RYK VAN NIEKERK: Welcome to this Market Commentator podcast. My name is Ryk van Niekerk and it is my weekly podcast where I speak to leading investment professionals.
My guest today is Alwyn van der Merwe, a veteran of more than 30 years in the asset management industry. He started his career as a fund manager in 1989 at Old Mutual, and stayed at Old Mutual Asset Management for 18 years before moving to Sanlam Private Wealth in 2007 as the director of investments, a position he currently holds.
Alwyn, thank you so much for joining me. It has been a long career and it’s not over yet. Do you still have a spring in your step when you wake up and get excited about market movements?
ALWYN VAN DER MERWE: Yes, Ryk. If I can use a winemaking analogy to quote another legend in the wine industry, when he was questioned about why some of the winemakers were doing well, and why I think we have the ability to stay in the market for 30 years – “it’s all about the genes”. I think if you like the job and it’s entrenched in the way that you think, that drives you. And for us, and for me in particular, there’s never a dull moment. The environment changes consistently, and in the process hopefully we can add value to the lives of people because, in the final analysis, we look after the life savings of people and we would like to do it in a way that is responsible and will add value to their portfolios and ultimately add value to their lifestyles.
RYK VAN NIEKERK: Yes, you’re responsible for their retirement savings and have a great influence on their ability to retire comfortably. It’s actually a big responsibility. But, over the years, how has your investment approach changed, because we’ve seen markets have changed significantly? Do investment strategies adapt to such changing markets?
ALWYN VAN DER MERWE: Your strategy is likely to change, but I think it is very important, when you work for a particular company and for yourself, that you’ve got to work out for yourself your investment philosophy that you think will deliver a competitive outcome for clients. And that philosophy I don’t think should change.
In South Africa, and in fact globally, there are many ways that you can outperform.
I don’t think that one single philosophy is necessarily the holy grail for outperformance, but I think if you chop and change between philosophies, that is a recipe for disaster.
We’ve seen it with different asset management companies, where they change their style, where they change the personnel – it normally doesn’t work.
So the investment philosophy that I associate with is more value-biased. I think the biggest margin of safety that you get is in valuation. The reason for that is that that is at least the one thing that you can hang your hat on. I don’t think that one can forecast accurately, because there are so many macro-variables and micro-variables that have an impact, and you can’t forecast that accurately. If you think you can, I think you’re very naïve. So the one thing that is constant is valuation.
But the other thing, and it’s been very prominent for me over the last 10 years or so, is that you cannot ignore the quality of the assets that you potentially invest in. The big risk, if you are more price-conscious, like I am, is that you can buy value traps. So the amount of work that you’ve got to do is enormous if you decide to associate with a value approach – and sometimes you do make mistakes.
But the one thing that I can say is, if you buy an expensive share and the story associated with that expensive share is a very good one, the risk is that the story can change.
Then you have that enormous double whammy, where the rating comes under pressure and the earnings come under pressure – and then you get massive underperformance. But it’s not easy to pick those. If I think about the mistakes that we have made at Sanlam Private Wealth here and there, one is Capitec. It’s a share that we held. It is an extremely well-run company, and at some point this share just became too expensive to us and we sold it. Today we would have been proud owners had we hung on to that particular share.
There are other examples. We also know you could have made a case for Investec, you could have made a case for Bidvest, you could have made a case for Imperial when they were in the initial growth phases. So it doesn’t always hold true. And when it becomes expensive the risk is that there’s a foot-fault from management and the share price goes in the wrong direction.
RYK VAN NIEKERK: Value investment – I think there’s a big debate between momentum and value investment. As you’ve said, it has performed quite poorly over the last decade or so. And, yes, there are many value traps. Obviously you learn from this. Good companies that are cheap are not always companies that will offer great returns. How do you approach that?
ALWYN VAN DER MERWE: Ryk, again, I think it comes back to the comment I made earlier. Sometimes a share is cheap for a good reason, and then you’ve got to do the work to ensure that you don’t buy that value trap. Maybe the one thing to mention is that we’re not necessarily deep-value investors.
The first thing that we try to ascertain or establish when we look at a potential investment is whether we think that this company has the ability to grow its intrinsic value. If we don’t think the company has that ability, then we’ll move on.
What does it mean when a company grows its intrinsic value? It simply means that the return that the company will generate on the capital that it employs is higher than the cost of capital. And sometimes companies simply destroy value where they don’t make the returns on capital relative to the costs. So that is the work that we’ve got to do.
But sometimes I think what gives us opportunities as more value-orientated investors is that the market or the herd gets absolutely enthralled by the story associated with the asset, and then they extrapolate the current trend as if it’s going to run into perpetuity. And we know that is not the case. That is where the risks sit.
So we like to think that we can find opportunities where the market is unnecessarily negative about the current events, but we believe that over time that company can indeed grow in terms of value – and we then buy that asset.
RYK VAN NIEKERK: One trend we’ve also seen over the past few years is a decline in the number of listed entities on the JSE – and the local asset management industry continues to grow. Is the investment universe large enough for you to follow such an approach because, quite frankly, you can pick from around 80 companies at best?
ALWYN VAN DER MERWE: Ryk, unfortunately what has happened under the political regime over the last 10 years, we’ve often spoken about the “lost decade” when speaking about the economic trends that we’ve experienced over those 10 years. And if that is the case ultimately it will have an impact on the number of opportunities in the listed market because, if the economy is not growing, it is very tough for the average company to make money. And it’s very tough then for a company to grow its earnings and therefore we’ve just seen that the opportunities in the listed space, as you correctly say, have declined.
So I think the point to make is that for the really big asset managers it has become a problem because, if your total number of assets under management becomes too big, it becomes problematic to go and look in areas where there’s not enough liquidity to express yourself in a big investment portfolio. So that is certainly problematic.
But, having said that, I think if you look in the retail space – in other words, private clients – a lot of money has migrated offshore. Even if you look at the institutional space, most of the institutional portfolios, if they have to comply with Regulation 28, will have their full 30% offshore.
Nevertheless, I think your point is very valid. You’ve got to look harder because I think it’s almost an over-invested space. But still, in a small space people can get it wrong and that still creates opportunities, but to a more limited extent compared to, let’s say, 20 years ago.
RYK VAN NIEKERK: I think that is one of the reasons why there was so much excitement when Treasury announced that inward-listed foreign instruments could be regarded as local investments. Many advisors and fund managers were very, very excited. And then the proposal was retracted. What did you make of this development?
ALWYN VAN DER MERWE: Ryk, it’s a very difficult one. I just think that at the moment sentiment in South Africa is so negative. So – should we proceed and allow people to invest more money offshore? Given the very limited interest from overseas investors in South Africa, I think it would put a lot of pressure on listed entities in South Africa. And if you look at where our own market is trading at the moment from a price-earnings (PE) multiple perspective, if you exclude Naspers – which on a PE basis looks pretty full – our market is trading on a 14 multiple, and on a forward multiple of less than 10%.
So I think if you open the gates now the timing would not be opportune and you would put further pressure on listed entities in South Africa. So for me – I know people have very strong views about it – but I think one needs to be quite responsible in terms of the timing that you apply for that particular measure that you’ve just mentioned.
RYK VAN NIEKERK: Interestingly, the market is currently in a type of Christmas rally. We’ve seen a very, very strong past two months. And I think asset managers like yourself should be going on holiday with a much better mindset than a few months ago. What do you think is driving the markets now?
ALWYN VAN DER MERWE: The word ‘think’ is a very important one Ryk, because I often listen to your programme, on a daily basis, and sometimes people mention why they think assets go up and down. And then I think, well, I didn’t think that – nevertheless you must understand that is my opinion.
But quite often people say, okay, we know that there’s value. And the popular question from clients and retail investors is: “What do you think the catalyst will be; what will unlock the value?” My answer is always “I don’t know – I just know that there’s always a catalyst.” In this case, to my mind the catalyst was when we had the first announcements of AstraZeneca, Moderna and Pfizer about the rollout of the Covid-19 vaccine. As you know, we’ve already seen the rollout in limited quantities in the US and in the UK.
What it means is that what we’ve seen with Covid, the economic mobility in the world has gone down and with that, of course, economic activity and therefore pressure on earnings. If the vaccine means that people can economically move around more freely, then economic activity should accelerate.
We should be more certain about the balance sheets of some of those companies that were unloved. And we should be a bit more certain about a potential recovery in earnings in those companies. That would apply for value shares globally and also apply for value shares in South Africa. It will certainly also apply for people who are prepared to take more risks and there’s more certainty.
So I think what the vaccine did is it changed the sentiment from a very uncertain one to one where the investors are starting to give the benefit of the doubt to those companies they think will firstly survive and, secondly, from a low base admittedly, we can start to expect recovering earnings. And that is [behind] the massive swing around, let’s say, in banks. Over the last two months the listed bank index in South Africa is up by 50% – five zero.
If you look at gold shares in South Africa from the beginning of August to yesterday, the price of the average gold share in South Africa has gone down by 50%. That just tells you how immense the change in sentiment is. But it also tells you how extremely negative the market was in some of these value situations.
So yes, I certainly sleep a bit more comfortably, but the sentiment is very fragile and can change very quickly again. But at least I think the market was a bit more rational.
RYK VAN NIEKERK: But if you compare it to the sentiment at the beginning of the year, where Covid wasn’t really perceived as going to have the impact it had, we’ve seen the impact Covid has had on the world economy since then. The world is actually in a worse place than it was at the beginning of the year, but equity markets have just exploded in recent times. Is that an overreaction?
ALWYN VAN DER MERWE: I think, Ryk, it is true that it might be perceived as an overreaction, but again, when we talk about markets, we talk about the average in indices, and indices are always dictated by a few heavyweights. So in the case, let’s say, of the US market, the so-called Faang shares – Facebook, Amazon, Apple, Alphabet [Google parent company], Netflix – those four or five shares [and] Microsoft constitute about 25% of the S&P 500, which is the index constituted by 500 shares. Those shares have become quite expensive.
So information technology shares globally, if you look at [the] Nasdaq, [the] Nasdaq is up 37% year to date. If you look at our own market, our own market’s only up by 4% year to date. If you look at the S&P 500, despite the strong performance of those Faang shares, it is up in double-digit territory. So remember that you measure off a very low base. That is the first thing.
So, within the market I think there are still really, really cheap shares. And a lot of the action that we’ve seen over the last two months was actually produced by shares that were very unloved and ignored by the market.
In the last two weeks or so we’ve seen another run in the IT shares, and where I see irrationality is still in the IT space. We’ve recently seen a number of new listings coming to the market globally – not in our own market, as you mentioned earlier – and to my mind the valuations of those we call IPOs [initial public offerings], those valuations look absolutely ridiculous and irrational. So there are certainly signs of things that we experienced back in 1999/2000 when we had the IT bubble. But unlike the IT bubble, I think the top five shares are expensive but not in bubble territory.
And unlike in ’99, you must understand that those companies have got very strong balance sheets. They’ve got superb earnings growth, and they’ve got millions, if not billions, of clients that use their products. So I think it is a bit different, but there are clearly some signs of froth that I certainly don’t like.
Then I just want to come back to your comment about the economy being in more trouble. I think, as a result of the massive stimulus response from economic authorities across the world, one thing is very clear to me. The positive thing is it revived the patient. The patient was in ICU, the patient got revived and momentum is picking up. You can see it in South Africa, you can see it in phenomenal momentum in the current growth numbers across the world. And I think the liquidity that was created will still be around, and that would provide support for risky assets. That is the one thing.
The second thing is that in the new year we will see a recovery in earnings, globally in equity prices, and that should provide some support.
And then thirdly, we spoke about the vaccine. I think that should just be good for sentiment.
In the shorter term I think there are enough factors that can support the market. But for me, the biggest risk is slightly longer term because the one side effect of the message stimulus is that the world sits with a massive amount of debt, and at some point that problem will come home to roost. And if you sit with debt – and debt sits on government levels rather than with individuals – you need, as we say in economic terms, to deleverage. In other words, you’ve got to bring your debt down.
And in order to bring that debt down – you can take yourself as an individual – if I have to reduce the debt in my own financial affairs, I can do only one thing. If I don’t get a massive income I’ve got to stop spending. And that brings hardship.
So for me, this debt at some point needs to be addressed, and that will lead to lower economic growth – and that might also lead into some assets that are irresponsibly high at these prices possibly collapsing. I don’t want to sound like a prophet of doom, but I think in the shorter term one must be careful not to be too negative, because there are certainly some momentum factors that are likely to support these assets.
RYK VAN NIEKERK: Alwyn, thanks so much for your time today. That was all Alwyn van der Merwe. He is the director of Investments at Sanlam Private Wealth.