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‘For the most part in the strategic asset allocation portfolios we held the line’

Cannon Asset Managers CIO Samantha Steyn says 2020 has been ‘not a year we want to remember or relive,’ while focusing on the Hummingbird and SuperDogs funds.

RYK VAN NIEKERK: Welcome to this Market Commentator Podcast. My name is Ryk van Niekerk and my guest today is Samantha Steyn. She’s the chief investment officer of Cannon Asset Managers, and she manages several of her group’s premier portfolios. Samantha, welcome to the show. We’ve seen a very volatile year, but in the past week or so we’ve seen a surge in most markets around the world and in South Africa. Now, there are many views as to why we’ve seen this surge. Some refer to the Covid-19 vaccine, others to the election of Joe Biden as the new US President. How do you see the developments of the past week or so?

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SAMANTHA STEYN: Hi Ryk, thanks for having me. Yes, I think a volatile year is an understatement. That’s probably the theme of this year. And, as you mentioned, month to date we’ve seen a massive increase in performance across the board. I was looking at the numbers this morning. You have the mid- and small-cap shares up between 12 and 14% month to date. So you ask what causes this. Price is often just driven by sentiment and you never know when, when it’s going to happen and when the mood is going to change. But I guess this week the mood is for risk-on, and we’ve just seen emerging markets in South Africa and the equity markets performing quite well.

RYK VAN NIEKERK: Quite well? Well, I think it’s an upward correction from what we’ve seen this year, and I think many investors would take 10% for the whole year. And we’ve seen this in less than two weeks.

But 2020 is a year I don’t think many fund managers will want to remember. Markets reacted to all sorts of news events without taking into account any fundamentals. I would assume that it’s very, very difficult for a fund manager to manage a fund in an environment like this.

SAMANTHA STEYN: Yes, I agree. Not a year we want to remember or relive. It was challenging, but I think the best thing for fund managers is just to keep their cool and not be reactive or overreact to these events. So, if you were able to do that, what you saw in the first quarter was a massive sell-off, but since then in most parts of the market you’ve seen quite a nice recovery. So I think it’s just trying to strip out emotions. Like you say, fundamentals aside, because you can’t really analyse the effect on fundamentals during that emotional rollercoaster in Q1 …

I think the best thing was to just hold the line and then continue doing what you do best and not trying to make emotional reactive decisions.

RYK VAN NIEKERK: So you sat on your hands, waiting for this to settle down in some way. Or did you maybe become more conservative, take money out of the equity market and put it into cash or money market?

SAMANTHA STEYN: Yes. So we manage a wide range of portfolios within our strategic asset-allocation portfolios. If you ask what we did, the answer is “very little”. We kind of held the line there, we made a small additional investment into bonds. And that was just given the yield spike we saw; it was hard not to not to buy some more. But, like I said, it’s a small incremental addition we added there, but for the most part in the strategic asset allocation portfolios we held the line.

In our more active equity portfolios we did reduce some equity exposure just to have some dry powder on the side. But that happened so quickly, whereby we are still sitting on some cash because, I think, with most managers, everyone was waiting for a pull-back or a second pull-back. And we haven’t quite experienced that. The markets basically sold off and rebounded within a three-week period. So we haven’t allocated some of that equity that we lightened in the first bit of Q1. We’re still sitting on a bit of cash, but it’s small, it’s 5%.

RYK VAN NIEKERK: We’ve seen, as with this correction, that sentiment can change quite quickly. We’ve seen it in March, which I think most fund managers still scratch their heads about, because we saw the significant drop and then a very V-shaped recovery and a very quick one.

Your investors – do they expect you to do more, try to maybe not time the market, but be a bit more proactive, to try and anticipate such sharp movements?

SAMANTHA STEYN: No, I think investors are realistic. Often they want to know what you did, and sometimes it’s harder to do nothing than something. So often they want to know did you do something, and to say “we did nothing” seems like you did nothing, literally. That is generally a harder choice to make. No, investors invest with fund managers based on their process and their philosophy and, as long as you continue to demonstrate that you’re sticking to that, I think they’re happy with the way things have turned out.

We definitely did make a few switches, where we saw opportunity. We are quite intimate with the companies we invested in. So when you see a 30% pull-back in a company where there is less risk than another company’s business model going into a pandemic or an economic crisis, we did make those changes. And I think our investors know us well enough, and know the companies we invest in and the companies we are familiar with, to be confident in our abilities and our decisions.

RYK VAN NIEKERK: I want to talk about two of your funds, which I find very, very interesting. The first is the Hummingbird Fund. You co-manage this fund with Dr Adrian Saville, and it’s different. If I look at the top 10 holdings within the fund, they are very SA Inc-focused. Tell us about this fund. What do you want to achieve?

SAMANTHA STEYN: Yes, Hummingbird is really a very concentrated portfolio and we are speaking 10 stocks for all intents and purposes. We like to refer to this as “listed private equity” – so really not where we expect investors to put the majority of their funds. This should be really a satellite portfolio, a very small allocation of your overall wealth. As you can imagine, with only 10 shares, the volatility is extremely high within this portfolio, but essentially what we are looking to achieve here is very high growth. And naturally, to get that you need a very concentrated portfolio that looks different to markets.

So the shares we have in there, as you mentioned, look like small-cap equity. And I think that’s obviously where we see value in the market. So, if we’re going to buy a stake within a company, what we really are doing here is trying to look for companies that we know – while we understand the business model, we are close to the management of these companies, we understand the value and we see significant upside from the current price. And we’ll tick those boxes; we’ll take in this portfolio on average a 10% holding within that company to try and achieve our objectives. That’s really the focus of this fund.

You mention SA-specific. That’s not necessarily the goal.

The goal is just to find companies where we understand the value and we see upside potential. That happens to be at the moment tilted towards the small-cap sector in this market.

RYK VAN NIEKERK: The holdings are in Indequity, Transpaco, Sabvest, Allied Electronics, Santova, Metrofile, Master Drilling, Capital Appreciation, Combined Motor Holdings or CMH, and Sasfin – a very interesting selection. But most of these shares haven’t performed well this year at all. As we’ve seen, if you take the performance of Naspers and Prosus out of the JSE, the whole market has performed actually a lot more poorly than the all the state or reflect..[8.05]…??. How do you go about picking these type of stocks?

SAMANTHA STEYN: As you mentioned, if you look at the mid- and small-cap performance, even the all-share performance if you strip out Naspers as suppose resource shares, you’re looking at quite dismal performance year to date, even over a three- and five-year period. And when we spoke about mid and small, up 14% month to date. That’s not nearly enough to still fit the hole, which is about ‑20% year to date. So it’s still a long way to go for a lot of these shares to recover. And likewise, the shares in the Hummingbird portfolio. If you have so much negative sentiment within this part of the market, it doesn’t matter what these companies ultimately do. They are going to trade on the post multiples and underperform, and that’s generally what we’re seeing within that part of the market and within the Hummingbird Fund.

So, for example, our fifth-biggest holding there is Altron. Altron isn’t necessarily even a South African-focused company. Half of its earnings come from Bytes UK, which is offshore, but the market doesn’t really care. It’s listed in South Africa, it’s in the mid- and small-cap space, and therefore the rating is going to be an SA Inc mid- and small-cap rating. So, even there, where management is planning on listing Bytes UK to try and unlock that value, the market still doesn’t realise that. So they’re even showing a value equal to R10 billion. The market cap of Altron is R12 billion, yet Bytes UK only makes up half of Altron’s Ebitda.

So you can definitely see a disconnect between the value and the earnings versus the price.

And we can’t control price. So generally we are looking for companies that have massive amounts of value versus the current price. And ultimately what we need is time, and when we never know when those two are going to converge and when the price is going to reflect the value. But ultimately, in this portfolio, that’s what we’re looking for. We’re looking for that disconnect, that inefficiency in the market. And the investor that’s going to buy into this portfolio needs to understand that, and needs to give the portfolio time, because there was a time, if you look at the 2013–2017 performance, where this portfolio did double, three times market returns. So really that’s what we looking for, and that’s the investor we’re looking for in this portfolio.

RYK VAN NIEKERK: It’s most definitely not a portfolio that will track the averages on the JSE and other markets – almost like gold companies. They would have a long down-cycle, and then, when there’s an up-cycle, it’s really an aggressive one – actually what we have seen now.

But value – there are a lot of value investors in South Africa. They look at the local market and they think, wow, this is probably the best value we’ve seen in decades, while others say, yes, they may be value, but it’s a value trap. We’re not going to see recoveries in the near term. How do you view the value-trap type of perspective?

SAMANTHA STEYN: I would agree with that. I think often, when you see all these companies trading on depressed multiples, that’s not good enough to say that’s value for us. Value is far more than a price/earnings multiple or a dividend yield or a price-to-book. That’s not really necessarily value in our mind. We try and assess value on a far more fundamental cashflow basis. So “value” is quite a general term but, I think we really want to understand the value of the company based on the underlying assets in that business, the balance sheet, the business model.

Often you can invest in a company on a low PE, but if it’s a poor business model in an environment that’s strained, like South Africa, you could definitely get yourself into a value trap. So it’s really understanding the cashflow drivers, how much cash is on the balance sheet, is the business model strong enough, what do we believe this business is worth based on the current assets and earnings of the business – disregarding growth or anything like that – and assessing that to figure out the value of the business. You really need to incorporate all those factors when assessing for value to try and avoid what you refer to as “value traps”.

RYK VAN NIEKERK: The other fund I would like to talk about is the SuperDogs portfolio. It is also managed by Dr Adrian Saville and yourself. I think it’s one of the more famous funds, because it’s really counter-intuitive in many ways. It has not performed well over the last few years, and the reasons are pretty much, I think, what you’ve summarised earlier – where this fund looks at companies that could make it big and make it big quickly but, due to the economic circumstances in South Africa just haven’t.

I also see many of the names or the holdings in the Hummingbird Fund also appear in the SuperDogs Fund. Just quickly, exactly what do you want to achieve with the SuperDogs Fund and how does it differ from the Hummingbird Fund?

SAMANTHA STEYN: SuperDogs is built more mechanically. So that’s built at the beginning of each year where we filter companies on the JSE based on multiples such as price/earnings, price-to-book, RoE [return on equity], and whether the company is profitable. We find the most highly attractive companies within each of the subsectors on the JSE in their categories. That’s how we build the SuperDogs portfolio.

What we do exclude is resource companies. So you can imagine, we can’t really filter a resource company based on those metrics. It would be nonsensical. You’re looking at historical data, which isn’t going to give you any sense of the resource company’s ability to generate future cash flows. This portfolio, SuperDogs, only does this for financial and industrial shares. So you can imagine, if you look at performance over the past three to five years on the JSE, even year to date, the only thing that’s really held the JSE up is resource shares.

So, not having resource companies within the SuperDogs’ portfolio really hurt performance.

I’m looking now at year-to-date financials down 24%, industrials up 15%, which we know is a lot of the rand hedges, and then resources really doing most of the heavy lifting. So I think that partly explains the underperformance in SuperDogs – just the lack of resource shares in the portfolio.

But as you mentioned, I mean, it’s really a diversified portfolio. We are looking at 40 shares within this portfolio, so not nearly as concentrated as Hummingbird. And then, if you look at this portfolio, you really need only five to 10 shares to shoot the lights out for this portfolio to do well. Even if you have one or two shares that do really badly, generally if you have a small number of shares that do really well the performance is quite good. So really, as you mentioned, it’s quite different from the rest of the market, but quite diversified. And SuperDog’s filtering process does give us a lot of ideas that filter through to the Hummingbird Fund, whereas we build a far more concentrated version of SuperDogs within Hummingbird.

RYK VAN NIEKERK: There’s a big focus on small- and mid-cap stocks. We’ve seen the number of companies listed on the JSE dwindle over the past few years. I think there are 340-odd companies listed currently, and that number will shrink, I expect, over the next few years. Are you happy with the investible universe you have at your disposal? Are there enough of these companies you can look at to construct such a portfolio?

SAMANTHA STEYN: It’s worth mentioning that SuperDogs is not focused on just mid and small. That filtering process will put even the large companies at the top of the sector, if it is unloved. So, following NeneGate in January, 2015/6, a lot of the banks sold off and a lot of them made it into the SuperDog’s portfolio that year. And they are by no means mid- and small-sized companies. And then even this year, at the start of the year you saw British American Tobacco, Aspen, a lot of our previous darlings on the JSE – these large-cap shares that have just gone out of favour because of perhaps their acquisitive business models that really the market is not liking – also fall into SuperDogs because of their drop in valuation, their derating, and therefore their attractiveness in their particular sector. So SuperDogs isn’t size-specific; it’s that in times where mid and small caps are completely out of favour they will naturally sit up in the subsector and therefore filter into the SuperDogs portfolio.

RYK VAN NIEKERK: Do you own any Sasol?

SAMANTHA STEYN: No, we do not own any Sasol. Sasol falls within resources. So that’s excluded from our SuperDogs and Hummingbird portfolios. To your point, is there enough place to shop? Honestly, the JSE is shrinking. Liquidity’s always a problem for us and, when constructing portfolios, we need to take liquidity into account. Given the negative sentiment, followed by the lack of interest in mid- and small-cap shares, the liquidity is almost non-existent in a few of the counters. So you speak 340 shares – I don’t think the last 150 are even investible due to liquidity. Yes, the universe is small, but there are still opportunities, and we still are finding opportunities that are investible in this market.

RYK VAN NIEKERK: Just lastly, the Hummingbird – I see it’s called a “pooled portfolio”. What exactly is a pooled portfolio?

SAMANTHA STEYN: The Hummingbird we have within an endowment structure on the Hollard platform. So that endowment is a pooled structure. It’s not a collective investment scheme. It is a pooled endowment and we have it in that structure because of the tax efficiencies within that, as well as the investment within an endowment generally has a five-year minimum investment. You can imagine, we can’t really have clients coming in and out of SuperDogs. So to manage that portfolio more effectively just makes more sense within the endowment structure.

RYK VAN NIEKERK: The minimum investment for the Hummingbird Fund is R250 000, and for the SuperDogs portfolio R100 000. Why do you set those relatively high minimum investment amounts?

SAMANTHA STEYN: The R100 000 for Hummingbird is set by Hollard. That’s the minimum they will take within those endowment structures at a time. So we take that from Hollard. With Hummingbird we are building that portfolio for clients on a segregated basis. We find a lot of clients prefer segregated portfolios, just due to the transparency. They can see the names. It just gives them a better look-through basis. They like to own the underlying shares in their name, as opposed to in a unit trust where they don’t have that full transparency look-through into the portfolio. So therefore a R250 000 minimum on Hummingbird just makes sense due to us building 10 shares. So you’re looking about 25 000 investments in one share, which is doable on a cost basis when you’re taking brokerage fees and all of that into account.

RYK VAN NIEKERK: Samantha, thank you so much for your time today and for sharing your insights. That was Samantha Steyn, the chief investment officer of Cannon Asset Managers.

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