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How do you solve a problem like Naspers? (Part 2)

The knock-on effects of holding a large position in a single stock.

The relative size of Naspers in the local market has become a challenge for many local fund managers. The company dominates the JSE so much that any fund that is measured against the performance of an index is almost forced to hold it, and in a meaningful way.

Many fund managers acknowledge that this is something they spend a lot of time thinking about. How do they manage their exposure to Naspers so that there is a balance between risk and reward?

Read: How do you solve a problem like Naspers? (Part 1)

Firstly, they have to grapple with how much of it they are willing to hold in their portfolios from a risk management perspective. The stock might be 20% of the index, but very few managers are willing to put that much into a single company simply because if something goes wrong it would have a material impact on the entire fund.

More subtly, however, managers have to consider what a large position in Naspers means for the rest of their holdings. For a fund to have a large exposure to the stock doesn’t just leave less money for other ideas, it also means having to think about how the rest of the portfolio performs in relation to that dominant counter.

Uncorrelated performance

Brian Pyle, co-manager of the Old Mutual Industrial Fund, says they constantly think about how to strike this balance. At the end of September, the fund had a weighting of 28.6% in Naspers. This is underweight relative to the FTSE/JSE Industrial 25 Index, but it is still a very large absolute position.

To manage the risk of this large exposure, Pyle looks to include more assets in the portfolio that show uncorrelated performance to Naspers.

“A lot of ‘SA Inc’ shares, such as Italtile, are not correlated with Naspers,” he explains. “The other thing that is completely uncorrelated is cash. So I’m running the fund with a little more cash than I would if I had a lower position in Naspers.”

While this is prudent portfolio management, it creates distortions of its own.

“It is the case that the rest of the fund might look slightly different to what it would if Naspers was only 10%,” Pyle says.

Benchmark-cognisant

There are also other ways fund managers look to manage risk. According to Morningstar, the Aluwani Top 25 Fund has the largest exposure to Naspers of any active general equity fund at 27.5%. This is actually down from 29.8% at the end of June.

The fund is benchmarked against the Top 40, and the managers are very specifically benchmark-cognisant – in other words, their starting point when building the portfolio is the Top 40 itself. They then overweight or underweight stocks to generate outperformance.

A number of analysts would argue that that is taking far too much risk in a single stock. While a Steinhoff-like event might be unlikely with Naspers, if it were to happen, it would wipe out almost a third of the portfolio.

In a recent note to clients, Aluwani recognised this as well:

“The absolute weight of the stock in the portfolio is a function of the benchmark,” the firm noted. “However, we are not completely oblivious to the absolute weight of Naspers in our portfolios, largely because, as investors, despite our best efforts and rigorous investment process, we can not know all there is to know on any investment we have in our portfolios, hence the need for risk management.”

It explained that it uses derivatives to hedge against a material pull-back in Naspers. This allows it to have the conviction to have such a large exposure to the counter, but still give its clients comfort that they are protected if something goes horribly wrong.

Growth exposure

Another active manager with large Naspers exposure is First Avenue. The First Avenue SCI Equity Fund has 21.47% of its portfolio in the stock, while the First Avenue SCI Focused Quality Equity Fund gives it a weighting of 22.13%.

Chief investment officer Hlelo Giyose explains that this is not just based on a positive view of the company, but also a desire to have exposure to growth. In the local market, Naspers offers the only quality option.

“If you are a fund like First Avenue that does not hold any resources, you run the risk of not having any exposure to growth-facing companies at times when the economy is doing well,” Giyose argues.

If their funds were to be heavily underweight Naspers, they would therefore run the risk of severe underperformance in this kind of environment.

“We made a decision that between the two, we would rather hold Naspers in a higher quantity than mining stocks,” Giyose says. “That’s why you would see our weight in Naspers being what it is, especially relative to our peers. But if you were to take our Naspers plus resources exposure, it would be lower than most of our peers.”

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The fund managers mentioned may as well allocate 90% assets into the index fund and spend 10% gambling on a few derivatives that they think will result in out performance.

Results would be the same.. sup par at best.

End of comments.

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