For the 12 months to the end of June, the Aylett Equity Prescient fund was up 41.2%. That is significantly ahead of the FTSE/JSE All Share Index return of 25.1%.
However, senior portfolio manager Walter Aylett is telling investors that they shouldn’t be oblivious to the warning signs that these kinds of returns indicate.
“Markets are pricing in a level of optimism with which we do not feel comfortable,” he wrote in his latest fund commentary. “Government debt levels are at all-time highs in many countries, aided by interest rates at all-time lows. Should anything change, the consequences could be dire.”
‘It’s going to be really ugly’
While Aylett is prepared to admit that, in 25 years, “we’ve had a very poor record of calling markets”, he told Citywire South Africa that he believes it’s necessary to temper the expectations of investors. This bull market will, at some point, have to end.
“Eventually it is going to play out the way we expect, and it’s going to be really ugly,” Aylett said. “We just don’t know how or when and in what form.
“There are generations now that have never seen a high interest rate environment,” he added. “Every metric looks to some form of too much optimism. We know it’s come from all the stimulus that has come from the central banks, and I think their tool kit is now empty. You can see how, as soon as there is a bit of talk of interest rates or inflation, the markets go into a complete spin.”
This is leading him to be extremely circumspect in his stock picking.
“I am now 60, and you do get a bit more cautious as you get older,” Aylett said. “I just can’t help feeling that, eventually, something has to give, otherwise you’ve wasted your time going to university.”
In this environment, Aylett is very aware of building a portfolio that can withstand significant shocks to the system. The fund has therefore been taking profits on some of its US holdings, particularly in financials.
“We sold them off thinking that we would just sit in cash, but some of our core holdings like travel-related stocks were hit due to concerns around the delta variant, and we have added huge amounts of money there in the last couple of weeks. We have also moved a lot of money into energy – particularly oil producers – and buying stocks that we know well that have come off.”
Locally, this includes stocks like Reinet and Royal Bafokeng Platinum. Internationally, the fund has increased exposure to casinos in Macao, and travel-related stocks like Sabre Corporation and Wabtec.
Sabre provides the technology for airline and hotel bookings, while Wabtec produces transportation equipment used in trains.
Aylett has also been seeing value in small and mid cap stocks on the JSE. Transaction Capital is a company the fund has held for some time, and he continues to believe in. He also favours platinum producers.
“We are only about 30% to 35% pure South Africa,” he said. “But if I was an international investor, I would have roughly 30% of my money in South Africa too. Everyone says you can’t buy Microsoft or Amazon here, but you can’t buy platinum companies in America.”
His emphasis when adding to these holdings is on building durable portfolios of companies that will endure.
“Our job is to think about the unknown,” Aylett said. “I want to buy great, uncorrelated investments that will survive despite whatever gets throw at them. We will always need trains, hotels, insurance. South Africa will need taxis.”
Arrows in the quiver
“You protect yourself by not overpaying for assets and then being able to withstand five to 10 years of no growth,” he added. “But when you overpaid for Japanese stocks 30 years ago, or the Nasdaq in 1999, some of those shares have never recovered. If you overpaid for Coca-Cola in the late 90s, you would have lost a fortune.
“For example, we are quite big into packaging at the moment. Lots of people don’t like the sector, but you are paying five- or six-times cash flow for these companies. Platinum is another. It is on three-times cash flow at the moment. When we are buying at those levels, if we are wrong, at least we get our money back.”
This does mean avoiding the ‘sexy’ stocks.
“We will just carry on buying things that we know, and things that we know we will need. But paying $2 trillion for Apple, in my mind, is just too much. It’s safer to buy old-fashioned, neglected stocks.”
It also requires discipline, and patience.
“My biggest fight with my young analysts is trying to explain that you need to think like you only have 20 arrows in your quiver. Every time you buy a share, that’s an arrow gone. You need to take that ‘buy’ decision so seriously.
“In fact, you should be prepared to spend two years not buying anything. People don’t want to hear that we might not do anything for two years, but the truth is that if the probabilities are not in our favour, why invest?”
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.