Understanding risk and its effective management

1. Understanding risk and its effective management Romeo Makhubela CEO

2. Agenda • Introduction – what is risk? • 3 big picture concepts • Time • Fund dynamics • Regime switching. • Conclusion

3. What is risk? Its all about perspective Institute of Risk Management considers • Uncertainty (travel arrangements) • Danger (skydiving) • Probability (SA to win Rugby World Cup 2011) • Variability (buying a lotto ticket) • Dread (shark attack). Peter Bernstein in his book “Against the Gods: the Remarkable Story of Risk” demonstrates a perspective that requires one to • “define what may happen in the future and choose among alternatives”. • he states that risk should not be feared, and goes hand in hand with challenge and opportunity.

4. What is investment risk? Investor Words definition The quantifiable likelihood of loss or less-than-expected returns due to Currency- Interest Rate- Inflation- Equity- Principal- Credit- Country- Unsystematic- Economic- Call- Mortgage- Business- Liquidity- Counterparty- Prepayment- Purchasing power- Opportunity- Event- Income- ……….RISK What factors are in play that can derail the expected outcome?

5. Some commentary • Risk is the future uncertainty of a current decision. • To be make money, we need to be exposed to it. • How much we can tolerate depends on • how financially wealthy we are, • what we are trying to achieve, and • how much time we have to wait. • It is the amount of exposure to risk, of the right kind, that determines success or not; but: • Risk is NOT independent of expected return.

6. Risk acceptance 3 big picture concepts that impact ability to assume risk • Time • As a general rule of thumb, the longer the time to one’s target date, the more aggressively one can invest. • Fund dynamics • one “solution” does not fit all; requires migration through complementary solutions • risk management solutions can no longer be static. • Prevailing environment (Regime switching) • within this dynamic solution, one must respond to differing market environments.

7. Time: Equity returns are uncertain... over the short term 1 year real returns data: annual total return and inflation data from 1900 to 2011 data source: Prof C Firer annual data 1900 – 2008

8. Equity returns... exceed inflation over almost all periods of 10 years or longer 10 year real returns (rolling annualised) data: annual total return and inflation data from 1900 to 2011 data source: Prof C Firer annual data 1900 – 2008

9. Bond market returns are driven by inflation 1 year real returns data: annual total return and inflation data from 1900 to 2011 data source: Prof C Firer annual data 1900 – 2008 data source: Prof C Firer annual data 1900 – 2008

10. Bond market returns stay negative in real terms for long periods as inflation rises 10 year real returns (rolling annualised) data: annual total return and inflation data from 1900 to 2011 data source: Prof C Firer annual data 1900 – 2008

11. Cash returns are not the perfect hedge against inflation (even before tax) 1 year real returns data: annual total return and inflation data from 1900 to 2011 data source: Prof C Firer annual data 1900 – 2008

12. Cash returns over the short or long term 10 year real returns data: annual total return and inflation data from 1900 to 2011 data source: Prof C Firer annual data 1900 – 2008

13. Asset class risk vs time Equities deliver higher returns but with exponentially higher risk over the short term absolute low risk moderate risk equity oriented growth risk equities bonds cash investment horizon - years

14. Fund dynamics • Risk management solutions can no longer be static. • Consider a closed pension fund with members with characteristics differing by • age • retirement date • gender • contribution value • tax rate • accumulated benefits. • The solution for the retirement fund as a whole is driven by the aggregate cash flows, which include contributions (by active members) and withdrawals by retired members. • This solution is not simply 100% allocation to one fund, to and from which contributions and withdrawals are made.

15. Dynamic solution superior

16. Regime switching Economic cycles, a starting point normal

17. Economic cycles need to be viewed in three distinct states

18. Temporal adjustment to the long term SAA to reflect the dynamics of each macro environment Equity Bond Cash Con13 27 60 Mod26 19 55 Agg35 15 50 Equity Bond Cash Con 29 29 42 Mod 50 25 25 Agg 65 15 20 Equity Bond Cash Con 40 32 28 Mod 64 27 9 Agg 75 20 5

19. Combining time, dynamics & environment value add

20. Conclusion • Risk is the future uncertain outcome of a current decision. • Especially in the new millennium, three important facets to recall and consider are time, fund dynamics and regime switching. • Time in the markets is a management tool. • Static solutions: no more. • Regime switching, as a critical component of the dynamic solution.

21. Questions?

22. Regulatory information Vunani Fund Managers (Pty) Ltd Physical Address: 6th Floor, Letterstedt House Newlands on Main Newlands 7700 Telephone number: 021 670 4900 Internet website: www.vunanifm.co.za Vunani Fund Managers (Pty) Ltd is an authorised financial services provider (license no. 608) approved by the Registrar of Financial Services Providers (www.fsb.co.za) to provide intermediary services and advice in terms of the Financial Advisors 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. All returns are in rand terms, unless otherwise stated. Investment deals done on behalf of clients by Vunani Fund Managers are all done on an arm’s length basis. Vunani Fund Managers (Pty) Ltd has been GIPS verified for the periods 1 January 2005 to 31 December 2010. A copy of the verification report is available on request.