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Northstar Asset Management
Market Report: Q3 2017
Page 1 Big picture thinking
Why invest offshore? Adrian Clayton
Page 4-7 From the analysts: equities Free cash flow. Rory Spangenberg
Super Group. Marco Barbieri
Page 8 From the analysts: fixed income Fixed income investing. Mark Seymour
Page 10 Client corner & Northstar news
General news & change of management company. Matthew Bertram
Page 11 Chatter in the corridors
Please mind the gap. John Steenhuisen
Page 13 Advisor corner
Buying high and selling low. How to guide your
clients away from this common mistake.
Daniel Esterhuyse & Nick De Villiers
Page 15 Staff member profile Operations. Ludi Cronjé.
RESEARCH-DRIVEN | LONG-TERM FOCUSED
Page | 1
This quarter we compare investing in South Africa with offshore investing. We look at how analysing a
company’s free cash flow can point to worthwhile investments and John Steenhuisen discusses the
accountability gap in South Africa.
NORTHSTAR MARKET REPORT 3rd Quarter 2017
THE BIG PICTURE
SEVEN REASONS TO INVEST OFFSHORE
By Adrian Clayton
Potential for significant re-rating of SA assets if pol-itics falls into place
As we race towards the 54th Annual Conference of the ANC
in December 2017, it is unsurprising that a deep obsession
on the pending election of a new ANC party leader domi-
nates news wires and corporate boardrooms.
Although the outcome of the elective conference is pivotal
to South Africa’s immediate socio-political and economic
future, we take a step back and ask ourselves the question:
Does it make more sense for a South African to invest off-
shore or in South Africa?
Before elaborating, we must make the point that the initial
purchase price on any investment is the single most control-
lable factor in determining prospective (future) returns.
With this in mind, the JSE has severely underperformed oth-
er emerging markets in recent times.
Foreigners have withdrawn R80bn of capital from the do-
mestic market this year alone, and sentiment is uniformly
negative towards the local bourse. This has culminated in
poor domestic returns for a number of years. In addition,
the rand remains undervalued on numerous conventional
metrics.
In light of this, any market-friendly political shift in Decem-
ber could have a profoundly positive affect on most rand-
based assets, this would mirror similar market reactions in
other emerging markets after constructive regime changes.
However, this does not detract from the long-term merits of
South Africans internationalising their assets, and we pro-
vide seven reasons to validate this view.
Seven reasons to invest abroad over the long-term
1. Global equity adds favourable risk versus return metrics
to a domestic portfolio
Over the past 5 and 10 year periods, in rand terms, global
equities have outperformed SA equities. These returns have
also occurred with lower levels of volatility than domestic
equities. Sure, over 100 years, the JSE is the best performing
market globally, but in decades past we were isolated from
foreign competition and SA companies earned abnormal
returns on capital. Over the past 35 years, probably a better
reflection of the new world, offshore equities have outper-
formed our market. Interestingly enough, combining global
and offshore equities, gives high returns with lower levels of
risk than owning each on their own.
Figure 2 on the following page shows this rather nicely.
Figure 1. Emerging markets vs. South Africa Source : Bloomberg, Northstar
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90
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130
150
Aug 15 Fe b 16 Aug 16 Feb 17 Aug 17
Emerging markets vs. South Africa (USD)
MSCI EM Index ALSI Index
Northstar Market Report Q3 2017
Page | 2
2. Lower levels of concentration risk
The top 15 companies on South Africa’s All Share Index ac-
count for 63% of the value of the entire market. Compare
this to the top 15 companies that constitute the MSCI World
Index; they account for a mere 14% of the total value of that
index. Our largest stock has a weighting of 17% of the ALSI –
as you know, this is Naspers. Bet against it as a domestic
manager and if it returns almost 50% as it has done in 2017,
you are left for dead. Conversely, it is certainly not without
its own risks and should these materialize, a 17% position
could well fizzle to nothingness and bang, that’s capital deci-
mation for clients!
Comparing this to the largest company on the MSCI: Apple.
It has a weight of less than 2% of the index. The 15th largest
company in the MSCI All World Index is Berkshire Hathaway,
it is less than 1% of the index. An offshore investor does not
need to take outsized bets against the MSCI to outperform,
clearly if beating the index is the acid test for success, a
South African manager is forced into some significant binary
decisions relative to what is required abroad. Most im-
portantly, from a client’s perspective, the risk being taken to
beat offshore markets is significantly lower than the risks a
manager takes back home in SA.
3. Infinite selection of options abroad
There are thousands of investment options on the global
stage versus a more restricted offering in South Africa. Simp-
ly comparing the MSCI World iShare versus the Satrix cre-
ates perspective in terms of the number of companies with-
in those indices and the underlying opportunities within
specific sectors. The Satrix is made-up of 129 companies;
the MSCI World (iShares) comprises 1149 stocks. In terms of
specific sectors, there are 8 times more financial stocks, 9
times more consumer discretionary stocks, 15 times more
industrial stocks, 60 times more information technology
stocks, and 74 times more energy companies within the
MSCI World iShares Index than is the case for the local Sa-
trix.
4. Country weightings
Our market represents 0.8% of the MSCI World Index. The
largest market is the United States at 50.4% of the index,
with Japan second at 7.7%, and the UK third at 5.7%. Assum-
ing an investor was to track the MSCI, the South African
weighting would constitute less than 1% of their allocation.
Most South African investors are invested in precisely the
opposite direction; nearly all their capital is deployed in
South Africa.
An extra layer of perspective with respect to the insignifi-
cance of our market versus others is revealed when we look
at the market sizes of Apple, Microsoft, and Facebook.
Northstar is not suggesting that these stocks are sized cor-
rectly, but it is illuminating that Apple is larger than the en-
tire South African market, Microsoft is approximately 80% of
the size of our entire market, and Facebook not too far off.
5. Exposures to diverse sources of growth
South African investors point to Naspers as a good reason to retain their investments in South Africa, the comment be-ing: “we do not need to externalize our capital, we have access to a host of international industries, even new-age technology, just look at Naspers”. Naspers is a great busi-ness, Tencent has performed superbly and enjoys an unri-valed franchise in China. However, as per the attached graph, Naspers is not unique and in fact, it has underper-formed similar businesses which are not accessible on the JSE – since 2008, Apple’s returns have matched Naspers whilst Netflix and Amazon have significantly outperformed Naspers. See figure 4 on the next page.
Figure 3. Market capitalisation of the ALSI vs US large caps ($ millions). Source : Bloomberg,
Northstar
SA Equity
SA Bonds
Cash
Gl. Bonds
$Cash
Gl. Equity
SA Equity 5 0% Gl. Equity 5 0%
8.6%
18.6%
0%
5%
10%
15%
20%
25%
0% 5% 10% 15% 20% 25% 30%
Return (ZAR)
Risk (Standard deviation)
Asset class performance 35 years
A sset classe s SA Equity 50% Gl. Equity 5 0%
Inflation Inflation plus 9.3% (average )
Figure 2. Asset class returns vs standard deviation. Source : Bloomberg, Northstar
0
2 00 000
4 00 000
6 00 000
8 00 000
1 000 000
2007 2009 2 011 2013 2015 2017
Market capitalisation (USDm)
All Share Index Apple Inc.
Microsoft Corp. Facebook Inc.
Northstar Market Report Q3 2017
Page | 3
7. Access to higher quality industries
Our 7th and final point is, in our opinion, the most im-pactful. McKinsey has explored industries with the highest returns on invested capital (ROIC) and the extent to which they are represented within various global indices. The JSE is under represented in terms of industries with high return characteristics when compared to the likes of the S&P. Not only is the JSE under-represented in terms of high-returning industries; it is also over-represented relative to the S&P in terms of poor-performing industries. Excluding Naspers, the JSE has 10% exposure to high performing in-dustries when returns on invested capital is the measuring yard stick. The S&P on the other hand, is 36% represented
by these top return industries. Top performing industries
include the likes of Software, Pharmaceuticals, IT services
etc.
With respect to low-performing industries, 13% of the JSE
SWIX falls into sectors or industries that deliver low returns
on invested capital over time – these industries include
chemicals, metals and mining, paper and forest products.
The S&P weighting to low ROIC sectors is a mere 2.4%.
For a long-term investor focused on buying into industries
with sustainable return characteristics, we believe the JSE is
fundamentally disadvantaged in terms of this metric com-
pared to the S&P.
Conclusion
We are not suggesting that investors liquidate every South
African investment and ferry this off to foreign shores. In
each case, a financial plan should determine how capital is
allocated. We are also mindful of the chance for a positive
surprise in December which could re-rate domestic assets.
However, over the long-term, we believe that the breadth
and depth of opportunities abroad combined with all the
reasons we raise above, provides compelling evidence for
South Africans to actively diversify excessive SA asset expo-
sure into foreign markets.
6. Access to better performing businesses
Another favourite stock amongst South African investors is Richemont and we understand why. Hard luxury has a strong heritage factor, cannot easily be replicated, de-mographics are playing into its hands and the business has been well navigated by Johan Rupert and his various man-agement teams over the years. However, none of this detracts from the fact that, over the last few years, rival LVMH has performed better. On all im-portant metrics, LVMH has outperformed Richemont since 2014 – this includes revenue growth, gross profit growth, free cash flow generation and earnings per share. This has translated into significant share price outperformance of LVMH versus Richemont over the past number of years – please see figure 5.
50
100
150
200
Dec 13 Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Dec 16 Jun 17
Richemont, LVMH - price return comparison (USD)
Richemont LVMH
Figure 5. Relative performance: Richemont vs. LVMH. Source: Bloomberg, Northstar
-1 000
0
1 000
2 000
3 000
4 000
5 000
2008 2010 2012 2014 2016
Naspers, Apple, Amazon, Netflix - share performance
Naspers 34.2% ann. Amazon 40.6% ann.
Apple 35% ann. Netflix 53.5% ann.
Figure 4. Returns for high growth shares: Naspers vs. others. Source : Bloomberg, Northstar
Northstar Market Report Q3 2017
Page | 4
FROM THE ANALYSTS: EQUITIES
FREE CASH FLOW—A USEFUL MEASURE TO IDENTIFY COMPANIES WORTH
OWNING
By Rory Spangenberg
A focus on free cash flow
At Northstar we spend most of our time trying to under-
stand the intrinsic value of a business, with the aim of
making an investment at an appropriate discount.
A primary area of focus and a measure which speaks vol-
umes to the quality of the business in question, is its abil-
ity to consistently deliver a high level of free cash flow,
defined as the cash generated after capital expenditures
to maintain or expand its operations.
While plenty of effort at Northstar is expended in building
a model of future cash flows, discounted to suggest a rea-
sonable estimate of the present value of the business; we
find that the market itself gives us a very clear picture of
its expectations for future cash flows. From the current
market price, we are able to back-out the implied in per-
petuity growth rate by solving for g in the following equa-
tion:
Present Value (PV) = Free Cash Flow (FCF) / [Weighted
Average Cost of Capital (WACC) – g]
Not that we consider ourselves deeply contrarian in any
way, but from time to time, the collective wisdom of the
market tends to be overcome by a level of excessive pessi-
mism or euphoria, from which we are able to profit. Two
recent examples of businesses in which we have invested,
offer an opportunity to describe this framework in a prac-
tical sense.
Apple and Gilead both have exceptional track records of
delivering growth in free cash flow per share, quite clearly
a function of their respective high margin smartphone and
pharmaceutical franchises. Despite their exemplary rec-
ords, the market began questioning future growth pro-
spects for both businesses, as the very high rates of
growth to which it had become accustomed began to tail
off in late 2015.
By solving for the implied growth rate – g – in the equa-
tion above, we were able to determine that in April 2016,
with the share price at $91, Apple’s market valuation was
discounting a free cash flow growth rate of -5.8%: in per-
petuity! At that point, Apple shares traded on a forward
Free Cash Flow Yield of 15.1%, premised on the fact that
analysts were expecting the company to generate more
than $54 billion in free cash flow in the coming 12
months. Admittedly, this was below the $60 billion esti-
mate a few months earlier, but the implication that one of
the most innovative companies in history, with one of the
strongest consumer franchises ever seen was going to be
going backwards by 6% forever, seemed a very unlikely
prospect in our minds. To put the valuation in context,
Apple’s 15% FCF yield compared to the S&P 500’s FCF
Yield of 5%.
-4
0
4
8
12
16
Aug 07 Aug 09 Aug 11 Aug 13 Aug 15 Aug 17
Free cash flow per share (USD)
Gilead Apple
Figure 6. Free cash flow Gilead vs. Apple. Source: Bloomberg, Northstar
20
40
60
80
100
120
140
160
180
25 000
30 000
35 000
40 000
45 000
50 000
55 000
60 000
65 000
2011 2012 2013 2014 2015 2016
Apple - consensus free cash flow vs share price
Consensus 12m forward FCF (LHS ) Price (RHS)
Figure 7. Apple Consensus 12m forward free cash flow vs. share price . Source : Bloomberg,
Northstar
Northstar Market Report Q3 2017
Page | 5
We have not been surprised by the subsequent strong
gains in Apple’s share price to $160, a level at which we
believe a more likely implied growth rate of ~2% is dis-
counted and at which we have been reducing our share-
holding in the company.
Another, more recent, example of the pendulum of mar-
ket sentiment swinging in our favour has been Gilead,
leading producer of Hepatitis C and HIV drugs. While we
would be the first to admit that Gilead faces a tougher
challenge than Apple, we nevertheless believed that at -
8.4%, the implied FCF growth rate in January this year was
painting too severe an outcome for a business generating
$13 billion in FCF and spending $3 billion on R&D annual-
ly. In-line with the “peak pessimism” valuation of Apple,
Gilead shares traded on a forward FCF Yield in excess of
15% in late January.
Supported by the valuation and robust FCF generation,
the investment case was partly premised on Gilead’s abil-
ity to “buy themselves out of trouble”.
We anticipated that, in the absence of any accretive ac-
quisition opportunities, Gilead would embark on a large
share buyback program in order to return all the free cash
to shareholders. As it happens, Gilead recently announced
the acquisition of Kite Pharma, an innovative oncology
drug company, for $11 billion. While the share price had
drifted lower after our purchase at $69 in January, it sub-
sequently rallied to $85, at which point we chose to sell
your shares in the company.
The examples of Apple and Gilead are probably quite ex-
treme, but we find that a reliance on FCF and FCF Yield as
measures of fundamental quality and value leads to a su-
perior risk adjusted outcome relative to traditional value
measures such as Price-to-Book and Price-Earnings Ratios,
which tend to favour unloved and often poor businesses,
leading to a considerably more volatile outcome and occa-
sionally a permanent loss of capital.
Figure 9. Gilead implied in perpetuity free cash flow growth vs. share price. Source : Bloomberg,
Northstar
50
70
90
110
130
150
170
-8 %
-6 %
-4 %
-2 %
0%
2%
4%
Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17
Apple - implied in perpetuity FCF growth
Implied FCF Gro wth (LHS) Price (RHS)
Figure 8. Apple implied free cash flow growth vs. price. Source : Bloomberg, Northstar
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110
120
-1 0%
-8 %
-6 %
-4 %
-2 %
0%
2%
Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17
Gilead - implied in perpetuity FCF growth
Implied FCF Growth Price (RHS)
Northstar Market Report Q3 2017
Page | 6
FROM THE ANALYSTS: EQUITIES
SUPER GROUP
By Marco Barbieri
Background
Super Group is a leading transport logistics and mobility
group providing end-to-end supply chain solutions, fleet
management, and dealership services to a diversified
global customer base. The share has been one of
Northstar’s long-term holdings in our unit trusts and a
strong contributor to performance over the past few
years.
Rising from the ashes
Super Group was founded in 1986 by Larry Lipschitz. The
business expanded quickly under Lipschitz as he made
various acquisitions over his 22-year tenure. This coincid-
ed with escalating debt - in mid-2008, the Group had gear-
ing of 72% and a history of poor returns to shareholders.
At the time, various significant shareholders, the likes of
Allan Gray and Sanlam assisted with recapitalizing Super
Group and in 2009, the company raised R1bn of capital at
45c a share. Ironically, Peter Mountford re-joined the
company in 2009 as CEO; he had left the company in 2001
as a result of a difference of opinion on strategy at the
time. Under Peter’s guidance, Super Group has complete-
ly transformed and has delivered exceptional returns to
shareholders. The attached graph shows how the compa-
ny has enjoyed a re-rating in valuation from 2009 as the
rights issue improved the balance sheet, reduced risk of
default, and new management carved-out a successful
strategy.
Business segments
As we indicated above, Super Group underwent a signifi-
cant transformation over the last few years through a
series of acquisitions. Management have successfully re-
shaped a predominantly South Africa centric business into
a well-diversified group with significant operations in Aus-
tralia, Continental Europe and the UK. Despite much M&A
activity, Super Group is now not heavily geared (net debt-
to-equity of 32%) and remains a highly cash flow genera-
tive business exposed to several drivers.
Rationale for acquisition-led strategy
In 2017, the South African logistics and automotive deal-
ership business accounted for approximately 50% of Su-
per Group’s operating profit, significantly lower than 2010
levels of 80%. While these divisions are exposed to a di-
verse set of retail and industrial customers across several
industries and have performed well over many years, they
remain broadly exposed to difficult and constrained South
African economic factors. Super Group’s acquisition-led
strategy has achieved not only geographical diversification
(see figure 12 on the next page), but has also exposed the
business to attractive and high growing industries as set-
out below.
Figure 10. Market capitalisation of Super Group in R billions. Source: Bloomberg, Northstar
Figure 11. Super Group operating profit FY 2017. Source: Bloomberg, Northstar
0
5
10
15
20
1995 1998 2001 2004 2007 2010 2013 2016
Super Group - market capitalisation (ZARBn)
14%
9 %
21%
6%7%
44%
Super Group - operating profit - FY2017
Dealership South Africa
Dealership UK
Supply Ch ain SA
Supply Ch ain Europe
(intime)
Fleet Afric a
SG Fleet (A ustralia) (after
minorities)
Northstar Market Report Q3 2017
Page | 7
New business focal areas: Australian fleet and no-vate market
Following the recent acquisition of NCI in Australia, SG
Fleet now accounts for approximately 30% of group profit
after tax. The Australian fleet and novated leasing busi-
ness has grown significantly since its listing in March 2014
and due to the industry’s fragmented and under-
penetrated nature, it continues to be an attractive oppor-
tunity. Furthermore, management has expressed interest
in pursuing further M&A opportunities at the right price in
this space. We believe the novate lease space, in particu-
lar, is attractive after the Australian Government last year
created more certainty around fringe-benefit tax which
could have had negative consequences for Super Group’s
business model.
European logistics
In 2015 Super Group acquired a controlling stake (75%) of
IN tIME, a time-critical delivery, services company head-
quartered in Germany, for a consideration of R1.85bn
(constituting 7% of group operating profit in 2017). While
the division has faced headwinds over the last two years,
mainly as a result of lower volumes attributable to their
large client, Volkswagen, facing an emissions scandal,
management remains confident of IN tIME’s medium-
term prospects and expects synergies to be realised. Su-
per Group views M&A in this space as earnings accretive
and has recently acquired an 89.5% interest in Ader, an-
other express transport operator, to establish a direct
presence in Spain.
UK dealership
The third area of expansion has been the acquisition of a
series of automotive dealerships in the UK under the Allen
Ford brand, with the latest acquisition of Essex Auto
Group and Slough Motor Corporation (2017) taking the
business contribution to 23% of group revenue. The divi-
sion has performed well ahead of industry benchmarks
and despite a slowdown of vehicle registrations this year
and fears over the potential impact of Brexit, we believe
the medium-term outlook remains positive. Another key
attraction of these investments is that motor dealerships,
that are well-positioned within the UK from a location
perspective, are literally impossible to replicate due to
space constraints. Consequently, these properties will
become extremely valuable over time.
Cash flow generation underpins investment case
The continued successful execution of the company’s
M&A strategy and impressive cash flow generation under-
pins Super Group’s investment case. Super Group has ex-
cellent free cash flow conversion and is currently display-
ing an attractive forward free cash flow yield relative to
South African industrial peers – see figure 13 below.
As our clients are aware, we rate all businesses on the
following factors – management, industry, moat and valu-
ation. We rate this management team highly and believe
they act as superior capital allocators on behalf of share-
holders. Super Group operates in certain resilient and
attractive industries, the most obvious being European
logistics. It also operates in industries where margins are
possibly too high, barriers to entry low and legislation
could potentially be destructive - its’ Australian operations
fall into this category. As far as a moat is concerned, we
do not see Super Group as being a company with castle-
like moats, but it is not devoid of client hooks either. In
conclusion, at current price levels, the company has just
surpassed our view of intrinsic value.
Figure 12. Group revenue Super Group. Source: Bloomberg, Northstar
Figure 13. Super Group Forward free cash flow yield. Source: Bloomberg, Northstar
0
5 000
10 0 00
15 0 00
20 0 00
25 0 00
30 0 00
35 0 00
FY 2010 FY 2011 FY 2012 FY 2013 FY 2 014 FY 2015 FY 2016 FY 2017
Super Group - revenue
Rest of World (Aus, UK, Europe) South Africa (incl other African expos ure)
9.7%10 .3%
8.6%
7.2%
5.7%
0.9%
0%
2%
4%
6%
8%
10%
12%
SUPER GROUPLTD
NAMPAK LTD IMPERIALHOLDINGS LTD
BAR LOWORLDLTD
BIDVESTGROUP LTD
GRINDROD LTD
Super Group - forward free cash flow yield
Northstar Market Report Q3 2017
Page | 8
FROM THE ANALYSTS: FIXED INCOME
FIXED INCOME INVESTING 101
By Mark Seymour
The basics of bonds
I chose to write on the topic of understanding bonds
as we often gloss over the intricacies of fixed income
investing with an unfair expectation that all our clients
comprehend exactly what we are talking about. What
follows is an introduction to fixed coupon bonds and
the characteristics of this debt instrument.
What is a bond?
A bond is a loan made by a borrower. The entity that
does the borrowing is called the issuer and they do so
by issuing a bond. The investor (bondholder) lends
money to the issuer and in return receives a steady
stream of income (in the form of coupons) as well as
the original capital back from the issuer on the date
the bond matures.
Fixed income investors tend to monitor the following
when it comes to assessing which bonds to own:
The yield to maturity – the nominal return for a
bond held to maturity.
The maturity date – the date the bond matures
and the issuer pays back the principal.
The duration – A measure of risk which indicates
the price sensitivity of the bond relative to a
change in the bond’s yield. For example a duration
of two years indicates that the price of the bond
can be expected to drop by 2% in the event of the
bond’s yield rising by 1%.
Credit rating – An assessment of the creditworthi-
ness of a borrower and the likelihood of the bor-
rower defaulting on the loan.
Other features include: how often coupons are
paid and whether the issuer has the option of pay-
ing back the loan before the maturity date.
Bond features that make them similar to equities
Bonds trade at a price, although the convention is
to quote the bond’s yield-to-maturity. This is a
function of the price, the size of coupon and ma-
turity date.
The investor (bond holder) receives an income.
The investor can realise a capital gain or loss as a
result of bond prices which fluctuate in the same
way share prices fluctuate.
Bond features that make them different to equi-
ties
How bonds are quoted
As mentioned above, bonds are quoted by their yield
as opposed to their price. The reason being that bonds
trade at a value which is relatively close to their issue
price (there are exceptions) and as a standalone figure
this price is not very useful to the investor. By combin-
ing three figures:
1. the coupon
2. the maturity date (the static figures) and
3. the price (the variable) one can calculate the yield -
to-maturity. So instead of quoting the price, the
market quotes the yield-to-maturity, a far more
useful means of understanding bond values.
An equity investment, by comparison, involves too
many variables to simply calculate an expected return
or yield-to-maturity. Dividends are not static, shares
have no maturity date and the market is the sole de-
cider of value.
Coupon payments are fixed
Bonds are relatively straight forward investments. As a
bondholder, you receive a regular income which does
not change over time. The advantage is the bondhold-
er knows exactly how much income is received over
any given period, making it suitable for investors with
specific income requirements.
By contrast, an equity investment may or may not pay
a dividend and the dividend fluctuates over time.
Northstar Market Report Q3 2017
Page | 9
As a shareholder, you stand in line to receive an in-
come (dividend), depending on the availability of earn-
ings and management’s needs for further investments.
Good businesses with good management can deliver a
steady income which grows over time. In this case divi-
dends are more attractive than fixed coupons, but do
not come with the same guarantee offered by bonds.
Bond investors face the risk of escalating inflation
Although a bond investment that is held to maturity
may provide guaranteed nominal returns, there is no
guarantee that an investor’s capital will grow in excess
of inflation. In this instance, inflation is the variable
and the bond holder may realise a return which is be-
low inflation, resulting in a scenario where the ending
capital cannot buy as many goods as the original in-
vested capital could at the start.
An equity investment however, can generate dividends
which are linked to inflation and result in an outcome
where an increasing amount of goods can be bought
over time on a fixed amount of shares. Once again, this is
a very attractive quality of an equity investment, howev-
er, equities offer no guarantees on dividends.
At Northstar Asset Management, we monitor the varying
factors which we consider critical to ensure that our cli-
ents receive a high level of steady income, whilst pro-
tecting their capital. The above was aimed at opening a
window for you to derive the basics of fixed income in-
vesting.
Northstar Market Report Q3 2017
Page | 10
CLIENT CORNER AND NORTHSTAR NEWS
CHANGE OF MANAGEMENT COMPANY AND OTHER OPERATIONAL NEWS
By Matt Bertram
General news
Towards the end of September, Northstar and the KZN
Crane Foundation hosted a very successful event at For-
doun in Kwazulu-Natal, attended by close on 100 people.
Adrian presented on Northstar’s offshore offering and
specifically the investment case for taking funds offshore
and this is elaborated on in his article. John Steenhuisen
spoke on the state of our nation.
As mentioned in the social responsibility article in our last
quarterly, Northstar continues to actively finance our vari-
ous charities. During the quarter Northstar provided fund-
ing to Ethembeni and Learn to Earn.
Change of management company from Metropoli-tan Collective Investments (Met CI) to Sanlam Col-lective Investments (SCI)
On 9th September 2017, the Northstar Met Income and
Northstar Met Managed Funds were successfully amalga-
mated onto the SCI platform. Northstar remains the asset
manager and for all intents and purposes clients of the
funds will see no change as a result of this process, other
than in future, all correspondence will come from SCI. SCI
has a great reputation in the market, a long-term outlook
and a robust administrative framework in place. Clients of
the funds will notice a special income distribution, which
was made immediately prior to the transfer, and was
done to reset the distribution quantum to RNil for the
new management company, SCI.
Lower fees
The fees of the fund were transitioned on the same basis,
but immediately following the transition, all clients were
transferred into “clean” unit classes, which will take effect
from 1 October 2017. Our total expense ratio (TER) will
reduce by 0.25% as a result of the use of clean classes
across our local fund range, which is in the interests of our
clients.
Private client news - reporting systems update
Northstar has made substantial progress on a series of
projects to improve client reporting and aims to reduce
the direct underlying costs for private client share portfoli-
os, both on and offshore. Ultimately, our goal at Northstar
is to offer our clients a high-quality service at a fair cost
that ensures safety for assets with market leading levels
of investment competency. Our toils behind the scenes
within the Operations Department are not visually obvi-
ous, but will become increasingly impactful to you, in
time.
Streamlining stock-brokers
We have also been actively working to streamline the
number of stock-broking companies which we make use
of, on behalf of our clients. This exercise will ensure that
these suppliers can offer our clients lower stock-broking
fees and elevated levels of service due to our bulk-buying
ability. In terms of brokerage service providers that we
have made use of, we have always negotiated excellent
terms on behalf of our clients, but new competition in this
space and technological advancements have led us to
reassess who we use and what they should offer our cli-
ents. Our focus has been on:
Reducing the annual total transaction costs (looking
at FX charges, trading volumes, custody fees) for pri-
vate clients, including managing minimum fees for
smaller accounts.
Ensuring that providers are able to provide quality
data and outputs for clients, including tax reporting
packs.
Ensuring that brokers are able to hold our funds
through their brokerage accounts, which will greatly
aid access to our funds for our clients, at preferential
rates.
We look forward to providing positive feedback to you in
the months ahead as we achieve these goals.
Northstar Market Report Q3 2017
Page | 11
CORRIDOR CHATTER
PLEASE MIND THE GAP
By John Steenhuisen
Accountability—SA falling short
Spare a thought for the British, with their inconclusive
elections, muddled politics and a rather messy Brexit un-
derway they don't seem to be getting much right at the
moment. One thing they do get very right however, is
accountability. Their politicians take the fall when their
decisions backfire. Public figures who don't live up to the
standards expected are dealt with and errant corporates
are punished for wrongdoing. The recent justice meted
out in London to the now disgraced public relations firm,
Bell Pottinger, was both swift and devastating. It is unlike-
ly that Bell Pottinger will survive as a result. The great iro-
ny of course is that the dark arts perpetrated on behalf of
the Gupta Empire by Bell Pottinger were not even com-
mitted on English soil but instead deployed on the shores
of our very own South Africa.
Contrast that with the glaring accountability gap which we
experience on a daily basis here at home. It has been
many moons since the now infamous #Guptaleaks scandal
broke. The emails and revelations laid bare the extent and
reach of the nefarious tentacles of state capture. Wrap-
ping themselves around the Union Buildings and burrow-
ing deep into state owned entities such as Eskom, SAA
and Denel and constricting our national, provincial and
local governments. These tentacles have smothered the
economy of our country and diverted vast sums of public
money and absorbed opportunity that should have been
expended on the citizens of our republic who need it
most.
Despite the lengthy passage of time and the continuing
daily barrage of new revelations it is astounding that not a
single government minister, from the President down, has
yet taken the fall or been held accountable for their role
in this grand theft of the public purse. This massive ac-
countability gap that exists within our society is a huge
problem and there appear to be no consequences for poli-
ticians and public officials who have abused offices of
state and aided, abetted, and benefitted from corruption.
Despite efforts from the opposition, Parliament itself
seems wholly unwilling to deal decisively with the matter.
An edict from the House Chairperson some four months
ago to “urgently deal with the allegations” has largely
gone ignored and efforts by some chairpersons and mem-
bers to haul fingered ministers before committees to ac-
count have all been stonewalled. On the criminal prosecu-
tion front the National Prosecuting Authority has once
again been mired in malaise and inaction.
Contrast this too with the series of high profile
“resignations” by senior players at the implicated audit
firm KPMG. The chairman has stepped down and directors
have been forced to resign for various acts of omission
and commission, including a dodgy SARS report, all in ser-
vice of the Gupta network. Clients of the firm are walking
away in protest at these revelations. The question we
should all be asking is: why is the same pressure not being
brought to bear on political office holders and public offi-
cials who have done the same? It’s simply not good
enough for accountability to be halted at the drawbridge
of executive office.
And this all comes at great cost for South Africans. The final tally on the bill for the state capture phenomenon is yet to be counted but will undoubtedly run into billions. And of course the lack of accountability at executive level only breeds contempt at lower levels. The Auditor General also regularly raises the lack of accountability. He esti-mates the cost of unauthorised, fruitless and wasteful expenditure for the 2016 financial year to be R46 Billion, and that’s just national and provincial departments. Again no accountability for the officials involved. The Public Fi-nance Management Act and rafts of other legislation con-tain stiff penalties ranging from jail time to civil recovery, yet these mechanisms are seldom, if ever triggered. In-stead errant politicians and public officials caught in the act are simply shifted to other departments or entities to continue their daylight robbery of the national fiscus. With such theft from the public purse its little wonder that the finance minister, Malusi Gigaba, finds himself in such a tight fiscal space and hungrily eyeing the prize of the Public Investment Corporation. A leaked cabinet memo-randum recently outed Gigaba’s plans to introduce a spe-cial appropriation bill in order for him to fund a R10 billion bail-out for cash-strapped South African Airways, the most likely option through a sell-off of government’s shares in Telkom. Talk about throwing good money after
Northstar Market Report Q3 2017
Page | 12
bad! South African Airways has been consistently badly managed by megalomaniac chairperson, Dudu Myeni, who has run the airline into the ground. Again, no ac-countability for her role in the crisis, with Gigaba instead seeking to reward her by unlawfully extending her disas-trous tenure as chairperson. We have to address this accountability gap in South Africa or things will simply get worse. The scale at which public officials and politicians loot will continue until there is nothing left. Corrupt politicians and rotten officials must be prosecuted, jailed and face large civil recoveries.
We have all the legislation and tools at our disposal to do this, it simply requires the will to act against the scourge. Only when the perpetrators are brought to book and held accountable will the culture of impunity change. In reality it would only take a few high profile heads on spikes to send the message throughout the system that things have changed and that the accountability gap is finally closing.
Northstar Market Report Q3 2017
Page | 13
ADVISOR CORNER
BUYING HIGH AND SELLING LOW—HOW TO GUIDE
YOUR CLIENTS AWAY FROM THIS COMMON MISTAKE
By Daniel Esterhuyse & Nick De Villiers
The data
The graph below (figure 14) shows the net capital inflows
into South African equity funds from 2012 to June 2017
(categorized according to the Association of Savings and
Investments South Africa (ASISA)). Against this, we have
plotted the indexed performance of the average fund in
the ASISA general equity sector. The data indicates that
inflows were marginal in 2012 and 2013 whilst invest-
ment performance was robust. Investment inflows
gained pace in 2014 and 2015, coincidentally peaking
post the performance surge which occurred in the two
years prior. As the performance of the sector tapers,
these inflows start diminishing.
What the data reveals
The graph is clearly an illustration of how recent past
performance can influence investment flows.
Why do asset flows originate after performance?
Behavioural finance is quite clear that investors feel
most comfortable when asset prices are elevated and
they commit more at these moments.
It is typical for investors to chase historic perfor-
mance.
Many investors do not follow an investment plan
making them prone to short-term trends.
Further influences enticing short-term thinking include
the increased availability of investment data, the growth
in fund numbers, index trackers and, very recently, the
introduction of cryptocurrencies. These provide alterna-
tives that promote switching. This behaviour is driven by
biases and heuristics that are triggered in uncomfortable
situations, if not managed.
How to change the behaviour?
Carl Richards, the author of “The One-Page Financial
Plan”, states that dysfunctional investor behaviour occurs
because they do not follow a clear blueprint which mani-
fests in the form of an investment policy statement (IPS).
The IPS sets out a client's original investment intentions
and is a useful reference when market noise or volatility
evokes an emotional response. Mike Tyson famously said,
"Everyone has a plan until they get punched in the
mouth". Fortunately, in financial services, clients can chat
to expert financial advisors who are trained to help focus
on the long-term plan after the proverbial “punch” has
been landed.
The IPS
With a client being instrumental in the development of
this strategy it is more likely that adherence to the initial
plan takes place. What should be included in an invest-
ment policy statement?
Define the duties and responsibilities of the client,
advisor, and any third-party service providers. The
statement would outline the client's goals and values,
the more detailed the better.
Define guidelines for implementing the financial plan,
stating inherent risks and how to react to these risks
if they become a reality.
Establish and agree on a reasonable expected return
over a specific investment horizon, and what a palata-
ble maximum drawdown would be in relation to this
expected return.
Asset allocation needed to achieve objectives, as well
0
4000
8000
12000
16000
2011 2012 2014 2015 2016 2017
100
120
140
160
180
Flows vs ASISA SA Eq General fund performance
Net Flows (LHS) (ASISA) South African EQ General (RHS)
Figure 14. Flows vs equity fund performance. Source: Northstar, Morningstar, ASISA
Northstar Market Report Q3 2017
Page | 14
as a clear definition of the due diligence criteria used
to select investment managers.
Defined criteria for monitoring service providers, as
well as defined procedures to control and account for
investment expenses.
The frequency of review meetings and the metrics to
assess the success of the strategy is established up
front. The review meeting allows for flexibility and
the realignment of the strategy to fit changes in ob-
jectives and goals over the client’s life time.
The IPS, in conjunction with the investment process, are
essential tools to guide investors through challenging
times and assist in managing expectations. At Northstar
we encourage advisors to share their client strategies
(IPS’s) with us in order for us to create bespoke solutions
that realise client’s individual investment goals and, in so
doing, work with the advisor to this end.
Northstar Market Report Q3 2017
Page | 15
STAFF MEMBER PROFILE
LUDI CRONJÉ
By Matt Bertram
Ludi Cronjé joined Northstar in July 2016 and is responsi-
ble for client servicing.
What did you study at University?
I completed a B Com Financial Accounting degree at the
University of Stellenbosch. I subsequently started my CI-
MA exams and have completed the advanced postgradu-
ate diploma in management accounting.
Where have you worked?
My previous employment includes Relate Software
(2016), and Quotient Financial Solutions (2014 to 2015).
What do you enjoy most about operations?
I enjoy interacting with clients on both a personal and a
business level. Although I am administratively competent,
I love people and have really enjoyed getting to know
many great clients who utilise our services at Northstar.
How do you best allocate your time for the highest
impact?
In an operational role my time is spent on administratively
intensive tasks, which are often ad-hoc in nature. It is im-
portant that from time to time, I step back and figure out
how to make processes more automated and efficient. My
highest impact is when I am able to understand a client’s
specific needs, show competency and demonstrate trust.
What is your focus at Northstar?
My focus is client support, being at the end of a telephone
and dealing with simple and complex client requests.
Where is your own money invested?
I have a passion for cars and am good at identifying great
value vehicles. I clearly invest with Northstar too. I specifi-
cally use Northstar’s Income Fund, the yields are high and
access is very easy when I need to buy another vehicle.
What do you hope to add to Northstar in the years
ahead?
I believe that our clients invest with us because they trust us
and have faith in our abilities. My main function is to ensure
that their relationship journey with Northstar is a happy one
and I will continue to work tirelessly to make this happen.
I also intend playing an ongoing and meaningful role in con-
tinuously enhancing our processes, which we regard as a
perpetual journey. We have come a long way over five years
and now have a powerful team, processes and research
platform to work off, all of which is a boon for our clients.
That said, our goal is consistency of performance and I con-
tinue to implement processes on the operations front to
attain this.
CIS DISCLOSURES
Collective investment schemes in securities are generally medium- to long-term investments.
The value of participatory interests or the investment may go down as well as up. Past perfor-
mance is not necessarily a guide to future performance. Sanlam Collective Investments (RF) (Pty)
Ltd (the manager) does not provide any guarantee, either with respect to the capital or the
return of a portfolio. The manager has the right to close certain portfolios to new investors, in
order to manage it more efficiently, in accordance with its mandate. Collective investment
schemes are traded at ruling prices and can engage in borrowing and scrip lending. The collective
investment scheme may borrow up to 10% of the market value of the portfolio to bridge insuffi-
cient liquidity.
Annualised returns are period returns re-scaled to a period of one year. This allows investors to
compare returns of different assets that they have owned for different lengths of time. Actual
annual figures are available to the investor on request. Income distributions, prior to deduction
of applicable taxes, are [included/not included] in the performance calculations. NAV to NAV
figures have been used for the performance calculations, as calculated by the manager at the
valuation point defined in the deed, over all reporting periods. Investment performance calcula-
tions are available for verification upon request by any person. Reinvestment of income is calcu-
lated on the actual amount distributed per participatory interest, using the ex-dividend date NAV
price of the applicable class of the portfolio, irrespective of the actual reinvestment date. The
performance is calculated for the portfolio. The individual investor performance may differ, as a
result of initial fees, the actual investment date, the date of reinvestment and dividend withhold-
ing tax.
Different classes of participatory interests apply to these portfolios and are subject to different
fees and charges. A schedule of fees, charges and maximum commissions is available on request
from the manager, or is available on the website at www.sanlaminvestments.com. Forward
pricing is used. The portfolio valuation time is 08h00 for fund of funds and 15h00 for all other
portfolios and the transaction cut-off time is 14h00. The transaction cut-off time should be
14h00, for portfolios except fund of funds, but execution is not always guaranteed. If execution
could not take place on the same day, it will take place the next business day, or at the earliest
possible opportunity. For fund of funds, the cut-off time for the execution of trades is 14h00 on
the day preceding the pricing date.
Foreign securities within portfolios may have additional material risks, depending on the specific
risks affecting that country, such as: potential constraints on liquidity and the repatriation of
funds; macroeconomic risks; political risks; foreign exchange risks; tax risks; settlement risks; and
potential limitations on the availability of market information. Fluctuations or movements in
exchange rates may cause the value of underlying international investments to go up or down.
Investors are reminded that an investment in a currency other than their own may expose them
to a foreign exchange risk.
The terms and conditions, a schedule of fees, charges and maximum commissions, performance
fee frequently asked questions as well as the minimum disclosure document (MDD) and quarter-
ly investor report (QIR) for each portfolio are available on Sanlam Collective Investments’ web-
site at www.sanlaminvestments.com. Associates of the manager may be invested within certain
portfolios and the details thereof are available from the manager.
Northstar Asset Management (Pty) Ltd, registration number 1996/001423/07 and FSP number
601, is the co-named partner and investment manager of the co-named portfolios within the
Sanlam Collective Investments Scheme and is an authorised discretionary financial services
provider under the Financial Advisory and Intermediary Services Act (No. 37 of 2002). This infor-
mation is not advice, as defined in the Financial Advisory and Intermediary Services Act (No. 37
of 2002). Please be advised that there may be representatives acting under supervision.
The manager retains full legal responsibility for the co-named portfolios.
THE FINANCIAL ADVISORY AND INTERMEDIARY SERVICES ACT, 2002
Northstar Asset Management Proprietary Limited is an authorised financial services provider in
terms of the Financial Advisory and Intermediary Services Act 2002. All information contained in
this document should not be construed, or relied upon, as advice. If you require financial and/or
investment advice, please engage the services of an independent financial adviser.
INFORMATION AND CONTENT
The information and content (collectively 'information') accessible in this document are provided
by Northstar as general information about the company and its products and services. Northstar
does not guarantee the suitability or potential value of any information or particular investment
source. Any information in this document is not intended nor does it constitute financial, tax,
legal, investment, or other advice. Nothing contained in any service or any other content in this
document constitutes a solicitation, recommendation, endorsement or offer by Northstar. Noth-
ing contained in any service or any other content in this document constitutes a solicitation,
recommendation, endorsement or offer by Northstar.
Illustrations, forecasts or hypothetical data are not guaranteed and are provided for illustrative
purposes only; returns or benefits are dependent on the performance of underlying assets or
other variable market factors; there are risks involved in buying or selling a financial product;
past performances are not necessarily indicative of future performances; and no guarantees are
provided.
NORTHSTAR ASSET MANAGEMENT
Northstar Asset Management (Pty) Ltd
Registration No. 1996/001423/07 | FSP number 601
Suite 1A, Madison Place, Alphen Office Park, Constantia Road,
Constantia PostNet Suite #784, Private Bag X16, Constantia 7848
Tel +27 (0)21 810 8400 | Fax +27 (0)21 794 2885
[email protected] | www.northstar.co.za
SANLAM COLLECTIVE INVESTMENTS
Sanlam Collective Investments (RF) (Pty) Ltd
Registration No. 1967/00865/07
55 Willie Van Schoor Avenue, Bellville Park, Bellville, 7530 PO Box 30, Sanlamhof, Bellville, 7532
Tel +27 (0)21 916 1800 Fax +27 (0)21 947 8224
[email protected], www.sanlaminvestments.com
Please refer to our website for directors & company secretary details
DISCLAIMER
Northstar Asset Management (Pty) Ltd, registration number 1996/001423/07 and FSP number
601, is the co-named partner and investment manager of the co-named portfolios within the
Sanlam Collective Investments Scheme and is an authorised discretionary financial services
provider under the Financial Advisory and Intermediary Services Act (No. 37 of 2002). This infor-
mation is not advice, as defined in the Financial Advisory and Intermediary Services Act (No. 37
of 2002). Please be advised that there may be representatives acting under supervision.
Legal Information http://northstar.co.za/page/legal-information/
