Senate Group
A Return to Normality
Jeléze Hattingh – Portfolio Manager René Prinsloo – Portfolio Manager
14 November 2013
René PrinslooPortfolio Manager
B Sc Hons (Act Sci)
FFA – Qualified Actuary
CFA
8 years’ industry experience
Joined Element in November 2007
Appointed Portfolio Manager in June 2012
Stellenbosch University - Lecturer
Glacier - Investment Analyst
2
Overview of Element Investment ManagersIndependent investment manager established in 1998
Track record > 15 Years
Rebranded from Frater Asset Management in 2009
Long-term contrarian value investors
Material focus on downside risk
We define risk as the possibility of permanent capital loss
Leaders in Responsible Investment and ESG analysis
Enhances our analysis of risk
>115 years’ experience in Investment Team - qualifications include:
8 CFAs (80% of Investment team), 4 CA (SA)s, 3 Masters, 1 Actuary
No performance fees charged on Element Unit Trusts3
Agenda
Backdrop to the Return to Normality
Extremely stretched markets globally
Warning signs
Element Unit Trusts
How are we positioned for the Return to Normality?
Element Real Income Fund
Conclusion
4
Market movements since we last met…
Asset Class 2013/03/14 2013/11/12 Move % Move
ALSI 40 908 45 220 4 312 11%
ALSI - EY 5.9% 5.4% -50bp -8%
Property - DY 6.0% 6.5% 50bp 9%
10y Gov Bond 6.9% 8.0% 110bp 16%
10y ILB 0.9% 1.7% 80bp 92%
3y NCD 6.2% 7.2% 100bp 17%
Repo 5.0% 5.0% - 0%
CPI 5.9% 6.0% 10bp 1%
USDZAR 9.16 10.34 1.18 13%
S&P500 1 563 1 768 205 13%
10y UST 2.0% 2.8% 70bp 36%
5Source: Element Investment Managers, I-Net, 12 November 2013
Green: increased, more expensive. Red: sold off, cheaper.
Correlation Coefficient: 56%
QE is clearly driving all markets
Source: Element Investment Managers, I-Net Bridge, 30 September 20136
7
What do the following 3 scholars have in common?
James Tobin
Professor at Yale
Nobel Prize Winner
Economic Advisor to
Pres. J.F. Kennedy
Credited with “Tobin
Tax” and “Operation
Twist”
Koichi Hamada
Did Ph.D. under Tobin
at Yale (1967)
Professor at Yale
Economic Advisor to
P.M. Shinzo Abe
“Brains behind”
“Abenomics”
Janet Yellen
Did Ph.D. under Tobin at Yale
(1971)
Economic Advisor to Pres. Bill
Clinton
Next Fed Chair
“Force behind” … QE infinity
starting Sep’12
The portfolio-balance theory found that policy makers had the ability to affect the
prices of individual assets by altering their supply and demand in the
financial markets.
“Do policy makers have the knowledge and ability to improve macroeconomic
outcomes rather than make matters worse?
Yes…” ~ Janet Yellen, 1999
More loose monetary policies to follow?
Source: James Bullard, St. Louis Fed, 1 November 2013 http://research.stlouisfed.org/econ/bullard/pdf/BullardStLRegChamberFinancialForum1November2013Final.pdf
In June and September, changes in perceived tapering scenarios led to large movements in key financial
market variables.
Moves were significant and in the conventional direction.
Changes in the perceived pace of asset purchases have a very similar financial market effect as
changes in the policy rate during more “normal times.”
Real 5y interest rates: Equity markets:
Is the FED losing control of the markets?
8
This phenomenon’s latest exampleUS Non-farm payrolls for October were released on Fri 8 Nov
The number came in at 204 000 compared to market expectations
of 120 000
i.e. 204k jobs were created over October, more than expected
This is good news!
The markets sold off on this news
SA bonds weakened by 10 points, US bonds by 14 points
Gold sold off by 1.7%
The ALSI closed down 1.2%
Why?
Good news => economic recovery => Fed more likely to taper
Insanity or markets becoming too addicted to stimulus?
9
US Bonds still have a long way to go…
End of multi-decade bull market?
Current yield
Average yield
10
US Equity market looks expensive…
11Source: dshort.com, October 2013
12
US Equities’ expected returns are very poor!
Source: Butler, Philbrick, Gordillo & Associates, 31 July 2013
US’s margin debt above dot-com levels…
Source: Motley Fool, 26 October 2013 13
And high margin debt is negative for US equities…
Source: GaveKal, August 2013
?
14
SA Asset classes - 15 year bull markets!
Source: I-Net, 31 October 2013 15
Bond yields still down 47%!
ALSI up 13 times!
Source: Element Investment Managers, I-Net Bridge, 31 October 2013
The end of a 15y bull run?
SA bonds move in lock-step with US bonds
16
The ALSI PE is currently very high
Market currently trading on 21.4x trend-earningsAnd 18.8x actual past 12m earningsBoth average around 11.9x
Source: Element Investment Managers, 31 October 2013 17
Returns from this starting point should be poor
Source: Element Investment Managers, I-Net Bridge, 31 October 2013 18
Expected 5 year returnfrom current PE
INDI only this stretched twice before
The INDI is currently on a similar valuation as the ALSI was in May 2008, just before the correction
Source: Element Investment Managers, 31 October 2013 19
ALSI in US$ vs World Index
A decade of materialOutperformance (5 x)
A great time tobuy SA market
ALSI in $ has rolled over – time for caution
Source: Element Investment Managers, I-Net, 31 October2013 20
All Share Breadth – June 2008
ALSI returned 10% over the previous year
Without these five you would have lagged the index by 24%
It was difficult to beat the index by omitting a few key shares (i.e. one-sided breadth)
The situation was exceptional relative to history
BHP Billiton, Anglo, Sasol, Implats and MTN skewing the ALSI’s performance
Source: Element Investment Managers, 30 September 2013 21
All Share Breadth – September 2013
Richemont, Naspers and SAB Miller skewing the ALSI’s performance
Breadth not as stretched or one-sided as in 2008
However, in the past year half of ALSI’s return came from 3 shares
Source: Element Investment Managers, 30 September 2013 22
6.50
6.70
6.90
7.10
7.30
7.50
7.70
7.90
8.10
8.30
8.50
8.70
8.90
-10 000
-
10 000
20 000
30 000
40 000
50 000
60 000
70 000
80 000
90 000
100 000
110 000
120 000
130 000
01
Jan1
2
16
Jan1
2
31
Jan1
2
15
Feb1
2
01
Mar1
2
16
Mar1
2
31
Mar1
2
15
Apr1
2
30
Apr1
2
15
May1
2
30
May1
2
14
Jun1
2
29
Jun1
2
14
Jul1
2
29
Jul1
2
13
Au
g12
28
Au
g12
12
Sep12
27
Sep12
12
Oct1
2
27
Oct1
2
11
Nov12
26
Nov12
11
Dec12
26
Dec12
10
Jan1
3
25
Jan1
3
09
Feb1
3
24
Feb1
3
11
Mar1
3
26
Mar1
3
10
Apr1
3
25
Apr1
3
10
May1
3
25
May1
3
09
Jun1
3
24
Jun1
3
09
Jul1
3
24
Jul1
3
08
Au
g13
23
Au
g13
07
Sep13
22
Sep13
07
Oct1
3
22
Oct1
3
06
Nov13
Cumulative Foreign Flows since J an 2012 (R'm) vs ALBI YTM
Cumulative Foreign Bond Flows Cumulative Foreign Equity Flows ALBI YTM
Foreigners: Buying BRICS to selling BIITS*?“What you will see is a lot more differentiation - what’s important is to distinguish
between one emerging market and another.”
Marco Annunziata, chief economist General Electric Co, Oct 2013
Foreigners hold > 38% of SA Government Bonds
7 Bonds > 45% foreign owned, SA’s 10y bond (R2023) is 60% foreign owned
Source: Element Investment Managers, I-Net Bridge, 11 November 2013*BITTS = Brazil, India, Indonesia, Turkey, South Africa 23
Warning signs of the
end of the “New Normal”
aka bubble territory
Anatomy of a bubble…
25
Party like it’s 1999…
Source: Element Investment Managers, Bloomberg, November 201326
Comparing Nasdaq (rebased to 1990) to the SA Retailers (based to 2002)
Exponential bubbles: Bonds and Farmlands
Source: Mauldin Economics, 3 November 201327
Caution warranted: Bearish sentiment at 20 year low…
30 October 201328
Jeléze HattinghPortfolio Manager
M Sc (Cum Laude), CFA, CMT
Business Mathematics and Information
Quantitative Risk Management
8 years’ industry experience
Joined Element in May 2010
Appointed Portfolio Manager in June 2012
Allan Gray Ltd – Fixed Interest
Credit Suisse and Deloitte Consulting (UK) – Risk Management
Standard Bank (SA) – Risk Management
29
Element Unit Trust Overview
and focus on
Element Real Income Fund
30
Element: Unit Trust Fund Profile
2% - 4% long term out-performance with lower than
market risk
Reduce risk with combination ofasset classes
Real returnwith material reduction in
risk
Reg 28 Balanced Fund – expected
position
Size of bubble = maximum drawdown
Offer investors a choice alonga risk/return frontier
Data: Fund inception to Oct 201331
Lower risk than the market
Element Global Equity Fund
Element Earth Equity Fund
Element Flexible Fund
Element Balanced Fund*
Element Real Income Fund*
Inception Date Feb 2011 Oct 2001 Oct 2001 Nov 2009 Oct 2002
ASISA CategoryGlobal - Equity
GeneralSouth African - Equity General
Multi Asset - Flexible
Multi Asset - High Equity
Multi Asset - Low Equity
Maximum Equity 100% 100% 100% 75% 40%
Benchmark MSCI World Index ALSI CPI + 5%Average of the Multi Asset – High Equity
GroupCPI + 3%
Performance at 31 October 2013 Fund
Bench-mark Fund
Bench-mark Fund
Bench-mark Fund
Bench-mark Fund
Bench-mark
Annualised since Inception
24.8% 25.2% 17.4% 18.5% 15.5% 11.0% 9.0% 13.3% 11.8% 8.4%
Annualised 10 Year 16.6% 20.0% 14.1% 10.8% 11.2% 8.8%
Annualised 5 Year 12.1% 20.2% 10.8% 10.4% 10.2% 8.4%
Annualised 3 Year 7.1% 17.9% 10.4% 10.8% 10.6% 14.2% 11.3% 8.8%
1 Year 45.9% 46.6% 7.6% 26.2% 13.6% 10.9% 14.4% 19.2% 13.7% 8.9%
* Regulation 28 Compliant
Element Unit Trust Performance Overview
Absolute AA Funds outperforming
First Quartile over 1y and since inception
Poor Equity Performance
32
Equity performance impacts all our Funds
EQUITY FUNDS
ASSET ALLOCATION
FUNDS
SCREENED FUNDS
EARTH EQUITY FUND
FLEXIBLE FUND
REAL INCOME FUND
BALANCED FUND
ISLAMIC BALANCED FUND
ISLAMIC EQUITY FUND
EQ
UIT
Y
EN
GA
GEM
EN
T
We manage and engage across “one” equity portfolio
When equity performance turns – will boost all our Funds
Asset Allocation calls have been good33
Source: Element Investment Managers, MoneyMate, October 2013
Our Asset Allocation calls have been good…
* For internal presentations only 34
Above average despitepoor Equity performance
Asset Allocation and Positioning
for a
Return to Normality
Asset Allocation Investment Process
Balanced Funds
Equity Income Foreign
Bonds ILBsFRNs/ Cash Property
CreditDuration Curve Shape Liquidity
Asset Allocatio
n
Income Allocatio
n
Security Selection
Prefs
36
Implementation
Cautioned against capital loss on “risk-free” assets
Source: Element Investment Managers, I-Net Bridge, 31 October 201337
There is no substitute for due diligence…
R925m corporate bond default – Element had zero exposure
Some of SA’s largest asset managers were caught – searching for higher yields
“We don’t know what happened here…Due diligence is only as good as the
financials that are presented to you.”
Leon Campher, CEO of ASISA, 26 July 2013
We disagree as there were numerous red flags raised!
Our credit process involves rigorous analysis of issuers
Detailed research on alternative investments
Including ESG research – particularly corporate governance
38
Mail & Guardian, August 2 to 7 2013
Investment in Renewable Energy Bond
Detailed research
Use alternative asset
classes to enhance our
risk-return profile
Actively manage our
income positions
Invest in CPV bond
…and kick the tyres!
39
-45%
-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
0% 1% 2% 3% 4% 5% 6% 7%
Cap
ital
Retu
rn
Exit Real Yield
I mpact of Real Yield Change for 10 SA Government I LB
ILBs: What did we say in April 2013?
Source: Element Investment Managers, I-Net Bridge, April 2013
Real GDP expectations:2013: 2.7%2014: 3.5%2015: 3.8%
Historical ILB Real Yield = 3.4%
Apr’13 10y Real Yield of 0.62%
Oct’13 10y Real Yield of 1.65%
8% Capital Loss in 6 months!
40
New Basel rules mean that preference share capital loses its recognition over time
African Bank Preference Shares effectively paying cash plus 7.2% after tax
African Bank Prefs are an attractive alternative
Reversion to historical norms implies price of R81: 21% upside
Prospect of company buy-back at price of R100: 49% upside
Even if this event only happens 5y from now, return earned is still 19% p.a.
Rights issue of R5.5bn is positive for pref shareholders and bond investors
Source: Element Investment Managers, I-Net Bridge, 31 October 201341
Active management of Foreign Cash
Leverage knowledge of domestic companies that issue offshore.
Hedge out currency risk.
Issuer YTM Exposure Currency TRR* TRR* of
ALBIRelative
TRR*TRR of
USDZAR
Old Mutual 5.2% USD 57% 15% 42% 33%
Aquarius Platinum 14.9% USD 71% 4% 66% 19%
Edcon Holdings 6.2% USD 40% 4% 35% 15%
Redefine International DY: 7% USD 108% 4% 104% 19%
* TRR in ZAR, since date of first purchase (not annualised)
At 31 October 2013 42
Peer Group Performance: Epoch Global Choice FundThe Epoch Global Choice fund’s reached its eight year track record in September 2013
For comparison, it outperformed all other funds in the ASISA Global - General - Equity fund
category since its inception.
Source: Epoch Investment Partners, Moneymate, 31 October 201343
Asset Allocation Investment Process
Balanced Funds
Equity Income Foreign
Bonds ILBsFRNs/ Cash Property
CreditDuration Curve Shape Liquidity
Asset Allocatio
n
Income Allocatio
n
Security Selection
Prefs
44
Implementation
The cyclicality of investor emotions…
45
RichemontNaspers
Platinum/Gold sharesResources
Retailers
Why have our equity funds underperformed?There is a material divergence between:
Low PE (Value) shares and High PE (Momentum) Shares
Resources (unloved) and Industrials (favourites)
Cyclicals (unloved) and Defensives (favourites)
Expensive shares have re-rated further
Cheap shares have de-rated further
Value managers are underperforming momentum managers
This is unsustainable and will change as it always has
46
Bottom 20 CTAR & Share Positions
6 shares account for76% of underperformance
Positions taken Earth Equity: Average relative weights of the latest 12 monthsending 31 Oct 2013
Benchmark ALSI47
Source: I-NET Bridge, Element Investment Managers, 31 October 2013
Oct 95: INDI 52% of ALSI
Sep 13: INDI 55% of ALSI
Mar 98: RESI 21% of ALSI
Jun 13: RESI 25% of ALSI
All Share Index: Industrials at all-time high
48
Resources look cheap, Industrials expensive…
Buy ResourcesSell Industrials
Sell ResourcesBuy Industrials
Series always reverts, only timing is uncertain
As stretched as ever
Source: I-Net Bridge, 31 October 201349
Sector Allocation
Holdings as per Element Earth Equity Fund, 31 October 201350
Top 10 Overweights
* Alternate to Platinum shares
Holdings as per Element Earth Equity Fund, 31 October 2013
SHARE% of Earth
Equity Fund% of ALSI RELATIVE
ANGLOGOLD 6.7% 1.0% 5.7%
SASOL 10.2% 4.7% 5.5%
NG PLATINUM ETF* 4.7% 0.0% 4.7%
MURRAY & ROBERTS 4.1% 0.2% 3.9%
TONGAAT 4.1% 0.2% 3.9%
TSOGO-SUN HOLDINGS 3.5% 0.0% 3.5%
GOLD FIELDS 3.8% 0.6% 3.2%
SUN INTERNATIONAL 3.3% 0.2% 3.1%
REINET 3.6% 0.5% 3.1%
HCI 2.9% 0.1% 2.8%
51
Murray & Roberts: Long Term Sheets
MUR trading at R102, a 564% premium to model fair value
Source: Element Investment Managers, 31 October 201352
History tends to repeat itself…
Divisional structures removed
Corporate office consolidated
Remuneration restructured
MUR market capitalisation Rm MUR shareholder’s equity
-
5 000
10 000
15 000
20 000
25 000
30 000
FY95FY96FY97FY98FY99FY00FY01FY02FY03FY04FY05FY06FY07FY08FY09FY10FY11FY12
FY95-FY99 Market cap -84%
FY08-FY12 Market cap -69%
-
1 000
2 000
3 000
4 000
5 000
6 000
7 000
FY95FY96FY97FY98FY99FY00FY01FY02FY03FY04FY05FY06FY07FY08FY09FY10FY11FY12
FY96-FY00 Ordinary shareholder's equity -48%
FY10-FY12 Ordinary shareholder's equity -36%
Leadership team strengthened
Non-core businesses disposed
Gearing reduced
Source: Company data, Element Investment Managers, I-Net Bridge to 30 June 2013 * Equity in FY12 adj for R2bn rights offer
Similarities between changes incorporated in 2001 & 2011:
53
Impact on gold as fiat currency => Gresham's law: “Bad money drives out good…
if they exchange for the same price.“
When a government overvalues one type of money and undervalues
another, the undervalued money will leave the country or disappear, while
the overvalued money will flood into circulation.
Source: Sharelynx.com, September 2013, BCA Research, 3 November 2013
?
Central bank balance sheet expansion and gold…
54
Anglos vs SAB: Cheapest in over 70 years…
At 30 September 2013
0.48
55
Bottom 10 Underweights
Holdings as per Element Earth Equity Fund, 31 October 2013
SHARE% of Earth
Equity Fund% of ALSI RELATIVE
SABMILLER 0.0% 8.6% -8.6%
CF RICHEMONT 0.0% 8.6% -8.6%
BHP BILLITON 2.6% 11.1% -8.5%
NASPERS 0.0% 6.2% -6.2%
MTN 1.8% 6.0% -4.2%
BA TOBACCO 0.0% 2.6% -2.6%
FIRSTRAND 0.0% 1.8% -1.8%
SANLAM 0.0% 1.7% -1.7%
REMGRO 0.0% 1.7% -1.7%
SHOPRITE 0.0% 1.3% -1.3%
56
Naspers: Long Term Sheet - EPS
Naspers Expensive
Naspers Cheap
Source: Element Investment Managers, 31 October 201357
Naspers now a bigger company than Sasol…
Source: I-NET Bridge, 31 October 2013
Sasol Market Cap
Naspers Market Cap
58
…despite Sasol earnings almost 5 times higher!
* HEPS per IFRS
Source: I-NET Bridge, 31 October 2013
Sasol Earnings
Naspers Earnings
59
Tech icons often fall to future competitors…
60
-94% downfrom peak
Conclusion on Element Fund positioning
Asset allocation - critical investment decision
Global and local markets do not look cheap
Diversify by asset class, geography and currency
SA Equities look expensive on a relative basis
We remain cautiously positioned
Material relative valuation differentials = opportunity
Capital preservation, dividend yield (rather than growth) key focus areas in equity markets over the medium term
“… but if you tell me that QE is going to be removed over 9 or 12 months, that’s a
big deal, because it’s my belief that QE has subsidised all asset prices and
when you remove that subsidisation the market will go down.”~ Stanley Druckenmiller, Sept 2013
Who should invest in the Real Income Fund?
Investors looking for a real return on their money
Target to outperform CPI + 3% over all periods
Have beaten its benchmark since inception 11 years ago.
A turnaround in equity performance will filter through in the Asset Allocation
Funds first
Investors who are more risk* averse – either older demographic or cautious of
the current environment
Low (<40%) exposure to equity
Well diversified portfolio across Asset Classes and Geographies
* We define risk as the possibility of permanent capital loss62
Asset Allocation – Element Real Income Fund
At 31 October 2013Holdings for Element Real Income Fund 63
Performance – Element Real Income Fund
As at 31 October 2013Element Real Income
FundCPI + 3% RELATIVE
Annualised Since Inception 11.8% 8.4% 3.4%
Annualised 10 Year 11.2% 8.8% 2.4%
Annualised 5 Year 10.2% 8.4% 1.8%
Annualised 3 Year 11.3% 8.8% 2.5%
1 Year 13.7% 8.9% 4.8%
64
Conclusion on Element Investment Managers
We have a proven philosophy, process and track record
Restructuring of staff completed, lessons learnt
Should lead to improved equity performance going forward
We have a well qualified, experienced and hard-working team
focused on ensuring our portfolios outperform our
benchmarks, cash and inflation on a long-term view
Strong Responsible Investment credentials
Our defensively positioned portfolios should hold up well in
the current environment of heightened uncertainty and
overvalued markets
65
Yellen and screamin’ into 2014…
28 October 2013
Justin Wolfers Univ of Michigan Public Policy & Economics Professor9 October 2013
“She’s an imaginative and technically adept economist possessed of a brilliant and precise mind.”
For:
Against:
66
Disclaimer
Element Investment Managers claims compliance with the Global Investment Performance Standards (GIPS®). The firm includes all portfolios managed by Element Investment Managers. Element Investment Managers is an independent, owner-managed company. It provides discretionary investment management services to retail and institutional clients.
Element Investment Managers has been verified for the period:
1 January 2003 to 31 December 2012
Copies of our verification reports are available on request.
A complete list and description of our composites is available by contacting Brenda Lambrick at:
+27 21 426 1313 or at [email protected]
67
Thank you
CONTACT DETAILS:
• René Prinsloo
• Jeléze Hattingh
www.elementim.co.za
Element - LISP Platforms
LISP Earth Equity Flexible Balanced Real
IncomeIslamic Equity
Islamic Balanced
Global Equity Fund
Momentum FundShop
FundShop
FundShop
FundShop
FundShop
FundShop Open
Glacier Open Fusion/Open Open Fusion/
Open Open Open Open
AIMS Yes Yes Yes Yes Yes - -
Investec FundChoice
FundChoice - Fund
ChoiceFund
ChoiceFund
Choice
Old Mutual Galaxy Galaxy/Max - Galaxy - - -
Sanlam Stratus/Topaz
Stratus/Topaz - - Stratus/
TopazStratus/Topaz -
Stanlib Classic Classic - - - - -
BoE - - - - Yes Yes -
69
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