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Developed markets winning the race

RYK VAN NIEKERK: Welcome to this Financial Advisor podcast – my weekly podcast where I speak to leading financial advisors. My guest today is Mduduzi Luthuli of Luthuli Capital. Mduduzi, welcome to the show.

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We are living in extremely interesting times, the world seems to be splitting in two, at least on an investment basis and it seems as if the developed world is splitting away from the emerging markets and like developed markets are winning this race, at least over the last few years. Do you agree with this and, if so, how do you manage money in such an environment?

MDUDUZI LUTHULI: I think as an advisor the first thing is you have got to do is consider yourself as a fiduciary and what I mean by that is that in all your decision-making you have to always put your client first. So the point I am making here is that in managing client money it’s not your responsibility to be patriotic. It’s your responsibility to look at the global investment world and [ask] where is it best to invest client money? So just because you are a South African advisor you can’t feel that you have an obligation to put the majority of the client’s money in the JSE.

If we look at the global world, definitely, developed markets have had a fantastic decade but one can also make the case that if you look at the grouping of emerging markets, they have certainly increased their market share in terms of what they add to the global economy. No matter what you feel about emerging markets, they still present the best opportunity in terms of the growth story, simply because part of it is they are coming off a low base, including us, in that there is still a lot to fix for us to realise our potential. Whereas what you get from the developed markets, I guess, is surety in terms of who is there, how is it regulated, what’s happening, that whole notion of ‘too big to fail’, especially the American market.

But speak to any analyst and at the same time they will tell you that looking at the developed markets and the run they have been on, surely they are way overdue some sort of correction. So then it comes to you to say, well, are you going to approach the investment universe with a level of fear or are you going to try and be brave? If you look at the developed markets, do you say I don’t know if I want to overexpose my clients to that because the probability – and investing is a game of probability – over the next five years is that surely some sort of pullback needs to happen there. But if you go with it in fear, then you end up with egg on your face and we could have another five years of exceptional market runs because what are the emerging markets, except for a few pockets, really offering you?

RYK VAN NIEKERK: So should you approach this market with fear or greed?

MDUDUZI LUTHULI: If we just look at the facts, South Africa makes up less than 0.5% of the global market, so that alone tells you that surely there’s much more value offshore. Just statistically, it’s 99.5% of the global market compared to 0.5% – surely you’ll find more value offshore. That’s not to say that locally there are no good businesses, but it seems harder and harder to actually find those businesses. We seem to be going through a period where we are looking at the private sector and there seems to be ‘poor management’ recently and the problem is that when a client comes to you as an advisor and pays you a fee, I might be cynical here, but clients are paying you a fee so that if things go wrong they have someone to blame, if I can put it that way. What I mean by that is they are putting the onus on you to say, ‘Listen, I could have done this myself but I am going to pay you a fee because I expect you, as a professional, to do the necessary research and don’t invest my money in…’  – they expect you to see a Steinhoff before it happens – and when you don’t see that then, again, it becomes hard to [answer] what am I paying you for, how do you justify your service?

Like we were saying earlier, the active versus passive debate carries on, it’s very difficult. It’s very difficult, but I don’t think you should ever approach investments with fear because you build a career and you build success in this industry by having a selection process and a research process that you live and die by. If it fails you that’s you, you are done. But if you have conviction in it and you ride it out – and that’s the mantra of our industry, long-term investing, ride it out – don’t worry because if you wait long enough I will be proved correct.

Adapting investments to current conditions

RYK VAN NIEKERK: But most financial advisors have this mantra of invest for the long term, invest in good value stocks, sit on your hands and don’t try and time the market. But the investment environment has changed so much in the last decade, if not longer – should the investment approach not also adapt and change to try and secure higher returns than a current ‘old school’ approach?

MDUDUZI LUTHULI: I think we are at a crossroads because you don’t have to go that far back to find a situation where as a client if you wanted to invest you had no choice but to go through some sort of advisor or stockbroker. That’s not the situation now. If a client wants to invest they don’t necessarily have to go through an advisor. In that change in the industry our problem as an industry is we’re trying to redefine what value we bring to the client. I think in such a low-growth environment and since the last global crash we have been acting out of fear, in that you talk about have a balanced portfolio, diversify, hold for the long term. I think a lot of that mantra is based on not losing client money, as opposed to ‘I am going to double your money every five years’, because the latter is actually very difficult to do in this industry.

What I am finding or my opinion is that going forward we have to come to a situation where as a financial advisor you need to specialise in something, because you will be caught out. There is no way in this industry – with all its complications, with new technologies, with new investment opportunities – that you can have one individual say ‘I am a master of all and I can sit with you as a client and I will look at your full portfolio and give you full comprehensive advice’. Rather we have to start becoming specialists and as specialists start collaborating and in that way you can bring value to a client, because there’s no way that one person can honestly look at a client and I say ‘I know all and I can handle every single aspect of your financial life’ because you will be caught out.

RYK VAN NIEKERK: I would assume that most of your clients have retirement money with you through retirement products like retirement annuities. Looking at the local market, which has performed poorly, those funds or a big chunk of that through Regulation 28 must be invested in the local market. Now obviously I am sure many of these investors are disappointed at the performances and most of that is due to external factors. How do you approach that side of the communication with your clients to try and justify the poor performances?

MDUDUZI LUTHULI: I think one of the main things is just being open and honest and what I mean by that is before the clients even invest with you, make them aware that there is this law and there’s nothing I can do about it, I didn’t make the law. So unlike a discretionary investment, where your strategy would look vastly different to what we can do for you in a retirement annuity, just make them aware of the restrictions and the limitations of your powers in terms of affecting that. But also don’t use that as a crutch, because again the client is paying you a fee because you have told the client that you are an expert and as an expert you add some form of value. So the onus is still on you to be able to look at this underperforming market and say that ‘I still feel that in structuring your portfolio in such a manner in the long term ….’ – and unfortunately we have to keep pushing that mantra because it’s definitely not going to be in the short term -‘…in the long term you will get a good return’, whatever the definition of that may be for each person.

I think it also comes down to one of the things I always try to make my clients understand: if you are investing then invest.

What I mean by that is if you open an investment account it should never be for a three-year term or a five-year term or a ten-year term or whatever – it is forever. If you are investing this is a lifelong pursuit and your pursuit is to have this account where you’re allocating capital and if you have a good advisor their job is to grow that capital in terms of compounded interest.

But have the mentality that the capital that you allocate to this portfolio is no longer yours – in fact, it’s for future generations – but that what you can derive out of this portfolio is a sustainable passive income if your advisor does a good job. Then if you have that mentality that your investment term is indefinite and this is something that I will be doing for the rest of my life, then market crashes, poor market performance where you have these… – because it happens and there’s nothing you can do about it – sort of become not a moot point but a secondary point, because you realise that it’s fine because my investment term is 50, 60 years or until I pass away. We will get through this because as much as a market is underperforming is this the end of the market? No.

Just like in a market crash, people lose money simply because they react emotionally and they are polite. What I mean by that is if you have a good portfolio, meaning the companies that make up your portfolio, [ask yourself] are the fundamentals still the same, will this company make it through this? Yes. Then what’s the fuss? Yes, you’re looking at the rand amount: yesterday my portfolio was R100 000, today it’s R50 000, [and you wonder] what’s happening? Don’t worry. In a market crash don’t look at the rand amount, look at the units. …The shares you’re holding, the companies, because that’s what you are as an investor, you are a shareholder in a company, do you still believe that this company will survive this correction, this crash?

Constructing a resilient portfolio

RYK VAN NIEKERK: But very few clients will be happy and appreciate those comments if their portfolio goes from R100 000 to R50 000. They would like action to try and rectify their situation or expect action to reduce the downside if there is a correction. Obviously there is some education involved but that is a very, very interesting scenario.

MDUDUZI LUTHULI: Ja, definitely. Don’t get me wrong, I’m not saying that if the crash comes and your portfolio halves just go to the beach and relax – no, that’s not what I am saying. I’m saying that in the portfolio construction and me, as an advisor, constructing your portfolio, I need to construct being aware that at some point the crash will come and there’s nothing I can do about that. Thus, again, it comes to the selection and research process to say this portfolio that I’ve constructed was it speculative, was there some sort of short-term trend that I was trying to follow or take advantage of or does my client actually have a good portfolio? Thus, when the crash or correction comes it’s rather yes, my action is minimising the loss, but my action is not saying let’s pull out.

I always make the joke to say that as an advisor most of the time you are acting as a psychologist more than as an investment advisor because, again, most clients don’t see the value of an advisor at the time because we’re making money. I communicate with my clients a lot. I write a lot and I used to get slightly offended because no one ever calls back and says ‘great article’, but then I realised that in good times you will never hear from your clients. It’s only in the bad times and that’s when they need you. That’s when they will lean on you to say, ‘listen, as my advisor what should I do now?’ That’s the responsibility of doing what we do is that people have entrusted you with their money and it’s not so much in the good times, because if the market is running [you] just pick a fund, invest, you’ll make some money. Some more than others, but you will make some money. But it’s in the horrendous times, the poor times that you see if you have a bad advisor or a good advisor, because that’s when they’re supposed to step up and guide you through that.

RYK VAN NIEKERK: But many people will say that we are currently in bad times because the international markets have had a phenomenal performance of late, while the JSE has gone nowhere – actually it went down and if you add fees to that it’s gone down a lot for investors. Are you seeing your clients reacting to this and that they appreciate the value you as an advisor add to managing their funds in this environment?

MDUDUZI LUTHULI: I have to say yes because in all our time since we started our business we’ve never lost a client and I think the one part of that is communication. I say to my clients that if in five years’ time we’re having the same conversations you need to seriously think about firing me because I have not evolved, I have not grown. Part of being accountable to clients is sharing information and educating them so that when you make investment decisions they become part of that, they can question to say ‘why did you do that?’ as opposed to just saying, ‘oh okay, rebalance my portfolio, he knows what he’s doing’. There needs to be more accountability, there needs to be more handholding and the only way to do that is by having transparency and educating clients. I say to clients that ‘I am your advisor but it’s still your money, you’ve got to have buy-in and you have to be interested, you can’t just open a portfolio with me and there’s a debit order going off and we never speak’. But again it comes back to the point that it’s not an offshore versus local; your job as an advisor is to go and find the best possible investment opportunity for your client and you have no obligation to be loyal to the local market if it’s not giving the value that offshore markets are giving.

Majority of allocations are offshore

RYK VAN NIEKERK: So where are you putting your clients’ money currently?

MDUDUZI LUTHULI: Definitely the majority of the allocation is offshore. If we’re looking at discretionary funds, our local allocation if we are being bullish will not exceed more than 20% to 25% of the portfolio. Forty five percent to 50% of the portfolio is definitely offshore; some of that is obviously going into property. I know property, especially locally, has had a horrendous year – it’s down over 28% or something ridiculous like that. But then again you hear these mantras, things like ‘when there’s blood on the street that’s when money is made’. There is truth in that, yes, if you look at the overall property sector it’s had a horrendous year but does that mean that property as an asset class is dead? No, there are still good companies out there.

RYK VAN NIEKERK: Well, I think South Africa has the most number of value stocks currently that it has ever had or at least in many, many years.

MDUDUZI LUTHULI: I think for a long time we have just forgotten the responsibility of what it is that we do. You are being paid a fee because you have said to someone else that you possess some sort of skill in terms of analysis and the onus is on you to prove that and if you can’t prove that the client has every right to leave you. One of the things that really, really make me angry is when I have to move a client’s portfolio, and it’s especially from the insurers, and when a client moves a portfolio and they charge a termination fee. How is that okay, because the client has said to you, as the provider, ‘I have lost faith in you and I want to go somewhere else’ and your response to that as a provider is to say ‘okay, I will punish you by charging you a termination fee’. It’s similar to, and a lot of people might disagree with me on this, it’s like advisors who charge initial fees on recurring premiums. You open an account with me, it’s R500 a month, I charge you an initial fee, an upfront fee of 3%, meaning every time you are paying that R500 then 3% is deducted and you are being charged an ongoing fee on the assets, meaning as your book is growing…what is that upfront fee for because are you giving new advice every month?

RYK VAN NIEKERK: If an insurer offers that product do you actually take a decision not to invest there just based on the fees?

MDUDUZI LUTHULI: You have to, that’s the thing. I think you will not survive in this industry going forward if you choose to ignore that element because clients have access to information, clients are becoming more aware. We are no longer the gatekeepers of how this industry works. More and more going forward the fee has to justify the value. I don’t charge enough for fees. It’s not to sit here and make myself the Mother Teresa of investments or anything like that but it’s to say that my role is to grow your portfolio. I charge an ongoing fee because there’s ongoing management and if I do my job then I’ll make money and you will make money. The initial fee is there if it’s something that’s once off or if you come to me – and this happens – where a client says ‘I heard you somewhere’ or ‘I read your article, I just want your advice, it’s a once-off thing but I have an advisor’. So that’s fine, that’s my time, I have every right to say that for this consultation or whatever I will charge you a once-off fee because I will never see you again. But if you are going to be my client why are there these two layers of fees, especially in such an environment? Not that it’s right if the environment was giving us 20% or 30% a year, it doesn’t make it right but at least you can hide it in that environment. But now a lot of advisors are being posed a question of what value do you add and there’s no response.