Pick n Pay had to spend a fortune on the Smart Shopper system and has ongoing expenses in terms of rewards and analysis. The curious thing for me is how many loyalty cards incur the system and reward costs for retailers, but without gaining the full benefit of analysis and thus insight into customers.

I don’t get tailored book suggestions from Exclusive Books. They also haven’t tried to entice me back to their stores since I started buying first from Bookfinder.com and then almost exclusively ebooks from Amazon. They’ve basically lost a customer and haven’t done anything about it.

Even my friend’s St Elmos offers sweet deals to customers who haven’t ordered in a while to entice them back. Pick n Pay turned sub R100 pm customers into R350 pm customers (at least while the special was one) by specifically targeting customers that are familiar with Pick n Pay but need a push to become regular, high-spending customers.

I haven’t had a movie card with Ster Kinekor in a while, but I always use the same email address and credit when I purchase tickets online (which I do almost universally). There have been periods of several months where I haven’t gone to the movies, but no attempt from Ster Kinekor to woo me back with free popcorn or a careful movie recommendation.

Retailers are missing a trick to get an edge over their competitors.

So what assumptions are pension funds making? The WSJ has an interesting article showing that the average US pension fund is assuming future returns of approximately 8%. To put that in perspective, yields on 30 year T-bonds in the US are about 3.9%, 10-year yields are below 3% and inflation is currently about nothing. This is a huge real return and suggests that many of these pension funds may be underfunded.

It’s also interesting to work out what Equity Risk Premiums these valuation assumptions imply. FinanceClippings makes  some educated guesses at likely portfolio construction, and estimates assumed ERPs of nearly 8%. For reasons I’ve described before, an 8% ERP is madness.

My own calculations

FinanceClippings assumes a simple portfolio mix of 50% equities and 50% government bonds in this calculation, and assumes the average yield will be consistent with 30-year assumptions. I would differ slightly here. If we are looking at an overall portfolio, I would expect some investment grade corporate bonds and property in the mix too. These assets could be expected to earn 1% to 2% over risk-free over time (after adjusting for expected default loss on the corporate bonds). These return assumptions may seem low to some, but this is another area where it’s easy to overestimate the possible returns based on inappropriate periods of data.

On the other hand, it might be a little optimistic to assume 30-year yields as the average yield for the portfolio, depending on the remaining term of these pension funds. If we use a shorter duration, the risk-free yields approach 3% quite quickly.

Using a range of assumptions that make more sense to me, I see the pension funds assuming ERPs of between 6% and 6.5%.  Lower than the 8% to be sure, but optimistic all the same. (The sharp-eyed reader may see in my calcs that I am assuming an additive ERP rather than a compound ERP. Small differences, doesn’t change the conclusions at all.)

Check the calcs and assumptions and play around with them yourself –> Pension ERP implied assumption calculator tool [XLS]

Irresponsible assumptions

Whichever methods one applies here, it’s clear that too-high ERPs are being assumed. It’s irresponsible and it’s setting up tomorrow’s employees, shareholders, customers and citizens for problems that companies and valuators simply didn’t have the courage to deal with today.

It’s done none of these because the logic underlying it was flawed. Analysts focused on interconnect as an expense, happily ignoring the revenue side (since it was a fee paid to another company within the industry). Never has a telecoms issue been so badly hijacked by lack of understanding.

Now, in a press release that is a little vague, BMI TechKnowledge reflect concerns that telecoms growth rates may be lower as a result of falling mobile termination rates.

The economics of a fund manager depends entirely on growing funds under management so that revenues (based on assets under management) grow to be larger than costs (significantly fixed and at most semi-variable). Details of performance fees and the second order impact of investment performance aside, a successful fund manager must attract positive net client cashflow, and lots of it.

Half the 960 available unit trusts have less than R100m in AUM. Some of these may be rapidly growing new funds, but many have been stagnant with slow growth for several years.

The FSB’s attention presents opportunities for consolidation between funds and should place larger funds in a stronger position competitively. Total Expense Ratios (TER) for these funds with significant scale should already be lower than smaller funds. Maybe it’s time the larger funds made more if their size and cost efficiencies. If they are going to take the heat for being too large to be nimble, they might as well reap the benefits too.

It will be interesting to see what this means for white labelled funds and whether the economics of these convince the regulator that they should survive.

Posted with WordPress for BlackBerry.

Their housing price index is more robust (and more independent) than those of the banks based off their own data and target markets. Rather than consider only the average price of houses sold in that particular month (which is a function of house price growth / decline but also how the type, condition, size and location of the houses sold that month differ from the prior month and year) they consider repeat sales where the same property has been bought and sold more than once.

This data is combined or “chain-linked” to provide a continuous measure of house price inflation over time.

House Price Inflation 2010 source: lightstone.co.za

The result of all of this data, best-in-class methodology and analysis? When Lightstone says “opportunities abound in local market” I actually listen. Since their business model is to sell information, I’m more likely to trust what they say.

1 The Competition Commission is necessary

Monopolies serve to increase prices for consumers. In Monopoly, the “rents” charged are instantly higher as soon as a player has a monopoly on property in a certain area.

Worse than the increase in prices and decrease in supply, the additional profit for suppliers is not equal to the cost to consumers from higher prices, resulting in an overall “dead weight loss of monopoly” or an overall cost to society.

To date, the Competition Commission has focussed on cartels and price collusion. We can only hope soon they will consider issues of local loop unbundling to provide real competition to the effective monopoly Telkom has on ADSL lines.

2 The easy availability of credit is a useful and dangerous tool

An important consideration in Monopoly is to prevent competitors from owning property (so that you don’t have to pay rent on as many properties as possible) and definitely don’t get a monopoly (so they can increase rents and improve the properties, increasing rents even further).

A key way of doing this is by buying as many properties as possible, even if you mortgage many of them with a fresh injection of cash from the bank and very reasonable repayment terms. Leverage, or borrowing, can provide cost effective (especially after tax considerations) financing for profitable projects. It can be cheaper to raise than equity and increases returns to shareholders.

Leverage also creates significant risks, both in Monopoly and real life. Overextending can make you more likely to end up bankrupt. Also, by artificially increase the supply of funds for purchasing property while keeping the supply constant, the price of property will increase dramatically with distorting impacts on the allocation of resources within an economy.

3 Trading is good for those who trade

Every time two people (or organisations, or countries) trade, both parties are better off than they were before. (A hint, otherwise they wouldn’t have traded.) The trading parties are each better off, and the non-trading competitors are worse off, because a potential trade is now off the table and they are not in a better position otherwise.

There are some plausible arguments for trade restrictions in very particular circumstances. For example, I think I buy the idea of nurturing infant industries, but only if there is a reasonable chance that the industries won’t only grow as far as pimply, sulky adolescents with no drive or ambition.

Other than that, trade is good as it increases prosperity on average, which is one important way to lift more families incomes above the poverty line.

4 Liquidity risk can be the end of you

While buying as much property as possible and mortgaging some to provide additional funds will generally work in your favour and allow you greater control over the board, it also introduces liquidity risk. If you don’t have the funds to pay rent or taxes or fines when they unexpectedly fall due, you will be forced into a fire-sale of houses and hotels at way below replacement cost. You may need to mortgage even more properties, reducing your income generating ability and possibly sending you into a debt trap where your income isn’t sufficient to meet your expenses.

Always watch your liquidity. It has almost become a truism that more businesses fail because of liquidity than solvency or profitability.

5 The world is full of randomness, but it always helps to calculate the numbers

In Monopoly, the player “roles the dice and moves the mice” so to speak. There is plenty of luck around and skill can seem to disappear in an avalanche of random numbers.

Nassim Taleb (of Fooled By Randomness fame) would suggest that in everyday life we underestimate risk and overestimate skill. I tend to agree with this overall comment. It doesn’t mean that we should try to use our skill as much as possible.

Did you know that certain properties are relatively more valuable than others? The properties just after Jail are more likely to be hit than others, since several cards and one square on the board send the player to jail. Similarly, several chance cards require the player to advance a certain way, making the squares immediately after a chance square less likely to be hit. The cost to benefit of houses on certain squares are better than others, and the best bang for buck is somewhere between 2 and 3 houses per property.

It’s important to be aware that risk and uncertainty exists, but it’s more important to understand risk in a way that allows informed, risk-aware decisions to be made.

Identify, measure, mitigate and monitor risk!

Are all the lessons good?

Slightly tongue in cheek, there are a few other lessons of dubious validity:

1. Stay in jail and make more money
2. You get to keep the money if the bank makes an error in your favour
3. You can take as long as you want to repay your mortgage and only have to pay 10% interest
4. If the bank runs out of money, it can always photocopy some more
5. When the game is over, you can forget about the debt you have and walk away

Zurich Financial Services has just been fined £2.3m for a data loss event incurred in 2008 in South Africa.

Zurich joins HSBC, Nationwide and Norwich Union in the club of companies fined by the FSA now.

In fairness, the fine wasn’t so much for losing the data, but rather for:

• losing
• unencrypted data
• and not having monitoring and controls in place
• so that it was only discovered and reported to regulators a year later

The South African perspective

The FSA’s seriousness about these issues is mirrored in our looming Protection of Personal Information Bill. This is not the same as the disturbing proposals for a Protection of Information Bill which covers public or government information.

The Protection of Personal Information (POPI) Bill seeks to effect provisions in our constitution for rights to privacy. As more and more private and confidential information about each of us is stored, processed, transmitted and mined by institutions, there is a clear need for controls around what can done with this information and what controls and safeguards are required.

Operational or legal risk?

The fines and penalties associated with data and privacy laws create additional risks for any enterprise with customer data on file.  Operational risk is often (although not uniquely) defined as the failure of people, processes or systems giving rise to a loss. Legal or compliance risk is the risk of falling afoul of the law through non-compliance with laws and regulations.

Yes, this risk should be covered by your risk management system

It’s not particularly important how your organisation classifies the risk, but it is critical to identify, measure, manage and monitor the risks as part of an enterprise-wide risk management system.

As with all risks, it’s often the allocation of specific responsibility for risks, the listing of risks in a risk register and the regular reporting on these risks that slowly changes and organisations attitude to it more than anything else. Whether or not you model the risk in detail or attempt some sort of quantitative analysis is decidedly secondary.

Parking on the top floor does have a cost. It takes longer to drive up all the ramps and does, perhaps, on average take longer than parking on the most convenient floor every time. This extra time is a premium I pay to reduce the potential for really bad outcomes and thus optimising the parking problem. For example:

• I avoid the situation of attempting to park on a lower floor (trusting the untrustworthy electronic vehicle counter) and, after driving around for a while trying to find parking, having to give up and try a different floor. This much longer time, even if it only happens rarely, is a much worse outcome than 30 seconds on every flight. It can easily be the difference between making and missing a flight.
• I don’t have to worry about remembering where I parked my car. I don’t know that I am more forgetful than the average traveller, but travelling almost every week makes each trip blur into the next. I don’t waste headspace on trying to remember where I parked my car, and I don’t worry about forgetting. I have the peace of mind from having purchased a time of insurance against the risk of forgetting where I parked.

I get no value out of successfully memorising my car location, but gain from removing this risk and this worry from my routine.

If your company has a foreign currency exposure due to imported input components, this is a risk and a worry over which you have no control. Your energies are better expended elsewhere, on the operational and sales issues that you can effectively change. Get rid of these risks and get on with your real business.