Notes from my inbox - October 2018
“When I consider what people generally want in calculating, I found that it always is a number.” – Mathematician Muhammad ibn Musa al-Khwarizmi, 9th century
“The element of surprise is common in a system where so many decisions depend on forecasts of the future.” – Iconoclastic economist Frank Knight, mid-20th century
OUR MODERN MASTERY of numbers is rooted in the Hindu- Arabic numeric system developed around 1 500 years ago and first encountered by Europeans 700 years later at the time of the Crusades. Muhammad ibn Musa al-Khwarizmi was a scholar based in Baghdad and is generally recognised as the founder of algebra (literally meaning the reunion of broken parts). Incidentally, his name is also the root of the word algorithm. It took another 400 years before the concepts of probability and formal risk management were developed during the Renaissance, which led to the development of sophisticated financial and insurance markets in the 1700s. This in turn enabled the rapid economic growth achieved during the Industrial Revolution. Since the Victorian era, the study of economics and risk became increasingly dominated by mathematics and the belief in rational decision-making. The backlash against this purely numerical approach started in the early 20th century when economists such as Frank Knight pointed out that in making decisions, we are typically dealing with unquantifiable uncertainty rather than quantifiable risks. Scholars such as Amos Tversky, Daniel Kahneman and Richard Thaler have further described how cognitive biases influence the way humans manage risk and uncertainty.*
So why the history lesson? Like in al-Khwarizmi’s time, investors today are still insistent on a number; in our case, a future return expectation. This need tends to increase when recent results have been underwhelming and pessimism is more common than optimism. We understand why many investors are concerned. 2018 continues to be a testing year, reflected in cash out-performing equities, listed property and bonds – both in South Africa and globally – over the first nine months of the year. For the past three years, local shares barely beat inflation, delivering a real return of 1.5%. Local economic conditions remain tough, with many signals of weak confidence and consumers under pressure. Quality shares that used to be loved by the market over years, or even decades, have been aggressively sold down after either delivering a poor set of results, a single missed expectation or in response to news that the company in question is faced by an unexpected challenge. Global investors, who a few years ago nearly universally believed in emerging markets and the African growth story, are now shunning the continent. Given recent experience, it is reasonable to ask whether this is just a particularly tough cycle, or whether the strategies that used to work are now broken.
Unfortunately, like Knight pointed out a millennium later, we can only respond with an imperfect answer. Uncertainty means that many paths can be taken, that the collective actions of millions of decision-makers will influence the outcomes in surprising ways and that it is only with the benefit of hindsight that we will know the eventual destination.
We have, however, been here before. Whether it was the tough transition to democracy in the early 1990s, the emerging markets crisis of 1998, the bursting of the dot-com bubble in 2000, the collapse of the commodity super-cycle and the global financial crisis in 2008, or the destabilising events of Nenegate in 2015, we have been able to navigate the choppy waters. During these periods, asset prices reflect a lot of negative sentiment. Starting yields on income assets become more attractive as investors sell bonds and property. Equity valuations become undemanding as earnings decline and shares de-rate. The negative jaws of depressed earnings and increasing costs that are causing today’s concerns often create tomorrow’s opportunities. In these conditions, small changes in circumstance can lead to large jumps in share prices. We still have very high convictions that a relentless focus on valuation, coupled with judicious implementation in well-diversified, risk-appropriate portfolios will deliver good outcomes over time. In nearly all instances, the investment cases remain intact for the positions in our funds that have recently disappointed.
IN THIS EDITION
Nicholas Hops unpacks one such investment case in his article, explaining why we have exposure to selected platinum group miners despite a very tough decade for the industry. For insight into a global opportunity currently in our portfolios, read Paul Neethling’s story on New Oriental Education, China’s largest provider of private educational services, mostly after-school tutoring. You can also read the flagship fund update here or the fund commentaries available here for further information on how we have deployed your capital.
We also include two financial planning articles. In a follow-up to last quarter’s article on setting return expectations, Christo Lineveldt unpacks the return outlook from the perspective of more conservative investors. We discuss the advantages of tax-free investments, which we believe are still the best tax break available to individual investors.
Marie Antelme provides an update on the Brexit process, another example of uncertainty in action. With the statutory exit deadline less than six months away, the outcome remains surprisingly open-ended.
We hope you enjoy the read. As always, you are welcome to email us at firstname.lastname@example.org if you have any specific questions, concerns or issues that you would like to discuss.
*If you are interested in reading more about this history, Peter Bernstein’s classic Against The Gods: The Remarkable Story of Risk is a good starting point.