RYK VAN NIEKERK: Welcome to this market commentator podcast. My name is Ryk van Niekerk and in this podcast series I pick the brains of the leading investment professionals in South Africa and we try to peek over their shoulders to see what they are seeing in their crystal ball. My guest today is Duncan Artus. He’s the chief investment officer at Allan Gray. He’s been with Allan Gray for more than 20 years, 15 of which as a portfolio manager.
Duncan, thank you so much for joining me. I want to start with comments you made last year when you spoke to the Sunday Times. It was shortly after you took the reins from Andrew Lapping in September. In the interview you said you were very, very worried about South Africa’s fiscal position, and that the country is approaching a death spiral, which could be very damaging for local equities.
Yet today our market is close to an all-time high, while our fiscal position remains dire. It doesn’t really change significantly, despite some bullish expectations of tax revenue. But are you still worried?
DUNCAN ARTUS: Longer term we must always remember, Ryk, journalists like very explosive headlines as opposed to long arguments, which you speak to them about. But no, for sure, if you look at the trajectory of debt to GDP, clearly if you are paying 5% or 6% real to borrow on your long bonds, and your GDP is growing at one real, it’s just a mess. This can’t carry on forever. Right? So the government’s paying a very high price to borrow for any kind of duration. In other words, for any kind of length. Then if the Reserve Bank cuts the short end, like it has, that’s not where the government’s borrowing. So to actually borrow for any length of period investors are demanding a very hard return.
We have been bailed out to a large extent by the strength of the commodity prices, particularly the platinum group metals, and within platinum group metals palladium and rhodium – and then if you look at the Kumba results, obviously the iron ore and the premiums we are getting.
We’ve been running these massive trade surpluses. Without that it would have been pretty interesting to see what we would have looked like. Of course we know commodities go through big cycles. This may be one that lasts longer, but South Africa has only really done well as an economy over the last couple of decades when the commodities have been strong. So they’ve kind of masked some of the fundamental issues for now. But I do think the long-term structural problem is that we need to grow; we can’t keep borrowing.
RYK VAN NIEKERK: Yes. That’s definitely been a common perspective. But, back to the markets, again, many people – many analysts and many fund managers – regard the local performance of the market as flowing through from the really excellent performances we’ve seen in international markets, and in many ways it is actually ignoring what is happening locally, economically and politically. Do you think that disconnect is justifiable?
DUNCAN ARTUS: Part of it is true. I mean, the Fed is printing $120 billion a month – it’s got to go somewhere. You can just do the maths if you put that into rands and, with interest rates being low offshore, if there’s any sort of positive sentiment towards emerging markets we will get our fair share even though we are a lot smaller. South Africa, I think, used to be 6% or 7% of the emerging market index. We are only around 3% now, and almost 40% of that is just Naspers. So that foreign money coming into the market I think is a potentially quite bullish thing.
If we go back to sort of March/April last year, we were saying we’re very bullish on local South African equities. One interesting thing about modern technology is you and can look what you said on videos now, so we’re not making it up.
I think what people have discounted was way too much bad news. All that’s happened is that the local stocks have produced results that were much better than people thought. That’s for two reasons. One, obviously cost-cutting, which is not sustainable over the very long term – but companies all cut their costs. And second of all, the cashflow has been much stronger. So you really focus on your balance sheet, you focus on your working capital, and that allows you to pay down debt.
If you had to say, which of the domestic-facing companies produced results, versus what people expected, all they had to be was somewhat less worse. And so we’ve seen a massive rally, particularly when we express it in dollars. People look at the share prices in rands – but don’t forget the rand has come back from R18-odd to R14.50. So in dollars the share prices are up even more than they are in rands.
To me what’s interesting is we had a slide that we were showing clients where you could buy the entire South African listed retail sector, plus Anglovaal Industries and Tiger Brands, which are the two biggest food companies if we express them in dollars, for about $22 billion last year. Just Tesco’s market cap was $25 billion. So you can either buy Tesco, which is not exactly in a high-growth country, or you could buy every single retailer in South Africa and the two biggest food companies. So I think what happened is South African assets just got too cheap.
It’s interesting if you start to look around, Heineken making the potential bid for Distell, Standard Bank looking to take out the Liberty minorities, Caxton buying sort of a large stake in Mpact, the producer. So I think that South African assets look cheap to foreigners who are willing, I guess, to take a longer-term view.
RYK VAN NIEKERK: We’ll talk about the perception of individual stocks a bit later. But several asset managers, such as Ninety One and PSG, have publicly stated that they see the local market as offering real value, despite the risks we face locally. Do you agree with that?
DUNCAN ARTUS: Yes. I think, Ryk, the best way to check that, rather than listening to people, is to look at their fact sheets. Right? So if you look at the fact sheet for the Balanced Fund, the equity weighting is – I looked this morning – around 71%, 72%, bearing in mind the max we can go is 75%.
So we currently have our highest equity weighting since post the GFC (global financial crisis). Why is that? Well, one, we bought a whole load of assets last year, and two, obviously the market’s been strong. The easy way I try to think about it is how we compare assets, which is to say, well, if I want to sell something today, is it easy to sell something in the portfolio to buy a new idea? It’s actually quite difficult when I go through the list of stocks in my portion of the funds. Let’s say I want to buy company X today and I have to sell a bit of company Y – I don’t really want to sell too much of company Y. What I would put as a proviso is we think the US stock market is high. So I think when people say South African assets are cheap, I think they are right in terms of equities, but that doesn’t mean that they go up 4% real, 4% real, 4% real. You could have dislocations in between.
If you had to ask me, you only have to look what has happened to Naspers over the last month. But we would be concerned about the US market, so we are very underweight the US market.
And if there’s a big selloff in America, does it come through to South Africa in the short term? It probably will, but I would expect South African equities actually to be better than American equities in any kind of global selloff.
RYK VAN NIEKERK: Would your portfolio still look the same if there were no exchange control, no Regulation 28, and you could take money from people’s savings for retirement and invest it for the long term anywhere in the world?
DUNCAN ARTUS: No. We’d have a much higher weighting offshore, depending where the different variables and valuations are. South Africa is only 1% the world. Why would you have 100% of your money in 1% of the world? So it kind of makes sense on the studies we’ve done. It was a number of years ago. So the number might have changed, but roughly 30% of a South African’s expenses are linked to exchange rates. You can make up some numbers closer to that or bigger than that. That’s probably the minimum you want to have offshore as a hedge against currency depreciation, or just to hedge the basket of goods you buy.
But it’s clear that more choice is better for the portfolio. But, funnily enough, the reason we don’t have a flexible fund – you’d notice Allan Gay has a Balanced Fund and a Stable Fund and an Equity Fund – we don’t have a flexible fund, despite many advisors and clients asking us to, because we have something on the institutional side where it takes a little bit more of an extreme view and the client behaviour is not great.
Certainly in my 20 years here the worst decisions I’ve seen by clients are that they always take their money out offshore when the rand’s very weak, and they always bring it back when the rand is very strong. So, if you kind of have a fund that’s very, very flexible, the client behaviour can often wipe out the extra returns you can get from I guess having a more flexible mandate.
RYK VAN NIEKERK: Given that position you’ve just articulated, what do you think the opportunity costs are for investors locally, if significant asset managers such as Allan Gray would say that the portfolios would look different if there were no regulations?
DUNCAN ARTUS: Funnily enough, over 120 years we do have the long-term numbers from the different studies. South Africa has actually been one of the top-performing equity markets. South African equities have done sort of 8%, 9% real, so 3% real is better than the global average over 120 years. That’s pretty good.
Now you can argue the last 20 years are maybe different. Those numbers have been coming down on a relative basis. I mean, it makes sense. The US stock market is 60% of the world. The US has basically been the only place to be. I often say to people, it’s very interesting if you look – and I haven’t looked in the last month or so – at the European equity markets and you express them in dollars, they are lower than they were in 2007.
People sometimes look at South Africa and they go, wow. I think if we look at the FTSE in the UK, it took till about 2017 to pass its peak from 1998. I don’t see people calling England a ‘failed state’. So what really matters is the valuation you pay. It’s not obvious. There’ll be periods like 2002 to 2010 when South Africa massively outperforms the World Index. And then there’ll be periods like the last 11 years, when we’ve underperformed the World Index. But I would like to stress that America has driven almost all the outperformance of global equities versus South African equities.
I think the argument more comes down to diversification. Unfortunately let’s just say as a local fund manager we want access to technology shares, just on the JSE.
In reality you can only buy Naspers. So it wouldn’t make sense to have exposure to Facebook and Google or whichever you want to name. Sure, it gives you greater choice. If you want to buy into pharmaceuticals, we only really have Aspen, and you can say Aspen’s more of a manufacturer than a pharma company. So that’s where I think the sort of potential opportunity costs are.
RYK VAN NIEKERK: I’ve looked at the fact sheets of your Equity Fund, your Balanced Fund and your Stable Fund. Interestingly, the underlying investments are relatively similar among the top holdings. In all three funds, the names of Naspers, British American Tobacco, Glencore, Woolies, Sibanye Stillwater and Standard Bank. Now these are all blue-chip companies, but does it make sense to have the same in all three funds?
DUNCAN ARTUS: Generally, remember the funds are very different, so obviously (for) the Equity Fund someone says, well, here is 100% you can put into equities, and we go and find the best equities we can. (For) the Balanced Fund, someone says, look, Allan Gray, I don’t want to do the asset allocation myself. No(thing) subject to Regulation 28, and please can you do the asset allocation? And then in the Stable Fund, which is very different, that’s got a maximum equity weighting of 40%. So we would generally tend to have the same shares across all three funds.
If you had to look through the full list, of which you can only see the top 10, the Stable Fund would look a bit different. So we would have a few more, for want of a better word, in ‘stable’ companies in there. You’ll see something like MultiChoice is in the top 10. So even though we own it in the Balanced and the Equity funds, it would have a greater weighting in Stable. Something like Anglovaal Industries, the food produce, Anheuser-Busch InBev would have bigger weightings in the Stable Equities than in Balanced and Equities. But in general the big holdings would look pretty similar because they are the shares we find most attractive.
RYK VAN NIEKERK: You own Naspers and not Prosus. Why?
DUNCAN ARTUS: Well I guess for both shares, when they trade, you can work out the discount that Naspers trades to Prosus and Prosus trades to Tencent. The discount in Naspers was around 50% to the combined Tencent and the rest of Naspers assets. And obviously, because Prosus is closer to the assets it traded at a lower discount. So I guess you could say it’s more – I wouldn’t want to say a bet – it’s more like an investment that management will have to keep being pressurised, and I guess one day would like to close the bigger discount in Naspers, if that makes sense.
But obviously from Monday we’re going to add a lot of Prosus because you’ll be exchanging your Naspers shares for Prosus shares. So when you open the fact sheets at the end of September, and you can see the new weightings, there’ll be Prosus in there, depending on the relative discount that each shares is trading at.
RYK VAN NIEKERK: So you did accept the share-swap offer?
DUNCAN ARTUS: Yes, we’ve tendered our shares. We’ll see how the shares react, because they obviously went ex I think yesterday or Wednesday and means declined to sell your Naspers shares for the next two days. So the first time you can sell your Naspers shares (is) on Monday. We’ll see what the shares do. It’s going to be very interesting.
RYK VAN NIEKERK: Interesting indeed. Covid-19 – It was and is a bit of a rollercoaster, especially on equity markets. How do you think this pandemic distorted markets?
DUNCAN ARTUS: Well, it has distorted markets in two ways. I think if we just look at the local equities, we didn’t think local equities were expensive in February 2020. Then Covid comes and they are sold off anyway, all the way to 37 500-odd on the All Share Index. But by far the biggest effect that Covid had, when I think about it, is we know central banks have basically, for want of a better phrase, been printing money or keeping interest rates close to zero since the great financial crisis.
But what happened, and it was happening before Covid but has really accelerated, is you’ve had a massive fiscal spending in the US and in Europe. So you’ve now got easy monetary policy, plus (big) stimulus spending by the government. You don’t often get the two of them together to such a great extent. No one really knows what the effect of this is going to be. We’ve seen inflation spiking in the short term, but to me it has completely distorted sort of economies and sort of markets.
The interesting thing to think about that is South Africa didn’t really do quantitative easing other than the Reserve Bank buying, I guess, a few bonds in the market. So I think the South African economy is more a real reflection of what the economy is, whereas in America, in the UK and Europe, where you printed these trillions of dollars and you’ve had all the spending, it’s difficult to know what the true level of the economy actually is.
RYK VAN NIEKERK: Did your approach change during this pandemic, or since February last year? Did you trade more within the portfolios or less?
DUNCAN ARTUS: We traded massively in March and April last year, Ryk, because there were lots of things that were falling significantly in those two months. For instance, Allan Gray never really had a long duration. In other words, in our Fixed Income we don’t go very long in the yield curve, we were normally pretty conservative on duration. But South African long bonds and the inflation-linked bonds – we saw where they sold off, and we bought a lot of South African government bonds. When the market’s as volatile as it was, it just gives you opportunities. If you think Anglo American is worth X and Naspers is worth Y, and the movement between the two is 15% in two weeks, you’re able to move some of the funds. And offshore we increased the equity exposure during March and April as well. It’s probably more just scanning sort of the markets, looking at the opportunities. But the more volatile the markets are generally, the more the portfolio will change.
RYK VAN NIEKERK: That’s interesting. Many fund managers would tell normal retail investors to rather sit on their hands during a crisis like that, that things will normalise in due course. But Allan Gray seems to have acted on it. How is your approach to such an event? Is it regarded as an opportunity, or do you just want to save and preserve capital?
DUNCAN ARTUS: Obviously if someone went 100% to cash in March and April, they’re already regretting it now. The market’s up more than that, it’s close to a 100%. So that’s what I mentioned about behaviour earlier – the difference between investor performance and fund performance. People can go and look it up on the internet, there are quite a few studies that show the average investor performs worse than the average fund because they tend to buy high and sell low.
But when you have these opportunities, you’ve got to think of it in two ways. Well, I’m buying the shares for 50% less than they were a multiple before; if everything’s equal, they should be cheaper and you should be increasing your exposure to equities. But we also think about the risks. I’ll give you an example.
In March, early April we spent two whole afternoons just on the South African banks. Instead of looking at their valuations, we spent the whole four or five hours just on their balance sheets – how do the balance sheets look, how does the liquidity look? What are the capital ratios? What will the capital ratios look like if bad debts are double what they were in the GFC.
You think about risk as well. We spent a whole day going through every company in the portfolio, and the analysts had to rank a probability of the company having a rights issue. You can imagine if in March and April you’re sitting with companies with lots of debt on their balance sheet; if you’re a casino or a hotel company you had to close. So we looked at that and we had a number in our mind of how much of the portfolio we would have to spend if all these companies had to raise money. As it turned out, only a couple did. So yes, take advantage of the opportunity, but also start thinking; we also think very hard about the risk in the portfolio. And you got to be prepared like that.
Otherwise, as you mentioned, Ryk, it’s difficult to make decisions. So you’ve got to be sort of in a frame of mind where you’ve already done the mental sort of preparation. You go: if this happens and it gets worse, what are we going to be doing in the portfolios?
RYK VAN NIEKERK: What has the result of this approach been? I’m looking at your Equity Fund fact sheet; over the last two years you underperformed the benchmark by two percentage points, and then over the last year, which is not a similar period to that which you are referring to, the performance was nearly 24% – which was 3% lower than the benchmark. How do you measure your success in taking this approach?
DUNCAN ARTUS: There are two ways to measure success. One is we want to grow people’s wealth in absolute terms, and we want to outperform the benchmark. If you look there, it depends on how you measure it. In some periods there’s good alpha. It’s just we thought South African domestic shares were not expensive, as I mentioned in February. So, for example, we had a reasonable position in banks, and when Covid came the banks fell and the big stocks outperformed. By definition for ‘outperform’, you’ve got to look different from the index. That means you’re going to underperform some periods, and that’s why asset management is a much more difficult industry than people think.
But if we look up until a month ago with Naspers, almost all the performance over the last three years in the South African stock market has really come from the big five shares – Naspers, BHP Billiton, Anglo, Richemont. Many managers do think about relative risk instead of absolute risk. In other words, even if they think Anglo and BHP are expensive, they’ll still hold a position because they would be worried about underperforming.
As an example in 2008, if you remember, Anglo American and BHP Billiton made up almost a quarter of the South African stock market – we were zero in them. And that didn’t look good into the peak of 2008, but then it looked very good afterwards. I think in hindsight that was the right decision.
So for a manager that has to look different from the index, almost all the performance has been driven by the big shares, and that’s been a nice thing over the last couple of months – the performance coming through, where the shares that are not the big shares in the index have continued to do well.
In South Africa, it’s a strange thing. You can look at the All Share Index, you can see the capped Swix, you can look at the Swix, all different sort of indices out there.
And second of all, as I mentioned, if you look at the Equity Fund and the Balanced Fund, obviously 30% roughly is offshore. Our sister company, Orbis, has been very underweight the US. So we’ve roughly got a quarter of the offshore equities in the US, whereas I would think most people would have 60 or 70%. Obviously the US stocks have been the place to be. We think they’re expensive and we’re finding much more value in emerging markets and Europe. So let’s come back in a year or two and see how that has worked.
RYK VAN NIEKERK: Just lastly, we are seeing many international fund managers offering some crypto funds and products. We also recently saw research which indicated that many more of the asset managers are looking at cryptos as an opportunity to expand product offerings. But this hasn’t happened in South Africa. Are you looking at any possible crypto-linked offerings?
DUNCAN ARTUS: No, we wouldn’t be looking at that Ryk. I think first of all obviously the point …… you can’t own it in a Regulation 28 fund. But let’s say you could, and maybe there ….. I personally have no problem with someone who says they want to put 1% or 2% of their wealth into cryptocurrencies. As we’ve seen they’re very, very volatile and difficult to put a value on. It is interesting because a lot of people say that the supply of Bitcoin is limited, but now there are a whole kind of other cryptocurrencies. My concern is whenever you have a big bubble, if I can call it that, in cryptocurrencies, there’s always dodgy stuff going on. You only have to see the amount of exchanges where people have lost all their money. There’s probably likely to be a big fraud globally in crypto. And, if people lose their confidence, what is the value that you can put on Bitcoin, or what is the value you put on whatever any number of the other cryptocurrencies are if they start falling and people lose confidence?
As I said, there are very, very smart managers. As you pointed out, offshore you will have a couple of percent of their funds in cryptocurrencies. But let’s see. If you put it next to the Nasdaq it dwarfs all the other price increases in history that we’ve been able to find.
So you’ll have believers and you’ll have non-believers. I think that that in itself tells you something pretty interesting. But we prefer to own equities at the moment rather than cryptocurrencies. Where we’ve done our work and what I think the big thing is: what do cryptocurrencies mean for financial institutions? We’ve done work on central bank digital currencies. China is likely to launch a digital yuan. America then will have to catch up because what happens if China says we’ll only accept payments for exports in digital yuan? What does that mean for the dollar? What does it mean for asset managers, life companies if you start using digital ledgers? It’s quite a complex subject, but that’s more where we’ve been spending our time rather than trying to trade cryptocurrencies, I guess.
RYK VAN NIEKERK: Duncan, thank you so much for your time and insights today. That was Duncan Artus, the chief investment officer at Allan Gray.