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There are still opportunities in local shares

Has a ‘shrinking’ JSE forced investors to flee offshore?
There are now far more local unit trusts than listed shares on the JSE. Image: Moneyweb

As the news has been dominated by a barrage of negativity for SA investors on the one hand and catchy headlines of ‘roaring’ US equity markets on the other, it comes as no surprise that local investors are questioning whether they should remain invested in underperforming local equities or jump onto the offshore bandwagon.

This is one of the questions posed by Simbarashe Mangwiro, associate investment analyst at Morningstar Investment Management SA, in a report titled ‘Is investing in South Africa still worthwhile?’.

Other asset and investment managers, as well as private investors in shares, are asking similar questions about a share market that seems to offer fewer opportunities every year.

In fact, the JSE has been shrinking for decades …

A lot of investors can still remember the interesting days of the 1980s when investors and speculators could choose from hundreds of mining stocks, ranging from gold mines, mining houses and exploration companies to granite producers, chrome miners and a host of small and large diamond mines.

The individually-listed gold mines – the rich Kloof and Driefontein, the massive Vaal Reef, marginal Randfontein and all of Gencor’s mines – mostly merged into their respective management companies or disappeared due to rising costs. The same happened with the platinum mines that were all listed separately, in the days when SA was still a proud mining country.

In some cases, they evaporated due to bad luck, bad management, corporate fraud and corruption, such as Rand Mines, JCI and JMF.

The smaller independent mines made way for illegal informal miners, while diamond giant and everybody’s favourite share De Beers was delisted.

Overall, the total number of JSE-listed companies declined from more than 600 in 1998 to only 352 at present, comprising only 283 local companies (including 42 listed on AltX). The balance is made up by 72 foreign companies, mostly secondary listings or some kind of inward listed instrument.

Dual listings

Russel Loubser, CEO of the JSE at the time of the listing of JSE Ltd, called it in 2002 in the JSE’s first annual report as a listed company: “It’s worthy to mention the growing number of companies seeking dual listings on the New York and other stock exchanges through American Depository Receipt (ADR) programmes,” he wrote.

“This has heightened the international profile of these JSE-listed companies. We welcome this as it benefits trading volumes on the JSE and allows JSE-listed companies to achieve international valuations.”

But he then warned that this “trend is not to be confused with those SA companies which redomiciled to London prior to their listing on the London Stock Exchange (LSE). Trade in these shares on the LSE is effectively lost to the JSE”.

Downgrade impact

Fast-forward to 2020 and current JSE CEO Leila Fourie laments that the downgrade in SA’s sovereign debt to junk impacted on the bond market, after SA government bonds fell out of the World Government Bond Index (WGBI) during the rebalancing of the index in April 2020.

“According to National Treasury data, foreign investors own 37%, which is approximately R780 billion, of SA’s local currency bonds. The continued lack of confidence in governance in South Africa has undermined the investment case for the country,” she advised investors in her annual address to shareholders and the investment community at large.

She said capital-raising activity on exchanges worldwide lessened with a decline in global initial public offerings (IPOs) during the first half of 2019, recovering somewhat in developed markets with tech-related listings later.

“The JSE’s five listings [in 2019] were largely the result of unbundlings,” she says. Not much has happened in 2020.

“The equity market’s value traded was lower overall than in 2018, although we did see renewed activity in the second half of 2019. Activity, mainly on the part of internationals, picked up in the second half of the year.

“However, this activity reflected a drive by foreigners to reduce country exposure to SA. Local participants remained underweight in equities and foreigners sold down, resulting in a total net outflow of R114 billion, more than double that of 2018,” she says.

Where does this leave local investors?

Jacques Plaut, portfolio manager at Allan Gray, indicates that there are still ample opportunities for local investors on the JSE and in local companies.

“For sure, some companies have disappeared, but others have joined – think Ab InBev, Glencore, Sibanye and Quilter.

“Today there are 200 companies listed on the JSE with market caps larger than R1 billion. If you adjust for inflation, this number has been constant since 2000. In 2000 there were 209 companies with market caps larger than R348 million – R348 million being the equivalent of R1 billion today.

“There are currently significantly more really large companies, each with a market cap larger than R20 billion, than there were in 2000 and in 1995,” says Plaut.

He disagrees with the perception that the only companies worth watching on the JSE are a few large international companies. “There are more than 20 large companies on our market where the majority of the value is offshore. Then there are local rand hedges like Kumba Iron Ore, Harmony and Sasol. They are domestic companies but benefit from rand weakness.

Read: Sasol shareholders struggle to keep up with its news

“Several SA companies are likely to do well even if the overall economy continues to underperform: Cashbuild and Capitec, for example, could continue taking market share.

“Some will do badly if the economy continues to weaken, but the shares are pricing in a ‘dire’ outcome, and a merely ‘bad’ outcome could see the shares do quite well. Examples here are Nedbank and Old Mutual,” says Plaut.

“I think there are quite a lot of cheap shares on our market, be they international companies like Glencore that just happen to be listed here, or SA Inc shares that are pricing in a dire future.

“By contrast, I struggle to find cheap shares on the NYSE or the LSE.”

The Morningstar Investment Management report says that while SA investors have had a challenging time in financial markets lately, largely due to lacklustre returns from local equities, there are still opportunities for local investors.

Valuation-driven investing

Mangwiro advocates an approach of valuation-driven investing, saying that while it is somewhat counterintuitive to buy undervalued assets and avoid overvalued assets, the returns lie in buying shares at discounted prices.

Read: JSE reflects doubts about government’s infrastructure plan

“This often means buying assets that have underperformed and avoiding those that have done well. In the context of SA investors, this would imply avoiding the richly valued global technology stocks and buying the unloved and cheap local equities,” says Mangwiro.

He says that while this is likely to be the least comfortable in the short term, it will likely serve investors well in the longer term, as it also comes with a lower probability of capital loss given the current margin of safety on offer.

Banking shares

He makes a case for local financials shares, saying most of these are attractive from a valuation standpoint. “Financials have lagged from a performance perspective and continue to show a meaningful disconnect between pricing and fundamentals, particularly for the banking sector.

“This sector was sold aggressively in the wake of the Covid-19 outbreak, as investors fretted over potential increases in loan losses, as well as the inability of banks to grow earnings in a low- to no-growth environment.

“The market is, in essence, extrapolating the current tough economic environment in SA into the future. However, SA banks are well capitalised, as evidenced by the regulatory roll-back we have seen since the start of the Covid-19 pandemic.

“Domestic credit extension [had] also been constrained heading into the crisis, with most banking books exposed to higher-quality borrowers at reasonable loan-to-value ratios.

“In other words, South African banks have been very prudent about who they have lent money to over the past few years and have been incredibly well managed and therefore entered this crisis on a much stronger footing.

“This should provide a reasonable degree of comfort for investors,” says Mangwiro.

Source: Morningstar Direct

Mining and resources

Mangwiro also notes that some mining and resources shares might offer value.

“From a resources perspective, supply side discipline and capital allocation should continue to be key focal points for investors. Strong free cash flow generation should provide an underpin for shareholder distributions and we have seen encouraging evidence of balance sheet repair and dividend resumptions from platinum mining companies.

“The market seems to be cognisant of this, as is evidenced by current fund manager positioning and the sector’s performance so far,” says Mangwiro.

He concludes that mid-cycle commodity prices could continue to provide a tailwind for the sector and income return from dividends and/or buybacks should support investor returns, particularly from platinum and diversified mining shares.

Thus, while we can mourn the disappearance of some once-popular shares and the loss of others through bad management decisions or bad accounting procedures, the growing list of local unit trusts – outnumbering the number of listed shares by far – shows that the SA market indeed still offers opportunities.

In addition, the changes on the JSE have introduced a host of new investment opportunities with the listing of exchange-traded funds and preference shares, very few of which existed in the 1980s.

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Desperate times, lots of codswallop to get to get some stockbrokers fees that have dried up. Be clever, stay with ETF’s in foreign shares. low cost, very good returns from USA, Chinese, and Japanese linked ETF’s.

Surely one has to weigh up the risk of investing in a very ill economy together with the potential benefits. Invest in emerging Markets-by all means-but why here in a high political and liquidity risk spot, coupled with SOE failure, spiraling debt, no growth and a government of tenderpreneurs.

For Allan Grey to say there are opportunities is probably correct but the late Chairman, Simon Marais, said he chooses to invest where there is rule of law.

Can we really say that there is rule of law here with EWC, a captured judiciary, ineffective SAPS and NPA, and many ANC cadres clearly not being prosecuted for cleaning out SOEs.

The risk/reward balance is way better in decent emerging market jurisdictions

I predict that the local market will do better than overseas markets over the next five years.

Best you define which markets you speak of…I suspect crypto markets will outperform JSE by at least 100x over the next 5 years (in $ terms).

Good luck with that, I truly hope you are correct. But for me I will gladly leave all my investments in the US/UK/EU.

Yep…Anything but ZAR. Key is diversified offshore & noshore with ZERO local!

I think you might be right… however only in certain sectors

After the US election…. US market will slump…. I got a feeling funds will flow to emerging markets

….you assume South Africa will get a nice slice of these funds streaming to EM?

In your past comments you have been bearish on Africa, notably SA

Responding to Leah.

I read something really interesting yesterday regarding the US presidential election. Post the Election, historically, US goes into a decline. It is in the second year, from the 1st October till the next US election … things go on an uptick.

So funds will be diverted elsewhere in the next 2 years. hence I feel they might be diverted to growth sectors

I did say certain sectors (and these are a few).

I do think Telecoms will grow in Africa and SA (MTN) providing both Telecommunications and Banking services until there is a major disruptor (SPACEX). MTN is definitely taking control of Africa and growing market share (see it in the Nigerian results 2 days ago).

Yes, still bearish on SA [High debt impacting currency long term, Human capital issues (BEE/restrictive labour policy, unemployment, skill drainage from the SA economy), property rights (Expropriation without compensation) , corruption and wastage of funds, role of Institutions, non replacement of infrastructure…. there is a long list of issues …. If we dont fix it …we in trouble!!!

I learned many years ago, from my own experience and also that of others, to not ever be the last rat on a sinking ship.

GLTY – you’ll need lots of it.

The JSE has become very concentrated on certain shares, think Naspers, Prosus, BAT and the like. If they have been “carrying” the JSE for some time now, what would happen when the inevitable occurs when they have a “bad day at the office”? The shrinking has been going on for some time now. Is the JSE still f any genuine relevance anymore from a medium to longer term investment standpoint? Are we still able to give real returns over “real” inflation rate in a “hard currency” that matters? This is a genuine concern when one takes into account that our pension/provident funds are overweight in RSA equities on the balanced/market growth scale. Tepid or none existent returns over the last 5 to 10 years doesn’t bode well for us come retirement. Where one was banking on retiring at age 60 has ballooned somewhat to a hopeful retirement age of 65 – that is if your employer is willing to keep you on till then? What if another fallout occurs; is age 70 then probable? I am not trying to sow panic here, but am asking questions, which to my mind seem like a real probability.

The decline started with the delisting of De Beers and the final nail in the JSE coffin was the sale and delisting of SAB. Various collapses and dodgy dealings like African Bank Steinhoff and Tongaat hasn’t inspired confidence either. All good things come to an end sometime… makes way for new opportunities like ETF,s Offshore Asset Swops, renewable energies and Crypto. Exciting times!

The JSE was a good place to invest. Note was. With the red tape and BEE and AA rules and the intervention of the state and with the threat of EWC all companies have declined also the reason why overseas investments have dried up hence the weak performance of the JSE.
Remember a couple of years ago when property was the favorite and climbed to dizzying heights until the government stepped in with new rules, regulations and laws and now the property section is dead.

One fund does it all – SATRIX MSCI CHINA.

One fund does it all – SATRIX MSCI CHINA.

End of comments.

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