Old Mutual Investors comment - Jun 17 - Fund Manager Comment06 Sep 2017
While the fund lagged its peers over the last 12 months, it continued to outperform its general equity peer group over three and five years. Our cautious view on China and the deteriorating commodity market lay behind our limited exposure to the poorly performing miners over the last three and five years. In addition, a low weighting in MTN meant that we largely avoided the large capital losses from the share over the period. We increased our exposure to mining shares at the beginning of 2016 and this added to performance but the lower weighting relative to the peer group acted as a headwind to relative performance over the shorter 12-month period.
We have long maintained a cautious approach when considering mining shares for investment, given the significant risk in forecasting the macro levers that drive these shares. Forecasting the future is impossible and yet many investors are willing to risk significant capital based on their forecast of US dollar commodity prices, which are themselves dependent on some difficult macro forecasts. In our view, investors in the South African market underestimate these risks, as well as the cyclicality of commodity prices. While returns are appealing as commodity prices rise, the painful capital losses resulting from the ultimate rollover in mining shares are not pleasant and are difficult to time. Our philosophy and robust portfolio construction mean that we purposely avoid taking on excessive market risk. While this assists us in driving long-term performance, it will also inevitably result in shorter-term periods of underperformance as we cautiously manage through the cycle. Another important point to appreciate is that a number of funds in the category invest some portion of their funds offshore where returns have been better than the SA market. The Old Mutual Investors' Fund is restricted to investing only in South African listed equities.
Shares that contributed strongly to performance in the second quarter included Datatec, which announced that they had agreed to sell their Westcon-Comstor North America and Latam operations for up to US$800m and the rest of Westcon-Comstor for US$30m to US listed Synnex. This deal valued Westcon-Comstor at a level equivalent to the then Datatec market cap and excluded any value placed on the attractive Logicalis business. This rewarded our long-term patience in holding a significant share in a business trading well below its intrinsic value and overlooked by the market.
Naspers has been another strong performer this year and has long been a large weighting in the fund. The strong performance of its underlying Tencent holding was the main driver of performance on the back of yet another strong set of results. While Naspers has performed well on the back of Tencent, in reality it has materially underperformed Tencent over time. This implies that the market is applying a negative value to the unlisted (rump) portion of Naspers, which, in our view, is unjustified. While they have been investing significant capital in internet businesses such as classifieds, which have yet to turn cash positive, we are positive that these investments will be successful in the long-term. A number of these investments have already resulted in attractive returns: Allegro (Naspers sold Allegro, realising an IRR of 19% in US$), MakeMyTrip (which is now part of a listed entity, with Naspers making a 250% return on investment) and recently Delivery Hero (Naspers realised a 20% return on investment in one month). And yet the market remains unconvinced. While we took some profits in Naspers during the quarter after its strong price appreciation this year, it remains an appealing and a significant holding in the portfolio.
The outlook for the equity market remains supported by the reflationary global environment and the ongoing global hunt for yield and favour towards emerging markets. However, the numerous "own goals" scored in the domestic political environment create an unnecessary and unfortunate headwind to economic confidence, growth and job creation in the South African economy. Needless to say, investing in this climate is challenging but our tried and tested, long-term focused investment approach provides a strong framework for our investment decisions. This includes us continually stress testing our base case views as we continue to seek out undervalued opportunities on the JSE.
Old Mutual Investors comment - Mar 17 - Fund Manager Comment12 Jul 2017
In South Africa, the quarter was marked by a significant strengthening of the rand against the US dollar, on the back of a generally improving outlook for emerging economies and more positive signs for the SA economy, in particular. By 24 March the rand had recorded a close of R12.43/US dollar, the strongest level in 20 months. However, after the quarter-end, rand volatility returned with a vengeance - following President Zuma’s radical reshuffling of the cabinet and replacing Pravin Gordhan with Malusi Gigaba as Finance Minister. This prompted Standard & Poor’s (S&P) to downgrade SA’s sovereign credit rating to sub-investment grade. In other news during March, the South African Reserve Bank (SARB) Monetary Policy Committee removed its tightening bias as CPI inflation decelerated from the recent peak of 6.7%. This was also supported by a significant decline in the current account deficit and a determined effort in February’s National Budget presentation to rein in the budget deficit.
During the first quarter of 2017, the FTSE/JSE All Share Index (ALSI) rose 3.8%, with resources up 2.7%, industrials up 6.6% and financials down 1.1%. The best performing sectors included personal goods (16.8%) and tobacco (15.9%), while the worst included healthcare (-10.3%) and household goods (-9.4%). In US dollar terms, the overall MSCI Emerging Markets Index was up 11.5%, while the SA component was up 4.6%. During the quarter, the rand rose 2% against the US dollar, while the SA All Bond Index rose 2.5%. The quarterly data masks the fact that the ALSI has traded in a narrow trading range over the past two years, generating a total return of under 3% (compound) - which has lagged inflation, the All Bond Index and the money market. This is not surprising given that the ALSI total return more than trebled in the five years following the Global Financial Crisis. Following such a surge, a period of consolidation was likely.
In the US, economic survey data remained strong, with consumer confidence recording new cyclical highs. However, although the economy is quite buoyant, it has not yet reflected the promise in the ''soft'' data. The US Federal Reserve hiked rates again in March - the third hike in this cycle - and guided to further hikes this year. In China, official economic growth remained stable at around 6.5%. The authorities have continued to tighten monetary conditions. Fiscal spending has slowed, but should accelerate again during the second half of 2017 in the run-up to the 19th National Congress of the Communist Party, where far-reaching changes in the top leadership are likely.
In Europe, economic activity remained buoyant and the European Central Bank (ECB) gave signs of preparing to scale quantitative easing (QE) back further. Key elections in France (April/May) could have a significantly negative bearing on the outlook - that is, should far-right National Front leader Marine Le Pen surprise and emerge victorious in the presidential poll.
Despite reducing the fund’s rand hedge exposure in the beginning of 2016, we have since maintained a weaker rand bias. While this acted as a headwind as the rand strengthened during the quarter, it provided support to the fund on the back of the S&P downgrade announcement. Shares in this group include Naspers, British American Tobacco, Reinet, Mondi and Sasol as well as the miners Glencore, Anglos, and Impala. The fund’s modest holding in gold shares has also served as a valuable diversifier amidst the uncertainty created by the downgrade. We have long considered many of the SA Inc. shares to be overvalued, other than the banks, which mostly trade at our ''bear-case scenario'' (which included the negative fallout from a potential downgrade). This overall positioning has protected the fund through this uncertainty as the rand weakened. '
During the quarter we added to the fund’s position in Glencore, AngloGold and Impala in the mining sector, while increasing the existing holding in Steinhoff, British American Tobacco, Transaction Capital and Woolworths. The performance of some of the larger positions in the portfolio has lagged the market in the short term, but their longer-term value is compelling. One such share is Steinhoff, whose appeal lies in its exposure to the ''discount'' segment of the international retail market - which is growing at a faster pace than most other segments within the greater description of ''retail''. Steinhoff gives us geographically well-diversified exposure to this ''discount retail'' market. The company has extremely efficient supply chain and logistics operations in order to provide appealing prices to customers. Parts of the business are vertically integrated all the way back into manufacturing, which brings with it further economies of scale, thus allowing the retailers in their portfolio to be extremely price competitive. Steinhoff management has a proven ability in the merger and acquisitions game, and further consolidation of fragmented markets (particularly in Western Europe), using extremely low funding rates, will continue to add fuel to the investment case.
We began adding Aspen to the fund in the second half of 2016. Our valuation is supported by the cost cutting and efficiencies identified by the company. We expect these efficiencies to result in improved working capital leading to improved cash flows. This is set to continue into 2019 and goes a long way towards the company reducing its debt levels, which sets up improved opportunities for sensible acquisitions in the near term. Netcare released a disappointing reading update, which was driven by lower patient volumes. However, we continue to find the industry attractive, due to the defensive nature of hospitals, and Netcare, specifically, due to its undemanding valuation.
The S&P downgrade is a severe blow to investor confidence and a very costly self-inflicted wound by Government, which now raises the costs of doing business in South Africa. This move will negatively impact the long-term growth potential of South Africa, which means that fewer jobs will be created and the poor will unfortunately suffer the most. A far more sensible approach for us is to implement policies that encourage investment, which leads to stronger growth and more jobs. South Africa can ill afford the cost of the current policy uncertainty and political turmoil.
Forecasting the future is impossible, which is why our focus always remains on building sensible, diversified portfolios that assume no more risk than the market. While sell-offs created by events like this can be emotionally draining for investors, instead we view them as opportunistic moments to buy or add to existing shares whose prices imply overly pessimistic assumptions.