Regarding… Vol 2 no 39 – Aggressively Passive

Dear Fellow Investors and Friends,

Welcome to this week’s edition of my investment musings, where I try to make sense of the world around me and share stuff that I find interesting.

Today is Thursday, October 24th, the 298th day of the year. There are 68 days left until the end of the year. We have had 212 consecutive days without blackouts (aka load-shedding), the longest run since 2019. Just think about that for a second.

We’ve endured a tough 5 years down here on the Southern Tip.

This week is the second part of my four-part series on the strategy I am using to build the equity exposure of the MWI Worldwide Flexible Fund (aka the cockroach). I started the series last week discussing an approach to investing that adds value.

This week, I talk about developing an “edge” in investing.

Investment success relies on finding an “edge” – something you can do better than others. For a long time, I believed if I just analysed more and harder than my competitors, that would be it. After all, I’m smarter than them. That misplaced belief gets us investors out of bed in the morning.

But then I came across this formula from Morgan Housel:

Compounding = returns to the exponent of time

It explains why investors get more bang for their endurance buck than their valuation work buck.

But surely this is heresy! Didn’t Graham command us to analyse financial statements to pick the investment with the best return prospects?

True, but back in Graham’s day, there was no internet or computing power. Financial reports on companies were hard to come by, and even if you could find them, accounting standards were so poor that most of it made little sense. Investment analysis was an edge because no one was doing it.

Today, AI bots can sift through exabytes of information faster than you can say CFA.

Instead of in-depth analysis, patient endurance is an edge that is hard to replicate. The investment industry naturally selects A-type personalities who believe they can “fix” things. Human nature abhors inaction. Investment professionals think even less of it.

In a recent article, Lindsell Train explained why the price you pay for a business matters much less than the company’s growth rate, but only if you are a genuinely long-term investor. They included the graphs below, which need some explanation:

All three charts depict a company growing its earnings at 11% p.a. (the dotted line), a derating of the multiple placed on those earnings from 25x to 19x (the pink line), and the net result, which combines the earnings growth with the derating (the dark blue line).

The only difference between the three charts is the period over which it is measured. In the left-hand chart, the period is 5 years, and the derating significantly lowers the net investment result to 5.1% p.a. growth from the underlying business growth of 11%.

In the middle chart, the time frame has been extended to 20 years, and the net investment result – earnings growth dampened by derating – at 9.5% p.a. is now much closer to the underlying fundamental growth of 11% p.a. In the right-hand graph, the period has been extended to 50 years, and the net investment growth approaches underlying fundamental growth.

The lesson? The real long-term investor should focus on two things only:

1. Identifying the earnings power of the business
2. Staying the course over the long term

The initial valuation plays a negligible role in the ultimate investment outcome, but only over the genuinely long-term period.

If medical developments and my physical health permit, I plan to manage money for at least another 30 years. During those 30 years, the odds are 100% that wars, recessions, terrorist attacks, pandemics, bad politics, and many other setbacks will impact my investments. The incidence is predictable, but the timing less so.

Over the long run, we are paid to bear risk. After all, if there were no risk of losses, we should not expect to earn anything above the risk-free rate. But eventually, risk will manifest itself and create losses in our portfolio.

What to do? How do we solve for war, pestilence, politicians – and risk in general?

It’s simple: time. Enough years of compounding can make up for a whole bunch of setbacks.

Using the Lindsell Train framework, let’s say you own shares of a company whose business value and share price has grown by 15% p.a. for 10 years. But then risk happens, and the valuation multiple contracts by half, causing the share price to also halve. What has happened to your investment return over the 10-year period?

• The share price has doubled for an annual return of 7.3% (you’ll just have to believe me on the maths).
• That 7% is just the stock price or financial return, not the business or intrinsic value return. The business’s actual book value, or invested capital, didn’t decline, and that book value is the base that will drive the compounding of future sales and earnings.
• The low market price might induce the company to repurchase shares, further compounding the business’s value.
• In so doing, a temporary financial loss can be turned into a rather sizeable permanent gain over time.

Only a few investors have the fortitude to endure a short-term halving of their financial investments. The A-types employed by most investment institutions have no choice but to DO SOMETHING, which generally entails selling the investment.

The incentives, personal and institutional, demand it.

The investor, who invests with a genuinely long-term mindset and understands that their job is to endure those inevitable setbacks patiently, will come out ahead.

Most investment approaches are easy to replicate, and any excess returns that accrue to them are easily arbitraged away, especially in this age of AI. The returns to patience are much harder to arbitrage, especially with institutional money, and therefore, more sustainable.

It follows that the key to investment success is not being more intelligent in your analysis than everyone else, although that might sometimes help. The real key is sitting back and doing nothing, allowing compounding to work its magic.

Aggressively passive.

That’s the edge.

Remember them? They were all the rage in the eighties when the gold price was last on a tear. Now, no one talks about them anymore.

I happened to buy a few in August 2001, but I completely forgot about them. I can’t even remember why I bought them. Maybe I was worried about the Rand, which was tanking then and had reached an unprecedented R8,00 to the US Dollar.

In any case, I remembered about them last week, my memory jogged by gold making new all-time highs:

Imagine my surprise when I calculated the returns on my shiny, useless (according to Buffett, in any case) coins. Let’s run through the math. In 2001, gold was $270 per ounce, and the exchange rate was R8 per US$. So, an ounce of gold was worth R2,016. Today, an ounce of gold is $2,730, and the exchange rate is R17.80 per US$. So, an ounce of gold is worth R48,594.

That equates to an annual return of about 15% – not too shabby. Of course, most of that comes from the increased price of gold.

My take:

• The Rand went from R8 to R17.80 to the US Dollar, an annual depreciation of 3.5% over 23 years. That doesn’t seem scary, so why is it almost the only topic we discuss at dinner parties?
• Over the period, the price of gold appreciated by 10.6% per annum in US$. That is a big number and reflects the steady decline in systemic trust in the Western monetary and political system. Worryingly, there is no sign of improvement on the horizon. More on the US election later.

I have earned a highly satisfactory return, mainly because I forgot about the coins. The gold price declined by over 20% during my holding period five times. Would I have weathered the storm if I had remembered I had the coins and was watching their price daily?

Sasol has become the red-headed stepchild of investors. People say they love the stock, but no one will admit to owning it. This week, I ran a poll on X about the most despised stock on the JSE. Of the 498 respondents, 55% said Sasol. Sasol was even more loathed than MultiChoice – which says a lot. The unit trust tables show that not even one institution is overweight Sasol. Here is why:

For 20 years, the stock has gone nowhere. It has been a serial disappointment. I have written about Sasol many times. You can read what I said in Vol 2, No. 3 – the Moot Point and Vol 2, No. 15 – Head Office Blues.

My take: The Sasol share price relative to the oil price in Rand is significantly depressed. Also, the current multiples of earnings are at historic lows and at a discount to European peers. I am busy changing my mind on China and Elon Musk. Maybe Sasol completes the trifecta. That is not a forecast, though.

Third-quarter profit at this property casualty insurer (or, as we know them in South Africa, short-term insurer) beat Wall Street expectations as higher underwriting gains and investment income more than offset catastrophe losses, sending shares of the insurer to new all-time highs:

If you read all the news about the hurricane season in the USA, you would have thought that insurers’ reserves (and share prices) would have been decimated. After all, it’s a climate emergency, isn’t it? And the first place such an emergency should show up is in the financials of insurance companies.

Except that’s not happening. It turns out that the only exceptionally stormy weather has been the way mainstream media has pursued the emergency narrative. This was an example, as quoted by Doomberg (Substack’s nr.1 paid finance newsletter):

“This year’s Atlantic hurricane season is expected to be extremely active, putting tens of millions of Americans in the eastern half of the country at risk from flooding and damaging winds, forecasters at the National Hurricane Center warn. The increased activity is partially caused by abnormally warm ocean temperatures driven by climate change.

Forecasters expect 17 to 25 storms to form in the Atlantic between June 1 and the end of November. At least 8 of those are forecast to be full-blown hurricanes, as opposed to weaker tropical storms. And 4 to 7 are expected to be major hurricanes, with winds powerful enough to uproot trees, destroy mobile homes and damage other buildings.”

Forecasters, it turns out, were unsurprisingly wrong. More from Doomberg:

“A funny thing happened after Beryl. Well, actually, not much happened at all. The rest of July and the month of August were mostly quiet, with only Hurricane Debby making landfall in Florida as a Category 1 storm. As August was coming to a close, scientists began to openly question why things were so calm. By early September, CNN found an expert willing to pin the lack of hurricanes on – you guessed it – climate change.”

No wonder experts are no longer highly regarded. This is not to diminish the storms that did happen, but if you live on the Southeast coast of the USA, this year was no worse than any other.

My take: Forget about the so-called experts and mainstream media. If there truly was a climate emergency, the stocks of property and casualty insurers would not be going to all-time highs.

I saw this chart today, which resonated with me:

In short, it doesn’t matter who wins the election. All the sound and fury is a waste of time.

My take: I refuse to read or listen to anything about the US election. The chart above proves that the performative clown show just doesn’t matter. There are much better things to do, like watching paint dry. To free up more time in my day for useful activities like that, I have muted anyone on X who posts about the US election. I will unmute after November 5th.

This is one of the best articles I’ve read in a long time. It’s by Ben Hunt of Epsilon Theory fame, and you can find the piece here.

In it, Ben tells of how he declined a trip to England to visit his father, who died shortly thereafter. He describes a problem we face: “In modern Western culture, it typically takes three generations for your stories to die before there’s no one left on Earth who has ever heard them. Once you get to great-grandchildren, that’s about it.”

What is the solution to this problem, according to Hunt? Generative AI. If you can feed all the information you have on, say, your father into an AI model, you can – at a certain level – commune with your ancestor.

Like everything else with AI, it is data-dependent, or, as they say in the classics – rubbish in, rubbish out.

The key is to gather all this unstructured data and then sensibly combine it. Make sure you place as much knowledge on physical record as you can and want to. Future generations will thank you for that.

My take: This is a challenging task, but it is possible. Being able to benefit from our ancestors’ wisdom and knowledge of family would arguably improve society.

I mentioned in an earlier letter that I had joined the board of Sakeliga, an organisation that works to improve the business environment in South Africa. While it is easy to criticise the system from the outside, contributing to making the country a better place for all its citizens is a much better use of one’s time. This is the route I have chosen.

Sakeliga is currently busy with a few major initiatives:

• Rolling back BEE –  legal pressure from Sakeliga has caused the Property Practitioners Regulatory Authority (PPRA) to retreat from its harmful BEE directive. This has provided immediate relief to business owners who lost their operating licences based on their race or who were at risk of doing so.
• Sakeliga is moving forward with efforts to curtail the regulatory reach of the Competition Commission (CompCom). The agency is now clearly being used as a wide-ranging and unconstrained economic intervention arm of the state, far beyond limited competition considerations.
• Sakeliga is preparing a comprehensive application to either have key elements of the NHI or the entire Act set aside.
• Two significant recent wins in our quest for local economic recovery in Ditsobotla (Lichtenburg).
  • Along with our local partners, Sakeliga protected businesses that were legally withholding their rates payments when the Ditsobotla Local Municipality unlawfully tried to cut their power supply. This shows the effectiveness of following valid statutory account dispute processes.
  • Sakeliga won a special punitive costs order against COGTA and North West Government in our ongoing litigation to restore key services and order in the municipality.

My take: I am proud to be associated with CEO Piet le Roux and his team at Sakeliga. You can learn more about them here. We would be grateful if you chose to contribute to the cause financially. Opposing our interventionist and incapable government and thereby improving the business environment costs money, but we must push as hard as we can.

Our associate Merchant West Investments hosts a monthly webinar called Coffee with Merchant West. Yesterday, my colleague Rudi van Niekerk and I discussed a solution to a problem many South African Investors face.

The problem? They do not have enough exposure to South African assets at a time when the negative consensus seems to be receding.

The solution? The MWI Value Fund – which Rudi and I jointly manage. This is a 100% South African equity fund with significant exposure to South African businesses.

You can watch a replay of the discussion, led by incoming MWI CEO Daniel King.

Alec Hogg has always been a top journalist in the business and political spheres. He started Moneyweb in 1999 (I think) and, a few years ago, the online business news site BizNews.

BizNews is one of the few independent voices out there. It is fearless in presenting both sides of a story and letting its audience make up their own minds, as opposed to mainstream media, which increasingly present their biased opinions as fact while actively suppressing opposing views.

BizNews also hosts interesting conferences with a wide array of financial and political speakers. I have been fortunate enough to attend – and speak at – all of their conferences so far. Their next conference is in March 2025, in Hermanus.

Hermanus in March can be a stunning place to be.

Here is the line-up.

The conference sells out quickly, so it’s best to register early if you plan on attending.

Rian wrote the classic book My Traitor’s Heart: A South African Exile Returns to Face His Country, His Tribe, and His Conscience, which was published in 1990. The book paints a dystopian picture of life in South Africa. His anger – the anger of a decent, moral, and intelligent man forced to contemplate a horrible situation in which he is inextricably bound – is sometimes barely under control.

Most of all, Rian is an excellent writer who can paint a picture that sears itself into your brain with just a few words.

Last weekend, I attended a talk by him in which he spoke about his experiences since writing the book, both good and bad. He admitted that he expected South Africa to fail miserably and was surprised when it didn’t.

He is now 70 and lives in VanWyksdorp, an outpost in the Klein Karoo, where he remains an active voice in discussions about South Africa’s past and present, using his platform to address the nuanced realities of life in the region.

He also has a band, which played for us on Saturday night. His ability to turn a phrase also comes through in the lyrics of his music. Phrases like: “I am allergic to the rituals of apology“ and “premature emigration” really hit home. One of his songs was called “Braai culture from the point of view of meat.”

Here’s a picture of the band:

Not exactly Linkin Park, but I enjoyed every minute of their performance.

If you like Afrikaans folk music, you can listen to his album on Spotify. The songs are vignettes of life in South Africa. The lyrics to the song “Trekboer” are especially poignant.

That’s all for this week. But do remember to be very, very careful out there.

Piet Viljoen
RECM