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Value funds worldwide have underperformed, but Ninety One holds fast

To invest in value investing, you have to believe inflation is coming – and we do: John Biccard, Ninety One.

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 John Biccard. He’s one of the most prominent value investors in the country. Many people regard him as one of our best contrarian investors and he manages the Ninety One Value Fund, as well as the Ninety One Premier Global Value Fund. He’s been in the industry for more than 30 years and I think he has seen it all.

John, thank you so much for joining me. Let’s just start with value funds. It seems as if value funds have been swimming against the tide for many years, and the management style has been out of favour for a while. Yet you are sticking to your guns. How do you see the current positioning of value funds in the future?

JOHN BICCARD: You’re 100% right. It’s been 12 years now that value funds globally and domestically have underperformed. So this is one of the most extended downtrends in value. In fact, one of the brokers put out a very good graph that shows values since 1930. This has been the worst period for value investing, ever, since 1930. There were bad periods in the thirties and the sixties and in the dotcom bubble at the end of the nineties. But basically from 2006 till today value’s been underperforming, and the principle reason is free money. After the global financial crisis the debt built up so much and real interest rates basically have just continued to fall. So the cost of money has fallen and has fallen to basically today’s level, where money is basically free.

There’s no risk-free rate at all. And that is why things like Tesla are valued like they are because, when there’s no interest rate, money in 20 years’ time is worth the same as money today. So everyone buys long-duration stocks. In other words, stocks that may pay a lot in 20 years’ time. And, when there’s no cost of money, you don’t mind waiting for 20 years. Value investing is really about money today, so you buy stocks which are not growing in 20 years’ time but are delivering cash flows today – and they’re on the other side of the spectrum. So 12 years’ interest rates have fallen in real and in nominal terms, and over this period values continue to underperform.

RYK VAN NIEKERK: But I think many analysts and investors and fund managers think that we will have low interest rates for years to come.

JOHN BICCARD: This is where it gets very interesting. Obviously we are value investors; we are looking for a turn in the cycle, so you have to take what I say from where it comes. But there is an interesting thing that is happening in the world at the moment. You’re 100% right that real interest rates have to stay low for a number of years, because the debt in the world has grown to like 280% of GDP. In essence, the globe is basically bankrupt. We were nearly bankrupt in 2008 and we built up more debt, and then Covid came – and the debt levels are through the roof. Central banks cannot allow interest rates to go positive in real terms. We are going to have negative real rates for many years to come, but there may still be a rise in nominal interest rates.

What I’m saying is there’s a chance, a really good chance in my opinion, that inflation is coming; we will still have negative real rates, but nominal rates will go up. And that would be good for value. What really matters to value are nominal rates, not so much real rates. So what central bankers really want to happen from this point is they want to create inflation, the only way out of 280% debt-to-GDP. We can’t save our way out from this position. They have to create inflation and inflate away the debts.

In 2008 they printed all the money, but no inflation followed. This time round the money has been printed but, because Covid has been so severe, the money has gone into the banking system, because a lot of corporates basically ran out of cash or the debt was too high, and they drew down all this emergency amount of debt in the last six months. So the central banks have printed the money. In 2008 the money didn’t go into the banking system, but today the money has gone into the banking system because of these emergency drawdowns of debt. And that is how, if you print money and the money doesn’t go in the monetary system, no inflation will follow. It has to go towards the banks, because it’s the banking system that creates inflation because they’ve got the fractional reserve system and they create money when the money goes into the system.

So, this time round, there is a real chance of inflation. And in essence, if you want to invest in value investing, you have to believe inflation is coming, which is something we believe.

RYK VAN NIEKERK: It’s a very interesting perspective, but it won’t happen overnight. It can happen over a period of time. Is now the time to start looking at value funds as opposed to some of the more momentum-driven funds?

JOHN BICCARD: Well, I would say it will take some time, but it may only take a year. We’ve already had six months of the money going into the system; actually it’s quite interesting because, if you look, the market that really counts here is the US market. And if you look at the last two months’ inflation numbers, both of the last two months’ inflation numbers were significantly ahead of expectations. So, in actual fact, two months ago the month-on-month increase in inflation in the US was the largest month-on-month increase since 1991. So this is not something that’s just in my head. In the last few months inflation numbers, off a very low base, have actually beaten expectations quite a lot. So it’s all this money coming [into] the system.

And there’s also another thing that is being created – which is that, because of Covid, the world of free trade has been disrupted. So one of the reasons why inflation has fallen for 30 years is that global trade has increased, and it’s been easy to trade across the world. And that has enabled prices to normalise and to come down across the board. Now, with Covid, a lot of ports are shut and it’s quite difficult to transfer goods and people across the world, and that’s causing some blockages in the system, which is causing high inflation as well.

So you’re right. It may take a year or two, although it’s already been six months and there are a few signs, but I think the most important thing to remember is, if there is any inflation that comes, the market is totally unprepared for it. I mean, if you look what we’ve spoken about in the last five minutes, the market does not expect that to happen at all. I mean, there is no way that the Nasdaq can be at 11 000 when people expect some inflation to come, because those stocks will be the most vulnerable if there’s inflation, because those stocks are priced off a bond yield of 0.5% in the US, the 10-year bond yield of 0.2%.

If there is suddenly inflation, if that goes up 1% or 2%, and the bond yield goes up from 0.5% to 2%, the number one asset that is at risk is long-duration stocks like Tesla or Apple. For these stocks that are trading on 0.5% dividend yields and 30, 40, 50 times earnings, if the bond yield rises from a 0.5% to 2% those are the shares that will really fall. So, if you look at [the] Nasdaq, and you look at value stocks across the world, there is no expectation that there is any inflation. This will be a big surprise to the market.

My advice to people is you need to think if you’ve got a 100% of your money in long-duration stocks – be it quality, be it healthcare, be it tech – you need to start looking a little bit on the other side of the coin. So maybe this is a time not to have 100% in long-duration growth stocks, but to look at these bombed-out inflation hedges which you find in value funds.

RYK VAN NIEKERK: What is on the other side of that coin? Can you talk about these inflation hedges in some more detail?

JOHN BICCARD: There are two basic areas, and in the Value Fund we have lots of both of them. The first one is commodities, and principally precious metals. All commodities will benefit from high inflation. But what we really like are precious metals, which historically have shown the best protection against rising inflation, and here I’m talking about gold, where we’ve got 30% both locally and internationally, on average, between the two funds in gold, and we’ve got about 10% in platinum. So 40% of the fund is in precious metals, and that is a place to look now. Obviously precious metals have done pretty well; though, on a 10- or 20-year view, they really haven’t done very much at all. In the last year or two they’ve done a lot. But we are still hanging onto that position.

And then the second part is you need to find old-economy assets that have large asset bases that are depreciated asset bases, and which are exposed to a broader level of the economy, where a high inflation number will help their earnings. So I’m talking about infrastructure, steel, cement – these sort of businesses. Cement may be the best example. Cement shares globally have done terribly because they’re old-economy stocks, and you can buy a global cement company on a 4% or 5% dividend yield.

But if inflation comes, it will not benefit the tech stocks; it will benefit the cement shares because suddenly the top line, which has been growing at 2% or 3% suddenly will be growing at 4% or 5%.

And when suddenly your revenue line is growing at 4% or 5% because they’re jumping inflation, and you’ve got this big depreciated asset base, where there’s no change in the costs, the profits instead of growing at 5% suddenly start growing at 25%. The short answer is precious metals, and then most of the bombed-out shares that you’ll find in a lot of global value investors, of which a lot are infrastructure and old-economy stocks.

RYK VAN NIEKERK: It’s interesting, because you own mostly shares in gold and platinum companies, but not the actual metal.

JOHN BICCARD: Why not? I’ve never really understood people who say: “I like gold and platinum; I buy the physical.” If you’re going to be right about gold and platinum – for instance, this year, I think gold is up 25%, but most gold shares are up 50% or 100% – you may as well buy the gold shares, because that’s where the leverage is, unless the shares are very expensive. So if I put the current gold or platinum or PGM [platinum group metals] prices into a model, and I see what sort of earnings these companies are earning, then I suddenly see these shares are trading on 15 times or 20 times earnings, then there’s a case that maybe you should buy the physical metal rather than the shares. But the truth is, at spot gold, you can buy a whole basket of gold shares on 12 PEs [price-earnings ratios] and, if you put the platinum group metals at spot, you can buy a basket of platinum shares for about five times earnings.

So that tells me that the market doesn’t really believe that gold is sustainable here, and doesn’t really believe that the platinum group metals are sustainable. Otherwise, why are the PEs five and 12? The warning sign about the shares is when the metals are high, like gold and platinum are – we think they’re going higher, but they are high – and the PEs are 15 or 20, then you need to be careful. But for more conservative investors, you can also buy the metals if you want to.

RYK VAN NIEKERK: Let’s talk about the South African market. If you strip out Naspers, Prosus and some of the mining companies, the market has performed really poorly over the last few years and there is a lot of value on offer. Where do you see the deep value?

JOHN BICCARD: That’s quite interesting, because we’ve also got a bit of a different take on the South African market. You’re 100% right, stripping out those shares, they say the market has basically been in a bear market for five years and has done nothing for 10 years. But there are a few points I’d make. The first point is the mainline South African shares – and here I’m talking about the big banks and the big retailers, and some of the industrial companies – came from an incredibly expensive level five years ago. And so it’s a bit unfair to say you can just shut your eyes and buy the banks or the retailers, because they’re down 50, 60% or 70% in some cases, remembering where they came from. And for some people who’ve been listening to value for some time, remember five, six years ago we kept on going, we cannot understand how South African retailers can trade on 30 times earnings, and that the price to book of South African banks can be three, three-and-a-half times.

So the first trap is you’ve got to be careful. The shares have halved, but they’ve gone from ridiculously expensive to a level where we actually think the mainline SA Inc shares are not as cheap as people would think, because South Africa has a real fundamental growth problem, a very high risk level, a lot of political risks, no growth, and an enormous amount of debt. And so what you’ve got to be careful about here is [that] the debt-to-GDP in South Africa is at 100%, and that is a real problem. So I’m saying South Africa is really bust. I mean, that is just the truth of the matter.

So you need to pick very carefully in South African shoes now, and you need to buy shares that are patently ridiculously cheap. I think you will make money, because some of them have got too cheap. But, to give you an example, a share that people might think is cheap is FirstRand, which I think has fallen from, say, R65 to R40. But FirstRand’s price to book is still 1.6 times price to book. Remember, global banks trade – some global banks are 0.2, 0.3 times book, and globally you battle to find a bank above one times book value. And yet FirstRand still trades at 1.6 times book value. So FirstRand might’ve fallen 40, 50%, but it’s gone from very expensive to a level where South Africa must still do quite well for you to make money buying FirstRand. And I’m not so sure about that.

And then, on the other [side] of the coin, I’m going to give you an example of a share we hold, which is a mid-cap, small-cap share, a share like Caxton, which is a printing and publishing company. This share has gone from R25 10 years ago to R4 today. And, at R4 Caxton has R1.7 billion worth of cash on its balance sheet – and it’s real cash that they earn interest on, so it’s not like cash that they show at the year end, it’s the cash they’ve got throughout the year – and yet the market cap is R1.4 billion. So what I’m saying is this is a company that’s trading R300 million below its net cash holdings, leave alone its plant and equipment and land and buildings, working capital, and leave alone the fact that it’s a R5 billion turnover business that, prior to Covid, made R500 million, R400 million cash flow every year, you get that, for minus R300 million. So, what I’m saying is in the small- and mid-cap arena, I think there’s some really good value to be had; that, even in a different South Africa – which is what I think is going to happen – you can make good money, even in dollar terms, buying these shares that have fallen 90%.

So we’ve got 20% of the Value Fund in small- and mid-cap shares, but we don’t hold any SA banks, we don’t hold any SA property, and we don’t hold any SA retailers, except we’ve got a small position in Lewis Stores, which is very much cheaper than the rest.

RYK VAN NIEKERK: In your fund commentary, which was published in August, you quite explicitly state that your exposure to South Africa is via small- and mid-cap companies which have performed substantially worse than local banks and retailers. Can you maybe refer to a few of those companies you’ve bought?

JOHN BICCARD: Ones like Caxton, and then there’s a little one called Novus. And then we’ve got Reunert, Oceana Fishing, Hulamin, Metair, Brait, Grindrod, Grindrod Shipping. Those are the sort of shares.

And if you look at that basket of shares, on average they are probably down 80% – on average –off their highs. And, instead of trading at 1.5 times book like FirstRand, a lot of these shares trade at 10% of book value; some of them trade at their cash value. So you are basically buying the businesses for free. In order for those shares to work, we don’t need South Africa to grow 3% for the next four years. We just need some sort of post-Covid recovery, to just some sort of normality, and these shares should do well from this level.

So that’s how we are playing it. And I think probably in the post-Covid world some of the larger SA Inc shares might have a bit of a bounce. But to me, as a deep-value investor, FirstRand is not patent value, if you hear what I’m saying.

RYK VAN NIEKERK: I’ve seen over the past year or so quite frequently that you also buy shares in your personal capacity, and take some big positions. I’ve picked up that you’ve bought into Hulamin, as well as African Media Entertainment, AME, which of course Moneyweb is a subsidiary of. Why not just invest in your own fund? Why buy these shares directly?

JOHN BICCARD: The answer is we have 5% of Hulamin in the Value Fund. We’re not allowed to hold more than 5%. In essence, for our clients we’ve bought as much as we can of these shares, and that’s all I’m allowed to buy. So I do invest in my own fund and 50% of any money I make from Ninety One goes into the fund, and I hold money in the fund apart from that. Apart from that, what I’m saying is there are a couple of shares.

And I also hold Hulamin in my personal capacity, Novus and Caxton – these shares. I’m embarrassed to say I’ve been in the market for 30 years in South Africa, and really you only get, in my opinion, a chance to buy shares like the shares we’ve been speaking about every 10 or 15 or even 20 years at such low levels. So I’ve put my own personal money in. We have very strict dealing requirements at Ninety One, so it has to be cleared by compliance. Basically I’m invested alongside the holders in the Value Fund. But when I’ve finished buying as much as I can for the clients, then I’ve bought for myself.

RYK VAN NIEKERK: That was John Biccard. He is a fund manager at Ninety One.

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Just watched Bill Evans of Westpac Australia on the Australian Budget. You can forget inflation for 5 years. Projected inflation between 1 and 2% in Australia. Limited cost push inflation – due to supply chain restructuring. Years before labour is full absorbed post Covid. No demand pull inflation.
I’d agree. Think 91 are talking their book.

Not true. 91 has many investment sub-teams with a host of different investment beliefs. John Biccard is a tried-and-tested value investor and has been for decades. He has every right to talk he’s book because that’s what he believes in, value investing.

Value is dead if you get it wrong. Have a look at top dog Perpetua.

Pragmatic, patient value.

There are worse performers out there…look at Excelsia…5 years in existence and negative returns, but still harping on being in value. Most of it is about marketing and being “different”..in the end your clients capital needs to be preserved and grown. Being active in twitter, cfa forums etc while your client suffers is where most of these managers find “value”

Never heard of them. Must be one of them BEE incubation fund managers.

Why do Perpetua and Excelsia both have Latin names?

Are they South African or from overseas?

‘Top dog Perpetua’! This is not the first time you have made a ridiculous comment re Perpetua. What’s your link to them?

7 years ago I invested offshore into Orbis. Last mistake I will make on “Value investing”. Told, be patience these investments into companies that will rebound, 2 years after initial investment

Still waiting

All is not lost…Your fees have been valuable…no doubt paying some mortgages, private school fees and nice holidays for Orbis Employees. Your thank you note is in the post.

So they should not charge fees? Do you also work for free?

There was a time ORBIS invested money in oil in Russia. I cannot remember when they did this but you know what happened to oil. They lost a lot of money and later on reinvested again in American Companies. I think you went in at the wrong time. Timing is everything. Imagine you bought when the units was at there lowest, you would be smiling.

Empirically, the Value premium has delivered handsomely over the last 100 years. It has been known to ‘disappear’ for periods in excess of 10 years, before reverting.
Declining interest rates have magnified the retina on growth stocks.
There is not much left in interest rates.
Looking at Japan, once interest rates flatten, the value premium returns.
91 May see their style return to favour, but not because of inflation.

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