Information overload is limiting investment returns

Dr Francois Stofberg
Managing Director: Efficient Private Clients, With Specialist Input From Christiaan Van Wyk

Since the arrival of the internet, talks about the “information age” and its many benefits have taken place continuously. Benefits such as cheap, or even free, access to large volumes of information. But the discussion rarely progresses to the potential negative impacts that might arise from too much information. We believe that the benefits of access to information are real, clear, and well-documented, however, as with anything in life, too much of a good thing is generally bad. Not only has the volume and accessibility of information increased but also its frequency, so much so that real-time data has almost become the norm. This creates a unique problem when the goal is to achieve a long-term target. People, in general, have grown accustomed to speed and efficiency, and get frustrated at the mere thought of having to wait, especially if the immediate environment seems uncertain. This picture is the polar opposite of investing.

Investing, especially in equity markets, requires a long-term mindset, with very little attention being given to the noise surrounding you in the short term. Warren Buffett said it perfectly: “If you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes”. This is generally the approach that most investment managers take when selecting assets to include in their portfolios, and it increases the probability of achieving optimal performance over the long term. Unfortunately, investors are not always as patient, and often impair their investment performance by making short-term decisions based on emotion, or as we will elaborate further, information overload. The average retail investor receives performance reports at least quarterly, with investment fact sheets piling into their inboxes monthly. Then we are not even talking about the myriad of competing investment managers force-feeding their marketing material via e-mails, social media, phone calls, and even airport terminals. No wonder the average investor feels overwhelmed by the investment question and second-guesses their decisions at every corner!

Investment managers are also being forced to adapt to the “information age”, not only in terms of the changing investment landscape but also from a client management perspective. Owing to the frequency with which investors can access investment information, and the vast amounts of alternatives being marketed to them, investment managers are being pressured to make shorter-term investment decisions, limiting their long-term return potential. An example of this problem is the performance differential between retail investments and alternative investments, such as private equity funds. One of the key differences is the investment period. A typical lockup period (the time in which investors cannot withdraw funds) for a private equity fund is at least five to seven years, with infrequent investment information throughout the period. This creates an environment wherein the investment manager can make long-term investment decisions without the pressure of clients withdrawing funds in the short term, which increases the probability of achieving favourable long-term investment performance.

As with most real-world problems, the solutions are, unfortunately, not simple. One approach that can address some of these issues is the bucket approach to financial planning. This approach involves creating different buckets or pockets of investments, each addressing a different investment need with its own investment horizon. This affords the client the much-needed comfort that their unique needs are being addressed, it simplifies how they look at their total investment portfolio, and it increases their chances of sticking to a long-term financial plan. For long-term financial success, we recommend trusting your investment manager, maintaining a long-term mindset, and avoiding getting distracted by short-term noise.

Do not miss the shift towards emerging markets

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

The strong June jobs report in the United States (US) is likely to leave the Federal Reserve (Fed) on course to raise interest rates to a 22-year high during their next meeting to cool off the economy and to combat inflation. Employers in the US added 209 000 jobs in June, causing the unemployment rate to fall from 3.7% in May to 3.6% in June. This is ever closer to the 53-year low of 3.4%. June’s increase was the smallest since December 2020 and is one of the indicators pointing towards a slowdown in the world’s largest economy. However, a tight labour market means average hourly earnings for private-sector workers rose 4.4% since 2022, maintaining the pace set over the last few months. Because hours worked also increased, the overall income in the US also rose in June. Persistently-higher incomes mean spending should remain elevated and add upward pressure to inflation. As the outlook for above-target inflation and a stronger-than-expected labour market persists, more restrictive monetary policy will be needed for a longer period. Consequently, many emerging markets and their currencies took a bit of a beating.

In South Africa (SA), the local equity market contracted 2.4% when the news broke, and the rand depreciated more than 2% to levels above R19.10 against the US dollar. Tighter monetary policy in the US will likely translate into more interest rate hikes in SA too. The South African Reserve Bank (SARB) has unequivocally shown that their primary concern is inflation and that they care very little for consumers or the broader economy. Although, with today’s data, we doubt that the SARB will need to raise interest rates by more than an additional 0.5% in 2023.

As the US Fed is likely to continue to increase interest rates, fears about a global economic slowdown have heightened. This, in turn, brought about some price alleviation in the energy market where oil prices fell despite this year’s supply cuts from the Organisation of the Petroleum Exporting Countries and Russia (OPEC+). Overall, production efficiencies and larger production outputs from countries outside of OPEC+, especially the US, together with weaker-than-expected demand in China, meant that oil prices have fallen more than 13% over the last year, despite OPEC+ cutting output by more than 6%.

Our base case also includes an eventual slowdown in the US but we do not believe that this will translate into a deep global economic crash. Rich-world countries, like the US, have been driven, to a large extent, by extremely loose monetary policy and generous fiscal policy, which have now dried up. This contrasts with emerging economies and their capital markets that have been under severe strain for multiple years, scraping by, fighting for every cent, and forced into structural change. We believe that global investors have not yet effectively priced in the expected slowdown in the US or the hard work that has gone into many emerging markets. When these realities sink in, and investor sentiment shifts to chase the real-world lucrative yields of emerging markets, an upward correction is much more likely in emerging markets. Unfortunately, like all good things, shifts like these do not materialise overnight. We will probably have to wait another 12 to 18 months, at least.

The active versus passive debate

Dr Francois Stofberg
Managing Director: Efficient Private Clients, With Specialist Input From Christiaan Van Wyk

The active versus passive investment strategies debate has been raging for many years, with both sides trying to make the case for their own strategy at the expense of the other. Without pre-empting our own beliefs on this matter, we will start with the words of John C Maxwell: “A great idea is simply the combination of many good ideas”.

Before one can start the conversation about active versus passive investment strategies, one must first look at the key characteristics of both. A passively-managed investment strategy is one where the investment manager pools large sums of investor money to buy assets in accordance with the constituents and weightings of a chosen index. The manager will, therefore, make no active decisions regarding which benchmark assets to include in or exclude from the portfolio, nor will the manager change the benchmark weighting assigned to the given asset. In contrast, an active investment manager will decide which benchmark assets to include in the portfolio and will, typically, deviate from the benchmark weightings. An active manager will further, typically, hold fewer assets than the benchmark, making the portfolio more concentrated than the comparable passive portfolio. In doing so, it affords the active manager the opportunity to outperform the benchmark.

Both active and passive investments have strengths and weaknesses. For example, passive strategies are usually cheaper than actively-managed portfolios but are limited to the benchmark they track, whereas active managers have the flexibility to invest in the specific assets that are expected to deliver index-beating returns. Tax is another topic of debate: Passive investors argue that the buy-and-hold strategy gives them the upper hand via pre-tax compounding returns, whereas active managers can manage taxes for the investor – offsetting taxes on gains in a year where the investor has realised other losses.

The decision of whether to use active or passive investment strategies usually comes down to investor preference. But could a “great” investment solution not simply be a combination of two “good” investment strategies? We believe that there is a place for both active and passive investments, and instead of choosing a single strategy, one can combine these two strategies to create a solution that will benefit the individual client. As an example, the investment manager can allocate a portion of a client’s portfolio to a passive investment, which will give the client beta/index returns, then use the remainder of the portfolio to make active decisions and only allocate capital to high-conviction ideas. The result is a cost-effective portfolio that can achieve alpha/excess returns over time; this strategy is commonly referred to as a “core-satellite approach” to portfolio construction.

The core-satellite example is but one of many ways that investment managers can utilise both active and passive investment strategies to build and to optimise investment solutions. In closing, we believe that it is, therefore, fruitless to debate which investment strategy is superior: In the end, it all comes down to the needs of the client and the skill of the investment manager to utilise all of the tools at their disposal.
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Masala money madness: Spicing up your portfolio in incredible India

Dr Francois Stofberg
Managing Director: Efficient Private Clients, With Specialist Input From Renier Van Zyl

Over the past two decades, we have arguably witnessed the greatest era in men’s tennis. We saw a constant tug-of-war between Roger Federer, Rafael Nadal, and Novak Djokovic. Federer, who originally held the most Grand Slam titles, was overtaken by Nadal, who was recently dethroned by Djokovic. It now seems likely that Djokovic will be crowned the Greatest of All Time. Well, at least until the next tennis star comes along.

Like tennis, we have seen countries battle for economic supremacy. One country after another has managed to dethrone the reigning world power either through war or sheer economic force. The trophy, however, is not a piece of Wimbledon silverware but rather the opportunity to call its currency the reserve currency of the world. As recently as the 1700s, it was the Dutch who reigned supreme with their superior shipbuilding capabilities. The British then overtook them in the 1800s with some masterful shipbuilding of their own. Finally, the United States (US) managed to come out on top during the 1900s. The US managed to go largely unscathed through two world wars while the Europeans saw their countries and economies plundered. Unfortunately, as with the Dutch and the British, there will come a time when the mighty US will also be dethroned by another rising power. In fact, we are already seeing signs of this happening. As to who the successor will be, it is anybody’s guess but we would put our money on India or China.

With regards to the US, it is slowly but surely losing its shine because of its ever-growing debt, internal conflicts, and external conflicts with other countries. Recent signs of this could be seen in the debt ceiling negotiations, the storming of Capitol Hill, and the geopolitical tensions between the US and China. China, on the other hand, is not a clear favourite to dethrone the US: Its population is shrinking and its impressive housing boom is over. There is also the Communist Party which reveres greatness over growth, and who exhibits self-reliance over interdependence that previously characterised its economic success. Foreign investors are more wary than ever, seeking to relocate or to diversify their supply chains and investment portfolios. India, conversely, offers investors and businesses transparency and assurance when doing business. It aligns itself with both the West and the East, and has a growing population as well as an up-and-coming middle class. Experts expect India’s economy to grow, on average, by 6.3% until 2030.

For investors who want to invest in India, there are several investment vehicles, ranging from US-listed exchange-traded funds (ETFs) to securities listed on the Bombay Stock Exchange. There is also the National Stock Exchange of India that investors can trade on. ETFs, however, represent the easiest way to access Indian markets. Furthermore, there are also US-listed companies, such as PepsiCo, Apple and Amazon, that offer investors exposure to India through their generated revenues.

At Efficient, we opt for the latter. We still view India as an emerging market with its accompanying risks. We believe that, at least for now, there are still better opportunities in other markets, such as the US and China, and we are happy to gain exposure to India through the likes of Alphabet, Microsoft, and Amazon, among others. We are, however, constantly on the lookout for our first Indian winner in our portfolio.

The Fed halts and the rand strengthens

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

At their latest Monetary Policy Committee meeting, the United States (US) Federal Reserve (Fed) decided to leave interest rates unchanged at 5% to 5.25%, following 10 consecutive hikes over a 15-month period. But the Fed remains unwavering in its commitment to bringing inflation down to its 2% target. Jerome Powell, the Chairman of the Fed, therefore, made the comment that more hikes may be needed later this year. According to dot-plot projections, two more hikes may still be on the table in 2023. Investors anticipate a 61.5% chance that the Fed will hike rates during their July meeting.

The Fed deemed it appropriate to moderate the pace of increases, albeit only slightly, and we agree with this. Powell explained that the brief halt in the increasing cycle will allow the Fed to assess more data, which they are hoping will assist them in making better decisions going forward. But a halt also allows the economy a little more time to adapt to the tightening environment. Now that rates are at, or very close to, what most believe are restrictive levels, the Fed’s job becomes increasingly difficult. If they do not do enough, inflation might spiral out of control again. But if they do too much, as they tend to do, then the US may experience that hard landing that many thought possible not too long ago.

The US economy and capital markets find themselves in a peculiar place. Up until now, they have been able to shrug off the monetary policy tightening cycle. Corporations keep on expanding and printing favourable earnings reports, unemployment keeps decreasing, and even the housing market seems to be bottoming out. This is because interest rates only impact the real economy at least a year or so after they are increased. Markets try to anticipate what could happen but they mostly get it wrong, as we believe they are currently doing in the US. Wall Street is betting that US markets will continue to outperform but Main Street is starting to think otherwise, as signs of a slowdown and cracks are starting to appear. The annual pace of US inflation eased last month to its lowest level in more than two years. Prices increased 4% in May compared with a year earlier, a significant step down from 4.9% in April, and a remarkable slowdown from the peak of 9.1% last June.

Overall, we believe that the US consumer, who has been insulated from pain, will experience a lot more of it in the short term (12 to 18 months). In the US, earnings will correct, markets will adjust, and more people will be laid off, which will assist in moving sentiment away from developed markets towards emerging markets. It is, however, worthwhile to note that this does not mean that all developed markets will underperform; we still see and invest in pockets of opportunity. But this is good news for South Africa’s capital markets. The rand has already responded positively, strengthening to R18.19 levels, down from the R19.88 high that we were at only two weeks ago. Soon, short-term capital will look elsewhere for yield and the emerging markets will be all too ready to receive it.

The individual’s role in South Africa’s recovery

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

To understand why South Africa (SA) will not become a failed state, it is important to understand how we differ from states that have failed. States like Yemen, Somalia, and Syria. According to research conducted by Fund for Peace, countries that we often ascribe failure to, like Zimbabwe and Venezuela, are not extreme cases of failed states. But before we address the question of SA’s failure, it might be worthwhile to distinguish between a state and a government.

A state consists of four elements: Citizens, territory, government, and sovereignty. The government exercises power and authority on behalf of the state by formulating the will of the state into laws, and then implementing and enforcing those laws. Therefore, even though they are distinguishable, the idea is that if the government fails, the state fails too. But when do governments and, by implication, states, fail? A failed state is a state that has lost its effective ability to govern its people; much like the position that SA is currently in. A failed state maintains legal sovereignty but experiences a breakdown in political power, law enforcement, and civil society, leading to a state of anarchy; some might say that SA ticks this box too.

But are we, in fact, a failed state, and, if not, are we going to become one? To answer this question, analysts often turn to the Fragile States Index (FSI), which considers key elements of a country, like cohesion, politics, economics, social well-being, and the level of external intervention. The FSI shows that while SA has been on a decline over recent years, we are still far from being a failed state, that is, being a country with a “very high alert”. Currently, we are the 79th most fragile country out of 179 and still better off than some of our peers, such as Brazil, India, and Turkey.

We maintain that SA will not deteriorate to the point of complete collapse because of five differentiating forces: Our love for democracy (freedom), freedom of speech, an independent central bank, an enforceable and equitable rule of law, and liquid and deep financial markets. But it does go deeper than that: At the heart of these five forces lies the “moral individual”. An individual who takes responsibility, who takes ownership of their own life, who is accountable and resilient. But also an individual who understands their responsibility towards the community. Collective individualists that drive stakeholder capitalism, not shareholder capitalism, where the current and future benefit of capital is enjoyed by more than just the few who own it now. Although these moral individuals are few, a remnant of them remains in SA. For this reason, even if our government should deteriorate further, as we expect it will, the remnant of moral individuals will ultimately produce constructive progress.

In many rich (successful) countries, governments ensure that the mentioned five forces, among others, move an economy towards equitable progress. But, because the South African government has failed, the moral individual must, once again, step up, as they have done so many times before.

What must the South African government do? The government must fundamentally change. Our current ruling party has been in power for too long, we have become too bureaucratic, too slow, and too fixed in our ways. We need a new growth mindset but, most importantly, we need accountable action. We need strong leadership and moral individuals in government.

Why South Africa’s economy will not slip into the abyss

Dr Francois Stofberg
Managing Director: Efficient Private Clients.

Over the last couple of years, we were often asked by both local and global investors if South Africa will become the next Zimbabwe or Venezuela. Today, this question seems more relevant than ever but, still, the answer remains an unequivocal no. As bad as things have become, there are five specific forces that work together, like reinforced concrete, to keep us from falling into the abyss. These forces are:

  • A functioning democracy: Our democracy might be unhealthy, owing to decades of corruption, state capture, as well as unaccountable and weak leaders, but South Africans still love their democracy and still believe in their individual freedom. This, in turn, protects our freedom and private property rights. Because our democracy is functional, we can by means of our vote change things, which is why every single vote matters. This is not the case in many other struggling emerging economies.
  • Freedom of speech: Before President Cyril Ramaphosa took office, when corruption was at its peak, freedom of speech was under constant attack. Now, the media is, once again, able to name and shame, as well as bring to light all of the shortcomings and corruption within the South African economy. In this way, we can get rid of bad apples and push our economy towards a new trajectory. In many other struggling emerging economies, this is not the case.
  • Rule of law: Although our rule of law is under severe strain, we are still able to take someone to court to fight for justice, even if that someone is a state-owned enterprise or a friend of a person of interest. This is not something that happens in most other struggling emerging economies. Our rule of law still helps to protect individuals and their property. Unfortunately, the rule of law breaks down at the enforcement level, that is, at policing. But this, in turn, creates opportunities in private security. Because of poor policing and the strain that our rule of law is under, it is becoming increasingly important for citizens to self-regulate and to not be part of the problem: Do not pay bribes, do not drive in the yellow lane, things like that.
  • An independent central bank: Although recent decisions taken by the South African Reserve Bank left many experts and consumers in shock, their independence means that corrupt officials cannot simply print money as they please. We might not agree with their zealot-like ideology, where an extra percentage point of inflation is the worst thing that can happen to our economy. But their ruthlessness has worked out well for our economy in the past.
  • A strong and liquid financial market: Because everyone’s fortune is somehow connected to our financial markets, bad policy translates into unhappy voters, which puts the squeeze on a dysfunctional ruling party. Liquid markets mean that we can borrow in South African rand, which is also not something most other developing countries can do.

The ruling party has, indeed, failed us but these five forces work together like reinforced concrete to keep the South African economy on the right side of history. At the heart of these five forces is the individual. An individual that must take responsibility for their own life by voting, by self-regulating, and by creating opportunity and wealth.

Be greedy when others are fearful

Dr. Francois Stofberg Managing Director: Efficient Private Clients, with Specialist Input From Christiaan Van Zyl.

Warren Buffett once said that a prudent investor should “be fearful when others are greedy, and greedy when others are fearful”. This sounds rather easy, but it is much more difficult to apply in practice because of the nature of uncertainty. Even though historic analysis gives us a fairly good indication of the potential outcomes, we, as humans, often complicate decision making by adding too many what-ifs. What if this time is different: What if I missed something, what if… The reality is (unfortunately) that the investment landscape is filled with uncertainties. As evidenced throughout history, when decisions involve uncertain outcomes, they often lead to emotional decision making. Market history is filled with examples of both investor exuberance, leading to asset bubbles, and despondency, which depresses asset values to the point where buying opportunities are in excess.

A perfect example of the latter is the recent selloff in the local equity and bond markets. We are witnessing valuation metrics that are extremely depressed, with historic analysis pointing to multi-year double-digit returns should you buy local shares at these levels. This type of thinking reminds us of the wise words of Mark Twain: “History never repeats itself, but it often rhymes”. Similar trends are evident in the local government bond market, with yields far exceeding most of our emerging-markets peers – indicating that investors are clearly “fearful” of our assets. Does this, however, warrant us to become greedy as Buffett suggests?

Unfortunately, one does not have to look far to find compelling reasons why our local assets should be trading at discounts, relative to the rest of the world, the obvious one being left in the dark at night owing to load shedding. But will the picture look the same ten or more years from now? The argument can go both ways depending on your perspective. There are two schools of thought: On the one hand, the Bears think South Africa is heading for a collapse and there is no hope. On the other hand, the Bulls believe that South African tenacity can overcome overwhelming odds. As realistic optimists, we are inclined to side with the Bulls; far too often, when the outcome seems obvious, alternative scenarios prevail. The world is rapidly changing and none of us can predict where we, at the bottom-most-tip of Africa, might find ourselves on the global stage ten years from now, with many of our current “issues” in the rear-view mirror.

As always, we are confronted with uncertainty. But, given the data that is currently known to us, we can say with a reasonable degree of certainty that the current environment has, indeed, led investors to become “fearful” of our assets, which is creating a great buying opportunity for long-term investors that dare to venture off the beaten track. What should investors do? As always, we would recommend that investors stick to their long-term financial plan. Contrary to the Bears out there, we believe that investors should diversify their exposures between both local and global assets. After all, diversification is the only free lunch in investing.

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