income funds, which grew well over the past 3 years, namely Bci Income Plus with 10.5% income for 2015 and MET Income Plus which gave 9.9%.  MET Income is year to date, up to end of September 2016 at 9.6%.  The 9.8% equals of course only 6.42% after tax for many, but that is better than -10% which equities can give you in 1 year.  The other disadvantage of conservative income funds is that in the case of a collapse of the Rand, inflation will increase dramatically.  For instance if inflation increases to 22% like during 1998, MET Income Plus fund real rate will be -15.5% for the year (9.88% minus 35% Tax = 9.88%(0.65) = 6.42% after tax, which gives 6.42% – 22% inflation = –15.5% after inflation).  The risk of inflation should never be underestimated.  During the period of land grabs in Zimbabwe inflation didn’t shoot up to 22% it went up to more than 220% in a few months and a few months later to more than a million percent, making money in money markets and income funds worth less than the paper it is written on.  35% in income funds gives us of course available cash to buy undervalued equities when there are clear signs of a turn around.

Under circumstances of runaway inflation, top equity funds with offshore exposure have the ability to outperform inflation, but up to now, our two unit trust fund of funds, Kanaan Bci Balanced FoF and Kanaan Bci Flexible FoF are at -5% up to end of September 2016, with a little bit of a comeback up to 17 October 2016 to -4.86%.

Our prudent strategy to be well diversified can cause us to end the year negative compared to the 9.33% Kanaan Bci Balanced FoF ended for 2015 and 10.04% Kanaan Bci Flexible FoF ended for 2015, nett of all fees.

However, we are still positive as there are signs that Pravin Gordhan will not be fired and if Pravin Gordhan is not fired there’s a chance that SA will not be downgraded to junk status during December 2016 and if SA is not downgraded to junk status during December 2016, the 37% equity and 12% property in our portfolio may see a very good bounce back.  It is then possible that the Rand will strengthen which will work negatively on the 25% we’ve got in Sanlam India, but we expect India to grow faster than the possible strengthening of the Rand.  Neil Smith of Denker Capital said that on a competitive basis, Brexit has made emerging market valuations more attractive.  He believes, generally speaking, that the state of most emerging market economies are much better than the developed world.  As a result valuations are very attractive when compared to the developed world.  Nathan Griffiths senior manager at NN Investment Partners favours Indian stocks.

India has emerged as the fastest growing large economy in the world.  Its strong macro-economic fundamentals and proactive reforms agenda are attracting the interest of overseas investors, with 7.6% GDP growth, manufacturing activity at 9.3% and foreign direct investment inflows of more than $55bn in 2015-2016.  India represents an island of stability in a volatile global economy.

Friendly greetings

Andre Delport

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