DOWN­GRADE

Event risks will come and go, but a well-struc­tured bal­ance sheet should with­stand short-term volatil­ity sparked by these events, writes Craig Gra­didge

CityPress - - Business -

The con­ver­sa­tion over the past six months has been dom­i­nated by the prospect of a rat­ings down­grade by S&P Global at the be­gin­ning of this month. For many, the down­grade was a for­gone con­clu­sion, and they wanted to know what our plans were. It got eas­ier to have the con­ver­sa­tion as the year went on, but the prospect of the down­grade re­mained firmly in the con­ver­sa­tion.

Typ­i­cally, when you have a risk event (such as a credit down­grade) dom­i­nat­ing the con­ver­sa­tion or mo­bil­is­ing one to re­view a port­fo­lio, it is a good time to con­duct a strate­gic as­sess­ment of your bal­ance sheet.

A strate­gic as­sess­ment typ­i­cally en­tails a num­ber of dif­fer­ent analy­ses. We are look­ing for in­for­ma­tion such as the size of the bal­ance sheet, the strength of it (as­sets ver­sus li­a­bil­i­ties) and its diver­sity (con­cen­tra­tion risks).

Once flagged, we start a se­ries of analy­ses: a gap anal­y­sis; a liq­uid­ity anal­y­sis; a cost anal­y­sis; and a risk anal­y­sis. The aim of this is to get a deeper un­der­stand­ing of the client’s bal­ance sheet, which is ul­ti­mately the con­text in which we pro­vide ad­vice for new in­vest­ments or re­struc­ture the ex­ist­ing port­fo­lio. ARE THERE ANY IN­VEST­MENT GAPS?

A gap anal­y­sis is sim­ply an as­sess­ment of the bal­ance sheet to see if there are any gaps that ex­ist. Given the var­i­ous as­set classes and in­vest­ment prod­ucts that a per­son can in­vest in, are there any miss­ing from the client’s bal­ance sheet?

A client we saw a few years ago had two clear gaps in his bal­ance sheet: no off­shore ex­po­sure and no listed prop­erty ex­po­sure. Once we iden­tify gaps, we have to ask: Will the client ben­e­fit if these gaps are filled? If the an­swer is yes, we make a rec­om­men­da­tion, but if not, we con­tinue with the process.

In this par­tic­u­lar case, the an­swer was yes, and we in­vested this con­ser­va­tive in­vestor’s ad­di­tional money in an off­shore fund, and in a listed prop­erty fund. Nat­u­rally, the client and I were both ner­vous, him of the volatil­ity, and me of the pos­si­bil­ity of find­ing my­self stand­ing in front of the Fi­nan­cial Ad­vi­sory and In­ter­me­di­ary Ser­vices om­bud, hav­ing to ex­plain this ob­vi­ous para­dox.

That ner­vous­ness stayed for a bit when the port­fo­lio re­turned less than 6% in 2013, while the rest of his port­fo­lio soared.

At the end of 2014, how­ever, we re­ported re­turns of almost 40% for the year. That was again the case in 2015, with listed prop­erty be­ing the top-per­form­ing lo­cal as­set, and off­shore the clear win­ner thanks to three fi­nance min­is­ters in four crazy days. The value of the process led to the ad­vice, not a pre­dic­tion. DO YOU HAVE AC­CESS TO CASH, QUICKLY?

One of the most im­por­tant strate­gic analy­ses is the liq­uid­ity anal­y­sis, where we look at how quickly an as­set can be turned into cash with­out hav­ing to of­fer a price dis­count. A very liq­uid in­vest­ment would be cash in the bank, while an illiq­uid as­set would be prop­erty or a busi­ness.

Typ­i­cally, in­vestors fo­cus on how quickly they can con­vert to cash, and ig­nore the pos­si­bil­ity of hav­ing to of­fer a dis­count.

I of­ten get told by in­vestors with mul­ti­ple prop­er­ties on their bal­ance sheets that they have ac­cess bonds on those prop­er­ties, so they do not need liq­uid in­vest­ments. How­ever, as many in­vestors found in 2008, those ac­cess bonds were not as ac­ces­si­ble as they thought they were. Many of the banks sim­ply blocked ac­cess to funds as liq­uid­ity be­came a ma­jor is­sue for the banks.

We usu­ally rec­om­mend a min­i­mum of 30% ex­po­sure to liq­uid as­sets, which al­lows in­vestors to take ad­van­tage of op­por­tu­ni­ties that may arise from time to time. UN­DER­STAND THE REAL RISKS

We look at the level and types of risks that al­ready ex­ist in the bal­ance sheet to en­sure that there is suf­fi­cient risk in the port­fo­lio for the client to achieve their over­all in­vest­ment ob­jec­tive.

Too of­ten, we find that in­vestors have a reg­i­mented ap­proach to risk man­age­ment and do not con­sider the over­all risk­i­ness of their port­fo­lio or bal­ance sheet.

Too many in­vestors de­fine risk as ab­so­lute cap­i­tal losses, whether those are short or long term in na­ture. There are two big­ger, more im­por­tant, risks: the risk of un­der­per­form­ing in­fla­tion and the risk of per­ma­nent cap­i­tal loss. Con­ser­va­tive in­vestors typ­i­cally run the risk of un­der­per­form­ing in­fla­tion, par­tic­u­larly on an af­ter-cost and af­ter-tax ba­sis. Be­cause their cap­i­tal is pro­tected in nom­i­nal terms, they only re­ally wake up to the real risk they are ex­posed to when it is too late.

It is a slow process for in­vestors to awaken to this re­al­ity. The risk of per­ma­nent cap­i­tal loss is one that the risk seek­ers tend to face. It of­ten in­volves tak­ing spec­u­la­tive bets on the next big thing.

But all in­vestors are ex­posed to the risk of per­ma­nent cap­i­tal loss when it comes to in­vest­ment scams. ARE YOU GET­TING VALUE FOR MONEY?

Fees have in­creas­ingly be­come a fo­cus point for many in­vestors, and rightly so.

If a per­son be­gan an in­vest­ment strat­egy more than 10 years ago, they would ben­e­fit from a re­view of the cost struc­ture of their port­fo­lio now.

The in­creas­ing pop­u­lar­ity of index-track­ing prod­ucts, and the sub­se­quent re­sponse by a num­ber of for­ward-think­ing as­set man­age­ment firms, means that in­vestors can find them­selves sav­ing as much as 50% on their port­fo­lio fees.

With each of the var­i­ous analy­ses, it is clear what value could po­ten­tially be added. Of­ten, the out­come of such a process is a more re­silient and re­fined port­fo­lio and bal­ance sheet.

I once heard some­one say that “a good strat­egy builds em­pires”. I tend to agree with that sen­ti­ment. Gra­didge is CEO of Gra­didge-Mahura In­vest­ments. Visit gmin­vest­ments.co.za

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