Few people remember the demise of African Bank in August 2014 as acutely as Sam Houlie. He readily admits that the large exposure he had in his portfolios at the time was his “biggest mistake”.
The Momentum Value fund, which he managed, lost 9.8% in just three days as African Bank’s shares were effectively written down to zero. A Morningstar analysis estimated that Houlie had more than 10% of the portfolio in the stock.
For years Houlie had been well known and respected for his contrarian approach. However, this was a major hit to his reputation, and its impact has lingered. Even nearly six years later, many people still remember him as the fund manager who lost the big bet on African Bank.
Houlie left Momentum just over a year later, and spent some time out of the industry in “philosophical” introspection.
“I ran the Momentum non-benchmark cognisant business from 2012 to 2015,” says Houlie. “That was a very difficult time to be a value manager, and when I stepped away I thought a lot – about the things I had done well, but also the mistakes I had made.”
The collapse of African Bank was the biggest of those, but he realised that he was perhaps fortunate that something similar hadn’t happened before.
“Up to that point, I had never had a big position that went against me,” says Houlie. “I had to ask myself: ‘Is this the way you want to invest – taking big positions in highly leveraged businesses where the worst case scenario is that the equity can go to zero?’
“I came to the conclusion that value was the right philosophy, but you had to be very careful about leverage, and about only investing in management that you admire and trust.”
In November 2016, Houlie re-entered the asset management world by purchasing a share of boutique firm Counterpoint Asset Management and taking over as chief investment officer (CIO). For more than three years, he has kept a relatively low profile there, putting a different kind of value philosophy to work.
“Counterpoint is a contextual value manager,” he says. “You have to think about where you are in the cycle, and the conditions that are in play. You can’t just put together a portfolio of deeply undervalued stocks that are all correlated, and it takes seven to eight years for them to recover.”
The firm’s approach is therefore cognisant of the macro environment, and also of the balance sheet strength of the companies in its portfolios.
“The thing we are most afraid of is leverage – companies with operational and financial leverage where the equity can go to zero,” says Houlie. “We have found that this is the real problem. That was my biggest mistake.”
Houlie is proud that this approach has shown its worth.
“We have avoided every equity landmine since 2017, including Steinhoff, EOH and Sasol,” he says.
The firm was invested in Sasol in the second half of 2019, but changed its mind about the suitability of the investment and sold out in February.
From trading at R239 at the start of February, Sasol’s share price collapsed to below R22 towards the end of March. Counterpoint avoided the fall.
“Most people think of deep value as buying cyclicals that are very bombed out and have debt issues,” says Houlie. “We don’t do that locally or globally.
“We are margin of safety investors. And, in our mind, in the history of value investing, that is what the Ben Grahams of the world have always been.
“Most people assume margin of safety is just in the price – a low price-to-earnings, or price-to-book or price-to-cash flow [ratio],” says Houlie. “That is one aspect, but we look at others as well.”
- The quality of the business, judged by its ability to produce cash flow;
- The quality of its balance sheet; and
- The quality of its management.
In a crisis such as the one the world is facing now, these factors become even more important.
This is evidenced by the fact that the Counterpoint SCI Value fund was one of the top 10 performing local equity funds in March. In a month where the FTSE/JSE All Share Index (Alsi) fell 13.3% and the Morningstar South African Equity peer group average return was -14.9%, the fund was down only 6.6%.
Back in the public eye
Houlie was in the news again in December last year when Counterpoint announced that it would be merging its operations with the boutique value manager RECM. This reunited Houlie with his old value investing friend and fellow Allan Gray alumnus Piet Viljoen.
“The merger was a combination of two boutique managers of similar styles – not exactly the same, but similar,” says Houlie.
Houlie will continue as CIO of the business, while Viljoen will manage the local equity offering.
The Counterpoint and RECM funds will amalgamate later this year.
That will see the Counterpoint Global Equity fund and the RECM Global fund merge into a single portfolio. The Counterpoint SCI Balanced Plus fund and RECM Balanced fund will also amalgamate. And the Counterpoint SCI Value fund and RECM equity fund will combine.
“Piet will manage the equity fund, and it will become a South African-only portfolio – not by mandate, but by expression,” says Houlie. “The reason is that we feel that South African equities are really in the sweet spot of value right now. In the context of the world, emerging market equities are very cheap relative to developed market equities, and smaller cap is cheap relative to larger cap. And South Africa is literally that.”
The fund will retain the ability to invest offshore, but in the current environment, will keep all its assets at home.
“We think that given the unique circumstances of South African equities today and how cheap the mid and small cap area in South Africa is, this is a niche fund, and we as a boutique can offer that,” says Houlie.
Patrick Cairns is South Africa editor at Citywire, which provides insight and information for professional investors globally.
This article was first published on Citywire South Africa here, and republished with permission.