RYK VAN NIEKERK: Welcome to this Market Commentator podcast, this is my weekly podcast, where I speak to leading investment professionals. My guest today is Sam Houlie, he is the chief investment officer at CounterPoint Asset Management. Sam, welcome to the show, let’s start in the US; on Thursday night we saw some pullback in reaction to Donald Trump’s decision to increase tariffs on aluminium and steel, of course, industrial inputs, and the market seems to be a bit spooked, suggesting that these types of sudden decisions and announcements could impact corporate earnings, especially within industrial in the longer term, what are your views and do you think this is very significant?
SAM HOULIE: Yes, thanks, it’s great to be here, Ryk. It is significant but how significant is hard to tell because this is potentially the first salvo of more of the same from Trump. So the difficulty with markets is there’s rhetoric in what he says versus actions, so the market is struggling to work out how much of it is just political rhetoric and how much of it is action. But this is very different in that it really is the first salvo in the protectionist type of trade policies, which I think will have a knock-on effect in a variety of ways. It has an inflationary impulse, certainly in the US. So I think the market is spooked by that, and rightly so, and what you saw was the immediate impact that if this is the case, there’s an inflationary impulse, then we really want to sell off in risk assets. The immediate reaction was to buy bonds as a safe haven but if you think about the inflationary impulse in the long run, that’s bad for bonds. So I would say that I think the market is still trying to work out where it is, we’ll have to see how it plays itself out, we are very worried for the long-term inflation, and we think the biggest difficulty for all asset classes is long-term inflation, certainly in the US, which will force the Fed to raise interest rates, which I think has a knock-on effect on risk assets all over the world.
RYK VAN NIEKERK: But if you look in South Africa there seems to be a very positive mindset at the moment, among investors we see a lot of inflows coming through, yet the market is down and largely possibly due to what is happening outside of our borders.
Listen to the podcast: Foreigners make their way back to SA markets
SAM HOULIE: Yes, I think the first thing, Ryk, if you think of our market being the [JSE] All Share or the equity market, you have to decompose it and disaggregate into the stocks that drive the market and that are very focused on the rand. So, since November, the South African rand has been the best performing currency in emerging markets, relative to the dollar.
Our market is a market of stocks that are heavily skewed towards the rand, so if that’s 23% stronger, a -23% on the rand hedge component of our stock market and that’s quite significant, it’s typically between 50% to 70% of the stocks, so that’s the one reason. What we’ve seen recently is that the euphoria around South Africa has literally meant that there’s a stronger rand and that means that the market and the big stocks are down, hence, the fact that our market is down 2% to 3% year-to-date. Underlying that there are other components of the market, a smaller percentage, probably about 30% to 40% of what we call SA Inc. equities and they, in fact, performed incredibly well but they don’t really make a difference in terms of the market capitalisation. So it’s really a story of almost two types of stocks in South Africa, the rand hedge component, dual-listed stocks and then you have these SA Inc. equities. If you look at those SA Inc. equities, Ryk, the euphoria around South Africa, the positivity around South Africa and the positivity about South Africa, relative to the rest of the world, has been reflected in these stocks because they are up quite a bit, particularly our banks, I think the banks have been the biggest beneficiaries in terms of the equities. So that’s what’s really happened.
Listen to the podcast: A positive outlook for local stocks
Sectors to watch in 2018
RYK VAN NIEKERK: But SA Inc., as you’ve put it, it’s the overwhelming majority of South African equities, you have the top 10, which basically earn their earnings around the world. You’ve referred to financials, are there any other sectors that you believe can perform well this year?
SAM HOULIE: The way we work is we struggle with making predictions and forecasts for very good reason, it’s not something that we do, we think the probabilities are low, so what we try to do is we try to identify assets that are priced appropriately or underpriced relative to what we think could potentially happen. So in terms of SA Inc, clearly the financials, which is really the banks, most of those are domestically focused, including short-term insurers, so financials as a group would generally be very domestically focused. In the other sectors you’ve got to be a bit more careful, so our retailers, which most people look at, excluding retailers like Woolworths and others, our predominantly in South Africa. Then in the industrial space you have to find the ones that are very domestically oriented and there’s enough there, and, of course, construction as well is very domestically oriented. Then, of course, finally, in the listed property space most of them are offshore related but you have a few that you can find that are very domestic. So what I’m saying is that you have to be very selective and look for that in South Africa. In terms of sectors that can do well, we think that the near-term outlook the earnings aren’t going to come through in the immediate term because the earnings that are reported today, like Nedbank reported on Friday morning, and Barclays Africa that’s now changing to Absa, the earnings that you see today are really what’s happened in the last 12 months, that’s not the ‘new dawn’ or the new positive impact in South Africa, it’s the earnings that you are going to see over the next 12 to 24 months and there we think that the banks and selected retailers and industrials are cheaply priced relative to future earnings growth and margin expansion. We can find them but they are very difficult, you have to do the work but we can find them, so we would say that we are happy to own them and we own them in our funds, and we think they are reasonably priced. But we definitely don’t want to make predictions because we think this is a bumpy road, it’s not just plain sailing one way, going up.
RYK VAN NIEKERK: I’m looking at your value fund fact sheet, the one until November, your main shareholdings were Naspers at that stage, more than 8% of the fund, Barclays Africa, MTN, Mediclinic , Impala Platinum, Sasol, Reinet and Anglo American, obviously most of these are big international companies, have you changed much in this portfolio since then?
SAM HOULIE: Yes we have, the fact sheet of November 30 2017 was a very different fact sheet to what you would see today, it’s definitely changed. In fact, in the early part of December, as the market unfolded and in the lead-up to the ANC elections the portfolio changed, and we are small enough thankfully, we are boutique in the context of South Africa and we are able to make these changes. So Naspers is not a stock that we own a lot of and we really swung the portfolio towards the banks, selected retailers and we reduced the rand hedge component of the portfolio. We never really want to talk about short-term performance on funds because we think that short-term performance really is exactly that, it’s just short term and we want longer term.
But the performance of the fund since December to now will show you that the portfolio was swung more towards the SA Inc. equities and away from the rand hedges, particularly Naspers, and it’s done incredibly well over the recent time and, of course, that’s three months ago so we have to manage the portfolio today and we are already changing the portfolio slightly from where it was in January because the market moves.
So that fact sheet is outdated relative to where the portfolio is today but all we do is look at the performance and our value fund has continued to perform incredibly well, relative to other funds. We didn’t own Steinhoff, we had zero Steinhoff for good reason, there were times when Steinhoff did well and we didn’t own it, our process really lead us to not owning the stock for a variety of reasons, including our concerns around accounting and corporate governance. So not owning Steinhoff, having zero in it, has been very good for CounterPoint funds, not just the value fund, and we also didn’t own any of the stocks in the listed property space, the Resilient stable. So we’ve had a very strong period based on what we didn’t own and then the fact that we have SA Inc. equities in our portfolio.
Buying laggards in the banking sector
RYK VAN NIEKERK: Can we delve a bit deeper into what you did in the last three months, what stocks did you actively buy?
SAM HOULIE: We bought all the banks, particularly Barclays Africa, which is Absa now, and Nedbank, we bought them significantly in the early part of December.
RYK VAN NIEKERK: Why those two?
SAM HOULIE: We’ve always owned Standard Bank and FirstRand, we continue to own them, but we bought Barclays Africa and Nedbank because they are the laggards in the banking sector and they’re also the cheapest. Barclays Africa has really been the cheapest stock, the highest dividend yield, very low P/E multiples and I think the lowest expectations in terms of banks for reasons related to previously obviously they had the Barclays connection and there probably was a lot of market share lost on the mortgage side. They used to be the dominant provider in the residential space, in the mortgage space, they have lost significant market share. So they were the cheapest and we bought them significantly. We had as high as 18% to 20% of the fund in December in the domestic banks but that’s not the case now because they have run incredibly hard. So we bought that and we bought Remgro, which I think is a conglomerate focused on domestic businesses. We also bought selected retailers, some of them ran so hard, the likes of Truworths and Woolworths, Truworths has run so hard that we sold that but we still own Woolworths. But those are the stocks that we bought and then we bought telecom stocks, Telkom and Vodacom have performed incredibly well for us and they are very domestically focused. If you add it all up that’s about 30% of the portfolio that’s had a phenomenal recent run and still remains undervalued. We don’t think it’s as significantly undervalued as December but it’s still very undervalued today.
RYK VAN NIEKERK: The fund is not a Regulation 28 compliant fund but we did see in the budget that there has been some relief or an extension of the offshore portion that Regulation 28 funds can invest in to 30%, do you think that will make a big difference?
SAM HOULIE: It will, yes. The value fund is not a Regulation 28 fund but it’s impacted by that change. So prior to that change we could go to 25% offshore at cost and then it could go higher if the rand gets weaker or it appreciates, and we can now go to 30% in terms of that new announcement. We also manage balanced funds, so at CounterPoint we manage across the entire asset class spectrum and our multi-asset funds are Regulation 28 compliant. So we find that to be a phenomenally positive announcement for two reasons, the first reason is I think it makes sense for South African investors to avail themselves of opportunities outside of South Africa. So here it’s a quantum of opportunities, so you want a wider opportunity set but it’s also the type of opportunity, so there are a lot of businesses that we can own offshore that don’t exist in South Africa and are not available, so that’s the first part of it. The next part is the currency element, over the last seven or eight years the rand has depreciated at about between 10% and 11% per annum and that’s been a tailwind for everyone who has made allocations offshore. It would appear that that was the easy decision, so the 11% depreciation covered a multitude of sins in that you didn’t have to pick as well, you simply had the tailwind of the rand weakening.
We think things have changed in South Africa, so you won’t necessarily have the same tailwinds or to the same extent but there’s a weakening bias because of inflation differentials and there are better opportunities. So, in summary, we think that it’s a great thing that we can go to 30% and we will definitely use up that opportunity by picking the ideas that we think meet our criteria.
RYK VAN NIEKERK: Thank you for joining us and sharing your insights today.
SAM HOULIE: Thank you, Ryk, it’s been a pleasure.
RYK VAN NIEKERK: That was Sam Houlie, he is the chief investment officer at CounterPoint Asset Management.