There was a gentleman looking for advice on how to invest his fortune, to be used solely for philanthropic purposes after his death. Hopefully for decades to come.
As part of the meeting, I brought two case studies from Benjamin Franklin and Cecil John Rhodes.
Ben Franklin was one of the four Founding Fathers from the United States, who set up an experiment to invest $4,000 when he died in 1790. Which could only be used after 200 years of compounding in 1990.
Cecil John Rhodes funds 100 students from all over the world every year to study at Oxford University through The Rhodes Scholarship.
£3.5M was invested in 1902 into a trust upon his death and today the trust has investable assets of around £550M.
The gentleman I met with wanted the right investment spread to ensure 200 years from now, his fortune would continue to give Africa’s brightest underprivileged minds, global opportunities.
The first thing I said to him was if that’s his goal, his investment strategy compared to Cecil Rhodes needed to be more growth orientated because it is of my personal belief that trust has underperformed.
Not through its own fault, but through opportunities that didn’t exist 124 years ago.
To give you an idea, growing from £3.5M to £550M over 124 years is an average return of 4.2% per annum.
But that return is slightly inflated because the trustees raised £75M in donations in 2013. Simply because the funds remaining in the trust, were no longer capable of meeting the costs of paying for Oxford fees, without adjusting Cecil John Rhodes’ wishes.
However if the original £3.5M had originally been invested into the S&P500, £3.5M was worth $17M in 1902 at an exchange of £1: $4.87.
If the money was left to compound without any withdrawals, it would be worth $1.9T today.
Which is half the size of the UK GDP.
Cecil Rhodes would have become an investor and picked the best stocks in Boeing, Coca Cola, McDonalds, Apple, Amazon, Facebook, Nvidia, and potentially Anthropic and SpaceX in a few months, all from his death bed.
Simply for holding an index fund.
However assuming the trust was instructed never to touch the capital and live off the dividends only, it would have grown to $13.9B today.
The present-day 1.5% annual dividends from S&P500 would pay the trust $208M a year.
Nearly 40% of its current total fund value. The Trust currently spends $19M a year funding students.
But at $208M, would be able to expand its current impact to over 3,337 students instead.
Now, why is this important? Because part of the plan was to invest a slice of his fortune in SA using the Top 40 and our conversation centred around where and how to do it.
If you personally wanted to invest into the Top 40, technically you could do it yourself. The JSE’s website tells you which companies make up the index, so nothing stops you buying each of these companies on your own through Easy Equities.
To ensure your ‘homemade’ Top 40 portfolio is accurate, all you’d have to do is to buy each company according to its weighting on the index.
For example, Clicks, currently has a 1.09% weighting on the Top 40. So if you were looking to invest R100,000, you’d invest R1,090 into Clicks on Easy Equities.
Standard Bank has a 5.13% weighting, so you’d invest R5,130 into Standard Bank. Woolworths, 0.69%, so you’d invest R690.
Etc etc.
You’d do this until you’d allocated the entire R100,000 across all 40 companies. And there you have it, your own ‘self-managed’ Top 40 portfolio.
Here’s the problem. Every three months, the Johannesburg Stock Exchange moves the weightings of this index around.
So in three months’ time, when the changes are announced, you’d have to rebalance right away to make sure that you’re still tracking the benchmark accurately.
But let’s say you didn’t rebalance. You forgot. Life got in the way. Or you did so but only 3 weeks later. So many market fluctuations would have happened during that time you delayed that you technically wouldn’t be tracking the index accurately anymore.
You might still have all the companies. But maybe the Standard Bank allocation increased to 7.2%, whilst you’re still holding on the old weighting, which ultimately affects your performance.
And at the end of the year because of this poor timing, your return would be slightly different to the benchmark.
To use fancy finance jargon this is something called “tracking error”. Several ETFs boast about how low their tracking error is.
Now you know.
Now for clarity, the benchmark is a measurement of what the performance should be if you executed everything perfectly.
So rather than doing this admin yourself, missing the timing and underperforming the benchmark.
Why not just pay someone? That’s why ETFs and unit trusts exist.
You’d think if these funds executed perfectly, they should technically get the same returns as the Top40 benchmark. Correct?
Not necessarily because the benchmark doesn’t account for fees. The benchmark returns are “imaginary” because although the JSE provides the framework of what companies make up the index.
The JSE doesn’t actually offer an ETF to the public.
They trust other financial services companies will create the products.
One thing this “imaginary”, benchmark doesn’t account for, is the cost of executing these trades.
Meaning in theory, the benchmark should obviously be “unattainable”. The pinnacle. You can’t outperform something that has no cost even if you replicate it perfectly.
To buy R100,000 worth of Standard Bank shares on Easy Equities would cost you R348 in fees. The benchmark would reflect all the return, but not the costs, so technically you can’t outperform it?
Here’s a summary of how well a few Top40 ETFs have performed against the benchmark.
| 1-Year | 3-Year | 5-Year | 10-Year | |
|---|---|---|---|---|
| Benchmark | 35.23 % | 18.54 % | 15.9 % | 12.34 % |
| Satrix Top 40 | 34.78 % | 18.25 % | 15.6 % | 12.09 % |
| Sygnia Top 40 | 34.6 % | 18.5 % | 15.6 % | N/A |
| FNB Top 40 | 34.7% | 18.25 % | 15.6 % | 12.1 % |
What’s not included in this table is that these returns are after investment management fees have been paid, but before admin fees.
FNB doesn’t charge an admin fee, so the returns in this table and on their fact sheets are final.
But Satrix and Sygnia charge an additional admin fee between 0.4 and 0.5% including VAT. Which further needs to come off these returns.
Dragging your performance further away from the benchmark.
So if you’re already banking with FNB, you’re comfortable with the platform, you’re looking to make a Top 40 investment and want everything in one place.
Then The FNB Top 40 could make perfect sense because it tracks the index fairly accurately. They’re cheaper than the competition and you’re already plugged in with their ecosystem. So why not?
Which brings us to our next example, the Prescient Core Top 40 unit trust. This fund has been opened since 2003, and what’s interesting is that it’s outperformed the “unattainable” benchmark since 2003.
| 1-Year | 3-Year | 5-Year | 10-Year | Since 2003 | |
|---|---|---|---|---|---|
| Benchmark | 35.23 % | 18.54 % | 15.9 % | 12.34 % | 15.66 % |
| Prescient Top 40 | 36.55 % | 19.54 % | 16.6 % | 12.48 % | 15.97% |
| Prescient Outperformance On Competition | + 1.95% | +1.29 % | + 1% | + 0.38 % | Unknown |
| Prescient Outperformance on Competition with Admin Fee | 2.35 % | +1.69 % | +1.4 % | + 0.78 % | Unknown |
But when you also consider Prescient doesn’t charge a 0.4% admin fee like Satrix and Sygnia do.
The outperformance gap over the competition becomes even more compelling as highlighted in red.
Now what we don’t have is the Satrix Top 40 performance since 2003, however we do know that since 2000, it’s averaged 14.22% which is 0.28% less than the benchmark.
The same benchmark which has also consistently underperformed Prescient.
So after accounting for Satrix’s underperformance to the benchmark and their admin fee, we can reasonably conclude that there’s about a 1% difference between Prescient and Satrix and Sygnia.
Now of course I’m going to explain how Prescient outperforms the index, but what’s the impact of that 1% difference over time?
And why these subtle differences had to be factored in by the new investor looking to leave a legacy. Assuming a R100,000 investment.
| 10 Years | 20 Years | 30 Years | 100 Years | |
|---|---|---|---|---|
| Satrix/Sygnia | R 364,000 | R 1.32 M | R 4.8 M | R 41.1 B |
| Prescient | R 397,000 | R 1.58 M | R 6.2 M | R 98.6 B |
Note: Assumes 14.8% net return for Prescient and 13.8% net return for Sygnia/Satrix.
Can you imagine 100 years from now, a R50B difference in your trust because you paid attention to a 1% spread today?
How many more lives could be improved?
To take this further using the Ben Franklin example who specifically set out a 200-year goal.
That 1% difference over 200 years is the difference between getting to 97 quadrillion vs 17 quadrillion.
From just paying attention to a 1% spread.
Ben Franklin was obsessed with compound interest and before he passed, invested £2,000/$4,000 which was going to be donated to the cities of Boston and Philadelphia upon maturity 200 years later.
When they finally did 1990, it was worth $7M. Which is an average return of 3.8%.
Now granted the only stock market that existed back then was the Philadelphia stock market. The New York Stock Exchange was only formed two years later in 1792.
However if that money had been invested in the Philadelphia stock market which averaged 8% across those 200 years, it would have been worth $19B by 1990.
At 10% in the New York Stock Exchange which formed two years later, $756B.
When you truly start thinking long term, you realise the margins are so thin, that it’s not enough to think compounding will save you. Admin fees, portfolios, small margins, investing passively, all adds up and make a big impact.
Finally, imagine you own the most beautiful house along the Atlantic Seaboard and you and your partner decide you’re going to live in Brazil for the next 2 years.
You leave the house, the most expensive house in South Africa in the custody of your 18-year-old son. With instructions to watch the house and leave it the same way you found it when they get back.
Deep down, you’d be happy if you came back in 2 years and the house was in 1 piece.
But to your surprise, when he picks you up at the airport after two years of exile, he shows you a company bank statement with R3M. The young man put the house on Airbnb and turned it into a money maker.
This is one of the things Prescient does once they’ve bought the stocks on the Top 40. They’ll own billions of rands in stocks and rather than sitting and holding onto these shares like FNB and Anglo they are going to put these stocks to work.
They lend them out to hedge funds and short sellers through something called scrip lending.
How scrip lending works is Prescient will have billions of rands in FNB shares. A short seller will approach Prescient and borrow these shares because they believe the FNB shares will go down.
So let’s assume 1 FNB share is worth R100 and the short seller wanted to borrow 500,000 shares which is R50M. They’d borrow from Prescient for a 110% premium in exchange for R55M in cash.
Prescient hands over 500,000 FNB shares worth R50M to the short seller who then sells these shares immediately onto the open market and the short seller now has R50M in cash.
Prescient parks R55M of cash into a money market account and they’ll share the interest three ways. With themselves, the short seller and you, the client.
This interest is one of the first ways that Prescient outperforms the benchmark because this interest gets added into your investment, because it’s now extra profit.
The second way is that short seller also pays a daily borrowing fee to Prescient for “renting” the shares. (Even though they’ve been sold).
Let’s assume the FNB share price drops to R80 as the short seller predicted. The short seller still has the R50M cash, and they buy 500,000 worth of FNB shares back for R40M.
They pocket R10M and give the shares back to Prescient. Prescient gives the short seller their R55M back.
That’s an oversimplification and I’m sure you have a tonne of questions. One of which I’m sure you have is. Is this legal?
Yes.
It’s standard practice and it’s regulated under the collective investment schemes control act and overseen by the FSCA.
Secondly, if this is so good why aren’t other companies doing it? Prescient’s Top 40 fund is a unit trust and not an ETF.
ETFs are designed to do nothing else except hold the ETF whereas unit trusts are more flexible.
Finally other companies do engage in scrip lending. But they just don’t give you back those profits. It’s kept for themselves, whereas Prescient reinvests the profit back into the fund to generate outperformance.
This is one of a few things Prescient does differently. Without blabbing on forever, very quickly something else they do is when FNB pays a dividend back to Prescient.
This dividend is for you, the client. But the dividend may be paid by FNB in August, and the fund is only meant to pay it back to you in December.
Instead of sitting on those dividends in cash, Prescient reinvests those dividends back into the fund straight away to buy more stock.
They might make small gains doing this, but an extra 0.1% or 0.2% over time doing this, adds up.
ETFs don’t usually do this. They’d park it in cash and distribute in December.
This is overly simplified, it’s as much as you need to know and I’ll leave it at that, otherwise this email would turn to a thesis.
But the point is, this fund is more dynamic and uses all tools available to try and find an edge. Rather than just sitting on your funds and executing trades as instructed.
