Quarterly Press Conference

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Quarterly Press Conference
2009 OUTLOOKINVESTING IN ASLOW-GROWTH WORLD
27 January 2009
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• Investment Options Craig ChambersDeputy MD,
  Umbono Fund Managers
• Low-cost solutions for a low-growth world

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Fees of increasing importance

• Most equity analysts expecting single-digit real
  returns fromthe JSE over next 2-3 years
• A reasonable forecast is for the market to revert
  to its long-termrolling average return of 8
  p.a. before the 2003-2007 bull run
• Therefore, costs will have a far greater impact
  on fund performanceover the next few years

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Impact of Costs on Investors Returns

• Active fund management fees plus estimated
  trading costs as apercentage of the expected 8
  real return (on a R100m fund)
• 14 pa
• Tracker fee plus estimated trading costs as a
  percentage of the8 real return (on a R100m
  fund)
• 2.8 pa
• On the previous real returns of 20 p.a.,
  investors were payingapproximately 6 in fees
  for active management as a percentage of the real
  return
• Please Note Rob Rusconis research showed
  that the cost of neutralised trades (active
  managers buying and selling to each other) can be
  as much as 2.20 pa. (Source Whos Money is it
  anyway?). However, given the lack of published
  data regarding hidden trading costs, we have been
  extremely conservative in our estimate thus
  utilising only 25 of the 2.20 i.e. 0.55.

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Other Costs

• There are many other costs levied on pension
  funds that we have not included in this analysis
  (Many of these costs will be higher if only
  active funds are used), these costs include
• Investment Fund Expenses
• Bank charges, audit fees, booking fees, Strate
  fees, Besa fees, levies
• Administration fees
• Governance fees
• FSB fees, trustee fees
• Guarantee fees
• Other fees
• Consultancy fees, actuarial fees, principal
  officer fees,fidelity cover fees etc
• In aggregation, these sum to the funds All-in
  Costs (In Chile, a funds typical All-in cost
  is 0.63 (Source Old Mutual) - we would estimate
  that a typical SA funds All-in cost is at
  least 100 higher than this)

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Discount Relative to Average Active Fees
Rule of Thumb From the 2007 Alexander Forbes
Retirement Fund Survey our Tracker Fees are
between 71 78 lower than average active fees
(Min Segregated Mandate of R30m)
Manager Watch Survey of Retirement Fund
Investment Managers, Dec 2007
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Index Tracking Funds as a low-cost portfolio core

• Overseas, low-cost solutions like index tracking
  funds are increasinglypopular
• Used as a low-cost core of portfolios
  (typically 30 of an aggregatedportfolio) by
  20-30 of retirement funds overseas
• Combined with actively managed satellite funds
  charging higher fees
• Best of both worlds Lower fees for a portion of
  portfolio plus potential for outperformance of
  benchmark

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SA investors paying higher fees than necessary

• In SA, index tracking funds are not yet popular,
  as investors are toldthe local equity market is
  not suitable for index tracking solutions asa
  portfolio core
• We would suggest the facts are the opposite the
  JSE is subject toinvestability constraints that
  do not allow investors to create a fullyactive
  portfolio when blending actively managed funds
• In fact, SA investors inevitably end up with a
  portion of their portfolioacting as a passive
  core
• As a result, they end up paying higher (active)
  fees on part of theirinvestments than they should

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The South African EquityInvestment Universe
Umbono template
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Aggregated Top 11 Managers No. of Equity Holdings
Source Riscura, OMIGSA, Inet
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A Tiny Universe
Source Riscura, OMIGSA, Inet
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Investability Constraints?

• Our definition of investability is based on
  practical first hand active quant management
  experience of managing (in this case) a R500m
  active quant equity fund
• Typically, we require liquidity of gtR100m per
  month or some R5m per day (Only 75 of these
  counters have this liquidity)
• Assuming a manager is responsible does not want
  to incur significant trade impact costs, he
  should not want to trade more than 20 of daily
  trade this means that he can only trade R1m of
  the stock each day.
• WE USE THE LARGEST TRADING DESK IN SA
• In reality these investability issues apply to
  funds much smaller than R500m given that many
  fully discretionary house view portfolios are
  treated in the same way i.e. trading decisions
  are implemented across many 3rd party funds

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Aggregated Top 11 Managers Equity Holdings
Next 10 Shares, 1
Other Shares, 3
Top 80 Shares, 96
Source Riscura, OMIGSA, Inet
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Shareholder Weighted Index (SWIX)
Next 10 Shares, 2
Other Shares, 4
Top 80 Shares, 94
Source Riscura, OMIGSA, Inet
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The Current Environment

• Most active managers are now using the SWIX/CAPI
  as their starting point (or a very similar
  internal Reg 28 benchmark)
• A vicious cycle?
• Equity AUM of the smaller managers within the
  Large Manager Watch has increased significantly
  over the last 6 yrs
• The increase in equity AUM in the last 6 years
  has not been matched by an increase in JSE
  investability
• Listed market capitalisation has increased but
  actual SISS and large new listings have not added
  much to the 80 or so investable stocks

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Proving that a substantial component of South
Africas active managers returns can be directly
attributed to the FTSE JSE SWIX Index
Umbono template
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Aggregate Manager Portfolio vs SWIX
Tracking Error of 2.5
Aggregate manager portfolio
SWIX
The Shareholder Weighted Index (or SWIX Index)
has the same investment constraints as the active
managers - only 80 stocks make up almost the
entire investment universe.
Tracking Error or TE is a statistical measure
that shows how differenta funds share weights
are relative to the benchmarks weights.(In the
US, an active manager will have a TE of 5 or
higher.A 2.5 TE fund would be defined as an
Enhanced Index Fund)
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1/3rd Aggregate Manager Portfolio vs 1/3rd SWIX
Tracking Error of 0.48
Aggregatemanager portfolio
SWIX
One-third of the aggregated managers portfolio
very closely resembles the SWIX- a 0.50 TE fund
would be defined as a full-replication Index
Fund. OMIGSAs attribution analysis confirms
this for the month of Dec08, 86 of the
aggregated managers Performance can be
attributed to the SWIX Index.
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1/3rd Aggregate Manager Portfolio vs 1/3rd RAFI
Tracking Error of 0.90
Aggregatemanager portfolio
RAFI
One third of the aggregated managers portfolio
still closely resembles the RAFI Index- a 1.0
TE fund would be defined as a optimised Index
Fund.
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SWIX Relative to the General Equity Units Trusts
Source OMIGSA, Morningstar
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SWIX versus General Equity Unit Trusts Average
(Net of Fees)
Source OMIGSA, Morningstar
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Average Manager Returns (Gross) Vs. SWIX
(Gross)5 Years to 30 November 2008
Source OMIGSA, Morningstar
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Implications of Only Utilising Active Managers

• Conservatively, at least one-third of a South
  African investors equity investments are
  needlessly incurring the following costs
• Active fund management fees
• On average for a R100m pension fund active
  fees are 390 more expensive, relative to
  equivalent tracker fees (See our Fee Table
  Attached) (Source Alexander Forbes Retirement
  Fund Survey)
• High churn or portfolio trading costs
• On average an active portfolio (which includes
  the de-facto passive SWIX core) will have a
  turnover rate of at least 200 more than a
  tracker fund (15 for a tracker versus
  approximately 50 for a buy-and-hold active
  manager).So, for the one third passive portion,
  the investor is needlessly paying away 200 more
  in brokerage, custodial and tax costs. (Source
  OMIGSA)
• Over-and-above that, brokerage costs are
  typically at least 100 higher for active
  managers
• Please note that these are hidden costs as
  performance is quoted after these costs (Even the
  ACI definition of TER does not include these
  costs they are well and truly hidden)

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Other Factors that Impact the Active/Passive
Decision

• Global best practice as well as SA research
  recently done by Afrifocus Securities, prove that
  there are other factors that clearly show that a
  100 fund allocation to active is not optimal
• Investors relative risk aversion levels
• Active management relative performance has been
  proven to be very cyclical (Investors who are
  risk averse to periods of active managers
  under-performing should not invest 100 in
  active)
• Benchmark Hugging
• Research has shown that during periods when
  managers under perform their benchmarks, they
  resort to benchmark hugging i.e. they take less
  active bets

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So, Why the Active-Only Infatuation?

• The IRONY from this research is that the
  rationale for utilising indexation within the
  overall investment blend has little to do with
  active vs passive performance
• This is completely contrary to what investors are
  being told i.e. active out-performs passive and
  therefore a 100 expensive active allocation
  should be implemented
• Given our markets liquidity issues, whether
  one-third of the fund is invested in a low-cost
  SWIX tracker or whether one-third is an expensive
  de-facto passive SWIX core the future total
  GROSS return will be very similar
• But, on a NET basis, the fund with the
  intentional low-cost SWIX tracker will have
  superior long-term returns

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Everyone is Fighting over the Same 80 Stocks
Apart, the active managers are different,
together a de-facto passive core is created.
Together they resemble the 80 stock investable
universe they are the market, so the argument
that tracker is bad because it buys into the top
of markets and visa versa makes no sense if you
are aggregating managers...
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Disclosing Our PooledTracker Fees
Umbono template
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FEE Schedule Pooled (ex VAT)
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Regulatory Information
Umbono Fund Managers (Pty) Limited Physical
address 1st Floor, Block A, Grayston Ridge
Office Park, 144 Katherine Street, Sandton
2196. Telephone number 27 11 562 6000
Facsimile number 27 11 262 0331 Umbono Fund
Managers (Pty) Limited is a licensed financial
services provider, FSP 721, approved by the
Registrar of Financial Services Providers
(www.fsb.co.za) to provide intermediary services
and advice in terms of the Financial Advisory and
Intermediary Services Act 37 of 2002. Market
fluctuations and changes in rates of exchange or
taxation may have an effect on the value, price
or income of investments. Since the performance
of financial markets fluctuates, an investor may
not get back the full amount invested. Past
performance is not necessarily a guide to future
investment performance. Personal trading by
staff is restricted to ensure that there is no
conflict of interest. All directors and those
staff who are likely to have access to price
sensitive and unpublished information in relation
to the Old Mutual Group are further restricted in
their dealings in Old Mutual shares. All
employees are remunerated with salaries and
standard short-term and long-term incentives. No
commission or incentives are paid by Umbono to
any persons. All inter-group transactions are
done on an arms length basis. Umbono has
comprehensive crime and professional indemnity
insurance. For more details, as well as for
information on how to contact us and how to
access information please visit
www.umbonofundmanagers.com.