‘Stay with companies where earnings can be sustained’

Tony Bell of Vunani Fund Managers on why commodities do not feature in top funds.
Tony Bell, chief investment officer at Vunani Fund Managers

RYK VAN NIEKERK: Welcome to this Market Commentator podcast, it’s Moneyweb’s weekly podcast, where I speak to leading investment professionals. The guest today is Tony Bell and he is the chief investment officer of Vunani Fund Managers. Tony, welcome to the show, it’s a Friday and we’re seeing the market is down 2%, it’s a bit of a bloodbath and it’s been a very volatile year for markets, and it seems like markets overreact on the slightest piece of economic data. Today we saw good jobs data from the US and that, of course, means that the rate rise may be announced before the end of the year. Do you not think that the rate rise has already been priced into equity markets and this could be an overreaction?

TONY BELL: Ryk, I think there is an interesting background picture to why everyone is so obsessively focused on the rate hike, maybe if I could just share with your listeners a few thoughts on the global macro environment at the moment. What I’m seeing is really just too much of a preoccupation with whether the Fed was going to raise rates in September or December and I think there’s a much bigger issue at play. What we’re really dealing with is a very depressed growth environment, some of the more popular economic papers coming out refer to this as a balance sheet contraction, and the gist of that is essentially that consumers are still largely indebted, that they are not borrowing, therefore, the credit cycle is very suppressed, companies can’t increase their price of goods and services as we would in a normal economic recovery. Therefore, Dr Yellen is engaged in a very, very delicate balancing act between withdrawing some of the QE from the market that has accumulated since 2008 and the need to normalise interest rates. What that essentially means is that the markets are dealing with the balancing act between how much companies can grow in this environment and how much the background of interest rates is going to change.

So what we see in the very short term, like we saw today when the jobs data came out, is a big spike in the US tenure, the rand spiked up to about R14.40, our bond yields went up to 8.45 and that’s part of the structural adjustment that I see happening as we move into 2016, where the market is going to discount growth into the future at a lower level and I think that’s why stock picking becomes so important in this environment.

RYK VAN NIEKERK: But the volatility I think is here to stay, as you said, stock picking is so critical, where are you looking for stocks at the moment? Where do you see value? It seems like most of the big companies doing business in the emerging markets, the popular American companies, Procter & Gamble, Johnson & Johnson, Yum! and the like, how do you find other companies that are not as popular but that may have the same growth potential?

TONY BELL: It’s another interesting question and perhaps the way I view the process of stock selection in both the local and global funds that I run is I’m looking for what many, many years ago was referred to by some of the popular writers at the time as the preservation of earnings power. I think for the listener it’s very easily explained with a shopping centre analogy, if you’ve got a shopping centre like you have in Joburg or Cape Town, which is very popular, Melrose Arch or Century City, where there’s a lot of business being done and there are good rental flows, turnover increases are coming through, those shopping centres are always going to be valued at a much lower yield, in other words a much higher price than shopping centres that are struggling. I think the secret in this particular environment, and perhaps the contentious point of discussion, is that it’s not about looking for stocks with low Pes, that’s where I think the value trap comes because a lot of those companies aren’t able to maintain their earnings power in this sort of environment. I think Benjamin Graham put it very nicely, the criteria he specified in looking for companies was find companies with earnings power, companies that are able to demonstrate sustainable earnings growth rate, low debt/equity, high cash flow and the ability to convert that cash flow into shareholder value. That’s pretty much what drives me when I look for stocks, so I’m not particularly sector-dependent. To give you an example, I would consider something like Coke and McDonald’s as a legacy consumer stock. In the global fund that I run one of my top picks is Amazon and Nike, and I think the distribution base that those companies have built from a global perspective, and the pricing power they have through their brand maintains and sustains that earnings power and in this environment of low interest rates the market is prepared to put a higher PE multiple on those stocks.

RYK VAN NIEKERK: I want to talk about two clients of yours who have elected you to run funds for them, for the financial advisors specifically, and that is Brenthurst Wealth, of Magnus Heystek, and Citadel, tell us how did it come about that you actually manage individual unit trusts for these financial advisers?

TONY BELL: A couple of years ago I was approached by both companies and what they were looking for, given the explosion in unit trusts available through the traditional product providers, was something that was a bit more bespoke for their clients. Both companies service very high net worth individuals and really what they are looking for is access to a comprehensive and very tailored solution for their clients. So the typical interaction that I have with both is I will do an evening dinner presentation with a very extensive overview of the global macro picture. The monthly reports tend to be quite comprehensive, seven to ten pages, looking at the decisions taken in the portfolio for the month and the quarter.

I think what’s driving both those clients of ours, plus others, is they are looking for something that is perhaps a little bit different from the more traditional general equity fund, they’re looking for higher levels of alpha, alpha has obviously become quite a sought after offering from the fund manager to the client. They are also looking for something where the fund manager’s happy to engage with their clients, both formally during the presentation and then afterwards, where clients can understand fully how their money is being looked after. So it’s really an extension of a product selection into more of a full service offering through to those clients.

RYK VAN NIEKERK: But there are over 1 200 unit trusts in South Africa, how do you differentiate yourself from those?

TONY BELL: That is the million dollar question [laughing]. Perhaps what I do a little differently is I think differently about the markets. I’ve been in the markets for nearly 30 years now, I look at the global macro picture from the point of view of understanding how it’s evolving. I don’t spend a lot of time thinking about what I can see on my screen at the moment and what the current opinion is, I really want to try and understand how the market will evolve, given the dynamic that we’re working with. So by spending quite a lot of time running a suite of target return funds, where asset allocation is the major core, I find myself being able to integrate that research and thinking into thinking about stocks and really trying to differentiate on the basis of putting the two pictures together and coming up with a portfolio structure that I believe has the ability to sustain the growth that I’ve been speaking about going into the future and as a result, deliver the performance that the client is looking for.

RYK VAN NIEKERK: Let’s look at the Global IP Opportunity Fund, that’s the one you manage for Magnus Heystek at Brenthurst, the top 15 shareholdings include very well-known names in South Africa, Nike, Starbucks, Amazon.com, Visa, Apple, Google, MasterCard, how do you do the research into companies? There seem to be over 6 000 listed entities in the developed market, how do you look at less popular companies, which may offer the same or better returns that those I’ve just mentioned?

TONY BELL: I think the first point to be made is those stocks have offered very generous returns, if I look at Amazon, for example, it might surprise the listener when I mention that it’s up about 154% in the past 12 months, Starbucks is up 103%, Nike is up 77%, Facebook is up 73% and so the list goes on. So within that portfolio that I run, the top 20 stocks have all generated returns of 40% or more. What I do when I look for stocks in the portfolio is I really don’t spend a lot of time reading broker research and looking at financial models. The reason for that is what I’m looking for in the stock is how things may change in the future, where through the analysis of the financials I’m very preoccupied with how a company’s capital is structured, how their margins and product and pricing are positioned, whether they’ve got a distribution and technical advantage and how they might use their free cash flow to translate into future value-add. So I’m particularly preoccupied with terms that listeners may have heard in the past. I’m looking for enablers, I’m looking for disrupters and I’m also moving the macro environment in my mind from old world to new world.

So to give you an example, instead of looking at material stocks, which is currently very topical, I look for material innovation. I find some companies starting to develop new technologies, going into aircraft to make them lighter, I find that quite interesting. If I have a look, for example, at the retail market it’s no surprise to me that Amazon has got a bigger market cap than American stores like Walmart because the format of making profitability out of a Walmart store is very much a legacy concept. If you look, for example, at banking, there is nothing wrong with FirstRand or JPMorgan but I’ve got much more Visa, MasterCard and PayPal in the portfolio because I think transaction banking through your smartphone concept is going to be a much more profitable endeavor into the future. So I try and evolve my thinking from a conceptual perspective to take what I’m seeing in the macro environment and then trying to develop key themes going forward and then looking for best of breed in each of those themes.

RYK VAN NIEKERK: The other fund that you manage is the IP Global Macro Fund and any retail investor can invest in that fund. The underlying holdings look very similar, is there a difference between the Global IP Opportunity Fund and the Macro Fund?

TONY BELL: Yes, the holdings are virtually identical. The brief that was given to me by Magnus Heystek from Brenthurst was really to make it a slightly more aggressive fund. The Global Macro Fund has a benchmark of 80% MSCI, it has 15% dollar benchmark and 5% cash. It’s a South African feeder fund into a global exposure base, but it has a slightly more conservative risk profile. So the real difference between the two is simply one of risk profile. The stocks in the Global Opportunity Fund for Brenthurst are slightly more concentrated in terms of exposure size.

RYK VAN NIEKERK: The Focused IP Wealth Fund, that is the one you manage for Citadel, is also interesting. It’s more South African-focused but I see that since inception it has grown by 23.6% annually and that beats the internationally-focused funds hands down that did around 17%.

TONY BELL: Ja, the stock selection there has been particularly pleasing. I think what has worked particularly favourably in the case of the Focused IP Wealth Fund is that the stock selection in the local market has generated quite significant alpha for the clients, largely because of a complete – and I hope this doesn’t shock too many listeners – but a complete absence of any exposure to resources and then really a focus in terms of picking up stocks like Adapt IT, which I picked up at around R2.75, now trading at R12.25 and many similar success stories. The portfolio itself has got about 25 stocks, so with its size being just under R400 million I can move quite quickly. I don’t tend to have a very high trading style, but the stock selection itself focused on companies like PSG, Tradehold, I have very big positions in Steinhoff, I picked Brait up early and there were a lot of companies that I invested in of a more medium cap size, where the growth has simply been explosive over the last three or four years.

RYK VAN NIEKERK: I see that only 17% of the fund is invested offshore, which is a bit different to some of the other fund managers, who really are pushing the 25% limit, why is this the case with your fund?

TONY BELL: I take a slightly different approach from just focusing on a 25% limit, the way I’ve evolved from a stock picking perspective is I look at shares across the globe and not just in terms of their sector but in terms of the thematic drivers I was describing. So if I can find very good stocks locally and there are many good stocks available on the local… I don’t duplicate that in the international market, I really look to merge and blend the local with the international exposure. So for example, companies like Amazon, Nike, Visa and Apple that are in the global component of that fund you can’t find on the local market. I don’t have a lot of retailers in the international space because in South Africa I found very good performance through the likes of Woolies and Spar. So I try and look at the world from an earnings growth perspective and say where is earnings growth likely to come from? How might that surprise to the upside or downside and to the extent that it surprises to the upside, which geography is it in and what’s it going to be driven by? I think the blend between the macro and the company and industry specific focus allows me to look at the portfolio cross-section and say I want to tap into the best growth streams I can find globally and if they happen to be South African I blend that with exposure in the US or elsewhere.

RYK VAN NIEKERK: Just lastly, you said you didn’t really dip into commodity stocks, it is the sector that, according to Pes, is really offering value. Obviously, it is an important part of the South African economy. Do you foresee entering that market, selecting some of the bigger counters in that sector any time soon?

TONY BELL: Ryk, not for these clients. For funds that we manage that are a bit more benchmark cognizant as Vunani Fund Managers we do have exposure. Given the nature and the tracking error risk that I’m working with, to give you an example of the Wealth Core Fund, my tracking error relative to benchmark is nearly 17%. So I’ve got very highly focused portfolios. I see an environment where we are going to enter into 2016 in a low growth, low inflation scenario. But I think, as we’re seeing today, a large portion of the action is going to happen through the currency markets, with the jobs data coming out and the market now starting to transition into a likely rate rise in December, it’s very hard to see that the dollar is going to weaken from this point. So until I start to see some sort of underlying fundamental demand for commodities and commodity prices, I’m more inclined to stay with the companies where I believe earnings can be sustained.

RYK VAN NIEKERK: Thank you, Tony. That was Tony Bell, he is the CIO of Vunani Fund Managers.




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