Rob Dower
Quarterly Commentary

2015 Q3 Comments from the Chief Operating Officer

When you buy a share you invest what the current owner is willing to sell it for. As the share's new owner, your returns come from a stream of dividends (which you may expect to grow or shrink) and the price you sell the share for at some point in the future. Betting on short-term movements in a share price is speculating: long-term investing emphasises purchase price relative to expected future earnings. If you are prepared to hold an investment for a long time, returns depend less on a lucky selling price (and thus changes in sentiment) and more on earnings over time. Rigorous rational analysis of a company's prospects can uncover opportunities to buy shares for less than they are worth, and thus to earn a return ahead of the market. We stand for long-term, rational investing.

Long term

The thing about communicating 'long-term rational investing' to clients and potential clients is that the first two words - long term - are often more interesting to the average reader than the second two - rational investing. Our new television advertisement is no exception and Zwelethu Nkosi sets out the thinking behind the ad in this edition. You may have seen the ad, which shows a couple separated by the Berlin Wall who wait for each other during divided Germany and are reunited when the wall falls. It is an emotional story with a simple point: perseverance and commitment are generally rewarding.

Rational investing

Each quarter we include some investment pieces that focus on rational investing. I suspect they are mostly read by the more sophisticated few who are looking for ideas on individual stocks. This is a pity. Ian Liddle's article on sunk cost, with a perspective on South Africa's mining industry, will be accessible to most readers and is worth the effort. Ian points out the importance of rationally avoiding sunk cost bias when making investment decisions. If a company is issuing new shares to pay down debt or to fund loss-making operations, or to develop part of a mine, the relevant considerations for investors are the value of their current investment, the amount of new capital being asked for, and expected future returns. It is tempting but wrong to consider, on top of the value of your current investment, the money that you may have invested in previous calls for capital, or the higher price you may have paid for your shares originally. Those are sunk costs.

If shareholders stop injecting capital to support a struggling business that is doomed to fail, there are consequences. Some businesses need to stumble or fail so that better run or more efficient ones replace them: that is an important part of how we make progress. If an industry has excess capacity, the worst-performing businesses have to fail or get smaller to ensure that the rest survive. The human costs of a business shutting down, or of a mine not being developed, are hard to bear and fall disproportionately on those who are less able to afford them. But there are also human costs to a subsidy from investors - who are mostly just ordinary pensioners and savers - to keep an unviable company going for a bit longer, and their capital could be employed more productively for society. Where a whole industry is in trouble the best things we can do for its survival are to channel scarce capital to only the most effective management teams or the best assets and to set predictable policies that encourage long-term investment.

Rigorous rational analysis

Rationality is the investor's defence against positive and negative hype. In Nigeria the oil industry that has underpinned that country's economy and trade balance for 15 years faces a supply shock from new production technology in the US, and things are looking bleak. Negativity in Nigeria has had a dramatic impact on share prices but in some cases this is overdone, making bargains of firms with stronger fundamentals - in particular, some of the Nigerian banks. In his piece this quarter, Nick Ndiritu explains that highs and lows come with the territory when investing in Africa. These extremes present opportunities to us as contrarian investors.

Repeating this argument, but from an Orbis perspective, Mahesh Cooper explains that being rationally different is hard, but it is part of our DNA. Being different at times can make clients uncomfortable, yet it is exactly by being different that we are able to outperform over the long term, with a lower risk of a permanent capital loss.

This quarter's piece from Allan Gray Australia touches on how we go about finding investment opportunities for our clients. Julian Morrison and Werner du Preez note that the overall level of the Australian stock market suggests that now is not a particularly appealing time to invest in that market in aggregate. Fortunately we don't have to invest in the aggregate. Analysts prepared to make bottom-up assessments of value in individual shares can identify individual companies that are well priced. In Australia right now, some sectors, and within them some individual stocks, are deeply out of favour. This is good news for all but the forced seller: it improves our likelihood of paying a low price and earning a better return in your funds.

How to evaluate performance

This is not an easy time for investment decision-making for portfolio managers or for individual savers. Local shares are expensive, or volatile, or sometimes both, global markets are unpredictably under the spell of monetary policy, our currency is weak. A goal or an objective won't help you avoid the uncertainty but it will give your decisions some structure. What is a sensible benchmark return to measure your portfolio against? How much risk are you able to take? Do you want your portfolio to perform better than a bank deposit, better than your neighbour's, better than another similar investment? Thandi Ngwane offers some useful pointers on how to evaluate performance as she answers the question of 'what is outperformance'?

Thank you for your trust in us and for your rational, long-term commitment.

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