Fund managers still courting SA Inc
Active fund managers love the mechanistic selling that has affected South African equity prices of late because it allows them to do what they do best: identify opportunities to generate alpha for their investors. “Any forced or mechanistic selling creates mispricing which is something that active managers love; forced sellers do not care what price they sell at, whereas active managers fundamentally care about price,” said Neville Chester, a portfolio manager at Coronation Fund Managers.
Too complex for a ‘yes’ or ‘no’ response
Neville was part of a three-person panel discussion at the inaugural INN8 Invest Summit. Their task: to determine whether multi-asset, high equity fund managers were still interested in equities that had significant exposure to the SA economy. The discussion was led by Jennifer Henry, Chief Investment Officer of INN8 and president of the CFA Society of South Africa. Henry opened with the now-familiar doom-and-gloom backdrop of sluggish economic growth; stage six loadshedding; and a slew of emigration parties as proof that South Africa’s star may be fading. It turns out there is not a simple ‘yes’ or ‘no’ answer to the complex ‘SA Inc or not’ question.
Macro-strategist and portfolio manager at Fairtree, Jacobus Lacock, said that active managers did not think of the South African listed space as a proxy for the domestic economy. “Two thirds of the JSE’s revenues are actually generated offshore; we have to have a key handle on what is happening in China, Europe, the United States and other emerging markets because those factors often drive domestic equity returns,” he said. Fund managers have to study the opportunity set in various sectors of the economy, and appreciate that companies within each sector may respond differently to global drivers.
Murray Winkler, owner and portfolio manager at Laurium Capital said that only about one third of JSE-listed shares were pure plays on the domestic economy: mainly the banks, insurers, retailers and property stocks. Winkler warned against a ‘take everything offshore’ approach in favour of a more sensible diversification and liability matching strategies. “There is a lot of negative news priced into South African equities at the moment,” he said, before singling out banks for outperforming the market by some 8% over the past 12-months. Many summit attendees were bullish on the short-term outlook for SA banks, based on their low valuations and high dividend pay-outs.
The index ‘cull’ creates opportunities
The recent decision to ‘cut’ three key SA Inc shares from the MSCI Emerging Market Index could create opportunities for active fund managers due to index trackers becoming forced sellers of Foschini, Mr Price and Multichoice. “There is quite a bit of index re-balancing happening at the moment,” said Chester, commenting on the decision to move Anglo Gold’s primary listing from the JSE to offshore. This move would result in the share being sold off on emerging market indices today, but only being added to international indices about nine-months hence. “This re-balancing creates opportunities for fundamental investors because people are selling for non-fundamental reasons,” he said. Unfortunately, there is a more sinister drag on local equities.
“The bigger issue is the lack of offshore interest in South Africa as an emerging market; we offer a low growth environment whereas foreign investors are attracted to emerging markets for their growth; if you are an emerging market without growth, you really have nothing to show,” Chester said, drawing attention to the common-sense high-return expectation that goes hand-in-hand with investing in riskier emerging markets. Earlier in the debate, Winkler had observed that South Africa’s GDP had averaged just over 1% annually over 14-years, a faction of the growth on offer from many emerging and frontier markets. As international interest dwindles, local investors can snap up stocks with better-than-market earnings and revenue outlooks at attractive prices.
Resources shares are in the spotlight of late, with many firms in that sector suffering from the triple-challenge of falling global commodity prices; South Africa’s ailing rail and port infrastructure; and China’s faltering economic growth. “China is a big part of the resource story as they import large chunks of the seaborne-specific commodities,” Chester said. There are, however, many other drivers that affect the demand and supply of specific materials. Case in point, the platinum group metals ebb and flow based on the outlook for the internal combustion engine. As for the Chinese slowdown…
Concerns over Chinese growth likely overdone
Chester pointed out that the world’s second largest economy was handling its internal economic challenges in a more sensible manner than the United Kingdom and United States, refraining from throwing money at the problem. “We are not concerned about China broadly and we do not see a crash, which is why we are comfortable with the resource position,” he said. The ongoing green transition was singled out as an important commodity price driver alongside warnings that certain commodities would be in short supply due to surging demand, and shrinking supply.
Henry steered the debate to the opportunity set in the domestic market, juxtaposing the value in so-called SA Inc shares to the overall SA equity market. Winkler pointed out that SA Inc shares, assessed on a forward price-to-earnings (PE) basis, were trading at more than two standard deviations below their historic trend. “The forward PE of 9.5 times the market is very cheap relative to history,” he said, singling out high bond yields as a potential contributor to this apparently low equity valuation. “The SA market, notwithstanding all the negative news and where bond yields are, is slightly cheap at the moment,” Henry added. SA bonds remained attractive, offering a real yield of 7%.
Lacock said that sorting out the electricity crisis could prove a catalyst for SA equity returns, with retailers set to benefit from a significant “unlock of profit margins” as electricity availability improves. As for bonds, Lacock said fixed income funds should focus on the “belly of the curve” to mitigate concerns over fiscal discipline, among other challenges. “We like the belly of the yield curve; we are kind of neutral on the front end and cautious on the back end because of the fiscal issues the country is facing,” he said. The final question put to the panel was where locally focused fund managers should turn to for quality. Chester answered the question from an earnings perspective, noting that a slew of 2023 results had been worse than what analysts expected.
The earnings impact of very bad things
“You are starting to see the impact of all the bad things that are happening in our economy; it has gone past the ability of local companies to deal with them,” he said. There are a lot of cheap shares on the JSE at present, and there is still interest in domestic equities. “This is not the time for you to go scratching around in the bargain basement bin; now is the time when you want to focus on quality,” Chester said. “There are winners and losers in every sector; but in an environment where the economy is not growing, you find that the winner is just taking market share away from someone else”.
His final advice, which will resonate with asset managers, financial advisers and investors alike: “Now is not the time to be dabbling with a ‘mean reversion’ mindset, by investing on the basis that a share has been hit really hard and will bounce back … it is about making sure that you favour quality businesses within the attractive valuation context”.
Writer’s thoughts:
There is an old English saying that goes ‘like turkeys voting for Christmas’ to suggest doing something despite knowing that the outcome is not in your best interest. Do you think fund managers would be as upbeat on SA equities if their respective fund mandates did not require them to invest here? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected]
