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‘Just because it’s cheap doesn’t mean you should buy it’

Nadir Thokan from 27four Investment Managers on the current market volatility, the importance of diversification and the case for hedge funds.

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 and my guest today is Nadir Thokan, he is the co-chief investment officer at 27four Investments. Nadir, thank you for joining me.

What a week. We saw the most significant decline in the JSE Alsi and many other world markets in decades, especially on Thursday. What is your interpretation of what happened?

NADIR THOKAN: Yeah, thanks for having me Ryk. Obviously this has been an extremely volatile week. You know, if you look at basically the Vix index [Volatility Index], what it’s done. It’s surpassed the level in the global financial crisis and as you correctly mentioned, we saw global markets having the biggest meltdown since the Black Monday sell-off of 1987. In fact, if you looked at the Canadian stock market at one point it was down the most since 1940 so down even more than Black Monday of 1987.

So you know, I think that the bottom line here is that it’s fairly evident that markets are reacting on the back of extreme levels of fear and in the absence of information, fear is going to reign supreme. So we know that Covid-19 is exceptionally contagious. We know that it’s spread around the world and we know that different governments around the world are taking various actions in terms of closing the borders, cancelling various events and that’s expected to have some kind of an impact – a knock-on impact on earnings of a diverse grouping of companies. You’ve already seen airline shares reacting probably the most, followed by hotel and lodging with the travel ban being implemented. Those are obviously the two most directly impacted and we’re already seeing a number of airlines cancelling earnings guidances.

We’ve seen Wall Street’s analysts worrying about Boeing having to cut their dividends on the back of reduced demand for aeroplanes because a number of these airlines are now cancelling ‘go streets’ as we call it or cancel up to 20% of their routes and we’ve already Lufthanza experiencing severe cash strain on the back of reduced demand for flying.

So you know ultimately like we don’t actually know what the full impact on a diverse set of company earnings is going to be and in the absence of that information, we have two things happening. We have guys who own these equity saying, I don’t know what the knock-on impact on earnings is going to be given the starting multiple of these companies at the start of the year or even heading into Covid-19 when the first news of Covid-19 broke kind of through the course of the late January and going into February, they were saying given that you know these guys aren’t demanding multiples, they need to deliver earnings for growth, we don’t know what the impact on earnings growth is going to be. We’d rather sit on the sidelines and the guys who are already on the sidelines are saying we don’t know what the impact on earnings is going to be. We need more information before we get in.

So we have the situation with the holders of these stocks are trying to get out and flooding the market with a supply of stock. The buyers are not coming in and stepping in and creating a floor on the price.

And we’ve seen bouts of buyers coming in and trying to provide a floor in the price. We’ve seen central banks coming in and cutting interest rates aggressively, the Bank of England and the fed by 50 basis points, the ECB not cutting rates but promising more liquidity and that’s ultimately resulted in there has been the occasional bouts of buyers coming into the market and trying to get into the market. And we’ve seen the odd bouts, I mean on Tuesday, which seems like a lifetime ago, let’s remember that the markets were up significantly on the back of potential central bank action and what they might do.

So, unfortunately, Ryk we are really trading on the back of sentiment and emotion at the moment. And we see the sellers are flooding the market with supply and the buyers are not – [buyers are] taking a wait and see approach until those announcements are released before they decide they have sufficient information to say, well actually these levels are bargain levels. Because if we see a dramatic impact, well then all these equities have just kind of berated and correctly so.

RYK VAN NIEKERK: What are you doing as a fund manager in situations like this?

NADIR THOKAN: Ryk I think that’s the most important thing is you don’t want to be exposed to exceptionally distressed companies in this environment. That’s obviously easier said than done. I mean Sasol is in the top 10 biggest shares on the JSE prior to these events, so not owning Sasol obviously a very big call but you want to stay out of companies that have exceptionally distressed balance sheets and that can’t afford to have a heightened amount of uncertainty around their shares.

I mean, we’ve seen exactly what’s happened to Sasol, $8 billion of debt, the oil price is crashing, a lot of uncertainty and the shares at something like 80% of its value in five trading days, you know? So those kinds of situations can happen around distressed companies when you’re in an information vacuum and that’s kind of what you want to avoid. In terms of getting back into the market, and I think that starting the year we were on very attractive valuations – attractive valuation selectively on the JSE with companies who are still able to deliver growth and trading on multiple subs 10 times earnings. Those obviously presented an opportunity at the start of the year. We’ve seen those gapping down quite sharply, but we are in an information vacuum so those continue to offer compelling value, you know, and you continue to hold onto those shares.

I think the important thing as a fund manager is not to panic.

We’re certainly not doing that. We are not cutting our positions aggressively. Um, in response to this, obviously we’re doubling down on – as a fund of funds we don’t buy shares directly, but we access the markets through underlying fund managers. But we don’t have any exposure to deep value in South Africa and we don’t have any exposure to deep value globally. And I think that those are the companies which are our view probably at the greatest risk of earnings down cycle irrespective of how low their multiples are.

So we maintaining onto our moderately valued quality opportunities and we know that once the dust settles and once calm returns to the market and as buyers come back in, once we have more information at hand with regards to the impact on earnings, these companies have just gotten a whole lot more attractive and we’ll (inaudible). But I think the important thing as well to note on the flip side of the coin,

buying something just because it’s cheap is not a sound strategy in this environment

particularly for as long as we are living in this information vacuum and fear and sentiment are driving these markets.

RYK VAN NIEKERK: What do you do on a day like that in a trading room or as a fund manager? Do you sit in front of the Bloomberg screen and a groan the whole time or what do you actually do?

NADIR THOKAN: Yeah, so I mean it’s obviously very difficult to keep a level head under these environments. That’s exactly what you have to do. You can’t sit and watch a screen and watch how sharply things are gaping down, particularly as a fund of funds, we have very little control over that. So it would ultimately be about saying, do we have a sound investment strategy heading into this event? Were we adequately diversified? Do we have multiple fund managers picking up various different components of the market but not exposing us to highly distressed companies?

If you’re in highly distressed assets at the moment, even if the valuations are exceptionally attractive, you want to reconsider those kinds of positions and do a lot of work around what might happen around that, but it can all get very overwhelming if you get swept up in the emotion and in the hype of all of this and watching your trading screen in a minute-by-minute basis, but it’s really about ensuring that you are adequately positioned even prior to these events happening.

There’s no point in trying to react once these events have happened.

It’s about doing the adequate amount of work to make sure that you’ve properly diversified before these events happened to prevent events such as this from [wiping] you out. Obviously you are going to have a negative market to market values. The JSE is down, if you include yesterday, the JSE is down close on 25% year to date and global stock markets in dollar terms are down about 25% in the developed markets and around 22 to 23% in the emerging markets in dollar terms and then obviously if you convert that to rands it’s slightly less because the rand has been exceptionally weak but even after taking into account rand weaknesses, those losses are still close on 16 or 17% year to date. So obviously you are going to get the negative market to market values in that sort of environment but to us, it’s about doubling down on the fact that we are adequately diversified across a number of good quality opportunities and not just buying cheap and when the dust settles those will relate to the valuations and the multiples that are more reasonable.

RYK VAN NIEKERK: 27Four is a multi-manager and that means you invest in other funds predominantly. Do you think that reduces the risk in a time like this?

NADIR THOKAN: So what I do think it does is that it enables you to be able to have greater levels of diversification and ultimately in this environment, diversification is going to be critical and diversification is going to be crucial in terms of trying to limit the amount of downside risk so we can allocate to different fund managers that have deployed different investment styles and obviously in the current environment, high-quality companies are holding up significantly better than those distressed de-value companies at a single stage as an asset manager you obviously you pick one of those styles. So if that style’s out of favour, you’re going to get carried out extremely badly. So as a multi-managers, you know, we can expose you to multiple investment styles and as a result of that, reduce your overall levels of volatility and enhance your risk-adjusted return over long periods of time.

RYK VAN NIEKERK: Who are your main investors? Are they retail or institutional investors?

NADIR THOKAN: We’ve got a combination of both. We run retail full traders, retail unit trust portfolios, that compete in a multi-asset, low, medium and high equity categories. And those are predominantly retail investors. So guys with discretionary savings or guys with compulsory savings just buying a living annuity or retirement annuity on our underlying product. But we’ve also got a suite of institutional portfolios which form part of member investment choice to various retirement funds around the country. So basically you work for a company, you’ve got to contribute to provident or pension fund every month and you have asset managers that manage that pension fund, those would be our institutional clients. So we have a variety of clients across both retail and institutional.

RYK VAN NIEKERK: You have a fund of hedge funds risk rating one, obviously more geared toward fixed income. Do you have a an equity fund of hedge funds?

NADIR THOKAN: Yes, we do. We’ve got four funds of hedge funds strategies and in fact, we’ve got an equity long-short, we’ve got a multi-strategy, we’ve got a fixed income and a market neutral. So we do have equity, long-short equity fund of hedge funds. But in the long-short and market-neutral space and obviously in this sort of environment your market neutral is going to be doing significantly better than your long only because your long-only has a slight market bias or more marketing niche market exposure and your market mutual funds are kind of more neutral. Trying to get the net exposure closer towards zero rather than having a net long bias and the fund of hedge funds has various hedge fund managers.

You know some are doing their job in terms of protecting capital in this environment and some are getting caught out of having too much leverage or being too net long. I think the primary function of your fund of hedge funds must be to protect capital in this environment and certainly, you want to allocate your hedge fund managers who have a more kind of capital protection mindset frame of mind and that’s exactly what they would do to offset your long-only equity positions in this inbox.

RYK VAN NIEKERK: It’s interesting because Jean Pierre Verster from Protea Capital Management, he tweeted this morning that his long-short fund, only lost around the half a percent on Thursday, which of course is a lot less than the market did. Do you think this could be a defining moment for hedge funds in South Africa if it is shown that they actually did protect some value in such a market?

NADIR THOKAN: Oh absolutely. You hit the nail 100% on the head there. You know, I think that generally the investment community, have become a bit disillusioned with hedge funds post 2016 and we had a couple of big market crashes then starting with Brexit and leading into 2018 and even leading into 2019 and generally these guys found themselves in the wrong side of those markets and not protecting investor capital. And as a result of that, we’ve seen general outflows from the hedge fund industry.

But I think markets like February and market environments like the current one, this is where really hedge fund managers can again make a name for themselves and really protect capital in such a market environment.

And show that they do offer a very unique, definitive tool within any balance fund and warrants an allocation in terms of protecting capital when markets get really hairy and being a true hedge against your long-only equity exposure. So undoubtedly agree with that. You know, I think the hedge fund managers that have managed to produce close on flattery terms in the sort of environment are going to be the ones that rise to the top and ultimately going to be the ones that are going to be saved with going forward. Because hedge funds should be all about protecting capital, not just vehicles of taking on excessive leverage or gearing up your exposure and exposing you to excessive market volatility.

RYK VAN NIEKERK: We’ll have to leave it there. Thank you Nadir. That was Nadir Thokan he is the co-chief investment officer at 27Four Investments.

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”The Chicken has come home to roost”?

Investec appears to be in big trouble with their share price down more than 40 % today.

The ”ZAR 770 million bill to unbundle Ninety One” could be the least of their problems.

The current management will also have to fave a plethora of bad publicity for their ”shameless shenanigans” in the Kebblegate sage when the Randgold minority shareholders have their day in court!

Are you sure that the 40% drop in share price is not just due to the unbundling of NinetyOne? I.e. the value of NinetyOne is now separately listed on JSE.

Structure

Post the unbundling, approximately 55% of Ninety One will be distributed to Investec shareholders (via the plc and Limited vehicles), Investec will now retain 25% (including the 10% originally earmarked for new/existing institutional shareholders) and Ninety One management will hold approximately 20%.

This management holding via a trust already exists, with Investec currently owning 80% of the asset manager. Ninety One will list as a dual-listed company.

The bill for this demerger is not miles apart from the €43.3 million, or about R736 million at the time, paid by Naspers to effectively offshore its international assets via the Prosus listing. This new holding company listed on the Euronext exchange in Amsterdam in September.

It’s not a ”Zero-sum Gamage” – there must surely be other forces at play here as well – the news came out on Friday already…..

NinetyOne is trading at about 30
Investec is trading at 37
so total 67
Investec closed Friday at 65

I think the chickens came home to roost with this comment.

The ALSI 90 day drop by -28.07% means the chicken is roosting – at home.

End of comments.

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