nottheaverageactuary

Actuarial news and views from Cape Town and beyond


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REITs – A Collective Investment Scheme

n preparation for part of today’s lecture topic, here is some clarification on where REITs fit in as an indirect investment.

I realise that this is a merger of Property and Collective Investment Schemes, but it made sense to explain REITs from a Collective Investment Scheme standpoint.

REITs (Real Estate Investment Trusts) are examples of investments trust companies as defined under Collective Investment Schemes. They are publicly traded, closed-ended schemes that allow investors to purchase shares of the company as a mechanism to invest indirectly in the property market. Listed property companies on the JSE have one of 3 statuses: REIT, Property Loan Stock or a Property Unit Trust. For more on Unit Trusts, see Izak’s post and for more on Property Loan Stock, see Wandile’s post.

So why REITs in South Africa? Basically, to boost South Africa’s property sector to international status and creating a uniform tax system that no longer confuses investors. It is a property market transformation from unit trusts and loan stock to investment trusts.

For more info on the introduction of REITs in SA, see

Analysis: REIT SA

For more info on the international status of SA’s property market with the introduction of REITs, see

REIT status puts SA property funds on global map

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Side Pockets. A double edge sword?

After the recent collapse of African Bank, 49 funds have segregated African Bank Investments Ltd (ABIL) shares from their investments by using a “side-pocketing” technique as of 20 August 2014. This is the first time the Financial Services Board (FSB) has allowed such a procedure in South Africa.

Side-pocketing is a process whereby illiquid assets (in this case ABIL shares) are separated from more liquid investments in a portfolio. After an investment enters a side-pocket account, only the present participants in the fund will be entitled to any increase in future value in ABIL shares. The capital related to such investment is not available for withdrawal until such investments are realized or otherwise become marketable securities. Future investors will not receive a share of these proceeds and will be protected from losses that may arise. This can be somewhat compared to a side pot in poker. It is seen as a method to carve out the bad assets and keep investor confidence in the funds.

Currently funds amounting to over R4.6 billion have been approved for these side-pocketing portfolios according to a FSB release. The creation of side-pocket funds doesn’t solve the problem but rather gives the issue a side-step. Some of the issue they create are:

  • Side pockets are sometimes seen as a way to protect fund manager’s fees by putting bad shares aside and they are usually never seen again. (Fund managers usually get paid a percentage of profits on funds and the fund would be inflated without the bad shares)
  • Complex issues may arise over the adjustment of High Water Marks. Investopedia explains High Water Marks as the highest value a fund manager has realised for that fund and thus may lead to conflict of interest in the future should the shares in the side pocket fund recover sufficiently.
  • Using side pockets has been viewed as adding a layer of secrecy and susceptible to abuse if the side pocket investments are not included in the fee calculations.

There are a number of issues that arise now that the FSB has allowed the side-pocketing process for ABIL shares. The FSB has somewhat opened a Pandora ’s Box.  When is it acceptable to use side-pockets? Does it become the natural go to answer for such problems in the future? Are we giving fund managers a license invest irresponsibly?

If implemented correctly, side pockets are a valuable mechanism to help deal with fund experiencing liquidity issues. Creating a side pocket is not a silver bullet for funds with liquidity issues and several key issues that must be considered before creating one. The main concern should be the fair treatment of all investors in the fund.

Here are a few articles that may be of interest :

CADIZ COLLECTIVE INVESTMENTS ABIL SIDE-POCKET CLIENT LETTER-http://www.cadiz.co.za/impact-of-exposure-to-african-bank-on-the-cadiz-unit-trust-funds/cadiz-collective-investments-abil-side-pocket-client-letter-august-2014/

http://www.businessweek.com/news/2014-08-18/south-african-money-managers-may-side-pocket-african-bank-debt

A list of approved side pocket portfolios-https://www.fsb.co.za/Departments/communications/Documents/Side%20Pocket%20Portfolios.pdf

http://www.iol.co.za/business/companies/investors-can-separate-african-bank-debt-1.1737491#.U_ZCqPmSy-Y

Definition of side pocket-http://www.investopedia.com/terms/s/sidepocket.asp

http://www.internationallawoffice.com/newsletters/detail.aspx?g=da6d290f-49de-49ca-9e7c-1db36641b7a6

What do you think about the use of side pockets?


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Are active funds becoming obsolete?

Active funds aim to outperform the market and generate higher returns by using intensive techniques such as data analysis, stock picking and short sell to achieve this, but according to recent statistics, it seems most of them failed to achieve their target despite their best efforts. There are plenty of statistics to show this, I give two graphs here as examples:23

In contrary to active funds, passive funds simply diversify their assets to track the market and earn the market rate of return. Therefore the funds that failed to beat the market also failed to beat the passive funds. It seems counter-intuitive that these simple funds were able to outperform the more sophisticated active funds, but economics theories such as Efficient Market Hypothesis have argued that the market is not predictable and no technique can help funds systematically outperform the market. Other economic theories have attacked the theoretical foundation of the active funds. For example, the Capital Market Pricing Model argued that all investors should hold the market portfolio (which is what most passive funds aim to hold) instead of picking stocks.

The reason why the active funds are performing so badly may be the economic conditions, unsound management or simply bad luck. But besides these generic reasons, the high expenses of running active funds might have a particular impact on the level of returns they were able to deliver.

The complex techniques and strategies deployed by active funds are all very costly. In addition, active fund managers also charge very high management fees. For example, hedge funds often have a “2&20” fee structure, which means 2% of total assets as management fee and 20% of any profits as performance fee. On the other hand the fees can be as low as 0.06% for some passive funds. State Street’s huge Spider fund, which tracks the S&P 500 index, charges only 0.09%. While the fees made many fund managers wealthy, in the long run such a 40-year period, they will greatly reduce the returns:

fund-returns-over-the-years

Assuming 10% return and various fee levels

The high fees the active funds charged allowed them to pay much higher commissions than passive funds to financial advisors to promote sales. That’s why historically active funds have been the dominant investment choice. However, as they fail to deliver results, monies are flowing out of active funds into passive funds and as a result active funds are gradually losing market share to passive funds:

Screen-Shot-2013-04-02-at-9.58.34-AM-1024x682 (1)

passive-vs-active

As you can see passive funds are not dominant yet at 26% but are becoming the mainstream approach.

Despite unsatisfactory performance in general, active funds still have some superiorities. As we have seen, not 100% of active funds fail to outperform and over the past two centuries there had been a number of star fund managers and investors who were able to beat the market for extended periods of time, although at the same time millions of other investors were not as fortunate.

9

The decreasing sale is also forcing active funds to change. Last year a no-fee hedge fund was launched in the United States in November last year. This fund did not charge a performance fee, but only a 1.25% management fee. It has achieved a 10% return as of about August, which is solid performance as most other active funds in the same category were losing money.

Therefore, although active funds may continue to underperform and see a contraction in market share, they are not likely to disappear. But, unless active funds have a radical reformation, passive funds would still be better a choice than active funds for the majority of investors for their low costs and guaranteed performance.


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Too much of a good thing?

Unit trusts have become one of the most fashionable and convenient individual-oriented investment products available. Simply pay your money into the fund and watch it grow. However, some are of the opinion that there simply are too many funds to choose from. See for example this list of unit trusts. There are more than a 1000 (1025 last September). 

A brief overview on exactly why this is troublesome is given in this Financial Mail article, and a less brief overview is given in this moneyweb article.

A very interesting comparison with other countries’ unit trust business is also made in the Moneyweb article. For example India, with its population of 1.2 billion (compared to SA’s 51.7 million) has about the same asset value under management as South Africa, around $140 billion. This despite India’s $2.4 trillion market capitalisation of listed companies, compared to SA’s $903 billion. (These numbers are as at 31 December 2012, so it’s a bit outdated)

Any ideas on why unit trusts are so popular in South Africa?


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Moody’s downgrade of South Africa’s four big banks hurts JSE investor confidence(group 8)

The recent downgrade of the four big South African banks spooks JSE investors.Moody’s reason behind the downgrade was not based on the financial position of those banks, but a perception that the South African Reserve Bank was willing to impose losses on creditors in case of an emergency, instead of protecting investors fully.

Details of the extent of the effect can be found in link below.

http://www.fin24.com/Markets/Equities/Moodys-downgrade-spooks-JSE-investors-20140820

 


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Collective Investments Overview

A collective investment is a way of investing money indirectly in a diverse pool of assets on a grouped basis with a large number of investors contributing to and benefiting from it. These investments provide access to a diversified portfolio, investments of large unit sizes and professional expertise of fund managers. The investors also benefit from economies of scale as expenses like transaction costs can be reduced for each member. In addition, the indirect investment shields the investor from issues such as the daily management of assets, which is handled by the fund managers on the investors’ behalf.

These funds can have specific aims and strategies. They may invest in certain geographical areas (domestic vs. foreign) or certain industries. Depending on their strategies, they can focus on capital gains and become a capital growth fund or focus on dividends as a high income fund.

The term used varies with countries and collective investment schemes or vehicles are often referred to as an investment funds or investment pools. There are also many branches and types of collective investments that differ by factors such as constitution, availability, investment style, fee structure, regulations and many others:

  • The constitution of funds may be close-ended or open-ended, which relate to how investors invest in the scheme. An investment trust company, for instance, is close-ended, while a unit trust would be open-ended.
  • An investment scheme may be offered to the general public or private investors only. An example of the latter is hedge fund, which is becoming increasingly popular today.
  • Broadly funds can be classified as active or passive funds by their investment style. The fund managers may invest actively by predicting market movements or passively by tracking the market to earn a stable return.
  • The fees charged often differ by the investment style. Active funds have high fees for their intensive operations and potentially higher returns. For example, hedge funds have a popular “2&20” fee structure, which means 2% of total assets as management fee and 20% of any profits as performance fee. On the other hand the fees can be as low as just a 0.06% management fee for some passive funds.
  • Different funds are subject to different types of laws and regulations such as company law or trust law. These may affect the operation of the funds by placing restrictions or guidelines on issues such as gearing and investment choices. Certain funds can avoid these restrictions and have additional flexibilities. For example, hedge funds can bypass many restrictions by being private.

Therefore, although there is a large number of collective investment schemes. They are differentiated by many factors and virtually every fund is different.