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‘We have stunning value in our equity and bond market’ – Karl Leinberger

‘We think SA equities are very compelling right now, and it’s a big change in view compared to where we were three years ago, five years ago’ says Coronation’s CIO.

RYK VAN NIEKERK: Welcome to my weekly Market Commentator Podcast, where I pick the brains of South Africa’s leading investment professionals. There are currently many divergent views about the opportunities and risks for domestic and international equity markets, and it’s always good to hear what the top fund managers are doing – are they buying, are they selling?

My guest today is called Karl Leinberger. He is the chief investment officer at Coronation. He has been with Coronation for 21 years and has been the chief investment officer since 2008, so he has been in the hot seat for around 13 years. Karl currently co-manages several Coronation funds, including the Coronation Equity Fund, the Coronation SA Equity Fund, the Coronation Balanced Plus Fund and the Coronation Global Opportunities Equity Fund.

Karl, thank you so much for joining me. That seems to be a mouthful. How much does it take to manage a fund?

KARL LEINBERGER: Especially in times like this, with what’s happening in China, it sometimes feels like it’s a 24-hour job. Managing many in a very uncertain world is always a very demanding task, and I think the big challenge is to try and keep as much balance in your life as you can, and make sure you do as much exercise as you can and spend time with family. Then you just hope to come through it all. South Africa as well – managing South African money with the unrest we saw a few weeks ago. We’re in the office now and just laughing between ourselves. You never know what’s around the corner. It really is a kind of crazy world we are all living in.

RYK VAN NIEKERK: I’m sure many inexperienced fund managers would sit in front of a screen the whole day and see what’s happening, being very nervous about any downturn like we are seeing today. For the record it’s Thursday, August 19. As we are speaking, the market is down 2.5%. So there needs to be a balance between having a long-term view, but also these 2.5% drops could be – what is the right word? – they could cause some interesting thinking within an office.

KARL LEINBERGER: I think most of the time, 90-something percent of the time, this kind of stuff is all noise. The challenge is to keep focusing on the longer term. The problem is trying to distinguish noise from signal. Sometimes 90-something percent of the time it’s noise, but sometimes there’s a signal in there.

For example, if you look at what’s happening in China at the moment, what I think all investors are trying to get their mind around is how much of this is noise? How much of this three or four years from now will I look back on as being something I barely remember as a big buying opportunity, or how much of what we were hearing was actually signal?

In the case of China, how much of it is a signal that the country and business prospects have fundamentally changed forever, and meaningfully so. That’s always the challenge – to try and distinguish noise from signal, because if you get sucked up in the noise, you are never really going to make good long-term decisions and you’re going to end up with very mediocre outcomes.

RYK VAN NIEKERK: So do you think what’s happening in China now is a signal?

KARL LEINBERGER: I was hoping you weren’t going to ask me that [chuckling]. In times like this we get together, the team, and we have a lot of debates. We do a lot; we don’t just sit and read journalism. We do a lot of proprietary research and we’ve been calling every contact we have in China. We have a lot of contacts because we’ve got a global and emerging market team we know, and a lot of people spend a lot of time in China over the years. We speak to as many independent experts based outside China as we can.

If you put all that together, we have a view, we have a base case, which I’ll take you through. But for sure we understand that that could be wrong. One is just that there’s so much uncertainty in a country like that, which really finds itself in a situation where it’s being run by one person who has power unprecedented in modern times. And it’s in a ‘pay’ place. We don’t for sure know exactly what he [Chinese President Xi Jinping] wants for the country and for industry.

But our base case is that we’ve had a major drawdown in some of the world’s best businesses.

Sure, life has changed for these companies. Whatever level of earnings we were expecting them to deliver five years from now is lower than what we would have thought six months ago.

But all in, we think it’s a buying opportunity for some of the businesses.

A second point I want to make is you’ve got to be very careful of broad brushstroke answers. It does seem to us that there are certain businesses, certain industries that have been meaningfully and permanently impaired by the regulations that are coming, and then there are some that are going to navigate them quite well. And then there are a couple which in fact might end up being beneficiaries of it all.

So I think that we’ve got to come in here with a scalpel. We’ve got to be careful of broad brushstroke answers that all of these stocks are buys. What we’re doing is we are focusing our efforts on stock-picking, trying to find out and work out who the beneficiaries are, or those who are going to be relatively insulated. And that’s where our portfolios are stacked at the moment.

RYK VAN NIEKERK: I’m looking at the fact sheet of your Equity Fund, your Balanced Plus Fund, your SA Equity Fund – and all three of them have significant holdings in Naspers and Prosus. They all feature in the list of top 10 holdings. So where does Tencent fit in with that view you’ve just explained. Do you think they will benefit from what is happening or not?

See the fund fact sheets:
Coronation Equity Fund
Coronation SA Equity Fund
Coronation Balanced Plus Fund

KARL LEINBERGER: We think the clear beneficiary is jd.com. We think that Tencent would be in the category of a business that is going to navigate it fairly well and come out of it, sort of, with minimal impairment. So some [will take a] knock, but small and manageable. The big reason for that is Tencent has always been enormously respectful of the government and government regulation, their employees’ welfare, consumer interests. So they’ve been very careful over the years not to push monetisation too hard, not to impair the user experience on their apps. They’ve been very careful with new verticals that they’ve gone into, like short-form video and fintech, not to move aggressively and to make sure that they always have clean content, to make sure that they never push the regulatory envelope.

They’ve put in Tony Ma – who has been their number-one person in charge of regulatory interactions for many years – as opposed to putting a more junior person in. I think, interestingly enough, that Koos Bekker and Naspers deserve a lot of credit for that. Tencent has told us many times over the years that that was a big contribution from Naspers – to not fall into the temptation of running your business aggressively and risk of running awry of the regulators.

So that commitment over 15 years of business we think should stand them in relatively good stead as the sort of regulatory announcements come over the months ahead of us.

RYK VAN NIEKERK: That’s interesting. Before we talk equities, I just want to talk about the US situation, where there could be an increase in interest rates. We are seeing higher than normal inflation right there that could trigger [interest] rate increases maybe earlier rather than later. Do you regard what is happening there as a potential signal, because there seems to be a lot of nervousness every time Jerome Powell [chair of the US Federal Reserve] takes a podium?

KARL LEINBERGER: In this particular case I think people are right to be nervous. I think that 12 or 13 years of zero-cost money has had a dramatic impact on every major bond market, equity market and currency market on the planet. We got a little foretaste of that with Hwang’s family office [Bill Hwang, whose asset management company Archegos Capital Management lost $20 billion in two days] – the collapse of that a few months ago – just the astounding levels of leverage that he had in some shammy office that no one had ever heard of. And I think there’s just this enormous wall of money around the world sitting on a view that interest rates are going to be low forever.

We do worry about a disruptive end to that status quo and what it would mean for markets and currencies and interest rates and bond markets. It is certainly something that worries us. I think the more nervousness there is in the system the healthier it is. What you don’t want is complacency, arrogance and indifference. So I actually take a little bit of comfort from the fact that the market seems to be a little worried about how the Fed exits this unprecedented period of stimulus that we’ve all lived through.

RYK VAN NIEKERK: I listened to [US President] Joe Biden when he addressed the world after the US withdrawal from Afghanistan, and what happened there, and the significant almost surrender of the Afghan government and army. So just to pull it through to equity markets, it is bound to happen that the US would close the tap, the money tap. But the question is, what will happen when it actually happens? Or will the action be prior to the closure of that tap?

KARL LEINBERGER: The one thing I’ve learned is you never know when you’ve got a very abnormal situation in the game that we all play, where you try and sort of work out what the path towards normality is. I think that that’s a very dangerous game to play because one is so often surprised. And so, certainly in funds today, obviously all managers ask themselves how to hedge the risk, and it’s not easy because so many assets are expensive. But the one asset that seems to have lost a lot of its shine is gold, and then particular gold shares.

We haven’t owned gold shares for almost 15, 20 years in a meaningful way in Coronation portfolios. And we’ve actually been quite meaningful buyers of SA gold miners in our Equity and particularly in our Balanced funds. There are some companies’ specific legs to that investment case, but at least half of it is that we think it’s sort of fairly cheap protection that you can avail yourself right now at a time of what we see as elevated risk.

RYK VAN NIEKERK: Let’s talk about equity markets. There has been a lot said in recent months – and years, probably – about the poor performance of the local market over the past decade or so, although there has been some good performance of late. The local market really underperformed the international markets over this period, and there are many voices that say this is going to continue in future, although some big asset managers, such as Allan Gray and Ninety One, have expressed some optimism about the prospects of the local market. What is your view on this?

KARL LEINBERGER: We’re in the camp of those two managers there. So, if you look at our balanced [fund] trends, we were very aggressively overweight in the GFC [global financial crisis of 2007/8]. And by about 2011, we had moved to an underweight position in SA equities. It initially hurt, because we had that raging equity bull market in 2012/2013. But then, as you point out, ever since 2013 our equity market has done really poorly. We have been underweight and low in SA equities all the way through until the middle of last year. I’m just talking about SA equities here, not equities in total.

And so for the first time in more than a decade we are overweight, and meaningfully overweight, to SA equities in our multi-asset class funds. As you say, SA equities have done poorly. We find fantastic value in the SA equity market – it doesn’t matter whether we’re looking in resources, whether we’re looking at some of the global stocks listed here that are cheap for their own company’s specific reasons, or many of the large number of pure domestic stocks that we have in our markets. When we contrast that against cash, given the kind of returns that cash offers investors, we think SA equities are very compelling right now. It’s a big change in view compared to where we were three years ago, five years ago.

RYK VAN NIEKERK: Is that a long-term view?

KARL LEINBERGER: Well, Coronation is always long-term, Ryk. We’ll never give you a short-term view. So I think, in fact, if it was short term, we may not have the kind of conviction that’s necessary to take that view, because we’ve all just lived through the rioting of a few weeks ago – and that’s got to shake any South African citizen or investor.

No, the view is entirely premised on the sort of long-term earnings power that we see from those stocks, very low multiples, management teams having navigated the Covid pandemic incredibly well, and protected earnings base, protected balance sheets. No, it’s all premised on very compelling value that we’ve seen across the board.

RYK VAN NIEKERK: You said earlier that you are buying gold mines or gold companies at the moment. Are there other sectors in the market which also attracted your attention?

KARL LEINBERGER: I think if I go through the categories, the diversified miners have been Anglo and Glencore; we think they’ve got the right commodity mix for the next decade. Then if you look at certain of the global stocks listed here, we think Aspen is very attractive. We think Bidcorp is very attractive as a business coming as a beneficiary of slow normalisation in the hospitality industry. We think of Quilter as one of the winning players in the UK wealth management industry, which is growing very strongly.

And then in the domestic market, what’s interesting is we think that there are a lot of businesses that have used the pandemic to strengthen their businesses, to strengthen their modes, to strengthen their franchises, to strengthen their standing with clients; and we have been big buyers of some of those domestic stocks.

Examples would be Metropolitan Momentum, which has a new management team and is becoming a very high-quality insurer after having a very tough 10 or 15 years. FirstRand, which we think – with an excellent management team and digitalising its business – is very successfully coming out of this as a winner. There are many other examples.

If you look at the private education space, it’s a big beneficiary of what’s happening in the public education spaces, and what a challenge Covid has been for them. So we look at ADvTech as a good example of a business that’s coming through a tough period very well competitively. There are just so many examples.

If you look at the restaurant space, businesses like Spur and Famous Brands are handling the Covid pandemic so much better than independent restaurants can. And we think once we come out two or three years from now to more normal times, they are going to be very big winners from that consolidation in the restaurant space.

So, yes, my real message to investors is that people feel incredibly pessimistic about South Africa, especially after what happened a few weeks ago. But it’s very important in investing to take emotion out of it. And in fact, we’ve got stunning value in our SA equity and bond markets, and we find ourselves in a situation where we are overweight equities and overweight SA bonds, both of them for the first time in a decade. I don’t think this is the time to move all your money offshore at a time when many global assets are actually very expensive after 13 years of zero interest rates.

RYK VAN NIEKERK: I’m looking at your Balanced Plus Fund; it’s a big one, close to R100 billion. If you look at the top 10 holdings, there are few companies that are really South African-focused. The normal big international firms – Anglo is the biggest holding. Then you get Egerton Capital Equity Fund. I believe that’s a British or an English fund. A Naspers. Then the other one I referred to, the locally focused one, FirstRand. The others are also international – Glencore, Prosus, Contrarius Global Equity Fund, Lansdowne Capital, Tremblant Capital – I don’t know those companies.

So would your focus still remain on these big international companies listed here, which earn most of the revenues and profits offshore?

KARL LEINBERGER: No. I think for that analysis the water’s been muddied by holdings in our Global Equity Fund of Funds. If you look at the stock, the SA Equities, you’d find plenty of domestic stocks in there, big positions. And then also what we find is quite a lot of value in the mid- and small-cap space. On their own, any single stock might not make it into a top 10 or top 20. But if you look at the basket of those domestic stocks, that is a meaningful weighting in the portfolio.

RYK VAN NIEKERK: How many holdings are there in your SA Equities portfolio?

KARL LEINBERGER: It’s not a metric I look at often, but I would guess there are 70 stocks. The reason for that is there would be plenty of sort of mid-cap, small-cap stock positions, like a Spur I mentioned earlier. It might be only a quarter of a percent, but if you add five or six or seven of those together, you get a meaningful position.

RYK VAN NIEKERK: That’s a big portfolio. I think there are probably not more than 200 to 250 investible shares on the local market.

KARL LEINBERGER: Yes. Obviously there are bonds and real estate, and there is global and there is cash holdings and commodity ETFs [exchange-traded funds]. So about 48% of that portfolio would be in domestic equities. And then we’ve been able to build meaningful positions and a lot of mid-cap companies that actually do move the needle in a fund of that size – just because they’ve been so cheap for so long, we can actually build up a decent-sized position.

I just think, for all of my career until the last two years or so, we were fighting against foreigners to build stakes in domestic stocks and they have disappeared from our markets. These days it’s just domestic managers and a few brave individuals who are prepared to own SA domestic stocks. And so you can build quite meaningful positions in companies that you might not have been able to five years ago when prices were a lot higher, ironically enough.

RYK VAN NIEKERK: Just lastly, there are many asset managers around the world who are looking at cryptos, also launching some crypto investment products. But the South African market has not done that. I don’t think there is any local fund manager who is offering a crypto type or a crypto-linked investment product. Have you glanced at that?

KARL LEINBERGER: It kind of feels to me like cryptos have moved into the age-old categories of religion and politics, where people don’t have mild opinions on it. In the last two or three years you can throw vaccinations and cryptos into that category. I always battle to talk to clients about cryptos, because opinions are so polarised and so high-conviction.

I think blockchain is fantastic. And I think that there’s a lot of scope for blockchain to be used in things like municipal title deeds, insurance contracts, where the public would like to see what people’s holdings are, as opposed to sitting with some financial intermediary or some intermediary where you never quite get the complete peace of mind that you want. Cryptos themselves are enormously difficult. I think for fund managers it’s quite easy at the moment because these things are not regulated. We are just not allowed to be there in most of the crypto assets.

There are some very real concerns I have about cryptos. I don’t think they are money. And the reason I don’t think they can be money is that they don’t have a stable value, and if something doesn’t have a stable value, one can’t really borrow or lend in that. That’s a very fundamental requirement for any currency. But I think I think it would be wrong for any long-term thinker and allocator of capital to completely dismiss cryptos. I think that they are having an enormous impact and there’s a lot of money behind them. So we are doing lots of work, trying to understand cryptos more deeply, trying to understand the role or value of decentralised finance, crypto exchanges that the blockchain might bring to certain industries and just to the world we are living in.

I think we’ve got someone who is basically spending all their time at the moment trying to understand all of this. I don’t think there’s going to be an enormous impact on our portfolios, but I think it’s incumbent on us to have a deep understanding of it all and there are definitely going to be industries that are disrupted from some of the things that cryptos have brought to the world. Definitely our first priority is just to understand those.

So we’re not dismissive, but we certainly don’t have any holdings. There are some concerns that we have that we are trying to get our minds around. That would probably be the best way of describing it.

RYK VAN NIEKERK: Karl, thank you so much for your time today. It was an absolutely fascinating discussion. That was Karl Leinberger, the chief investment officer at Coronation.

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“We have used the recent market correction to add to our local equity holdings, on the basis of their compelling longer-term valuations. We continue to favour the quality global businesses that happen to be domiciled here, such as Naspers, British American Tobacco, Steinhoff and Anheuser-Busch InBev. These companies have robust business models, are diversified across numerous geographies and currencies, and remain attractive based on our assessment of their intrinsic value.”
Coronation’s Duane Cable view on JSE July 2016.
Fund managers are ALWAYS bullish on the local market….

Rubbish, they most certainly are not. This narrative, very much advanced by Magnus to somehow emphasise his own amazing prophetic genius, that SA based fund managers are somehow incentivized to ‘keep’ all your money in SA assets, is getting tiresome. Trust me, Coronation and most of the other large ‘local’ fund managers have a suite of offshore fund options which they would be very happy for you to invest in.

Yes, they do have local Reg 28 compliant balanced funds which are limited to 30% offshore but that is not their choice, it is our dear Treasury’s, and you would find that they have consistently maintained the offshore max level for years in any event, its not as if they don’t recognise the merit of a globally diversified portfolio.

Impressive Karl, a balanced and thoughtful outlook. One critical point missed is that the CEO of SA Inc. remains the ANC and as they so beautifully say in Dragon’s Den, for that reason ‘I’m out’! The ANC creates a chimera of value in our equity market, as prices are low compared to a value investor’s valuation. However the true value of these stocks is rather a function of our regulatory, political, social and legal environment and that is controlled by the ANC. I thus have to mark their value as ‘indeterminable’ – thus to be avoided at all costs

Luckily they still have a higher valuation than Bitcoin.

I agree Ryk, indeed an insightful and fascinating discussion. Lots of food for thought here from a rock-solid and quality CIO and indeed the rest of their investment team as a whole.

No, I think research this guy. He has a very good track record. Go and look at some of the things he said before 2008 and after that. He is worth his salt.

My US portfolio went up again just because the Rand is tanking. Sorry, but I will stick to overseas for now

Rand Hedge Stocks should go up as well.

Crypto’s once regulated will be a new asset class. For some it already is. Most if not all fund managers are looking at it for good reason.

Regulation is the key but as is the norm in SA it will come too late or it will not make sense.

Crypto for SA’s might become an offshore investment like most others.

I forgot to mention.

When a country’s police force and army has to protect it’s citizens from their “fellow citizens” it does not take a lot of brainpower to work out that the country is politically unstable and civil war is probably not that far away.

Best to have your money elsewhere.

Be honest!!!!

The small and fragile local stock market must be viewed through a global lens. Firstly, the JSE only reacts to global sentiment and secondly, is driven by foreign speculators. This is exactly how the uninformed gets sucked in. You need to do your own home homework and form your own global macro view. So, what will happen to the JSE when the offshore stock market bubbles burst, which I believe is imminent? I rest my case.

Now heres a CIO who is not talking up his book!

Can’t say that I trust Coronation

End of comments.

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