RYK VAN NIEKERK: Welcome to this Market Commentator podcast. It’s my weekly podcast, where I speak to leading investment professionals. My name is Ryk van Niekerk.
My guest today is Kokkie Kooyman from Denker Capital. He has been in the business for more than 30 years, and he currently manages the Denker Global Financial Fund and its rand-denominated feeder fund. Kokkie has received the prestigious UK-based Investment Week’s Fund Manager of the Year award four times in the Financials category, and he’s widely seen as the “the best” financial analyst in the country.
Kokkie, thank you so much for joining me. We live in interesting times. We see a tech sector that has absolutely exploded, and other sectors like the financial sector – not only in South Africa but around the world – under real pressure. How do you see the current market environment?
KOKKIE KOOYMAN: Yes, you’re totally right. It was a phenomenon that was already starting before Covid. The underlying driver of this market shift was low interest rates. So low interest rates drove investors towards what we call “growth stocks” because, in the end, when you calculate the value of an investment that you’re going to make into a company, you’re effectively doing two things. You are forecasting the future earnings or future dividends of that company into, let’s say, the next 10, 15, 20 years. And then you are discounting those future earnings back to today’s present value. And then you calculate how much upside is there on that discounted value to today’s share price. Okay, that’s investments 101. Now you’ve listened to that, guys, you can now go and write the exam.
RYK VAN NIEKERK: [Chuckles]
KOKKIE KOOYMAN: But what happens when interest rates go down? The discount rate at which you bring back – you discount – those forward earnings is lower. So the market places a higher value on future earnings than it would in a high interest-rate environment.
You’ve had two things happen in the past few years.
Low interest rates have meant people have been buying shares that have strong growth potential. But, secondly, there has been an ongoing shift towards technology everywhere. And so this shift has obviously helped technology shares to post stronger growth. And especially in a global environment, it’s much easier to transcend borders and sell your product in other countries than it was 10, 20, 30, 40 years ago.
At the same time, your financial shares bore the brunt of that because lower interest rates are bad for financial companies. We can talk about that later. Obviously, all the good banks, good insurers, have been fighting that – cutting costs. And in fact, with most of the banks, we talk to now, if you talk to them, the main thing is digitalisation.
So banks, as well, have also gone on the bandwagon to automate processes, both in what we call the back-office head office, but also front office, your sales and servicing of clients. And that’s one thing that Covid and lockdown have accelerated. The banks that were ahead of the curve in so-called digitalisation strategies, serving their clients via web-based or phone-based applications, have seen a tremendous increase in the volumes of that, away from branches. And so, just as a look-ahead for that, I think we’re going to see in the next few years, generally, that bank branches are going to be cut, and we are going to see much more online banking.
Back to the original question. So you saw two things happening – growth stocks in the technology sector being pushed up because interest rates were low, and stocks that seemed not to be negatively affected by that wave were sold.
And then the third thing took over.
Then you see the momentum players come in, and also passive investing, because the growth stocks became bigger and bigger in the index, and money that goes into the index perpetuates that cycle and pushes those shares higher and higher. I think we’re very close to where that cycle is going to turn.
RYK VAN NIEKERK: I’m looking at the MSCI World Financials Index. Since the beginning of the year down 17%. The MSCI World Index gained just over 5% over the same period. That shows the significant pressure the international financial sector is under. But looking at the technology sector since the beginning of the year, the MSCI US sector or index is up 31% – what does that say? Is it that tech stocks are overvalued? Last week we saw a significant sell-off in some of the tech stocks, or are financials just totally undervalued?
KOKKIE KOOYMAN: [Laughing] Now remember, Ryk, I’m a financial specialist, so I’m biased. But, look, I think you’re right on both sides. So we think – and obviously we do a lot of research based on this – all the indicators show that your tech stocks are ridiculous, grotesque, whatever. They are very overvalued. I mean, something like Tesla is on a P [profitability] exceeding 200 times. And it’s just driven by pure momentum plays. I mean, something stupid happened as well. They split the shares and the share price goes up 8%. We saw the same in the dotcom bubble when a lot of day traders came in, and they drive the stock’s behaviour.
Secondly, on the other side, the financial shares have been pushed down because they are unwanted, and so the momentum investors are not investing in them – or have not been investing in them. And in fact at discounts in the valuations between the MSCI World and the S&P, of which the tech sector does make a big portion or the biggest portion.
So the discount between the MSCI World and the Financial Index is now the largest ever. It’s a 62% discount, based on valuation. The elastic has stretched and the question is more “What makes that turn?” It looks as if we saw the turn starting. Normally there are two things. One, valuations don’t matter anymore. But when things do turn, then suddenly people see – I’ve been buying shares that are ridiculously valued. There are no buyers when the sellers come in. But it’s a bit like a Ponzi scheme, where money comes in. And finally, when the last money has come in, and no more money comes in, and the guys who invested early start selling, then the whole thing collapses.
We think the tech sector could see a correction of 20, 30% quite easily in the space of a week or two – not in the next two weeks. I don’t know when it will happen, but the correction will happen. That is for sure. Your history of the past hundred years shows that when a segment has become this expensive, it just falls back. And what we are seeing at the moment is that most of that money is going into the financial sector. And, in fact, after Thursday evening, when the tech sector was very strong, on Friday morning we saw the European banks up, actually, whereas the tech sector was down.
RYK VAN NIEKERK: Yes, interesting. Indeed. Looking at the indices, the financial sector has really not performed well, but you say there have been some inflows into the sector and some recovery over the past few months. At least since we saw the crash in March.
But how do you now look at this market? Financial stocks are providing a lot of value at the moment, but value does not put butter on your bread. You need to wait for it to materialise. So how do you think an investor should look at the option of investing in financials, while you look at a performance this year of down 17%?
KOKKIE KOOYMAN: Maybe, just to step back for a second on that, bear in mind that that down move that you’re measuring now over eight months or so, can be broken down into two periods. The price of financials, as with the rest of the market, fell significantly up to March 23, and financials sold down more. It makes sense. When you do get a recession as sharp as this one was – and I’m saying “was” because I think the world is coming out of recession – when you get a downturn as sharp as this recession, there are two risks to banks and the financial sectors; insurers as well. The one is just a loss of business and, worse, significant bad debts as clients default on their payments. And the second one is that, during recessions, your central banks cut interest rates and so you get significant margin pressure.
As you go into a recession, you’re not quite sure how bad it’s going to be. So the wise thing to do for investors is just to sell out of that sector, or reduce your exposure to that sector, until you get certainty. On March 23, Jerome Powell, the Fed chairman, gave his speech, basically saying they are going to stand behind the economy and make sure that “we have a recovery”. And since then they’ve followed that up quite a few times, saying they’ll do everything they can to get the unemployment rate down in the US again, and the US economy growing. And since then, finances have recovered.
And recovery has actually been in line with the other indices. It’s just that the initial fall in those first three months of the year was actually significantly more than anything else. So, if you look forward now, as I said, the discount of financials to the rest of the index is significant but, more importantly, the financial sector now, and by the way the other cyclicals, will all follow the same [way] – your industrials, your manufacturing companies – or follow the same pattern. We see this in any recession.
If you go back the past 100 years, you just go and study recession – obviously, we focus on the financial sector – your bad debts peak just after the recession troughs. And that makes sense because that’s when all your bad debts come through. But, as the economy recovers, they start falling off and you’ll recall, in the results that we’ve seen over the past few weeks, every financial company that’s been reporting has been reporting earnings down 90, 70, 80% – significant amounts.
But largely those falls in earnings have been due to provision for bad debt charges. Remember, those are provisions for bad debts; they are to come. If those provisions are sufficient, then that means they are going to be once-off, and next year those provisions don’t recur. And then next year you’re going to be having interviews with management. They’re going to report earnings have jumped by 50, 60%. And so I think for investors now you want to invest in those sectors that have been the hardest hit, and you want to invest in the companies that have come through strongly. So you don’t want to bank on turnarounds. In South Africa, for instance, your FirstRand is a brilliant company, well managed, a very good senior team, with a good track record of shareholder value growth. And so next year they’re going to report on very strong earnings.
So I think for investors now, you need a bit of patience because there is still uncertainty in the next three months about the strength of recovery, once the aid programmes are discontinued. Especially in the US and the UK you’ve had aid programmes, and those run out. So then we are really going to see in October, November, whether the economies can stand on their own legs. The banks tell us in all our interviews that they will be able to do that. So we are going to see a strong, a good recovery in earnings, and then specifically the financial sector will start paying dividends again. A lot of them will be on different yields of 6%. So, for investors with patience of a year, I think certainly your financials and most of your cyclicals in terms of industrial companies – even, though, your hotel groups, even airlines, have a bit more risk – will outperform technology shares, I think, on a 12-month basis.
RYK VAN NIEKERK: Yes. It’s a very interesting point you make, because we are seeing significant provisions for bad debts and other things within the banks and the insurers, and that has slaughtered their profits this year. And if those provisions are not there next year, it will actually reverse the situation.
Kokkie, I’m looking at the fund fact sheet of your global financial fund. It’s a dollar-denominated fund, as well as the local feeder fund of that fund. And one thing I immediately see is that your TER, your total expense ratio, for your local fund is 2.3%, but for the international fund it’s at 1.4% – almost half. Why is there a difference in the costs for these two funds, if they are broadly similar?
KOKKIE KOOYMAN: Yes, there are basically three reasons. One is that the TER should be coming down in terms of the management company. We’ve been very concerned about the high charge, and we’ve been reducing the charge that we charge. So, in fact, in Denker, we’re going to almost break that down to zero, so that the charge effectively is just a charge that investors pay for the fund that is registered in Ireland.
But there obviously are other costs as well. So, bear in mind, investors in any local fund, what we call a feeder fund, put money in rands. Essentially the management company then takes those rands into dollars, and obviously that costs the management company as well. So the three factors that make it more expensive are, one, it’s historical. So that is coming down and unfortunately, TER is reported on a three-year moving average. So, every month now you should see that coming down.
Secondly, there are costs involved in moving the money offshore. But, over time, the local charge will always be higher than the international charge, simply for the convenience of being able to put in and take out rands without having to go to the bank and do it yourself.
RYK VAN NIEKERK: The fund size of the feeder fund R121 million, and the fund size for the international fund, $68 million. But, from South Africa, where do you see people invest? In the local feeder fund, or do they go into dollars in the international version?
KOKKIE KOOYMAN: The easiest. It’s a bit of admin for the individual, but it’s much better for individuals to invest directly offshore. A few years ago that wasn’t possible. That is now possible. So you can actually instruct Absa or First National Bank, whichever your bank is, to directly transfer your R1 million per person, or your R10 million for which you need approval, into Citigroup – in our case it’s Citigroup, who are the bankers for the offshore fund.
So we’ve been advising clients, where they can, to rather put money directly into the Dublin funds. And I think the same goes for most management companies. So that’s why the local fund should always be fairly small. Your more sophisticated client has got a bit more time and will take his money directly offshore and invest directly in Dublin. And that also has the advantage that the money is offshore. It is also legally offshore, which is obviously very important. But, should you benefit as well from the fall in the rand, in terms of tax, it is also much more beneficial to have the money offshore because you’re not paying capital gains tax on the fall in the rand.
RYK VAN NIEKERK: That was Kokkie Kooyman, a portfolio manager at Denker Capital.