Macroeconomic factors are not good predictors of returns, says RECM

"Changes in factors such as interest rates, GDP growth and exchange rates have little input into how our portfolios are positioned,” says Jan van Niekerk, Chief Executive Officer of RECM. "Research on stock markets around the world has consistently shown that economic variables are extremely poor predictors of investment performance.”

 

RECM is sceptical about the value forecasting of economic trends adds to an investment process, says van Niekerk. "We don’t put any effort into trying to forecast economic variables. There are just too many inputs to consider and we don’t feel anyone can forecast accurately on a consistent basis. We prefer to focus our efforts on things we can control. We are bottom-up stock pickers, so we work hard to understand the companies we invest in and the intrinsic value of these businesses.”

 

According to van Niekerk, the most reliable predictor of future returns is the price at which you invest. "The price you pay for an asset is not only completely within your control, but it is also the most dominant driver of investment returns – far more so than changes to economic variables. Our aim is to allocate capital to quality companies at prices significantly below intrinsic value. This builds in a margin of safety that limits the downside in a share price that may arise from bad news or short-term challenges for the company. It also maximises the likely upside if our investment thesis plays out as we expect.”

 

Van Niekerk notes that there are currently very few quality companies in South Africa trading at a discount. "In fact the opposite is true – most are trading well above their intrinsic value. We always prefer to invest in quality businesses – those companies that have a sustainable competitive advantage. But when these are not available at prices below their intrinsic value, we’d rather invest in an average company at a significant discount to intrinsic value than pay too much for a quality company. Even investing in high quality companies is likely to have a poor outcome if you pay too much for them.”

 

Nevertheless, macroeconomic variables are still a key input in RECM’s investment approach, says van Niekerk. "While we don’t waste time forecasting these variables, that’s not to say that we completely ignore the prevailing macroeconomic situation when we analyse a company. Where we are in the economic cycle gives us very valuable information about where a company is likely to be in its business cycle. Our value investment approach means that we’re most likely to allocate capital to companies when they’re at the trough of their business cycles. These troughs are usually a direct function of the economic cycle. But there’s little justification in spending a lot of effort trying to forecast where these variables are likely to go and when these changes are likely to happen.”

 

This is not necessarily an easy or comfortable way to invest, concludes van Niekerk. "We often find ourselves at odds with the prevailing market views on a particular share or sector. But we’d rather follow our convictions, be patient and wait for the opportunity to invest in an asset at the right price. Building in a good margin of safety definitely makes it easier to sleep well at night.”