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15 minutes with SIM’s Fred and Patrice

03 November 2017 Fred White, Patrice Rassou, Sanlam
Fred White from SAnlam.

Fred White from SAnlam.

Patrice Rassou from Sanlam.

Patrice Rassou from Sanlam.

According to Morningstar, both the Sanlam Investment Management (SIM) Balanced and the SIM Top Choice Equity Funds have comfortably beaten their peer median over three and five years to 30 September 2017. We’ve interviewed Fred White, portfolio manager of the SIM Balanced Fund, and Patrice Rassou, at the helm of the SIM Top Choice Equity Fund, to find out how they deliver consistent value to long-term investors.

The SIM Balanced Fund offers investors a well diversified blend of asset classes. What role do equities currently play in the portfolio?

Fred: More than ever investors need to get growth on their assets to meet their long-term savings goals, especially given constantly rising longevity, which means investors would need far more money to retire than the previous generation. The unprecedented lowering of global interest rates in the wake of the Global Financial Crisis has led to a change in the pricing of all assets, due to the significantly reduced outlook for returns from global cash and bonds. High price to earnings (PE) ratios are a rational outcome of this re-pricing. Despite the higher prices, equities is still the asset class that is most likely to produce inflation-beating returns over the long term, going forward.

Is the SA equity market currently expensive?

Fred: Given the poor earnings outlook for many South African companies and the high current PE ratios of the major JSE indices (around 20), you may think that local equities are currently expensive. However, any local equity measure is heavily influenced by Naspers, which has grown to around 20% of most of our indices. Once SIM excludes Naspers from its valuation measures, local equities ex Naspers seem much more palatable (PE ratios of around 15x historical earnings), especially in a global context of higher priced equities. Furthermore, companies that primarily derive their earnings from South Africa have become cheap.

How comfortable are you with the excessively large PE ratio of Naspers?

Fred: As value-oriented investors we are naturally sceptical of companies trading on high PE multiples, but the business models of companies are being turned on their heads. Naspers is the best known local example, but there are now several of these high growth companies around the globe – Amazon, Alphabet (Google), Facebook and eBay, to name a few. And it is not rare for these to trade at high PEs. Despite Naspers’ very high PE ratio, the share still offers upside, just not when measured by elementary methodologies such as PE multiples. It requires a proper analysis of the business model and potential and an appreciation for the under-valuation of much of Naspers’ non-Chinese investments.

How does the SIM Balanced Fund protect investors against drawdowns?

Fred: Among other things, we put protection in place for shares like Naspers - to reduce investors’ losses in the case of a big drawdown. By doing that, there is the risk of incurring an opportunity cost: should the Naspers share price rise by even more than expected our fund’s exposure would be capped. But at least by the time that happens investors would already have received massive upside and could rest assured knowing that they’re not exposed to the full potential downside of the share’s price. So we effectively follow an approach of investing in the most likely growth opportunity and putting in place “calamity insurance” where that growth opportunity might come with an increased risk of drawdown. We aim to get the best of both worlds: vigilantly seeking returns, being bold when necessary, and also cautiously searching for protection.

Why is the SIM Top Choice Equity Fund such a compelling offering?

Patrice: The fund has delivered returns well above its unconstrained equity peer group while taking risks broadly in line with the peer group. This has resulted in a compelling risk-adjusted return since inception. The fund is still quite nimble and has been able to gain exposure to some of the less liquid mid-caps, such as Dischem, since listing. This is also reflected in the fact that the fund has been in the first or second quartile ranking in an extremely competitive category over most short- and long-term periods – testimony to consistent outperformance.

What is the process for selecting a stock for the SIM Top Choice Equity Fund?

Patrice: The fund represents the best ideas of the general equity and sector specialists at SIM. We aim to scan the universe of some 250 large and small caps and select around twenty of the best ideas which are likely to outperform the market over the long term by leveraging a team of analysts who are experts in their field. As pragmatic value investors, a rigorous bottom-up valuation process remains our bedrock in order to identify undervalued stocks.

Almost 20% of the SIM Top Choice Equity Fund is invested in Naspers. What is your view on this company?

Patrice: Naspers has a market cap of over two trillion rands and Tencent, an associate investment, has grown to become one of the ten largest global companies by market value. Therefore, Naspers provides a way to gain exposure to the global technology theme and to a wide range of emerging markets, including China and India, without having to use any of one’s annual offshore allowance. At the moment Naspers trades at a large discount to the value of Chinese internet giant Tencent, providing a sufficiently large margin of safety.

What should investors expect with regards to the returns of SA equities for the rest of the year?

Patrice: While the JSE has hit record levels, we still see pockets of value. However, equity markets are likely to be braced for a potential credit downgrade and the outcome of the ANC policy conference in December. Market reaction is likely to be binary and hinge on political developments. The SIM Top Choice Equity Fund has withstood a number of shocks since the Global Financial Crisis and has come through with flying colours. We have invested in companies with dominant positions in their industries and diversified geographical footprints. Any dislocation usually presents excellent entry points to pick up quality stocks.

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