Over the last few years the JSE has become dominated by a single stock. Naspers now makes up 20.5% of the FTSE/JSE All Share Index, 24.5% of the Top 40 and 24.8% of the SWIX.
This means that these indices, and by extension any funds that track them, are heavily impacted by how Naspers performs. This has clearly been evident in 2017. Naspers is up over 80% for the year-to-date, and has accounted for the bulk of the 16% gain in the All Share Index.
Of the 25 top-performing unit trusts so far this year, 14 are either large-cap portfolios or index-tracking funds. These are strategies that have clearly benefited from carrying large exposures to Naspers.
The general consensus is also that Naspers should continue to perform well. Its holding in Chinese internet giant Tencent has been the main driver of returns, and earnings there remain outstanding. For the third quarter of 2017 the company reported an increase in profits of 67% over the same period in 2016.
‘What happens if it goes wrong?’
All this good news does however create a conundrum for both fund managers and individual investors. With Naspers making up such a big part of the JSE and continuing to perform so well, how much should you hold in a portfolio?
“The biggest issue to consider is what is a well risk-managed position to hold,” says Claire Rentzke, the chief investment officer at 27Four Investment Managers. “Here portfolio construction is key. It’s not about the outlook, how the stock is going to do, or how much value is there to be unlocked. It’s about asking what are the risks in having an allocation to a single stock. What happens if it goes wrong?”
Things may be very rosy for Naspers right now, but that certainly doesn’t mean that the company doesn’t face risks. The questions raised over its corporate governance and management that have recently surfaced bear this out.
However, investment strategist at 27Four, Nadir Thokan, cautions against getting caught up in on a single issue.
“There are many potential banana peels that companies like Naspers or Tencent could slip on in a rapidly evolving space like internet technology,” he says. “It’s not our job to identify exactly which one it will be. Our job is to identify that there are a number of banana peels and therefore how do we position the portfolio.”
“Naspers has always had no voting rights for ordinary shareholders, which is itself a governance issue. What that highlights is that within every company there are company-specific risks, and the more exposed to a single stock you are the more exposed to those company-specific risks you will be. It comes down to having to manage your position sizing. The golden rule about building a portfolio is to make use of the benefits of diversification.”
The quandary is that while controlling for these risks and therefore underweighting Naspers relative to the market benchmarks makes good sense, it hasn’t been the right thing to do from a return perspective. If you have been underweight Naspers this year, you will not have kept up with the market.
There is value elsewhere
Thokan however argues that one shouldn’t lose sight of the longer-term potential in the rest of the market. The valuation discrepancies between the cheapest and most expensive stocks on the JSE are still extremely wide, and well above the long-term average.
“So there is a lot of value to be extracted from being tilted towards value as a style,” he believes. “When the value unlock comes either through the cheap stocks re-rating or the expensive part of the market de-rating there is a lot of alpha to be captured. We are finding quite a lot of opportunities in the local equity market, and not just within big counters that have already run significantly.”
To put this in context, he says investors should consider what they could buy for the value of Naspers. The table below illustrates that for the same R1.4 trillion it would take to purchase Naspers’ entire market capitalisation, you could buy 44 other locally-listed companies.
“You also have to look at the earnings of those 44 stocks relative to Naspers,” Thokan argues. “They generate almost six times the earnings that Naspers does.”
This is not to say that Naspers is necessarily over-priced, but that its performance has overshadowed other opportunities available to local investors.
“You only have to consider that year-to-date two of the top performers on the JSE have been Kumba Iron Ore and Anglo American, which are stocks that few managers held in 2015 because commodities had sold off so much,” Rentzke says. “We were even talking about the possibility of Anglo going bankrupt, but those stocks have rerated and performed incredibly well.
“So it’s difficult to know what’s going to be the next driver of returns and which stocks are going to be the best performers in 2018,” she adds. “But if history teaches us anything it is that you need to be well diversified because you don’t know what the next star performers are going to be.”