Clubbing together

PFM IOL 1stq 2014 investment clubs main Istockphoto

This article was first published in the first-quarter 2014 edition of Personal Finance magazine.

It’s a good time for investing directly in the stock market. The Johannesburg Stock Exchange (JSE) has been breaking all records, commentators are bullish about the long-term prospects of investing in stocks and shares (see Taking Stock, Personal Finance fourth quarter 2013), government is encouraging financial self-reliance, and retail investing has never been better supported by the investment industry.

Even stokvels, which traditionally save for short-term goals, are moving into long-term investing, according to a 2011 survey by research company African Response. Instead of saving for funerals or groceries, a growing percentage of these community groups are “learning about and jointly investing money with the aim of creating wealth and security for … members”, according to Mampudi Nkgadima, managing director of African Response.

The JSE is right behind this trend, striving to make retail investing more accessible to the population at large. Zeona Jacobs, the JSE’s head of investor relations, says: “Retail investment is becoming part of the life of the stock exchange, as it already is in other parts of the world, and we are keen to break down the perception that the JSE is just for the wealthy.”

Fertile ground then for the growth of investment clubs, created by groups of individuals who have all the usual tax-efficient savings but want a piece of the stock market action.

The concept is wonderful: you link up with friends, relatives and/or colleagues, agree to get together regularly in a pub or at someone’s home with a beer in your hand, and talk shop for hours on end, discussing and investigating shares, deciding what to buy and sell and – hopefully – making loads of money.

Of course, nothing in the financial world is ever that simple. One company that is enthusiastically behind the investment club concept is financial services provider PSG – more specifically, PSG Online (www.psgonline.co.za) – which offers a free, comprehensive guide in PDF format, “An introduction to investment clubs”. The author of the guide, Shaun van den Berg, PSG Online’s head of client education, says the profit motive is part of it, but “members should also look on investment clubs as a great way to learn about successful investing”.

In fact, he says clubs should focus on education first and foremost, with profit following as a consequence of good decision-making. “If club members are too concerned about having their portfolio show lots of big numbers in the profit columns, especially when they are first starting out, their share selection is likely to suffer,” he says.

Van den Berg sums up the idea thus: “Investment clubs are a terrific way for those new to investing to learn about it in a friendly group setting, as members cough up modest sums and invest carefully together, after deliberating the pros and cons of any action.”

Organisers of investment clubs should emphasise to all prospective members that these are not get-rich-quick schemes, he says. Members should be in it for the medium to long term, by which he means at least three to five years.

Above all, his advice is that you invest money in the stock market that you can afford to hand over and forget about. That way, you are able to sell your investments at a time of your own choosing and will not be forced to sell when share prices are low.

Channelling funds into an investment club should never be a substitute for tax-incentivised retirement saving and is unlikely to be the most tax-efficient way of investing.

Back to the future

If you join or start an investment club, you become part of a global movement that started back in 1898 in the United States. The first club was established in Texas, as industry geared up and people moved away from agriculture and cattle farming.

Oddly enough, the French are particularly partial to the investment club idea, with an estimated 15 000 clubs, but the concept is enjoying something of a revival in the United Kingdom. The first club opened in 1959 and rapidly spawned at least 3 000 more, but that movement faded. The new wave started in the early 1990s, encouraged by a non-profit lobby group, Proshare, set up by the UK government to promote share ownership among the public. Its investment club arm helped more than 12 000 clubs to get started between 1992 and 2003, when it was sold as a going concern. Proshare Investment Clubs continues to support clubs, runs the annual National Investment Club Conference (the seventh such event was held in November 2013 in London) and has started to compile a national register of clubs.

In South Africa, it is not known how many clubs there are, because there is no register or association, but there is a surprising amount of support available from investment platforms such as PSG Online and etfSA (www.etfsa.co.za), the information and transaction website for exchange traded products (ETPs).

Mike Brown, managing director of etfSA, responded to the “huge potential” in this market last year by publishing a guide called “How to start and manage an investor club/stokvel”, spelling out the administrative requirements and providing a sample constitution. The company also partnered with the JSE to

produce a series of dedicated seminars for members of stokvels and investment clubs, taking advantage of the JSE’s enthusiasm for educating prospective retail investors and promoting ETPs as the ideal start-up investments for clubs.

Nicola Comninos, senior manager for equity market development at the JSE, says that individuals and clubs can start with small steps, investing as little as R300 a month.

“It can be very daunting for people taking the first step in investing to choose which shares to buy, so we suggest they kick off with one of the exchange traded funds (ETFs) that tracks the performance of the top 40 companies on the JSE. That way they get a broad-based, managed investment and have lower entry costs to a spread of products,” she says.

The JSE offers a comprehensive range of resources for the new investor, including its own free seminars on all aspects of investing and a range of online educational courses, such as “Stock market for beginners” and “Shares made easy”. The exchange also publishes what it calls “educational pullouts” from JSE Magazine and other articles specifically for retail investors. So there is no shortage of free, easily accessible information for the uninitiated, all good for sharing in investment club meetings.

Time is your best ally

If the first principle is to start small, the second is to allow plenty of time – “the longer, the better”, Van den Berg says. The effect of time on investments is easy to illustrate: take the FTSE/JSE All Share Index (Alsi) after the stock market crash of 1987. For those who bit the bullet, value was restored to pre-crash levels within two years and had more than doubled by the end of 10 years.

Similarly, those unfortunates who invested on the stock exchange in 1998, at the start of the so-called “Asian contagion”, needed steel in their spines, but they were back in profit by mid-2000. Then there was the “dotcom bubble” in 2002, which sorely tested investors, but if they held their nerve and continued holding and investing, they would have seen the Alsi soar from 7 600 at the start of the recovery in 2003 to about 40 000 today. After the crash of November 2008, the Alsi recovered by 52.5 percent within a year (October 2009) and reached an all-time high four years after that, in October 2013.

Again, the caveat is that you must be able to ride out the small and large fluctuations in the market and take your money out when it suits you, not when circumstances dictate.

Business principles

The foundation of a successful club is to treat it like a business; after all, it involves your money and eventually, if done right, can involve substantial profits, even though the contributions may seem insignificant.

This means putting friendships aside for the period of the business on the table and establishing strict rules that everyone is happy to abide by, clear criteria for entry and exit, and a protocol for resolving disagreements.

The club needs to be big enough to give it weight in the market, and small enough to be manageable. Thirty people all trying to give their input could be daunting and make meetings very long.

Sasha Planting, a financial journalist with the website www.moneyweb.com, wrote about her experience of being part of a club that collapsed (“The revival of investment clubs”, June 14, 2012).

“We were a group of about 10 professional women, with good brains, a keen eye on the markets and a small amount of spare cash to invest each month,” she wrote. “So some time ago, we set out to achieve big things by pooling our knowledge and capital.

“We lasted about six months. And then the politics began. To buy or not to buy? To listen to the chartist in the group or not? To move more aggressively into gold? Alliances were forged, the stronger personalities dominated and the fun went out of our evenings together.

“The portfolio was dissolved and we emerged with our original capital. We were lucky. But we also missed out on one of the longest rallies the JSE has seen.”

As they say, the road to hell is paved with good intentions. This example underlines the absolute necessity of agreeing on a constitution, defined roles and responsibilities, and – most important of all – an investment philosophy, or strategy.

Van den Berg says: “All the members of an investment club should agree on their investment objectives and strategies before they start. If some members are interested in ‘playing the market’, rather than taking a more studied, long-term approach, the conflict has the potential to tear the club apart.”

The long view

Eric Salomon is an accountant, and as befits someone in his profession, he takes an uncompromising line on his investment club’s policy, which has been unchanged since 1988. He and nine friends and clients got together one evening and decided that their investment club would aim at supplementing their pension savings – which, for Salomon at least, would probably not need to be accessed for at least a quarter of a century.

The members each contributed R1 000 to a start-up fund and pledged R100 a month. The policy was strict: only blue-chip shares would be bought and all dividends would be ploughed back. Over the years, the contributions have increased marginally until they now stand at R500 a month.

“Our common interest was in buying shares and saving. The incentive of the club is that you have control over what you buy. Unit trusts are fine, but they are out of your hands. And they have become so big and unwieldy. They have huge holdings, so they cannot buy and sell on a huge scale because that would affect the market. By getting 10 people together and establishing a base fund of R10 000, we had purchasing power,” Salomon says.

Pragmatically, the club also invested in the expert opinion of a stockbroker, who fills in gaps in members’ knowledge of market conditions and companies. “We are not experts. We know what we want, but with a broker, we get some advice. The only difficulty for investment clubs is that you need at least half a million rand before [a broker is] interested. But everyone goes through a stockbroker, even if it is though a bank’s stockbroker on the internet, and you still pay a fee. It is so much better if you can have your own as soon as possible,” Salomon says.

Stockbroker and Personal Finance columnist David Sylvester says that the minimum to open a stockbroking account can be as high as between R1 million and R3 million. “Minimums vary from broker to broker and exceptions can be made under certain circumstances,” he says.

All purchases and sales go through a stockbroking company or partnership registered with the JSE, and Sylvester says they all operate differently.

“I would say that, with rising costs and regulation, the general rule is that ‘execution only’ is where a client rings in and gives a simple purchase or sale instruction. ‘Advisory’ (where a higher fee would apply) is where a client rings in and discusses the order that they wish to place, getting input and advice before finally deciding what to do.”

In the early stages of Salomon’s club, some members pulled out and were replaced by others who were able to buy up the departing members’ share of the portfolio. But as the portfolio grew, that became impractical, and those who chose to pull out were not replaced. Seven remain and the portfolio is now worth about R7.6 million.

Salomon’s club was created as a close corporation (CC), and although that is no longer possible, since registration of new CCs ended on May 1, 2011, forming a small private company is not much more onerous.

“It made it so much tidier in terms of taxation,” he says. “The corporation paid income tax when it was due, which relieved the members of any tax burden in their personal capacities.”

The growth of the club has been impressive, thanks entirely, he says, to the share selection policy and, of course, time. “Time is such a wonderful thing,” he says. “Not for us, because we grow old, but for investment. When you add to that the compound effect of putting the money back, it is phenomenal.”

One of the first shares the club bought was Rembrandt. In 1989, Rembrandt shares were R5.90, which was expensive at that time; but since then they have split into Remgro, Richemont and British American Tobacco, priced at R201, R102 and R545 respectively (as at October 29, 2013).

Says Salomon: “I was told once by a stockbroker, and it’s worth telling again: ‘I have never known anyone sell Rembrandt shares and not say he regretted it.’ It’s the perfect example of a quality share that did not pay massive dividends, but put profits back into growth and security.”

Salomon’s club spread its net far and wide and now lists among its holdings heavyweights such as Pick n Pay, PPC, Anglo American, Sasol, SABMiller, AVI and Tiger Brands, all of which have reaped huge rewards. It ignored new shares and focused on companies with proven track records, solid management and a solid dividends policy, with dividends currently yielding R195 000 a year for the club. Shares that no longer met those criteria were sold.

The key to the success of this club was the resolute strategy of the members to stick to the declared aim. They knew and accepted that, in the early stages, growth would be small as they accumulated funds to buy quality shares.

“We also had strict rules regarding members leaving the club. To ensure that no one could take unfair advantage if the market suddenly leapt – in other words, to avoid profit-taking – we had a three-month notice period and then paid out three months after that. In practice, though, when we could see the reason for leaving, it was shorter than that,” Salomon says.

“There were various reasons for leaving. One member thought that he could do better on his own; another really needed the money for his daughter’s wedding overseas. But on the whole, we selected people who were in it for the long term. It is not a savings club, there for when you want to buy a new car. We all bought into the philosophy of creating a pension pot over which we had control. If you treat it as a savings club, it will be finished in five years, and if you take the dividends, instead of reinvesting them, there will be extremely slow growth.”

But, like investing in a fine wine, when is the right time to taste the fruit of your efforts?

“We are all getting to the age of retirement, so it is something to think about now – if not to take the investment, then perhaps the dividends. But we are all still working, and when I raised the issue a little while ago, the members decided to maintain the club’s policy for a little longer. If someone were to suggest taking dividends, I would probably go along with it.”

The club has never had dissension, but if the members were divided over the issue, a meeting would be called and it would be put to the vote. If there were strong feelings about it, the members would have to be paid out, Salomon says.

To summarise the power of the club, Salomon lists three main factors: “Put everything in, take nothing out and never have a fight.” Sounds simple.

A textbook case

Diversification is the driving philosophy behind the club set up by Warrick Fulford and nine friends in Pretoria in 2008 – named Proshare, after the British investment club backers.

Fulford, a property developer, was attracted to investment clubs while working in England, and set this one in motion on his return, using the Proshare template and now using the resources of PSG.

“We were almost oversubscribed when we started out, because the word spread as one friend recommended another. But we really wanted to learn about investing in the stock market and we set about getting a diverse interest base. We divvied up the sectors, obviously according to knowledge, but then we also asked ‘what sector would you be interested in?’, to expand our knowledge,” Fulford says.

The club was formed in the uncertainty of the 2008 crash, but they saw it as an opportunity. They all contributed R3 500 as a start-up and now contribute R1 500 a month.

“We accepted we didn’t know much about the stock market, and we were very cautious at the start. It took us a long time before we made our first buy.” Pragmatically, they went for Satrix ETFs.

“We scented that the market would make a recovery, but we didn’t know which sector was going to recover better, or what shares within that sector were going to be of value. So we wanted a broader managed exposure to spread the risk,” Fulford says.

As they became more confident, they ventured into more high-risk sectors, now committing about 30 percent of their funds to those, and they have a rand hedge in dual-listed firms and overseas markets.

The Proshare investment club was set up as a partnership, in which members are taxed as individuals, because the members feel that tax is a matter for each member and his particular circumstances.

“We meet 10 times a year in various offices with a beer and pizza and have a good time. It is all very democratic. Each member has to motivate a share purchase, which we sometimes reject. We committed ourselves to a five-year plan and set as a target a 15-percent growth rate,” Fulford says. Theirs, like other clubs, reinvests everything and has seen the portfolio grow to about R750 000.

“The dynamics of the club have shifted a bit, too, because in the beginning we were building a portfolio. Now we are not only building, but managing one too. Each member who punted a share is tasked with monitoring it, and we discuss every share at our meetings.

“We really make it a social occasion, and every year we celebrate our gains with a nice lunch.”

Incentives to save and invest

There could be added incentives in future for investment clubs, according to Comninos. Government has already announced in a consultation paper that they are considering a tax-incentivised savings vehicle to encourage individuals to save for short- and medium-term needs without relying on their retirement funds. Individuals will be able to save up to R30 000 a year in this account, with a lifetime limit of R500 000. Holdings in the account will be exempt from income tax, dividends tax and capital gains tax. A broad variety of assets will be permitted, including bank deposits, shares, RSA Retail Bonds and collective investment schemes.

Comninos reveals that the JSE, in collaboration with its retail advisory committee (consisting of both stockbrokers and financial services providers), is designing an investment account that they hope will meet National Treasury’s requirements.

Says Comninos: “If the proposed investment account gets JSE executive committee approval, we envisage discussing it with Treasury. At this stage, our understanding is that an individual would have to hold the account. That would imply that both individuals and learning clubs (in which club members hold individual accounts) would be able to hold such accounts.

“However, it is not known at this stage whether Treasury will also allow investment clubs and stokvels to hold such accounts, but, as long as each individual adheres to the R30 000-per-year contribution and lifetime limit of R500 000, that could be the case.”

She expects to have greater clarity very soon, and Treasury wants to introduce the new accounts by April 2015. Something to chew over in the convivial atmosphere of the investment club.

THE UNIT VALUATION SYSTEM

One method of calculating the value of each member’s share of the holdings of the investment club is the unit valuation system, whereby value is expressed in units which have a monetary value. PSG Online’s “Introduction to Investment Clubs” explains the system.

Determining the share held by each member of an investment club is supremely simple if, say, there are four members and those four members stay together to the end. Each gets 25 percent of the gains and pays 25 percent of the costs. But clubs tend to be more fluid than that, and membership can and will fluctuate. Hence the need for the unit system.

In a nutshell, each founding member is allocated one unit for every rand invested. The rands are used to buy shares, and the units take on the value of the shares.

The value of the units is calculated at the end of each month, based on the investment club’s assets, and the unit price determines the allocations for the following month.

As an example (using PSG Online’s figures), 10 members contribute R500 as a start-up fund (R5 000), and agree to pay R200 a month as a regular contribution.

The initial value of each unit is R1. The club buys a tranche of shares with the R5 000, with each of the 10 members owning 500 units. The shares leap to R7 500 within a week. There are still 5 000 units in issue, but now each is worth R1.50 (R7 500 ÷ 5 000 = R1.50 asset value per unit). Each member has 500 units, worth R750 (500 x R1.50).

In the second month, the members send in their R200 contributions, swelling the club’s assets by R2 000.

R200 buys 133.3 units based on the previous month’s net asset value of the unit (R1.50), so the pool of R2 000 buys 10 x 133.3 = 1 333 units. There are now 6 333 (5 000 + 1 333) units in the club and each individual member owns 633.3 units. The assets of the club are its shares worth R7 500, plus the R2 000 in cash.

Let us suppose the club is researching shares, so the money stays in the bank. In the meantime, the value of the shares drops, so that by the end of the second month they are worth only R7 000. The club still has its R2 000 in cash, so its assets are worth R9 000. There are 6 333 units in issue, so the unit asset value is R1.42 (R9 000 ÷ 6 333).

In the third month, the members contribute their R200 and are allocated 140.8 new units (R200 ÷ R1.42). Now each holds 774.1 units. Due to the growing popularity of investment clubs, another member joins. He pays his R500 starting fee and R200 for the current month, and will receive 493 units (R700 ÷ R1.42).

In total, the club now has 8 234 units in issue (6 333 + 1 408 + 493). Its assets are R7 000 in shares and R4 700 in cash (R2 000 in cash from the second month + R2 000 from the third month + R700 from the new member), or total assets of R11 700. The unit asset value is still R1.42.

* Mark Salter is a freelance journalist.

MAKE SURE YOUR CLUB IS GENUINE AND LEGAL

Investment clubs are a great option for investing, and learning about investing, in almost anything – from stock markets to private equity and property. But you need to be sure that the investment club you join is both genuine and legal. You also need to know that proper controls are in place to ensure that no one can loot the money.

The heart of the issue is that if investors are publicly invited to pool their money in order to access underlying investments that they would otherwise not have access to, the investment is likely to be regarded as a collective investment and needs to be registered as such. If the offer to pool money and invest is made to select individuals only, it will be regarded as an investment club.

In 2011, Pretoria-based financial services company Dynamic Wealth closed its doors after the Financial Services Board (FSB) finally won a battle against it that had gone on for many years. The company was side-stepping the Collective Investment Schemes Control Act (Cisca) by marketing and administering what it called investment clubs.

In the process, many of the investors have lost money, because they were not protected by Cisca, which requires the provider of a fund to place your money with a custodian, proper independent daily valuations of the fund’s assets, and ensures your money is invested in what you are told it will be invested in.

The FSB’s grounds for placing the various Dynamic Wealth entities under curatorship included its assertion that a number of investment portfolios offered by Dynamic Wealth under the guise of investment clubs were, in fact, illegal collective investment schemes.

Some of the investments in the “investment club” portfolios were placed in a fund managed by Corporate Money Managers (CMM), which has since been sequestrated. The fund masqueraded as a unit trust money market fund, but, in fact, it pooled investors’ money to invest in risky property developments, which subsequently failed.

After the FSB’s initial intervention and prior to the curatorship order, Dynamic Wealth’s “investment club” portfolios were converted into companies. The troubled money market “investment club” became a company called Specialist Income Ltd (SIL). SIL is likely to be the biggest loser in the collapse of CMM, with a potential loss of R230 million.

Converting the “investment club” portfolios into companies reduced the rights of investors, because they became shareholders rather than investors with a preferential claim to any assets. Legal investment clubs may use a company structure to ensure that they do not contravene Cisca.

Despite the Dynamic Wealth affair, the dangers of phoney investment clubs still lurk. For example, some operators in the imploding property syndication industry are now trying to relaunch their operations under “investment club” labels. So instead of buying into a syndication scheme that is labelled, for example, Acme Property Syndication, it is now called Acme Property Investment Club. However, underneath the scheme is the same structure (in simple terms, a company that sells shares and issues debentures to investors) and poses the same danger, which has seen thousands of investors losing billions of rands over the past 10 years.

Typically, the money raised by a property syndication company is used to purchase shares in another company that actually owns the property. This means the investor has no claim on the actual property asset.

When you join an investment club, you need to be sure that:

* It is a true investment club. If it is not, and pools your money in a way that contravenes Cisca, without being registered as a collective investment scheme, you will not enjoy the protection offered by collective investment scheme legislation.

* The legal structure of the club is properly set up. Structures must be in place to ensure your share in the club investment’s will not be pilfered.

Jurgen Boyd, head of collective investment schemes at the FSB, says that there are specific exclusions in Cisca allowing for private investment arrangements. These exclusion apply when an:

* An investment is made by restricted circle of individuals;

* The restricted circle of individuals has a common interest;

* The restricted circle receives an invitation into a domestic or private business venture; and

* The domestic or business venture is between the restricted circle and the person making the invitation.

“Where all these elements are met, the scheme will be exempt from Cisca,” he says.

Boyd says that in the Dynamic Wealth case it was shown that the members of the association were not a restricted circle of individuals engaged in a domestic or private business venture, and the associations were therefore operating illegally as collective investment schemes.

He says that once the FSB has determined whether those invited to invest are the public at large or not, the scheme itself is examined.

“Fundamentally, in a collective investment scheme, the investors own the assets of the portfolio proportionate to their participatory interest; they therefore have real rights of ownership. In a company (investment club) on the other hand, a shareholder owns an interest in the company itself and not the assets (underlying investments of the club) of the company, and such a shareholder has personal rights,” Boyd says.

So it is here that you may encounter a second problem if your investment club is not properly structured: you may have no claim to investments bought by the club.

If, for example, the club is a company and it borrows money to invest on the stock exchange and the money is lost, the lender would have first claim on any assets if the company was liquidated.

If the assets are, in effect, placed under the control of a single person and the money is stolen, your claim is only on any residual assets.

As was shown in the Dynamic Wealth case, investors lost even more rights when the company attempted to “legalise” the so-called investment clubs by converting them into companies. – Bruce Cameron



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