When politics trumps economics

For the last few years the investment landscape has been one of repressed volatility, the result of low interest rates and the quantitative easing actions of central banks globally.

FAnews spoke with Clyde Rossouw, Portfolio Manager of the Investec Opportunity and Global Franchise Funds, to find out what happens when politics trumps economics.

Question: What is your outlook for South African assets, specifically equities versus bonds?

Answer: We are concerned about the real return prospects for the domestic equity market. The risk of a downturn remains elevated, driven by high valuations, rising volatility and concerns about growth. We believe there is very little earnings growth to justify the current high valuations.

This leaves investors in expensive stocks which have poor earnings growth vulnerable to sharp market corrections. We invest in fairly valued opportunities that have the highest probability of generating a sustainable and growing free cash flow.

We believe South African bonds provide attractive yields and continue to offer value. In our view, it is our best local opportunity, relative to other South African Inc alternatives, for the following reasons:

• South African listed property stocks are expensive; they provide a yield of 6% versus 8.5% to 9% for bonds. We believe risks such as a sovereign credit rating downgrade and vacancies are not priced into local property stocks. Many property companies are not a true South African Inc play as they have expanded offshore and are more exposed to global market volatility;
• local retailers have had a dismal earnings season. Many are not a true South African Inc play as they have expanded offshore. We believe valuations are not reflective of the risks such as poor consumer demand and bad debts, and a sovereign credit rating downgrade;
• banks have better valuations, but there are still many risks to their business models. We have increased our exposure to banks such as RMB Holdings and Standard Bank; and
• bonds are a true South African Inc play; they are pricing in the risks of a sovereign credit rating downgrade and they are offering a real yield.

Question: Are there still opportunities in global equities?

Answer: We believe global equity markets have largely been driven by momentum rather than underlying fundamentals. Prolonged low interest rates, the brief oil recovery, and the positive sentiment sparked by Hillary Clinton’s lead in the polls have bolstered stocks. This momentum has driven major equity indices in the US to record highs. Yet there has been no earnings growth to justify this rally.

So how do we find offshore opportunities for our portfolios in an environment where many firms’ profits are not growing? While consumer staples and tobacco stocks remain key investments, we have exposure to technology and consumer services sectors. All these factors underpin consistent earnings growth over meaningful time horizons, helping to compound investors’ wealth over the long term. The Investec Global Franchise portfolio has a return on invested capital of 19.9%, compared to the market of around 9.5%.

This means that our offshore global stock holdings, as a consequence of their resilient business models, strong financial models and smart capital allocation decisions, have consistently generated nearly double the return versus the market for the same level of invested capital.

Question: How has this view translated into recent offshore stock purchases?

Answer: Recent purchases include Check Point Software Technologies and Oracle. The network security industry has been growing in the high single digits, a trend which is anticipated to continue amid rising cyber-attacks and data breaches.

Check Point is one of the leaders in the industry with a highly dominant position; it provides firewall software to large enterprise customers. Organic growth combined with smart capital allocation has resulted in attractive long-term earnings growth. Oracle is successfully transitioning its business from traditional software to cloud-delivered software and has also been winning new business.