The South African Index Investor

The South African Index Investor

www.indexinvestor.co.za

Newsletter: May 2006

Traffic

By Daniel R Wessels

I am one of the thousands of commuters travelling daily between the city and the suburbs: a unique group of people who spend considerable time, exercise extreme patience and burn an enormous amount of fuel to arrive at the workplace in the morning. Many people consider this daily routine to be sheer torture. The question is asked frequently: why do you not open an office closer to home and therefore avoid the daily traffic?

I have to admit that I could never really give a convincing explanation for putting up with this daily routine, but the more I think about it, the more I realize it benefits me in some specific way, namely, management of potential “pressure cooking” situations. I see a number of similarities between how I manage the traffic situation and some aspects of my investment approach. Therefore, bear with me on this short journey (If the Arrive Alive campaign is hereby promoted, it is unintentional!)

I have come a long way in managing time. I wake up early – anything from 3 to 4 am – to do some reading or writing (as I am doing now!). This really gets me going and motivated for the day. Another reason for being an early bird is simply to avoid the peak hour traffic (6.30 to 8 am). However, even if I leave home some time past six in the morning the traffic is already slow-going. But I am grateful for the 30 to 40 minutes spell on the road, because I use them to plan the day ahead and think through some ideas.

The second aspect concerns road behaviour. Basically, you have two choices. You can assume an aggressive driving strategy; actively pursuing the gaps opening up in front of you by frequently switching lanes, or, you drive patiently along your chosen lane. Over the years I have learnt that you do not gain much by following an aggressive strategy, in as much as the right-hand line (the “fast” lane) does not really help you reach your destination earlier. If anything, you are increasing the risk of accidents by not obeying the following distance. Ironically, I have noticed it is often better to be stuck behind a large truck or bus since most motorists would rather move over to the next lane than being “slowed down”. The net result is some congestion in those lanes, while you would have a smooth, uninterrupted drive if you stay behind the large vehicles.

The third aspect concerns your economy of transport. I prefer to travel “small” and economically. Whereas in the past I used to re-fuel every week, I do that now only every second week with the same number of kilometres driven. Over time that will have a huge impact on your pocket. Even if you argue that you can afford to travel regularly by 4x4, you are still wasting valuable, scarce energy resources.

By now you should have recognized the analogies in my attitude towards traffic and towards investments, which I believe will stand you in good stead in both instances. First, consider the attitude towards time: If you start early, you are not pressurised; you are not trying to beat the clock.

Revisit the first principle of successful investing: “start now, not later” (see The seven principles of successful investing in the “Toolbox” menu). People in their late forties or early fifties often realise that they will not be able to retire comfortably and then frantically pursue investment strategies that are risky and less than prudent. They are trying to beat time. I am not saying it is impossible, but highly unlikely without generous help from Lady Luck. The correct strategy should include time as your companion; only then the powerful source of the Eighth Wonder of the World – the principle of compounding – is at your disposal.

The second principle is about whether you should follow an active or a passive approach towards investments. We cannot predict the future, just as we cannot foresee major hold-ups on the road ahead. My only conclusion about driving in the fast lane is that you face an increased risk of accidents or you will experience at the least a stuttering (stop-start) journey from start to finish. A simple reason therefore is that not all motorists display the same judgement and consideration skills or driving abilities to ensure a safe and smooth journey.

Similarly, when we switch from an investment (asset class) that has not performed to a star-performing investment, we are quite often disappointed by the end result. Switching is not always bad, but make sure that you have sound reasons, considering much more than just past performance, to justify such action. Alternatively: understand why you are making switches; do not switch just because everybody else seems to do so.

How does one invest “economically”? Is one not perhaps foregoing too much of the potential upside if only the cheapest investment vehicles are sought, such as index or passive investing strategies? Basically, these are available in two formats, namely collective funds (unit trusts) and exchange traded funds (ETFs). Theoretically, index investing should give you only an average, mediocre return (market return). Yet, history has shown that the end result is more likely to be above average compared with actively managed portfolios over time.

But that does not mean there is no scope (market circumstances) for active managers to pursue by adding something extra to the equity market performance. I certainly subscribe to that argument too. The question remains how to pick those active managers beforehand.

There is probably no golden rule. Some would say “track record” is the most important criterion. I think it is imperative to look at the manager’s business model and investment philosophies. Some investment houses have gone a long way in adapting investor-friendly cost structures. Furthermore, I prefer managers with definite views and strategies on why they could outperform the equity market, in other words their equity portfolios are not going to resemble the market index, which I can buy at a much lower cost.

My strategy: I integrate both strategies (active and passive) in my equity portfolio. Overall, I believe it is cost-effective and designed to give top-quartile performance, or very close to it, in the long term. Selah

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