Rob Dower
Quarterly Commentary

2013 Q1 Comments from the Chief Operating Officer

South Africans save too little in general but we especially save too little for retirement. People who have no savings have to live only off the returns they get from their labour, since they have no capital working for them. Even if they are careful only to borrow for emergencies, those without any savings have to pay interest on the money they borrow to those who have the capital to lend. You can keep working for as long as possible, but jobs are scarce and even those lucky enough to be employed until late in life eventually can't work anymore. In old age, without savings, we have to fall back on the kindness of relatives or on the small state old-age grant.

To improve retirement savings, National Treasury is leading a collaborative effort to make the retirement funding mechanisms in our country work better for savers. The current system is not completely broken, but it has some challenges. For example, the current rules allow people who lose their jobs and therefore leave their pension fund one opportunity to draw up to 100% of their pension. As a result, there is an incentive to take it all out, to the extent that some people resign simply to access their savings. One of the proposed reforms will help preservation by allowing "slow release" access to pension savings, without affecting any vested rights.

Too much complexity and choice is a barrier to savings

Over the five years to the end of 2012 the 800 or so South African unit trusts,excluding money market funds and considered as a whole, have delivered average money-weighted returns after fees of almost 2% ahead of inflation(see text box). This sounds good, but it is no more than the returns of money market funds over the same period. At the same time, investment risk pooled across all of these funds was similar to that of a balanced fund. Those who actually did invest in balanced funds did almost a full percent better. Doing the same analysis over three years, investors in the average balanced fund beat the average all-unit-trusts investor by about 2.5%. Simplicity, it seems, pays off. A good balanced fund reduces risk and switching, which should help the average investor"s outcome. Treasury is proposing a mechanism for retirement fund trustees to nudge members towards pre-qualified default choices, a proposal which has the potential to reduce the negative impact of too much choice without reducing competition.

Time-weighted returns ignore when money flows into a fund. If a fund performs really well when it has few investors and little
capital to employ, and then poorly after attracting strong flows, each of these periods are weighted equally (hence ‘time
weighted’) in the return calculation. Money-weighted returns measure more accurately the average investor experience in
the fund, weighing periods when the fund has more capital invested, more heavily. The published returns of a fund are time
weighted, since these are under the control of the investment manager; investors control the flows.

The proposals from Treasury announced in March are targeted at the biggest problem areas and, if implemented carefully and with the collaboration of a client-oriented savings industry, will do a lot to improve inclusion and outcomes for savers. Some of the problems we face will be hard to solve, for example reducing costs while increasing coverage. Yet, with capable and committed people engaged on all sides, this feels like an exciting and rare opportunity for positive change. Richard Carter sets out some of the details of the proposed reforms in his article this quarter.

Is inflation dead, or is it just sleeping?

As bottom-up investors we are focused on our search for good value investments, choosing not to get caught up in predicting macroeconomic events. Nevertheless, some macroeconomic factors have a big influence on valuations, for example any view of bond valuations has to be informed by an expected future inflation rate. After two decades of low inflation in developed economies, people behave as if price stability is the norm. Sandy McGregor explains how recent developments in monetary policy may undermine this comfortable paradigm, creating a much more volatile investment environment.

Increasing our footprint

As you may be aware, we cast our net widely when looking for interesting investments. Over the last two years we have established stock and bond research coverage for Africa (excluding South Africa) and we have recently opened a small representative office in Nigeria. We now have offices in South Africa, Botswana, Namibia and Nigeria. Our sister companies Allan Gray Australia and Orbis are established in London, Bermuda, San Francisco,Vancouver, Hong Kong and Sydney.You don't have to have an office in a country to research the companies listed there, but this geographic span definitely helps Allan Gray and Orbis to uncover and research long-term investment opportunities globally, while being fully accessible to South African investors. A global perspective is important, not only to deliver the best returns, but also for diversification. Simply put, diversification means choosing investments that behave differently from one another under different circumstances, thus reducing the impact of the individual risks associated with each. This includes picking investments in different sectors and with operations in different countries. Seema Dala discusses how investing offshore allows you to gain exposure to sectors that are underrepresented in South Africa.

I hope you find this quarter's spread of articles beneficial. Thank you for your ongoing support. We appreciate the trust you place in us.

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