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Jean Pierre Verster on his ‘quantamental’ investment approach

Protea Capital Management CEO talks shorting Steinhoff, his best and worst trades and the role of luck when investing.

RYK VAN NIEKERK: Welcome to this brand-new ‘Be a Better Investor’ podcast. It replaces the old Market Commentator podcast, which I have been doing for many years. The Be a Better Investor podcast will be different, as I will pick the brains of professional investors on why they choose to invest or disinvest from certain shares, the information and the data they use to make these decisions, and their successes and their mistakes. Hopefully these investors will offer a few nuggets of wisdom that will allow average amateur investors to improve their investment decisions and skills.

The very first guest is Jean Pierre Verster of Protea Capital Management. He is a chartered financial accountant, or a CFA, and he is a chartered alternative investment analyst or a CAIA, and he has been applying his trade for many years. He has worked for Fairtree and 36One, but he is probably best known as the guy who shorted Steinhoff and African Bank before they imploded.

Jean Pierre, thank you so much for joining me. In how many conversations do the Steinhoff and African Bank short positions you took emerge? Is it still top of mind for many other investors?

JEAN PIERRE VERSTER: Yes. Hi, Ryk. Thank you. It is, which is quite interesting because as the years go by those events are further in the past which makes them maybe less relevant. But I would hope that they are still relevant because it indicates exactly what you will be discussing in these podcasts – and that is the process rather than the outcome of what professional investors follow.

Those were two examples of outcomes which indicate that a certain process was followed and therefore I still believe that it’s still relevant. Yes, a lot of people still refer to those two events.

RYK VAN NIEKERK: We’ll get to the process in a minute. But you also are a charted alternative investment analyst. What exactly does that mean?

JEAN PIERRE VERSTER: It is an academic qualification that is offered by an internationally accredited association. Basically to get the accreditation one must have some practical experience in alternative investments, which refers to non-traditional investments. Your traditional investments are equities and bonds. So other things like hedge funds, private equity and, some people would even say, property or real estate are seen as more alternative investments.

They send you a lot of information to go through, a lot of books to read through, to study. There are two different exams, multiple-hour exams. If you pass the exams, plus have the requisite number of practical hours, you can then attain the CAIA qualification. That is something I did early on in my career.

RYK VAN NIEKERK: How many of these CAIAs are there in South Africa?

JEAN PIERRE VERSTER: I have seen the qualification around. If you go onto LinkedIn, you see quite a few people for instance put them at the back of their surname to indicate the qualification. I don’t have an exact number for you, but there are I would guess at least 100 CAIAs in the country, and there could be substantially more.

As alternative investments have become a more popular field, those professional investors who want to gain more academic insight and a good theoretical basis to go into the alternative asset management industry have turned to the CAIA, which is more specialised when compared to, for instance, the CFA qualification, which is broader and includes traditional asset classes as well.

RYK VAN NIEKERK: Let’s talk about your investment process. How do you go about analysing a company and deciding whether you want to go long or short?

JEAN PIERRE VERSTER: Yes – quite a simple question and maybe a complicated answer, but I’ll try to explain it as simply as I can.

We follow a process that I first made my personal process, and it has now become the Protea Capital Management process which we refer to as a ‘quantamental’ process. Now quantamental is a made-up word. It’s a mix between fundamental and quantitative and it implies two different ways in which investors or analysts generally approach the analysis of shares, and is normally seen as two distinct types of approaching investment analysis. We have combined, and we use both a fundamental and a quantitative approach in our process.

Regarding each one of these separately, I’ll start with a fundamental way of looking at businesses and deciding on investments. That is what one would understand most business people would. You assess the qualitative aspects of a company, you go through the audited financial statements of a company, you read through the notes to see if there’s anything strange – or perhaps the accounting policies that this specific company has applied are unusual. At the end of the day you would, specifically for that company, build an evaluation model – whether it’s simple or complex – and get to a valuation in the traditional fundamental way of looking at a company.

The other approach is quantitative in nature. The term quantitative implies a lot of data being used. What we do there is we use a data provider to get data points on a lot of companies. Our current universe is 10 000 companies globally. Those data points include price data, market data, but also fundamental data, which [involves] the individual line items of the company. So, for instance, what the assets, the liabilities and the equity are for each year of the history of the company.

And then we use algorithms on that data to forecast the individual line items, That is a quantitative way then to build a valuation model and decide what a company is worth with no human insight, without going through the notes and thinking about the quality of the management team, for instance, or the competitive advantages that this company might have. It’s purely based on the numbers. What we do at Protea Capital Management then is to combine the fundamental way of looking at businesses – which is, as we say, more qualitative in nature – plus the quantitative way of looking at businesses which is much more data-intensive. We combine those two, and that is how we then decide if a company might be attractive to either buy or short.

RYK VAN NIEKERK: How successful is this process? How many hits do you get and how many misses are there?

JEAN PIERRE VERSTER: Ah, yes, that’s a good question because when we analyse if what we are doing works in practice, and not just in theory, we have two major ways of looking at it.

The one is what we call the hit rate, or as you then say – what percentage of the time are we correct? If we think a share should go up according to the way we choose shares, are we right more than we are wrong?

The other way we look at it is batting the average. The batting average means that when you are right you want to make more money than when you are wrong. And if you can combine a high hit rate, therefore being right more often than you are wrong, plus a high batting average, which means that when you are right you make more money than when you are wrong, then you get above-average results.

When we analyse over the last decade or more that I’ve applied this quantamental process, I’m pleased to say that both our hitting rate is above average – we are right more than we are wrong – and our batting average is above average. So we make more money when we are right than we do when we are wrong. Those are the two ways in which one can assess if your approach is working.

RYK VAN NIEKERK: What have been your returns over the past decade or so? I know you manage different funds – long funds, short funds and hedge funds – but what is the number you have in your head that you regard us a fair reflection of your performance?

JEAN PIERRE VERSTER: I think firstly one must be very careful of theoretical numbers and back-tested numbers and just numbers in anyone’s head. The good news is that I actually started managing outside money in 2009, May 2009. I invited my friends and family, a close circle, to invest in what I called the Verster Investment Partnership. Even though it was a small amount of money at the beginning, it allowed me as an analyst at the time to have some capital that I could then later on say, ‘This is a true reflection of real money being invested by me making the decisions, and these are the returns I generated on that money’.

From May 2009 to date, that money in real terms, the partners in the Verster Investment Partnership who were there from day one, their money has compounded at just over 19% per annum. That compares to the JSE compounding at roughly 13% per annum. The difference between 19% per annum and 13% per annum over a period of 12 to 13 years is quite substantial. So the partners in the partnership now have got almost 10 times the money that they invested in 2009, which is an above-average return and, I’m pleased to say, is a real return, a true return, not just a return in my head.

RYK VAN NIEKERK: Are you more successful in shorting shares than going long?

JEAN PIERRE VERSTER: It depends on where we are in the cycle, as we call it. At times when we have bull markets and shares generally rise we generally make more money from long positions than short positions, and quite often, as has been the case over the past 18 months, we could quite often lose money over the part of the cycle which we call the bull market cycle [when] markets rise quite sharply.

But then when the other part of the cycle happens, the bear market cycle, and markets fall sharply, then the shorts come into their own. Quite often they generate meaningful profits which help to cushion the pressure we might feel on the long positions that would also then drop in price during a bear-market cycle. Over a full cycle if we can make any positive return on shorts, even a small positive return, we would say that it shows that the short book added to performance and made a positive contribution.

At the moment because of the last 18 months and how sharply shares have risen, our short book has just stepped into a situation where it has not generated a positive return. So we need to wait now for the next cycle, the next bear-market cycle for our short positions to make money. Then I can say that we have made money on our shorts historically. At this point in time the shorts have been a very slight drag, but at the same time allowed us to have more than 100% exposure on the long side. So it has in an indirect way added to our performance because, even though it detracted from performance, it allowed us to have more long positions than we otherwise would have had if we did not have a short book in the portfolios.

RYK VAN NIEKERK: Let’s talk about retail or amateur investors. How skilful do you think an average South African retail investor is?

JEAN PIERRE VERSTER: It’s difficult to say, because to measure that we need to know what the returns of the average South African retail investor has been historically. As far as I know there aren’t really a lot of studies that have been done on that topic. There have been studies done in international markets, specifically in the US. What that has indicated is that retail investors generally do quite a bit worse than the funds managed by professional investors. The reason why they do worse is they normally invest after a fund has had a good run and has shown a good historical return, and they typically disinvest from a fund after a shorter poor period of performance. That means that retail investors generally buy high and sell low, while to make money in markets you need to do the opposite. You need to buy low and sell high.

So if this South African experience is similar – and I have no reason to believe that it wouldn’t be – I would guess that South African retail investors on average do worse then professional investors. That is why we refer to them as retail amateur investors, because it’s very difficult even for professional investors to get over the psychological bias of being scared when markets fall and, out of fear, selling when prices are low – and on the other side getting over-eager and having a lot of hope when share prices are high, and therefore buying more shares when prices are high. Those are typical behavioural bias problems that make that both retail and institutional investors make less optimal decisions than they should when it comes to investing.

RYK VAN NIEKERK: It’s also a matter of research and access to proper data. I don’t think – and it’s my experience – that retail investors do enough research before they actually make a decision on whether to invest in a certain company or not.

JEAN PIERRE VERSTER: Probably, yes. I would go a step further to say you can probably take that issue you’ve identified and split it in two. The one is access to information and the other one is what then to do with that information.

When it comes to access to information, I think that the playing fields have been levelled in the last few years. In the US again there was a regulation more than 20 years ago that came out called Regulation Fair Disclosure, RFD, and that meant that professional investors can’t, for instance, call up the financial director of a company and get any material information in that phone call that is not disseminated to the whole market, and therefore [information] which retail investors would also be aware of.

So the playing fields have been levelled when it comes to access to data, in my opinion. The same thing with big data and tools like Google Trends, for instance. Anyone can now use opensource tools that are available and see, for instance, how popular certain search trends are on Google.

A few years ago, call it a decade ago, that type of data was accessible only to institutional investors and it was very difficult for retail investors to get their hands on that data. Today that’s not the case.

But the second element I think is a bigger reason for the difference between institutional investors. That is that even though they might have access to the same data today, what they do with the data is different; one needs to really understand data, financial results, accounting standards, [how] to interpret data correctly and do the right thing based on that data. I think there is still a big difference between what retail investors do with data versus what institutional investors do with data that is broadly available.

RYK VAN NIEKERK: But not all institutional investors are equally successful. We’ve seen in recent times that many of the South African leading asset managers have actually performed quite poorly and didn’t even come close to beating their own benchmarks. Why do certain investment approaches fail, especially from professional investors?

JEAN PIERRE VERSTER: True. I’m actually going to use two Protea funds as an example. Quite an interesting example here, Ryk. If one looks at 2021, our Protea South Africa Fund performed roughly in line with the benchmark, which is the local markets index, the JSE All Share Index, while our Protea Global Fund significantly underperformed the global index. Both these funds followed the same approach.

So, even when one follows the same approach you can have different outcomes. The reason for that is, again, what I would call the typical market cycle, and we’ve had different cycles play out under the JSE and in global markets. So the first point, and an important point, is whether an institution investor is viewed as being successful or not, quite typically as you do with where we are in the cycle and over what period one is measuring performance.

When it comes to equities, because share prices move in irrational and unpredictable ways in the short term, I would suggest that one should always look at periods of at least three years when assessing whether any investor has done a good job or not, because random things happen in shorter periods.

Then in terms of different approaches, one can use an approach that sounds like a solid approach, but it also works at different times in the market cycle. Here the most typical approaches that are referred to are growth and value investors. If you look again at the past two years, we’ve had a very interesting cycle of growth investors or a growth approach doing very well from early 2020 to early 2021. Then all of a sudden the growth approach [was] underperforming over the past 12 months – from January 2021 to January 2022 – and the value approach significantly outperforming over the past year.

So investors who use very different approaches, the value approach versus the growth approach, would have vastly different returns for the years 2020 and 2021, when one could say that both those approaches could be seen as reasonably successful approaches over the long term.

So be careful, I would suggest, in looking at the outcome of an approach over any period shorter than three years. One only sees if an approach is a successful approach if it works over a period longer than three years.

RYK VAN NIEKERK: What has been your best investment ever, and what has been your worst one?

JEAN PIERRE VERSTER: Wow. For my best investment I would need to go back and I would say it was in South Africa property companies, where I bought significant long exposure to South African property companies; probably roughly 10 years ago. Importantly, even though the shares of those property companies became expensive in my mind, I held on because I viewed them as being high-quality companies. At the end of the day they went up almost 10 times in price. Thank goodness I also sold them near the top of the South African property market, roughly five years ago.

So in terms of pure performance, that was my best trade – buying South African property companies roughly 10 years ago and selling them roughly five years ago.

In terms of my worst investments, two come to mind. The one is being short gold-mining companies in December 2015. You might remember that we had Nenegate happen in December 2015; that caused the rand to depreciate sharply and our local gold buying shares to rise very sharply. Because I had shorted those shares, I incurred significant losses.

The other one is actually in the past year, Ryk, where we had exposure to significant high-growth companies in our Global Fund. All of a sudden in the past two months, the months of December 2021 and January 2022, those shares have come under significant pressure. It’s been disappointing to see that some of our holdings have dropped 30% or even more, and it has had a negative effect on our funds. I would therefore also categorise it as one of the worst outcomes of my investment career over the last 13 years or so.

RYK VAN NIEKERK: And then, just lastly, can you tell us what companies you are currently buying, and which sectors or companies are you staying away from?

JEAN PIERRE VERSTER: On the local side we are still finding a lot of high-quality mid-cap companies that are still relatively cheap, even though their share prices have recovered over the past 18 months; we are buying those. And in global markets I mentioned that a number of high-quality growth shares have been sold off quite sharply over the last two months, I can think of companies like Netflix, which fell 30% in a day, or a company like Facebook, which has just come out with results and fell by more than 20% on the back of those results. So those high-quality, high-growth companies are also what we are buying most recently.

RYK VAN NIEKERK: And locally? Can you give us a few names?

JEAN PIERRE VERSTER: Sure, yes. We’ve been buying shares like Hudaco, Cashbuild, Afrimat. Those are the typical mid-cap companies that we view as being high quality – Italtile as well – which have recovered from their lows; but we still see significant long-term value in those companies because they’ve got very good management teams. They’re not quite as cheap as they were, but from prior experience I’ve also learned that just because you buy a share and the share price doubles in the short term, it doesn’t mean you should then sell the share. Sometimes one of the worst mistakes you can make is to sell high-quality company shares too early.

RYK VAN NIEKERK: And then just lastly, what advice would you have for retail investors, normal amateur retail investors?

JEAN PIERRE VERSTER:

For those types of investors, Ryk, I would say diversify, because an amateur investor, typically as I mentioned, might not have the technical skills to interpret financial statements to the same degree as a professional investor would. The best defence against that is to diversify.

And the second word of advice I would give is to stick to quality rather than trying to buy shares of companies whose share prices you see falling very sharply and you think that means that necessarily the share prices must recover – even though it is a mediocre company that doesn’t have pricing power and doesn’t have a strong competitive position. Rather focus on strong companies with pricing power, good competitive positions. Hold them for the long term. That’s how a retail investor has the best chance of outperforming even the institutional professional investors.

RYK VAN NIEKERK: How important is luck to be successful?

JEAN PIERRE VERSTER: I believe it has a very big impact on success. I mentioned earlier that we measure our hit rate, how often we are right versus wrong. Our hit rate is just under 60%, which means that we are wrong 40% of the time. A large chunk of that 40% of the time where we actually lose on a company whose shares we buy or short is because of bad luck. These things happen because of the random nature of short-term share-price movements. The only defence against that is diversification and, secondly, to have a repeatable process where, when bad luck happens, it’s not too detrimental to your investment returns.

But at the same time you can then also benefit from good luck. I definitely would not discount luck, and I personally can think of many examples, both where bad luck had a negative impact on my returns and good luck had a positive impact on my returns. Again, it’s only over the long term that you can see, without the impact of luck, both good and bad, if a process would’ve generated above-average returns based on skill rather than luck.

RYK VAN NIEKERK: What did Gary Player say? “The more you practise, the luckier you get.” It is probably very relevant in the investment industry as well.

But Jean Pierre, thank you so much for joining us and giving us your insights. Good luck into 2022.

JEAN PIERRE VERSTER: Thanks, Ryk, I appreciate the chat.

RYK VAN NIEKERK: That was Jean Pierre Verster. He is CEO of Protea Capital Management.

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