Tuesday, June 29, 2010

What's the Point of Macro?

By Dylan Grice

Most people would see the macro strategist's role as timing macro events ... switching between defensives and cyclicals, adjusting duration, risk-on/risk-off trades, and so on ... the only problem is that most of us are rubbish at seeing macro events coming, let alone timing them, as our evolutionary programming blinds us to events which are forecastable (and many are not even that). Perhaps we should embrace our limitations by accepting that 'outlier events' are actually quite regular, and use macro research to aid in the search for appropriate insurance strategies.

* A few weeks ago I mapped out a strategy that was based on the idea that since global banks' solvency was so dependent on government bond holdings, central banks would have no option but to quantitatively ease in the face of future government funding crises. I argued that such funding crises could provide opportunities to buy cheap risk assets before liquidity/QE-induced rallies and that some value was beginning to emerge, but also that that value still wasn't extreme enough to go all in.1

* As usual, I received some interesting feedback - some favourable, some not (one pm said my 'deflation-begets-inflation' view was a "dog's leg" forecast). But one client asked why I bothered looking at valuation at all. Surely my extreme macro views trumped such considerations? "I just don't understand how you can separate your ... economic research from your stand-alone valuation tools." I thought this was a brilliant question because it gets to the heart of a permanent tension between macro and micro: what should the relationship between top-down macro and bottom-up valuation be?

* At the risk of oversimplifying what our more macro-focused clients do every day I'd characterize pure macro-focused managers as being less concerned with valuation. For a start, the traditional macro instruments such as commodities and currencies are difficult to value. But by far the biggest macro market - the bond market - is largely priced off central bank perceptions of what the economy is doing, and risk assets tend to be priced off those bond markets. Since mispriced assets can become even more mispriced depending on the macro climate and central banks' reading of it, timing is everything and for such managers an understanding of the 'big picture' is far more important than valuation.

* But at the opposite end, where the pure value hunters reside, Warren Buffett has said that even if he knew the Fed's exact interest rate moves two years in advance it still wouldn't make any difference to how he would invest today. Indeed, most value investors shun macro completely and focus entirely on bottom-up valuations. They view recessions as good times to buy and have little confidence in anyone's ability to predict them. But they don't really care because they know recessions occur frequently enough and they are patient enough to wait. So why bother with macro?

At last year's Value Investing Congress, David Einhorn neatly reconciled the top-down versus bottom-up investment philosophies. He was describing his Damascene conversion following a foray into a high quality US homebuilder just before the housing bubble burst:

"At the May 2005 Ira Sohn Investment Research Conference in New York, I recommended MDC Holdings, a homebuilder, at $67 per share. Two months later MDC reached $89 a share, a nice quick return if you timed your sale perfectly. Then the stock collapsed with the rest of the sector. Some of my MDC analysis was correct: it was less risky than its peers and would hold up better in a down cycle because it had less leverage and held less land. But this just meant that almost half a decade later, anyone who listened to me would have lost about 40% of his investment, instead of the 70% that the homebuilding sector lost.

"I want to revisit this because the loss was not bad luck; it was bad analysis. I downplayed the importance of what was then an ongoing housing bubble. On the very same day, at the very same conference, a more experienced and wiser investor, Stanley Druckenmiller, explained in gory detail the big picture problem the country faced from a growing housing bubble fueled by a growing debt bubble. At the time, I wondered whether even if he were correct it would be possible to convert such big picture macro-thinking into successful portfolio management. I thought this was particularly tricky since getting both the timing of big macro changes as well as the market's recognition of them correct has proven at best a difficult proposition. Smart investors have been complaining about the housing bubble since at least 2001. I ignored Stan, rationalizing that even if he were right there was no way to know when he would be right. This was an expensive error.

"The lesson that I have learned is that it isn't reasonable to be agnostic about the big picture. For years I had believed that I didn't need to take a view on the market or the economy because I considered myself to be a "bottom-up" investor. Having my eyes open to the big picture doesn't mean abandoning stock picking, but it does mean managing the long-short exposure ratio more actively, worrying about what may be brewing in certain industries, and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if they are hard to time."

I think most people would agree with this very reasonable hybrid approach: use macro analysis to avoid economic turbulence by managing your portfolio's "long-short exposure ratio" more, and bottom-up analysis to maintain a value bias to the holdings within your portfolio.

But there is still a problem with the applicability of this philosophy: your ability to 'actively manage' your portfolio's beta is a function of your ability to accurately call the market's shortterm direction correctly on average over time. But just because most of us think we are reasonably competent at calling such short-term moves doesn't mean we are. In fact, the reality is that we're appalling at it.

The future is wild, but our forecasts are mild

One problem is that many of the big moves we're supposed to "trade around" are fundamentally unpredictable (Taleb's Black Swans) and no amount of research will predict such events. Perhaps a more important thought is that we're simply not hardwired to see and act upon the big moves that are predictable (Taleb's Grey Swans).

To see why, it's important first to understand the nature of those big "outlier" moves. Benoit Mandlebrot, the inventor of fractal geometry, distinguished between uncertainty that is "mild" and that which is "wild."2 For in a sample from a population that is only mildly random, extreme occurrences won't change the estimated characteristics of the population. To use Taleb and Mandlebrot's example3, imagine taking 1000 men at random and calculating the sample's average weight. Now suppose we add the heaviest man we can find to the sample. Even if he weighed 600kg - which would make him the heaviest man in the world - he'd hardly change the estimated average. If the sample average weight was similar to the American average of 86kg, the addition of the heaviest man in the world (probably the heaviest ever) would only increase the average to 86.5kg.

With mild distributions, extreme outliers are insignificant to our understanding of the likely weight of someone randomly chosen from the population. The insignificance of such outliers makes the uncertainty around people's height, blood pressure or IQ so mild that fairly accurate probabilities can be judged using the well-known Gaussian "bell curve" distribution. The bell curve is usually referred to as the normal distribution because it has known and convenient properties, yielding safe and predictable probabilities, and we like to think that safe and predictable is normal.

But it's not actually that normal. There are plenty of very important variables which are more "wildly" random and in which outliers make a transformative difference. For example, suppose instead of taking the weight of our 1000 American men, we took their wealth. And now, instead of adding to the sample the heaviest man in the world we took one of the wealthiest, Bill Gates. Since he'd represent around 99.9% of all the wealth in the room he'd be massively distorting the measured average so profoundly that our estimates of the population's mean and standard deviation would be meaningless. If wealth distribution was mild this would never happen. But it's not. So it does. If weight was wildly distributed, a person would have to weigh 30,000,000kg to have a similar effect!

The simplest way to see if something is mildly random - if it follows a Gaussian distribution - is through a QQ plot. You plot the variables of the series you're interested in on one axis with manipulations of the same variable (which ensures it is Gaussian by construction) along the other, and if the scatter plots a neat diagonal line, your distributions roughly match and your variable is likely normally distributed. If it doesn't you may have a "wildly" random variable on your hands.

The following chart shows a QQ plot of three-month changes in various dollar exchange rates from mid-2006 to the present. Simply eyeballing the data shows that we can't draw a neat straight line through the scatter plot, suggesting the data is non-Gaussian (more rigorous statistical tests show this to be true) and the "fat tails" are clearly visible. It has been known for some time that financial market variables were not mildly random, but LTCM demonstrated just how dangerous assuming away wild randomness could be.


Now take a look at a similar plot below, only this time of forecast 3m changes (I calculated these using Bloomberg's history of quarterly forecasts relative to the 3m forward rates prevailing at the forecast date). Contrast the near perfect diagonal straight line below to the poorly fitting one above. Forecasts are mildly distributed along Gaussian lines (more formal statistical tests show this to be true). Thus, even though we know changes in financial market variables are non-Gaussian, our expectations of those changes remain Gaussian. We see the world in which we live as mild even though we know it's wild.


Why we all think we're great traders

I was dumbstruck in a recent meeting I did with Albert when one of the attendees, who was a well known tech bull in the late 1990s, dismissively claimed (with a completely straight face) that Albert's call to overweight bonds relative to equities in 1999 was "pretty consensus at the time really." This was a time when the tech mania was in full swing, when adding "dot com" to the end of a company name was enough to double its share price that day, when the Nasdaq was trading at a PE in excess of 50x, and when Jim Cramer was telling investors in his hedge fund that PE ratios were redundant because none of his favourite stocks even had earnings "so we won't have to be constrained by that methodology for quarters to come."4 Yet Albert's call to sell stocks and buy government bonds at this time was "pretty consensus"!

Niall Ferguson has given a brilliant example of how such "selective memory" can permeate the collective psyche. In his book "War of the World", his fascinating interpretation of the 20th century's rolling conflicts, he shows that pretty much any narrative of WW1 will painstakingly show how all the warning signs of an impending conflict were there and how inevitable the war must have seemed at the time. Germany and France almost came to blows in 1911 over Morocco in the Agadir crisis, a European arms race was in full swing as Russia committed in 1912 to rebuilding its military, and the Kaiser's determination to surpass Britain's naval supremacy was intensifying the armaments build-up in Germany and the UK. Indeed, at Germany's Imperial War council meeting of 1912, von Molkte even argued (now famously) for an immediate attack on Russia since war with her was "unavoidable, and the sooner the better." The march to war was clearly on, wasn't it ....

Well yes, with hindsight perhaps, but no-one realised it at the time. The now familiar historical notion is that a tension was slowly building up between the European powers and that this reached such a fever-pitch that by 1914, when Archduke Franz Ferdinand was assassinated in the Balkans, Europe was a like a barrel of gunpowder just waiting for a spark. But as Ferguson shows in his book, this notion is in fact highly dubious. It implies that everyone knew how significant the above events were at the time, which they did not.

Or at least, the bond market didn't. The chart below shows German bond prices (which were considerably higher than they had been a year earlier) had barely budged following the assassination of the Archduke, which ultimately triggered the "war to end all wars"!


The classic study on hindsight bias was done by Fischhoff and Beyth5 who asked their students to estimate probabilities for possible outcomes during Nixon's visit to China in 1972 before it occurred (for example, "what is the probability that the USA will establish a permanent diplomatic mission in Peking, but not grant diplomatic recognition"). What the subjects didn't know was that they would be later asked to recall those probabilities. But when they did, between two weeks and six months after the visit, they recalled that their estimate of events that did happen was much higher than their actual estimate had been, and likewise that their estimate of events that had not transpired had been much lower.

This hindsight bias helps explain our inability to see outliers. If you were perfectly rational in forecasting returns, an unexpectedly positive or negative number would widen your volatility estimate. But if you "knew it all along" you wouldn't accept that the return was unexpected. Your estimate of potential price volatility would be unchanged and you'd continue to disregard the possible outlier events as too unlikely because your forecast range would remain too narrow. This was actually evident when I put the data together for the QQ charts above. The standard deviation of the actual exchange rate changes was 5.7%; that for the forecasts was only 1.8%.

This over-confidence bias is well documented. In spelling tests, subjects who mark answers they're "100% certain" of are only correct 80% of the time. Where an error of 0% is expected, one of 20% occurs. But hindsight bias contributes to this natural pre-disposition towards overconfidence because if you think you predicted past events accurately, you'll think you can predict future events too.

If you ask a class of students how many expect to finish in the top 50%, come the end of the year around 80% will put their hand up. Similarly, I've been amazed at the number of clients who've told me they think "buy and hold is dead" and that "these markets have to be traded." For traders in the market, the odds are considerably worse than students in exams. Performance data typically show that around 70-80% of active managers underperform the indices6 while studies of brokerage accounts show similar odds for individual traders.

There is absolutely nothing wrong with "trading these markets" if that's what you love doing and it's what you're good at. But the evidence clearly shows that the vast majority of us aren't. Worse, the vast majority of those who think they are good at it aren't either, and they will be competing against traders who are. So my advice to anyone about to embark upon Einhorn's path of using macro to "actively manage your long-short exposure." is to think long, hard and honestly about what your sphere of competence actually is. Otherwise, the chances are that you'll be making your broker far happier than your investors.

So what is the point of macro research?

So if our confidence in our forecasting ability is for most of us more likely to be reflecting a cruel trick of our evolutionary development than any real ability, is macro research completely redundant? I don't think so. In fact, I agree with the second part of David Einhorn's conclusion in the excerpt above, of "when appropriate, buying some just-in-case insurance for foreseeable macro risk".

At this year's Berkshire Hathaway conference, Charlie Munger said that while most people and firms do whatever they can to avoid large losses, Berkshire Hathaway is designed to take them. "That's our edge", he said. When asked about his successor at the helm of Berkshire, Buffett said that the most important thing his successor at Berkshire must be able to do is "to think about things which haven't happened before." Most insurance companies lose money on their underwriting operations but make money on the float. Berkshire Hathaway makes profits on both. They haven't been able to do this because they've been better at predicting the future than the competition - they openly admit to not even trying - but because their whole approach is grounded in a) the understanding that "outlier" events happen every few years, and b) being patient enough to hold capital in preparation for deployment when such "outliers" inevitably arise.

There are two broad approaches to a more insurance-based approach. The first and most simple is the avoidance of the purchase of overvalued assets. Ensuring an adequate margin of safety against the unknown and unknowable future - rather than trying to predict it - is the central philosophy behind Ben Graham's concept of value investing and one of the simplest differences between investment and speculation. It's as important today as it has always been and is why a careful and prudent analysis of valuation is so important. This is why I spend what some might think is an unusual amount of time on equity valuation for a macro strategist.

The second approach is to focus on the "grey swans" - the tail risks which are predictable - by devoting time to thinking about them and to finding effective and efficient protective insurance should they happen. Most of the research Albert and I write aims in this direction. It is for most of us, I believe, a more fruitful use of macro research than trying to predict various markets' short-term moves. There is a very big difference. Some have interpreted my work on government solvency as a reason to short government bonds, and JGBs in particular. I've actually never suggested doing this. To get it right you have to get your timing right, and ? well ? see the above on how confident most of us (myself included) should be about that.

But just because you can't predict when something will happen doesn't mean you should act as though it won't happen. If, for example, you are as worried about the implications of what appears to be widespread public sector insolvency in developed markets as I am, there are numerous insurance products worth considering. Popular Delusions is of course a strategy product, and regulatory boundaries preclude me from making too specific recommendations, so I'm going to end by doing something I very rarely do: shamelessly plug my colleagues (look away now if you don't want to be soiled by such unbridled commercialism!).

I think it's fair to say that derivatives is one of SocGen's genuine competitive strengths. We have a world class and award-winning derivatives operation and, as far as I know, compete favourably with any other house on the street. So if you're like most of the clients I talk to and are interested in insuring against any of the scenarios Albert and I have explored in our research (whether an inflation crisis in Japan, the break-up of the euro, a funding crisis in the US, a Chinese hard landing) or indeed any that we haven't, but don't know the best way to do so, let me know and I will put you in contact with the appropriate members of the derivatives team here. Having sat down with them in recent months, seen them work and seen the tailevent hedges that can be squeezed out of the options market I'd be surprised if you weren't impressed at what can be done. I certainly have been.

Monday, June 21, 2010

Making Money on Businesses that Lose Money

Can an investor make great returns from a company that continues to lose money? Absolutely. This may sound counterintuitive; it seems strange that a business owner can make money on a business that loses money, but in the end it all comes down to the price that is paid for that business. When the margin of safety is so large that the company can lose money for years and still not erode the investor's principal, big profits can come from even companies that are experiencing losses.

Consider Sport-Haley (SPOR), marketer and distributor of fashion golf apparel. When we last discussed this company, it was losing a few hundred thousand dollars per quarter. Fast forward to today and it is still losing money, having lost almost $500,000 in the quarter ended March 31st, 2010. And yet, its stock price has almost doubled over this time frame!

Is this stock return just a lucky outcome? After all, how often can a company's earnings and its stock price appreciation have so little in common? My contention is that while there are some elements of luck involved (e.g. the investor cannot determine whether the stock price will be up a certain amount in such a short period), the investor puts the odds firmly in his favour when he considers an investment's margin of safety first and foremost when making an investment decision.

In the case of Sport-Haley, three months ago the company traded at a massive 80% discount to its net current assets! This means the company could continue to lose money for several years, and the investment principal would still be protected. It also means the potential for stock price appreciation is rather high. After the recent stock price run-up, the stock still trades at around a 60% discount to its net current assets.

Of course, no investment return or time frame is guaranteed. But when the investor buys at the right price (i.e. utilizes a large margin of safety), the odds of generating market beating returns are on his side.

Courtesy Baral Karsan

Sunday, June 20, 2010

BP: A Great Long-Term Value Play

Things just seem to be getting worse and worse for BP (BP). The company has been ordered to put $20 billion into an escrow account by President Barrack Obama (despite the fact he has no authority to do so), while oil continues to gush from the Deepwater Horizon rig which exploded several months ago.

The company has also suspended its dividend to shareholders, in an effort to quell attention from the US Government and population. BP (BP) is certainly feeling the fury of a public backlash, which really has been building since the financial crisis. Strange how these days we don’t see much about Goldman Sachs (GS) in the papers.

What exactly is the investment case for BP (BP)? The company currently trades at $31, for a market capitalization of just under $100 billion. This is in stark contrast to its market value of $191 billion, or $61 per share, less than six months ago.

There have no doubt been big losses in BP (BP) stock, where investors may have been drawn in at $50, and $40 and now sit with big paper losses. Investor behavior is strange though – if McDonald’s decided to lower the price of hamburgers today, would you avoid them? What if the price was cut by 50%? Why then do investors flee when a quality company is sold down by over 50%?

At $31, BP (BP) is incredibly attractively priced. The price to earnings ratio sits at a juicy 5 times, while the price to sales is just 0.37. The company is now trading below book value and has a price to cash flow of 3.05 times. There’s no other quality asset in the market trading on such a low valuation. The dividend yield is over 10% although dividends have been suspended. That’s the key word really: suspended. It’s my opinion that these dividends will be reinstated at some point in the future and investors made good on what is owed. It’s far more convenient to suspended dividend payments now in the face of public fury and pay them out at a later date, when nobody cares about the problem anymore. My money is on that occurring.

BP (BP) is an international oil and gas company, operating in more than 80 countries, providing its customers with fuel for transportation, energy for heat and light, retail services and petrochemicals products. Upstream activities include oil and natural gas exploration, field development and production, while Midstream activities include pipeline, transportation and processing activities related to its upstream activities. Marketing and trading activities include the marketing and trading of natural gas, including liquefied natural gas, together with power and natural gas liquids. The company is integral not only to the United States and United Kingdom economies, but the world’s oil supply chain too. As such, it’s not going anywhere.

While investors that are looking for immediate income should steer clear of BP (BP), I think the market is providing a golden opportunity for the more aggressive value investor. I believe given BP’s (BP) reserves and operations, the company is worth at least $200 billion, before the costs of litigation and related oil-spill expenses. That figure has been put at $20 billion at the moment, which would imply on a conservative basis perhaps a valuation of $160 billion. That’s 60% above the current market price and with the catalyst of restored dividend payments (in the form of a special dividend) in the future.

To see the BestCashCow Dividends page, click here.

Friday, June 18, 2010

World Cup an "Economic Turning Point"

The hosting of the 2010 Fifa World Cup presents an economic turning point for South Africa, Deloitte Touche Tohmatsu said on Thursday.

International communities were not only watching their countries fight for the Cup, but were also witnessing a South Africa that continued to emerge as a competitive 21st-century economy, the consultancy said in a paper entitled 2010 FIFA World Cup, A Turning Point for South Africa"

"South Africa is reaping the rewards of hosting the Cup - namely infrastructure improvements, an economic boost, and increased national self-esteem," it said.

South Africa had been likened to a mix of the developed and developing world, said Deloitte southern Africa public sector industry leader Lwazi Bam.

"On the one hand, a strong technological and economic base put it on a par with the well-developed nations of the world. On the other, infrastructure shortfalls have contributed to keeping it from realising its full economic potential."

Bam said the World Cup had acted as a catalyst for much-needed infrastructure improvements.

"The need to move tens of thousands of soccer fans, teams, and accompanying support personnel rapidly from one place to another prioritised the strengthening of South Africa's transportation system."

Bam said South Africa had completed much of the first section of its new high-speed Gautrain passenger railway and additional bus lines.

Moving towards greener energy sources

"Highways were upgraded and the city of Durban was able to finish the country's first new greenfield airport in five decades."

South Africa had already realised many of the benefits hoped for by any national host of a major international sporting event, said Deloitte Touche Tohmatsu global public sector industry leader Greg Pellegrino.

"The event has provided a boost to national infrastructure improvements, increased employment during hard times for the global economy, and provided a unifying rallying point for a still-developing nation."

The World Cup had brought renewed attention to the challenge of generating power without an unduly adverse environmental impact.

"New stadia built for the event include such environmentally friendly features as natural ventilation and rainwater capture systems.

"In addition, hosting cities have undertaken large-scale tree-planting projects in an effort to soak up excess carbon dioxide," Pellegrino said.

As a coal-dependent economy, South African faced challenges; however, these steps moved the country towards greener energy sources.

Pellegrino said that to ensure security, the minister of police had consulted with officials from more than 30 different countries whose nationals would be in the country, resulting in an unprecedented level of international cooperation involving South Africa.

"Seeking to balance a welcoming atmosphere with rigorous security standards, the minister of police has assigned 40 000 officers, 25% of its total force, to police the Cup.

"All of these activities have required a renewed spirit of cooperation between national and local agencies and departments."

He said that moving the World Cup from a developed economy such as Germany to an emerging economy such as South Africa, and to a continent that had never hosted the tournament, created an important precedent for future hosts such as Brazil in 2014.

Wednesday, June 9, 2010

Lost Ben Graham Speech Discovered

Jason Zweig has unearthed an original typewritten text of a speech Benjamin Graham gave in San Francisco one week before John F. Kennedy was assassinated. Says Zweig: In this brilliant presentation, Graham explores how an investor should go about determining whether the market is overvalued, how to tell what asset allocation is right for you, and how to pick stocks wisely.

Read the piece here, courtest Jason Zweig.

Ghana Wins S&P Equity World Cup

Standard & Poor's (S&P) on Wednesday crowned Ghana as the winner of the 2010 Equity World Cup.

"S&P Indices data charting equity performance between January to May 2010 have been used to simulate an 'Equity World Cup' that compares the relative performance of equity markets in the countries that have qualified for the football World Cup," the ratings agency said in a statement.

Nations were pitted against each other in accordance with the World Cup draw and the country with the better equity performance moved to the next round.

"Even before the first ball is kicked in South Africa, S&P Indices has crowned Ghana as the winner of the 2010 World Cup."

S&P said Ghana’s victory underlined a strong showing from a number of nations classed as emerging or frontier markets.

"Ghana heads the field with a rise in its equity performance of 50.73 percent in the first five months of 2010.

"Nigeria, beaten by Ghana in an all-African semifinal, also performed strongly with a growth of 19.97 percent."

S&P said that the Chilean market was down 5.48 percent but the country still made the semifinals was a testament to the weak average return across markets in Europe and North America.

"S&P Indices' Equity World Cup shows a string of results that stands in sharp contrast to the expectations for South Africa 2010.

"Spain remains the bookmakers’ favourite for the competition, but with its equity performance retracting by 37.49 percent in 2010, it was vanquished in the group stage of the equity simulation."

S&P said traditional football powerhouses Brazil and Argentina fared little better; Argentina (-6.93 percent) succumbed to Nigeria in the quarter-finals, while Brazil (-23.38 percent) was eliminated by Chile.

"A number of European markets have had disappointing returns in equity markets in 2010, reflected by the fact that Denmark was the only nation (-10.46 percent) to reach the last four."

Italy performed weakly in the S&P simulation and with an equity performance of -33.07 percent, the current World Cup holders were eliminated by Japan in the last 16.

S&P said England fans would also hope that the Equity World Cup was not a bad omen for the main event: "a poorly performing equity market (-19.67 percent) ensured defeat at the hands of the United States (-4.30 percent) and a crushing defeat to Ghana in the last 16".

"Football fans don't need to panic at the results of the Equity World Cup, but S&P's project will be of real interest to the investor community," said Marius Baumann, senior director Custom Indices EMEA.

"The excellent performance of Ghana and other frontier markets is a fascinating and emerging trend," he added. - Sapa

Tuesday, June 8, 2010

South African companies continue expansion into Africa

Metropolitan Holdings , which aims to create SA’s third- largest life assurer by merging with Momentum, has plans to earn at least 25% of its annual revenues from international operations within five years.

The group will even attempt to break into non-English-speaking countries as it prepares to take on the big players on the continent.

This year, however, the group would rather focus on consolidating its operations in Ghana and Nigeria, and also the merger with Momentum, one of the largest corporate deals to be concluded in SA so far this year.

The embedded value of Momentum — a subsidiary of FirstRand — was estimated when the deal was announced last month at about R18bn for the transaction, while that of Metropolitan was R12bn. The embedded value in insurance terms measures the present value of future profit plus net asset value of a life assurance company.

Metropolitan CE Wilhelm van Zyl said international expansion would secure adequate growth opportunities rather than merely becoming another means of diversifying its source of profits, and would also provide a cushion against the competitive nature of the new business landscape.

Mr van Zyl could not be reached yesterday to comment on how the merger with Momentum would affect Metropolitan’s international expansion.

The group joins a clutch of South African companies venturing further into Africa, targeting potentially high-growth markets such as Nigeria, whose large population makes it an attractive proposition for the financial and telecommunications sectors.

Standard Bank , Africa’s largest by assets, already has operations in Nigeria and is said to be eyeing further growth, while FNB and Nedbank are also known to be seeking out opportunities.

Mr van Zyl said Metropolitan was committed to deriving up to 25% of its earnings from international operations in five years .

In the year to December, it reported diluted core headline earnings of R934m, compared with R1,01bn the previous year, according to a five-year review in the report.

“Plans to establish ourselves in new countries are on hold for 2010 while we consolidate operations in Ghana and Nigeria … but we are planning to expand into at least three more African states within the next five years.

“In all likelihood, we will then also cross the self-imposed boundary of countries using English as their official means of business communication for the first time,” Mr van Zyl said.

Monday, June 7, 2010

McKinsey and BCG Believe in Africa

The spotlight is now shining brightly on Africa. Not only as a result of the Football World Cup will be hosted in South Africa, but also because some of the world’s most excellent think tanks are now endorsing the continent as a place with a bright and prodigious future.

During this week alone, apart from the habitual parties such as the OECD, The African Development Bank (AfDB), the United Nations Economic Commission for Africa (UNECA), both the Boston Consulting Group and McKinsey, have published research papers that make the case for continent’s bright future.

Could the advent of the first Africa hosted football world cup be the inspirational factor behind this? Possibly so but we tend to think that Africa’s shiny reality has now become impossible to ignore when contrasted with the economic hardship most of the world is going through.

All these efforts have produced so much insight and material that we are struggling to choose what to exactly to feature in this special update. We thought we’d let others do the storytelling about the opportunities in Africa for a change. Both groups make similar conclusions that the economies are steadily growing and that the opportunity it is not only about resources but more about economies that are increasingly diversified across different sectors. Hopefully the below serves as a good summary of the key points.

BCG’s African Challengers

The Boston Consulting Group released a study titled the “African Challengers, Global Competitors Emerge from the Overlooked Continent”. Africa’s top 40 companies are emerging as competitors on the global stage, propelled by economies whose performance now rivals the BRIC nations.

According to the study, 500 African companies have been growing at more than 8 per cent a year since 1998. The report selects the top 40 among them, ranging in size from $350m to $80bn, and argues that these companies, already regional players in mining, consumer industries and services, are now well positioned to “spread their wings and look beyond the continent”

The report also highlights the fact that between 2000-2008 Africa’s annual GDP grew by 5.3% (adjusted for purchasing power parity) compared with 4% globally and single out that the local equity markets also outperformed global indices. They single out Egypt’s 39% annual returns compared with 2% for the MSCI World.

In addition, while the great recent recession shrunk most economies, the continent’s GDP still expanded by 2% during 2009. During the same period, the USA dropped by 4% and Europe’s dropped by 2.8%. while averages can be suspect, 60% of the continent’s GDP is shared by Algeria, Morocco, Egypt, Nigeria and South Africa. We find it refreshing that, just like us, they chose to use the term ‘Lions’ as a metaphor for the top economies in the region.

Another point that is made is that these ‘Lions’ have a GDP/Capita which exceeds that of the so-called BRIC nations. The GDP/capita of these two groups are $10,000 and $8,800 respectively. Great diversity exists between the Lions and the BRICs but their development rests on similar pillars.

Going back to the African Challengers, BCG highlights that the keys to success that most of these companies share and have allowed them to prosper lies in

· The benefit from doing business in a place where with many native advantages, including natural resources, cheap labor and a fast growing population that is unencumbered with legacy technology and systems.
· They enjoy a beneficial business environment that includes market deregulation, national economic-development policies, and commodity prices that, for most of the past decade, have been rising.
· They share a challenger mindset – a willingness to be bold and to recognize that a challenging economic environment is an opportunity to be creative and expand globally.

During the decade between 1999 – 2009, the Compounded Annual Growth Rate (CAGR) for shareholders of the Challenger companies with more than double the returns of the MSCI Emerging Markets Index and more than 20 times that of the S&P 500 over the same period!

Finally, the point is also made that many Western companies are trying to do business in Africa, some gain access by investing in local companies while at the same time, many of these African companies are – or will become stiff competitors, even outside of the continent.

McKinsey’s drivers of African Growth

McKinsey Quarterly also released a report on Africa this week. The publication is titled “What’s driving Africa’s growth?”.

The report highlights that the rate of return on foreign investment is higher in Africa than in any other developing region and that Global executives and investors ‘must pay heed’

They highlights that Africa’s collective GDP at $1.6 trillion in 2008 is now roughly equal to that of Brazil or Russia. The continent is now among the world’s most rapidly growing economic regions and that this acceleration is a result of hard-earned progress and promise.

They make the point that natural resources and the related government spending they financed only accounted for 32% of Africa’s GDP growth during the past decade. The remaining two thirds came from other sectors, including wholesale and retail, transportation, telecommunications and manufacturing. Economic growth accelerated across the continent, in 27 out of the 30 largest economies. Countries with and without significant resource exports had similar growth rates! This clearly challenges the general perception of investors that Africa is essentially a commodity play.

The long term growth prospects will be driven by :

· Global economic ties: although this story about more than just resources, global demand for oil, natural gas, minerals, food, arable land, etc will continue to act as a support factor for Africa’s economies
· The rise of the African urban consumer: the long-term growth will increasingly reflect social and demographic changes creating new domestic engines for growth.

A key driver for changing demographics will be urbanization, an expanding labor force, and the rise of the middle-class African consumer. People living in urban areas increased from 28% in 1980 to 40% at present. The continent has more than 500 million people of working age, this number will increase to 1.1 billion by 2040, more than in China and India. Over the past 20 years, 75% of the continent’s increase in GDP per capita came from an expanding workforce, the rest from higher labor productivity. If Africa can provide its young people with the education and the skills they need, this large workforce would become a significant source of rising global consumption and production.

While Africa’s collective long-term prospects are strong, the growth trajectories of its individual countries will differ. Economists have traditionally grouped them by region, language, or income level. McKinsey takes another approach, classifying 26 of the continent’s largest countries according to their levels of economic diversification and exports per capita.

· Diversified economies – Africa’s growth engines: Egypt, Morocco, South Africa, Tunisia
· Oil Exporters - Enhancing growth through diversification: Algeria, Angola, Chad, Congo, Equatorial Guinea, Gabon, Libya, Nigeria
· Transition Economies - building on current gains: Cameroon, Ghana, Kenya, Mozambique, Senegal, Tanzania, Uganda, Zambia
· Pretransition Economies – DRC, Ethiopia, Mali, Sierra Leone


Everyone seems to be chanting to the same tune. We have all noticed a strong increase of visits by heads of state from developed countries to the region over the past few months and they are all clearly trying to forge closer ties with the local leaders. It is also more than well known that China and India are aggressively expanding their activities across the African continent.

Many leading corporations of the developed world are trying hard to gain market share in Africa. It has become a competitive environment and the foreign entrant is often faced with the reality that they at times are competing with indigenous regional players who have expansion strategies of their own. The fact that the major consulting and accounting firms have set up shop across the continent is yet another piece of evidence that there is serious business to be done there.

So if all these organizations and countries are trying so hard to get into Africa, why are professional international portfolio investors taking so long to invest there? If we had a rational answer, we would be delighted to share it with you but unfortunately we don’t. What we do know is that investors are certainly running out of excuses not to start investing in Africa. The African markets have only begun and the investors will eventually come…

The reports can be found on:

Boston Consulting group: here
McKinsey: here

Courtesy Silk Invest

Thursday, June 3, 2010

Setting Up Increased Trade between Africa and India - the Next Big Trade Route

South African President Jacob Zuma is currently on an official state visit to India accompanied by a trade delegation of leading South African business people. Nimesh Kampani, Chairman of JM Financial Group, and Sizwe Nxasana, CEO of FirstRand, signed this landmark MoU during the conference organised in Mumbai as part of this state visit.

Trade and investment between Africa and India is significantly on the rise, with India set to become one of Africa's major trading and investment partners over the next decade.

The bilateral trade between India and Africa is likely to grow by an estimated 22 percent in the next two years from the current levels of close to $45 billion to $55 billion in 2012.

Both economies offer tremendous growth potential given their large consumer base. The MoU signed between RMB and JM Financial will enable corporates at both destinations to explore and leverage opportunities in the economies of India and Africa.

According to the MoU, JM Financial and RMB will jointly provide M&A advisory services to:

- Indian clients seeking to make investments into entities or transactions in Africa; and
- South African and African clients seeking to make investments in entities or transactions in India.

Nxasana commented: "A partnership between RMB and JM Financial will unlock significant value for both parties by leveraging their individual expertise and sharing distinctive local market knowledge for the benefit of clients and shareholders."

In addition RMB's parent, FirstRand, is one of the largest financial services groups in Africa, and will provide JM Financial with opportunities to enhance its service to its domestic customers seeking to do business in Africa.

FirstRand also brings significant balance sheet capability to support future investment flows in the Indo-African corridor.

"This co-operation represents a significant step in furthering both RMB's and the Group's strategy to grow in the Indo-Africa corridor."

Kampani said: "In recent years, several Indian companies have shown interest in Africa. Both, Africa and India, are vibrant emerging economies, each with a rich resource base, a vast talent pool and low cost business models, offering immense business opportunities to investors, and thereby being a favourite investment destination world over."

"JM Financial's strong advisory and execution capabilities along with RMB's market knowledge and expertise will enable both parties to provide its clients with valuable advice and service. We are delighted to partner with RMB and FirstRand."

Also: South African President Sets Target of $10 billion trade between India and South Africa

- I-Net Bridge

Wednesday, June 2, 2010

Estimating the Magnitude and Age Distribution of Lifetime Healthcare Expenditures

Research Paper by Berhanu Alemayehu and Kenneth E Warner

Principal Findings:
Per capita lifetime expenditure is $316,600, a third higher for females ($361,200) than males ($268,700). Two-fifths of this difference owes to womens' longer life expectancy. Nearly one-third of lifetime expenditures is incurred during middle age, and nearly half during the senior years. For survivors to age 85, more than one-third of their lifetime expenditures will accrue in their remaining years.

Given the essential demographic phenomenon of our time, the rapid aging of the population, our findings lend increased urgency to understanding and addressing the interaction between aging and health care spending.

Link to Full Paper

Tuesday, June 1, 2010

India steps up coal search in South Africa

India's Tata Power, the country's largest private-sector utility, is looking for coal resources in Indonesia and South Africa, a senior official said on Tuesday.

Speaking at the Coaltrans conference in Bali, J.K Niyogi, head of project, said Tata Power forecasts coal imports to surge to 22 million tonnes per year by 2014, from 5 million tonnes per annum in 2009

Tata said in March its trading unit is looking to help arrange coal supplies from Australia, Indonesia and Africa for small power producers amid a growing shortage of the resource in India.

- Reuters