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Oxygen for emerging markets

‘We see a world and a country where the metrics and growth factors start improving’ but take steps to protect ourselves – Jason Forssman, Ashburton Investments.

RYK VAN NIEKERK: Welcome to this Market Commentator podcast, it’s my weekly podcast where I speak to leading investment professionals. My guest today is Jason Forssman, he is head of equity and multi-asset fund management at Ashburton Investments. Jason, welcome to the show. Let’s start with the local market – we’ve seen several companies report in recent weeks the SA Inc stocks have performed poorly, at best single-digit or low double-digit growth numbers were reported, some even negative. But despite that, we are seeing that the JSE has gained around 8% to 10% since the beginning of the year. How do you see the current market dynamic?

JASON FORSSMAN: It’s been very, very positive from about the day after Christmas and markets have rallied all over the world. We’ve had significant gains in China, Brazil and broad emerging markets.

What really happened [is that] just after December 24 we saw the Fed chairman in the United States saying that perhaps they wouldn’t be raising rates as aggressively as they initially had anticipated, and that allowed oxygen to be released back into emerging markets, which had almost at that point in time been down in US terms about 30-odd percent, so we tend to forget because we’ve got this buffer called the rand.

The rand weakened by 20-odd percent and just before Christmas we were down almost 12% for the year. So that’s 32% down. So when we say we’ve had a decent rally, I think up until the end of February markets were around about 8% and continue to rise this year, recovering in rand terms, but it was really a recovery post quite a significant risk-off period for emerging markets, generally speaking.

RYK VAN NIEKERK: What you’ve explained there seems to be the old correlation between what happens in the US happens in South Africa, but over the past few years it seems like that correlation has diverged – it’s not as close anymore, is that your perception too?

JASON FORSSMAN: I think over the last couple of years we have seen a bit of a delinking in terms of SA performance and the US, but not so much a delinking in terms of SA vis-à-vis other emerging markets and particularly commodity-producing nations, and we tend to be more sensitive both for the rand and the implications that that has – so the rand weakens, inflation goes up, interest rates go up and so on, to what’s going on in China and China demand and so on. So we’ve shifted over the years to a focus of what’s happening there and the reason for that is China is ultimately our biggest customer, they buy the stuff that we produce, so you see a big sensitivity there towards that commodity basket and the growth dynamics of the world outside of the US far more so than perhaps in the past.

RYK VAN NIEKERK: But the local market has also underperformed international markets significantly in recent years. Everybody now, or many people, refer to the market as offering good opportunities, but the underlying economic conditions just don’t justify or suggest that we will see a significant upturn in the medium-term future. How do you read that?

JASON FORSSMAN: A couple of things. I think the first thing is when you look at our market you need to divide it into three sections, if you like.

One is non-resources rand hedges, those are industrial companies that are largely offshore-based, get the majority of their income from offshore, if not all of their income from offshore, so a typical example would be Richemont, British American Tobacco – and Naspers would also be a good example of that.

Then you’ve got your resource shares, which are SA-based but driven by global commodity markets and prices, priced in US dollars, and that’s driven by the demand dynamic specifically coming out of China. Then we’ve got our Anglos, Billiton, South32 and those kind of things.

And then you’ve got – as you referred to – SA Inc; those shares that are specifically sensitive to what’s going on in South Africa and that’s the component that has done particularly poorly of late. That’s why we had a very short technical recession, but then emerging out of that was very low levels of economic activity in the country. So I think if you’re a South African it will be no surprise that your retail-type stocks, banks and so on are giving you muted returns, nowhere near double-digit returns. At the same time business has done pretty well and efficiently to give you numbers that are above our nominal GDP growth.

So I think that’s how I look at the market – in three components, focusing on where the value is right now. Or perceived value. That would be at SA Inc’s trading at ratings or PEs [price-to-earnings ratios], if you like, forward PEs at levels that I’ve – I’ve been trading markets since 1997 – very rarely do you see these low valuations on SA stocks, and that’s because of the current environment we find ourselves in.

So when it comes to equity investing, one has got to look forward – so do you see a world or a country that over the next 18 or 24 months can recover to a high level of GDP and, therefore, profitability? If so, then this is a good time to buy those equities or to up-weight them. If not, if you see a negative outcome in the election, a further deterioration in SA, a further downgrade and so on, then, of course, those low prices are possibly justified.

Positioning for alpha

RYK VAN NIEKERK: So which companies are you buying within that scenario now?

JASON FORSSMAN: We’ll talk about our stocks just now, but we run a more or less balanced approach – we’ve got some resources, we’ve got some non-resource rand hedges and then we’ve got SA Inc. Into this weakness, I’ve been shifting our bias from an offshore bias into a local bias. But then we’re focusing, also to protect ourselves, so we do see a world and a country that can start improving and where the metrics and growth factors start improving quite reasonably over the next 18 to 24 months. Therefore, I am seeing value, but to protect ourselves we tend to try and only up-weight those stocks which we regard as decent quality.

In other words, those stocks that have quite a solid – decent – balance sheet; already have good solid margins. So that if we don’t get our timing quite right, these are businesses that at the very least will outperform their competitors and if competitors fail, will actually take market share from them, so that over the long term you are putting yourself in a good position for alpha.

RYK VAN NIEKERK: Can you name a few of those stocks?

JASON FORSSMAN: Yes, recently you saw Mr Price come off quite aggressively as it released results that in my mind were not unexpected but slightly lower than the market expected and the rating came back quite aggressively. Here you’ve got a company that has by far the best return on invested capital than any other company, significant margins, which gives you lots of safety, good cash flows and almost no debt, so we’ve been up-weighting that a bit. Then on the food retail side we like a Shoprite kind of story, and then entering into weakness on that one.

RYK VAN NIEKERK: I’m looking at the fund fact sheet of your equity fund, one which you co-manage, and the composition is interesting, very much blue chip stock-focused. Naspers represents 12.5% of the portfolio, FirstRand 7.8% and then the other names in the top 10 list are BHP Billiton, Bidvest, Standard Bank, Anglo American, Richemont, Sanlam, Mr Price and Sasol. Have you changed a lot at the top end of the portfolio?

JASON FORSSMAN: I wouldn’t say changed a lot. What we do is we call it macro focus quality; we look at the macroeconomic environment and how does it pertain to the stocks. We construct a pool of stocks, which are high-quality stocks, and depending on that macroeconomic environment and various valuations, we’ll shift the weightings in these shares.

So we carry this core quality, [and] by virtue of carrying the core quality you’ll always have a focused portfolio. So you’ll see a high weighting: when you see banks, you’ll only see two banks, so we want to pick the top two banks. If you see insurers, you’ll only see one and so on. So that’s how we construct the portfolio of quality to ultimately, through time, reduce volatility. So when we see shifts in the economic environment – [for example] over the next 18 to 24 months we see opportunities in value – we shift the weighting.

So we add this position, large overweight, in the resource shares, and that worked very, very well for us as they recovered over the last three years. Slowly but surely we are starting to feel that the rand might be overvalued and that the local investors might be over-pessimistic; we’re starting to shift that right away from there into these value SA Inc plays that I chatted about earlier.

RYK VAN NIEKERK: Naspers, of course, the star performer on the JSE over the past few years, actually more than the past few years, what do you think the prospects for Naspers are?

JASON FORSSMAN: Naspers obviously is a massively dynamic and powerful company through Tencent. I think the main focus is actually Tencent, it’s the driver of the Naspers share price, you pretty much get everything else for free.

So if you want to invest in Naspers you need to understand the dynamic that’s driving that market, and that’s really China-focused – it’s all about mobility, access to social networks and so on in China, and payment systems, and everything that is tech. There’s a very powerful movement in China as they transition from a manufacturing agrarian-type economy to a consumer services-based high-tech economy.

So we truly believe that Tencent is well positioned to continue to benefit from that cycle. Obviously, like all things, it doesn’t go up in a straight line and there are bumps along the road, and the more recent bumps being legislative-type of interference from government. But at the end of the day Tencent constitutes quite an integral part of Chinese government policy with regard to growth trajectory over the next five to 10 years, and so we believe they will be accommodating and supportive of the company over the long term. So one just really has to understand that it’s never going to be a one-way street but it is a very powerful space that they find themselves in.

Naspers is obviously a significant component in our All Share and if you benchmark towards the All Share, which we are, it’s very difficult to have a no-weight. You’ve got to have a very strong negative opinion on the stock. We don’t – we like it, but we’ll tend not to go much beyond that kind of weighting in the stock, regardless of whether we think it has additional value or not.

Ashburton balanced fund outperforms equity fund

RYK VAN NIEKERK: At 12.5% it seems underweight. I’m looking at your balanced fund and the first thing that is interesting is that the performance over five years of your balanced fund exceeds the performance of your equity fund.

JASON FORSSMAN: Yes, and I think that tells a story about South African risk assets generally speaking and those globally.

I’ve just been on a roadshow with my fixed income colleague and, of course, he beats both of those funds and I said to him in my entire life we didn’t used to invite the fixed income people into the room and now you guys are the heroes.

So we live in a world where cash has been king and there’s been a big risk premium on South African cash, so you can get a yield of about 8% in a money market fund, while we’re sitting at inflation of 4.5%. So that’s about as high as I have ever seen it. So we’ve lived in a world where you’ve deleveraged out of risk and you’ve actually profited from taking …to be able to persist or sustain profit it’s probably unlikely but the timing is also difficult.

I think we live in a world faced with a lot of tricky things going on and a lot of hurdles, which have to be overcome before one can fully embrace risk and buy wholly into an equity portfolio.

So I think a balanced approach is the right approach for now. Not only has the performance been better, the volatility is significantly lower, and it’s really just a function of global markets as we’ve found them over the last five years.

RYK VAN NIEKERK: Over the last five years the balanced fund returned 6% per annum, while the equity fund returned 4.6%. Just lastly, I also see in your equity fund you have only 6.7% in cash. Wwhat is the thinking here? Some fund managers are being cautious and they have a higher cash allocation – what is your thinking?

JASON FORSSMAN: Strategically at Ashburton the equity fund is more or less fully invested. I think the logic is if you want to invest in the equity fund our goal and our target is to be fully invested. So for us a high cash weighting would be around about 10%, which we go to in times of volatility or when we think that market valuations are overstretched, and we’ll use that cash and redeploy it back up to 98%, 99%, almost 100% level as we see opportunities.

So for us a 6% cash holding is reflective that we are seeing risks out there, volatility, which should lead to opportunities along the way, which we will try and capture as and when we see them.

RYK VAN NIEKERK: Is the fund only invested in South Africa?

JASON FORSSMAN: The equity fund is invested only in South Africa. It’s an SA equity fund. We have recently changed the mandate to allow us to transition offshore, and we’re going to do that gradually.

RYK VAN NIEKERK: Just lastly, we are facing more exciting times politically, economically and internationally. What do you expect for the next year or two?

JASON FORSSMAN: I’m expecting a lot of volatility, but I do think that in all the risks that we face there are roads signs out there that will tell you danger or safety.

So we know the world is fragile, it’s fertile for things to go wrong but luckily we understand what actions are taken that will lead it to a difficult place and those actions that will take us to a place of safety.

So I am expecting a lot of volatility and the way we are reacting to that is when there’s volatility, when markets sell off, we have cash, we deploy it into risk and then obviously as you recover and enter a period of complacency you do the equal and opposite.

The volatility will be part of our lives for some time to come but right now there are a number of critical issues which heighten this sentiment, which, as we overcome them, should see an underpin to risk assets over the next 12 months.

RYK VAN NIEKERK: Thank you, Jason. That was Jason Forssman, he’s head of equity and multi-asset fund management at Ashburton Investments.

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