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South Africa: Yield-rich but growth-poor

While the opposite applies to the international market, says Tony Bell of Vunani Fund Managers.

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 Tony Bell. He is a portfolio manager and head of global at Vunani Fund Managers. He has been an investment professional for many years and has been the chief investment officer at several asset managers including Nedcor Investment Bank, PeregrineQuant, and now Vunani. Tony, welcome to the show.

We are currently seeing very volatile markets, especially in emerging markets due to the Coronavirus. What are your views on the impact of this virus and the way markets have reacted?

TONY BELL: Ryk, thanks very much for inviting me onto the show and a good day to all the listeners. The Coronavirus really has been a little bit of a black swan to use that term in the sense that no one really knows what the origin or source of it is. There are rumours floating around the markets that it has certain biological capabilities attached to the virus. I think that’s why the Chinese authorities have moved very aggressively to contain the virus as quickly as they can. Not being a medical expert, I can’t comment further on that, but I think where it impacts the markets is on, obviously, capital flows and certainty on earnings growth.

And if you look at the interconnectedness of markets these days, the sheer impact of China’s imports and exports to the rest of the world is very meaningful for [the emerging market] EM complex, Australia, South Africa in terms of minerals. And then exports, you know, the iPhones that we all enjoy are largely produced in China so the disruption in the product train-line could start to impact companies’ growth prospects down the line. And that’s what the markets are very unsettled about.

Market decline

RYK VAN NIEKERK: But we have seen a significant decline in many markets. Even the US market reacted very negatively. And then, as if something miraculously happened, it turned around and was hitting new highs virtually on a daily basis during the past week or so – is that a normal reaction?

TONY BELL: I think that one is going to try and separate. I [have] always looked at it in terms of the three drivers:

  • Liquidity injections by the central banks, particularly [the] People’s Bank of China, have been very significant. I think the People’s Bank of China has pumped more liquidity into the market in the last month than [any time] since the 2008 crisis and the Fed [US Federal Reserve] has quite literally changed its stance from one of tightening to one of liquidity. So liquidity is pushing these markets very, very hard in the short term. As a fund manager, what I try to do is I look at the liquidity drivers, the change in earnings growth and the interest rate environment drivers, and there one finds that for the time being, the interest rate drivers are also supportive of equities.
  • Bonds yields have firmed in the last while, indicating that even though the US is now 10 years into its recovery, inflation is still very absent from the picture as is the case with Europe and Asia.
  • And I think given the geopolitical environment which we are in, there is really a lot of talk about fiscal spending. In other words, government spending. [US President] Donald Trump will use it more specifically as he moves into his presidential re-election campaign; [British Prime Minister] Boris Johnson has used it very aggressively and, of course, China is spending very heavily to keep the economy afloat, and I think that’s what markets have responded to as opposed to the short term impact – on earnings growth – of the virus and the knock-on effect onto growth.

 

Investing in this market
RYK VAN NIEKERK:
Tony, this is a complicated environment. How do you invest in this market?

TONY BELL: A very simple answer to a complex question is when I look at the 11 sectors that the MSDI [Multivariate Standardised Drought Index] is broken up into, I find that in eight out of the 11 sectors, the top five companies globally dominate margin and earnings. And so one of the core strategies I have followed for a while in this fund is really to focus on companies with low volatility and high sustainability of earnings. And that certainly has pulled through in the performance numbers.

The fund has a very broad base of exposure to a range of stocks. The most, the highest exposure in the portfolios is Apple at 4.67%, and the lowest one at the moment is waste management at about 1.22%.

What I try and do is I find sectors and companies within sectors that have very dominant and sustainable earning streams, and then I pair them together in a way where there is no specific single stock exposure to any company. And the other aspect of the portfolio that has been true since inception is that I manage the portfolio risk very aggressively so that if I do start to see weakness in either the markets, I move to cash, or in a stock, I reduce position size.

 

MI-PLAN IP Global Macro Fund

RYK VAN NIEKERK: You refer of course to the MI-PLAN IP Global Macro Fund. It’s a fund that has won Raging Bull Awards, and congratulations on those awards. The one-year performance last year actually was 18.3% over the past three years – nearly 14% – which is excellent indeed. I just want to question the top two positions you are in, Apple as well as Microsoft; two big companies. But several people would look at Google, look at Tencent, [and] some of the other significant players in the international technology space; Facebook even. Why are you specifically looking at Apple and Microsoft and not to the other players?

TONY BELL: Yeah, it’s a lovely question. I struggled a little bit with identifying the persistency in earnings streams from companies like Facebook and Google. They are very much one-revenue-stream models, mostly advertising. Whereas what I like with Apple and Microsoft [is that] they are different arguments to each. Apple really is a product originated with a very big distribution platform that it can monetise. We all like our iPhones and Mac books and so forth. And Microsoft, like Adobe, which is also held in the portfolio, has changed its licensing model from an annual to a per-user cloud-based system.

So in my research, I have preferred to go for companies that have high levels of annuity income with a very dominant presence in the cloud space – over which they can add products and margin over time.

Google is a very, very distributed company. It has a significant amount of R&D [research and development], and it’s trying a lot of new things and [is] certainly a great company. But I just liked the, I liked the conservatism of those two. And at the time I was buying Apple heavily into the portfolio. Believe it or not, it was on a PE [price-earnings ratio] of 11.

RYK VAN NIEKERK: It has run extremely hard, but so have most of the US shares you have in your portfolio. What do you think of the current valuation of the American market?

TONY BELL: Another interesting question. We did a little exercise the other day where we had a look at what the price-earnings multiple of the market would be if you adjust for the very significant share buybacks that have taken place over the last number of years. And for listeners who might not understand what a share buyback is, it’s simply a company using cash to buy back its own shares instead of paying dividends or reinvesting in new products.

So when a company buys back shares, it reduces the number of shares in issue and that’s very earnings-enhancing over time.

If you adjust for share buybacks, the price-earnings multiple of the S&P goes from 18 to just below 40, and that would suggest to me that we’re in the final phase of a very extended bull market. We’ve seen a number of the key indicators showing lower growth ahead. US Treasury’s has declined, the Brent oil price declined significantly, copper has declined, and gold is moving higher.

So for the time being, investors are still desperately searching for any growth that they can find and they’re paying higher premium and PE multiples on these stocks. In the many years that I’ve been engaged in fund management, it’s not often you get a repeat of 70, 80% per annum on companies like Apple and Microsoft. And perhaps just to illustrate the points, the current excitement around Tesla is very indicative of the liquidity excess in the market, which I am monitoring very closely because I do think having been through about seven bear markets, that if the liquidity taps get turned off for whatever reason, these valuations will prove to be very vulnerable.

RYK VAN NIEKERK: Looking at MiPlan’s local funds – I’m looking at the Inflation Plus 3 fund, Inflation Plus 5, as well as the Inflation Plus 7 funds – the fund allocation or the positions you have are very similar in the three funds. You have Naspers, Anglo American, British American Tobacco, Bidvest [and] Anglo American Platinum. Oh, just take us through your – you know, your perceptions, because all of these companies have a lot of external or international exposure. What is your thinking within these funds? And why do you include, you know, the same companies in your different funds looking at different inflation targets?

TONY BELL: Right. Nice question. When those funds were designed – I’m the manager on those funds, and when those funds were designed way back when, they were designed to provide a client with consistency across exposure to different investments that you’d expect to see – very similar bonds, very similar shares – that where they differed was in terms of how much we allocated to each asset class in terms of risks.

So, logically speaking, a CPI Plus 3 [consumer price index plus 3%] fund would have half of the risk of the CPI Plus 7 funds in equities. So the main focus on those funds is very much to get the asset allocation right. You will see if you look through the fact sheets that for the past year we have pulled the market reasonably well. We have been long global equities, which had done very well. We have been long nominal bonds, very short domestic inflation-linked bonds, and we’ve had a fair proportion of cash in the funds. The objective of the fund of each of those funds is to try and achieve targets with the least possible risk and certainly with the focus being on minimising drawdown risk. So while there would be some scope and opportunity to have, for example, a different set of stocks in the CPI Plus 7 from the CPI Plus 3, I find that the difference at the end of the day is far more ascribable to the assets, getting the asset allocation call [right] rather than worrying whether I’ve got 8% in Naspers [or] the one on 12% in the other.

 

Valuations in the local market

RYK VAN NIEKERK: So it’s just definitely an asset allocation decision, which is interesting. But looking at the local market currently, my perception is many asset managers regard it as relatively cheap. Oh, and that there are great companies trading at a very low price-earnings ratios, but there’s not an expectation that the market will arise, uh, in the short and near term. How do you look at the valuations in the local market in that perspective?

TONY BELL: It’s an interesting question. I mean, I really have for a long time thought about this emerging market valuation argument because the same arguments have been applied to other emerging markets as well. So I think the crisp answer is we have the State of the Nation Address tonight [Thursday, February 13]. I think there’s a significant amount of continuing policy uncertainty. And South Africa doesn’t really have a growth problem – it has a capital allocation problem, and that is [that] very few businesses are prepared to commit some new capital and very few foreign investors prepared to invest new capital in the face of uncertainty around ownership and things like policy uncertainty. So I think the market discounts all of that. Companies themselves have been aggressively restructuring their balance sheets. But if you look through into the banks, the insurance companies, many of the retailers, the growth vectors are very single-digitish. So until you see some sort of the impetus where we have fiscal policy stimulus, which the country can’t afford, or external injection of capital, I just can’t see the growth vector improving. And I think the market will keep the P rating low as a result.

 

Company selection

RYK VAN NIEKERK: So how would you look at individual companies? Would you prefer companies who actually invest or allocate capital into the operations or do you look at companies that are conservative and preserving cash?

TONY BELL: It depends a little bit on what sector the company is in. You know, for telecom companies – for example, MTN and Vodacom – it’s growth. It really is a question of how well they can maximise their margins given a very, very low growth top-line environment. Other companies, what you looking for in terms of producing really good long term returns, as we’ve seen in the global macro portfolio, is you want a company to be able to take a portion of its free cash flow, invest in new projects and in the process either maintain or improve its return on equity.

So when I have a look at the characteristics of the global macro portfolio versus the MSCI [Index] you typically find that the portfolio has a higher return on equity, higher free cash flow generation – yes, you are paying a slightly higher PE, but you [are] also less worried about high levels of debt.

If you flip that onto the reverse side and companies are not generating cash, not able to expand their ROE [return on equity] – a simple example would be if you compare Transaction Capital to any one of the major four banks or Capitec. Transaction Capital and Capitec have been able to expand their businesses quite aggressively using internally generated cashflow and not debt. And that reflects in the relative price performance between those two banks and the four more stable banks with a largely stacked, with a book that isn’t growing. So at the end of the day, one as a fund manager always has to try and find a balance between the dividend arguments, where companies – certain companies – are paying very high dividends; that’s a good example, Vodacom. And you’ve got to balance the client’s exposure with the same growth aspect. Otherwise, all you’re going to end up producing is a high dividend-yielding portfolio.

 

Local vs international selection

RYK VAN NIEKERK: Yeah. So how would you advise investors: look at the value in the local market, or go for the safety of more expensive international markets, but that removes some of the local risks – how do you think investors should approach the current scenario?

TONY BELL: Maybe just a slightly different choice of words. To answer your question, I would say that South Africa is yield-rich but growth-poor and the international market is growth-rich but yield-poor.

So typically, where we have the opportunity, we take as much exposure to yield in the local market – either through nominal bonds or high bids in yield companies where you’re not expecting a lot of growth. And within the international market, even with the risks which we’ve spoken about at any point in time, I’m very comfortable with between 30 and 50 global companies with the growth vectors [that] are quite impressive going forward.

And my role as the fund manager [is] to balance the market-related risk of a setback in markets with the growth that those companies are producing. And if you look through the portfolio in the global market space, you can get the exposure right the way through from Alibaba. I used to have some Amazon in the portfolio had actually sold it all. Nike has done very well. Waste management has done well.

So there’s a lot of companies in very different sectors that are benefitting from this very aggressive push by governments both fiscally and monetarily to keep growth going. And that’s been reflected in the difference in share prices.

 

The current single biggest risk

RYK VAN NIEKERK: Just coming back to that point: there are a lot of short-term incentives, short-term liquidity, [but] it can stop actually quite abruptly. Is that a big risk?

TONY BELL: Yes. It’s probably the single biggest thing that I concern myself with at the moment.

I’ve been through about six or seven stock market declines in my career, 30% or more starting in 1987, and almost every single one of them was precipitated by liquidity-driven events.

I think ironically, although the Coronavirus is, you know, very serious, it has paradoxically created a surge in this stage of the business cycle that would be unprecedented for central banks to follow – China, Central Bank of Europe and also the Fed pushing hard on liquidity, with a lot of fiscal spend. So it’s a very delicate time for investors to balance reward and risk.

In my humble view, some of the stock prices have moved too high and so I’m adjusting my position sizing more aggressively than I usually do just to accommodate that liquidity risk that you asked about.

RYK VAN NIEKERK: Thank you, Tony. Always interesting to talk to you. That was Tony Bell. He is the head of global at Vunani Fund Managers.

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I think that SA is now yield and growth poor.

Interesting in a broad way, e.g. blurring returns between USD and ZAR. This caught my eye “Waste management has done well”. Whe know Amazon and Nike but who is he talking about here; SA, Europe, globally, the US, specific companies?

As long as we have a commie govt pandering to voters/grant recipients that keep them in power/gravy this country will continue down the zim venezuela route

End of comments.

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