Is it time for emerging markets to take a breather?
China is the undisputed leader among emerging market economies. The country has shown a remarkable ability to grow its economy at near double digits, going back more than a decade. But the world’s second largest economy could be running out of steam. Late
One fund manager ‘buying’ into this scenario is RE:CM, which recently cautioned investors against getting caught up in the ongoing hype around emerging markets and commodities. The value based asset manager believes opportunities in these areas are overvalued at present. And with assets under management totalling R18 billion and growing it is worth considering their view. Daniel Malan, Investment Director at RE:CM, says that the prices of most emerging market assets are currently above estimated fair values and as a result the RE:CM Global Fund has near zero exposure to assets domiciled in these markets.
Commodities are looking expensive too!
Malan believes commodity stocks are also expensive at current levels. “By comparing direct commodity prices to the marginal cost of production, we draw the conclusion that the current prices are trading at substantial premiums and that investment in direct commodities do not afford attractive odds to long term investors. Furthermore, the stocks of businesses that operate primarily in commodities markets are trading above our estimated fair values.” His sentiment was echoed at an Investec Asset Management quarterly media presentation held in Sandton, 5 July 2011. Portfolio manager Chris Freund was particularly concerned with prospects in the platinum and gold mining sectors. But he was more upbeat about companies with exposure to coal and iron ore. The Investec Balanced fund still lists Sasol (4.9%), BHP Billiton (3.9%) and Exxaro (2.1%) among its Top 10 shareholdings.
Although fund managers have different investment mandates it is interesting to compare strategies between fund houses given the small size of South Africa’s listed-company universe. In this case, despite resources making up a major portion of the JSE, two asset houses are limiting exposure to the asset class. “In fully invested South African equity mandates, our clients currently have less than 10% cumulative exposure to commodity stocks such as Sasol, Harmony Gold and Omnia,” notes Malan. Omnia is a company with major exposure to so-called soft (or agriculture) commodities through its fertiliser division.
An easier way to explain stock market performance
RE:CM ascribes their impressive long-term track record to a bottom-up value investing approach. The company believes in buying shares (or other securities) only when market prices are significantly below intrinsic value. And they believe this strategy will produce superior results in the long run – protecting capital when prices and risks are high – and growing capital when prices and risks are low. How does one apply this strategy?
Malan explains. Instead of obsessing over whether day to day market movements reflect a change in the overall investment cycle – spending hours trying to explain last month’s sell off in emerging markets and commodity stocks, for example – investors should simply avoid allocating capital to overvalued assets. It is inevitable these assets will under perform over time. A better option for long-term investors, including those saving for retirement, is to allocate their capital to cheap assets that have the potential to outperform in the long term. In today’s investment environment you’re not limited to one economy, so your hunt for value could lead you to opportunities on stock markets across the globe. Malan says RE:CM has uncovered good value in high quality businesses in developed markets like the US, Europe and Japan. “This is not a result of a top-down view of the world’s opportunities, but rather because we build our portfolios from the bottom up by researching individual businesses and buying them when they are priced well below fair value,” he says.
Investors looking for proof that value investing works should pay close attention to Warren Buffett’s track record. His “buy and hold forever” strategy has helped him become one of the wealthiest men in the world… Over time he has turned up his nose at tech companies like IBM and Microsoft and focused on value opportunities at companies like Gillette, Coca Cola and American Express!
Pay attention to the fundamentals
The value question pops up whenever shares are discussed. At the Investec Asset Management presentation we laughed about the ludicrous values assigned to recent listings in the social media space… Shares in Linked In (a popular Internet networking company), quipped Freund, had just priced down from a ridiculous 600 times price-to-earnings (PE) multiple to a more reasonable 400 times. For those not familiar with stock market terminology the PE is simply how many years it will take to repay you investment in a share out of its annual earnings. The average PE on the JSE is around 13 times at present!
Trouble is, people are prepared to “follow the herd” and buy companies such as Groupon, Linked In and Google at ridiculous PE multiples. Malan says investors are better served focusing on the fundamentals. “Many market participants are driven by human emotion and prefer investing in ‘winning’ assets and regions, avoiding and even discarding ‘losers’,” he says. “It is the investor that loses the least in deep market declines who receives the best long term returns, not the investor that makes the most when markets advance.”
Editor’s thoughts: The great thing about value investing is it fits nicely into the retirement saving methodology. You buy a company because of its potential to grow over time – in much the same way as your retirement funding grows over time thanks to market return, compound interest and re-invested dividends. Do you buy into the more conservative ‘limit your losses’ value investment approach? Please add your comment below, or send it to [email protected]
