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‘Rate rise may boost share prices’

Deon Gouws on Credo Wealth’s London positioning and why a US Fed rate-rise may bring normality to markets.

RYK VAN NIEKERK: Welcome to this market commentator podcast: Moneyweb’s weekly podcast where I speak to the leading investment professionals. Today we speak to Deon Gouws, chief investment officer of London-based Credo Wealth.

Deon, welcome to the show. You are based in London and Credo also employs many other South Africans or ex-South Africans. It was founded by Roy Ettlinger, who hails from Johannesburg. Tell us more about Credo … do you regard yourself as a South African company in London?

DEON GOUWS:  Hello, Ryk. Thank you very much. It’s a pleasure to be on the show. To answer your question about Credo, we see ourselves very much as an international business. We have a bit more than 70 staff today: 50 of whom are in London, about 15 in Geneva, and a handful of others around the world, most of whom are in South Africa. We have four or five colleagues in South Africa in a client-facing capacity. The business was founded by South Africans, as you mentioned, in London about 17 years ago. Today a number of the senior people are still South African, but increasingly the personality of the business is becoming more international, more English, if you like. In my investment team, for example, out of about eight or nine people, there are only a couple who hail from South Africa.

RYK VAN NIEKERK:  Do you regard yourself as a niche asset manager because in South Africa there seems to be massive competition between such players? And we’ve seen some very successful listings of a few of them – Anchor Capital and Sygnia are just two examples.

DEON GOUWS:  Ja, I guess to some extent you can describe us like that. We describe ourselves as a fully developed wealth management business. If you go back to the founding that you referred to 17 years ago, it was largely a stockbroking business at the time. From there it has evolved into a few other fields and therefore we are an integrated and diversified wealth-management provider today. We take our client service and the relationships there very seriously. And I think what’s important is that we partner with a lot of people in South Africa, a lot of smaller IFA businesses, some larger ones, even some institutions. So we do not compete on the ground in South Africa with any of those firms, which means that we can partner with a number of them.

RYK VAN NIEKERK:  You were at Rand Merchant Bank and Sanlam before you moved to London. Do you think there is an mindset difference between London and South Africa?

DEON GOUWS:  It’s a tough question to ask. Just to mention, my date at Sanlam was in fact in London as well. So I lived in London before then, and moved backwards and forwards a couple of times. But that’s all history now.

In terms of different mindset, I think to the extent when you sit in London the world is your oyster and you have an international outlook. You have the London Stock Exchange. The typical large company listed there is a very international company, but not really a British company any more. So to that extent there is maybe a slightly different mindset. There’s a much bigger opportunity set, and that’s the way we look at the market. But if you meant by your question the way people look at investments, the level of professionalism that, say, is the way one analyses the companies – that I think is not that different. And I think South Africa has a very strong industry.

RYK VAN NIEKERK:  Let’s talk about markets. We are currently seeing a lot of liquidity in the markets, and this will be reduced when the US hikes interest rates. Are you worried about this? How do you see the value on the different markets – US versus Europe, versus China?

DEON GOUWS:  I think there are a couple of questions in there. Firstly, I’ll answer in reverse order, if you ask about value we’ve been at pains for the last couple of years to point out to our clients, at conferences and one-on-one conversations and in some of the things we write, that markets simply have been relatively expensive. So if this is your stating point, if you get a large amount of cash all of a sudden and for the first time you are going to invest in markets – this is trite to say – this is not as good, as attractive a starting point as it may have been three or four years ago when PEs were significantly cheaper, etc.

So from that perspective I think one has to realise that, even if you ignore the noise – the volatility and some of the downtrends we see from time to time – even an optimistic scenario for the next few years is relatively muted at times. Perhaps high single digits if you do a good job, if you are a bit lucky. But double-digit returns, 15% compound for the next three or four years, is just mathematically and statistically quite improbable because markets are relatively expensive. Of course, they are slightly cheaper now after the volatility we’ve seen for the last couple of months but where they are today we’ve made most of that ground back. They were not cheap to begin with. That’s my answer on the valuation.

Then you ask about interest rates and the Fed and liquidity. I think time will tell exactly what the Fed does, clearly. We’ve been in the school of believing that interest rates are likely to be lower for longer. I’m prepared to stick my neck out slightly and say even at the next meeting of the Fed and for the next couple of quarters I don’t think we’ll see a rate rise. I may be wrong and at some point I will be wrong. If I keep on saying this I will be wrong at some point, by definition. But the day that I’m wrong, which will come – time will tell when – beyond that I don’t think we are going to get a very steep path in interest rates going up. I think it’s something that will happen, but after that it’s likely to be quite muted. It won’t be a rapid rise in interest rates.

And then to answer your very first question – are we worried about it? We are not. I think the first rate rise is largely in the price. When it comes the markets may go up, because one may be relieved and say normality and sanity is returning to the market, let’s do business.

RYK VAN NIEKERK:  Let’s talk about your flagship portfolio. You call it a portfolio. It’s the Best Ideas Portfolio. Firstly, what is the difference between a fund and a portfolio?

DEON GOUWS:  These are managed portfolios, which we manage for our clients in their names. So basically what it boils down to is if you became our client and opened an account and transferred some cash – typically the clients are slightly larger than the typical fund client – we will take that money that we had in your name at the custodian and buy a portfolio of stocks in your name. So when you have a fund you only essentially have one structure, as a manager, which you buy and sell the shares in, and people can buy into that structure or sell out of the structure. It’s called buying and selling units. In our case it’s buying the shares in your own name.

RYK VAN NIEKERK:  It is your flagship fund, as I’ve said. What is the investment philosophy and how big is the portfolio?

DEON GOUWS:  The portfolio has been going for nearly five years now – it will be five years in April. There’s approximately $300 million in the fund, and the philosophy is a very old-fashioned, down-to-earth investment philosophy. We like to believe that we invest in this product in the same way that a private client would be investing his or her own money if they chose to do so themselves.

So we focus on what we know and what we understand. It’s diversified, because one has to do that from a risk point of view. But it’s also concentrated. So we only have 29 investments open in this portfolio. We don’t have 30 or 40, as a lot of products like this may have, so it’s relatively concentrated. We focus on things like valuation and value, but also the yield of the portfolio, transaction costs and the like. As I said, it’s a fairly old-fashioned approach. It’s a stay-rich portfolio, rather than a get-rich-quick approach, and that’s the way we’ve always done it and will continue to.

RYK VAN NIEKERK:  Well, what are the larger or the main underlying counters within this portfolio?

DEON GOUWS:  … it’s a concentrated portfolio with only 20 stocks and one of the principles in terms of how we manage it is that it’s actually equally weighted. So a new client who comes in tomorrow will get our 20 stocks, the current version of the portfolio, and he or she will get them in equal proportions. So it will be 5% each. Clearly, from the perspective of a specific client, who may have become a client a while ago and to the extent that we haven’t rebalanced, in that client’s portfolio when they look at their exposures, the answer to your question will simply be that the best performance will be a larger exposure today than the weaker performance. But that will be a client-specific sort of reality, depending on when the client came on board.

As I say, that’s one of the differences between a fund and a portfolio, because in a portfolio you’ve got the shares in your own name. Two clients who came in at different points in time will have the same exposures, but they will have slightly different performance, depending on the starting data and also therefore slightly different weights.

RYK VAN NIEKERK:  So you buy the same shares for all the clients, but in their own portfolio. What is the minimum amount of money you need to invest in this portfolio?

DEON GOUWS:  It’s a fairly low amount of money for this proposition in terms of the world of wealth management. The answer is $150 000 or £100 000. Bear in mind then you get your own portfolio in your own name. The reason, by the way, why we chose those minimums is not simply because we want to be difficult and get rid of smaller clients. We are happy to take any client’s money in terms of helping them fulfil their financial objectives. However, in the way that we manage it, if the portfolio was smaller than this, if you take $150 000 and divide it by the 20 stocks that we are going to do, always when you buy and sell a share there are transaction costs. And some of those transaction costs are in fact fixed costs, regardless of how big or small the transaction is. So we’ve essentially done the work and come to these numbers, these levels I’ve just mentioned, because under that it simply won’t be cost-efficient for the client for us to manage it in the way that we do.

RYK VAN NIEKERK:  Just back to shares, what shares are the most prominent in the portfolio?

DEON GOUWS:  Well, I sent you a copy of the 20 stocks. If you look at the portfolio today, there are some there which I think a typical South African may not really have heard about, and some very boring names, some of which we’ve had for a while and they’ve done very well. We have, for example, a company like AutoZone, which is a commercial distributor of auto parts in the States. It’s really a simple model. If you drive across America and you break down somewhere in the Nevada desert, they will get a part to you within 24 hours. We bought this company about two years ago and it’s gone up probably about 70% since we bought it. So that’s an example of fairly boring old company which has done very well for us and is today in lots of clients’ portfolios because of its performance. It will be one of the bigger exposures as well. So that’s just one example.

We, to change the topic slightly, have been on record for about the last none months or so. We had a client conference in South Africa in January – so our clients would have heard us talk about the oil story, which has clearly been one of the bigger stories for the past 12 to 18 months, and we do have oil exposures in the portfolio which, frankly, have not done well for us, given what’s happened to the oil price – and not only the decline in the oil price but the fact that it has stayed down at the levels where it roughly is today. And therefore it’s one of the weaker performers. What we are relatively bullish about going forward would be companies like BP as well as Halliburton in oil services. So we’ve got both those exposures in the portfolio as well.

And then maybe a last thing I’ll say is that we have a few shares that some clients don’t like, because they say to us that the world is changing when it comes to diets and to health and the like. For example, we’ve held McDonald’s for some time and a lot of clients will come to us and say, listen, I’m on the Tim Noakes diet, I don’t want you to hold McDonald’s any more. We think the world’s going to eat fewer hamburgers. Now, as you may or may not know, McDonald’s is trading, as we speak, at an all-time high and I think those kid of brands, those kinds of business model that can roll out across the world through emerging markets and the like – we are happy to still own them in spite of the fact that there might be a trend in yuppie world that people eat fewer burgers. I think as far as the masses are concerned McDonald’s will remain a very good company going forward for many years.

RYK VAN NIEKERK:  Do you own any companies on the JSE?

DEON GOUWS:  We don’t. We used to own Anglo American – and between you and me and I guess all the listeners who are listening to this, it was an unfortunate holding. If we could turn back the clock clearly we wouldn’t invest in it at the time and price that we did. We all know what’s been happening to that company, but also to all commodity companies in the world. Of course, when we owned it we didn’t see it as a JSE company. We saw it as a FTSE-listed company – that’s where we bought it. But yes, it’s one of the companies that we owned that are common to both stock exchanges.

SIKI MGABADELI:  What is really interesting is that when you did sell out of Anglo American you put out a special statement explaining why you took the decision to disinvest. It seems like it’s a typical conundrum for many investors – you buy a share and then the value just evaporates and you need to make the call when to get out. Can you just briefly tell us why and you decided to get out, because many people regard Anglos as being near the bottom?

DEON GOUWS:  Ryk, yes. Firstly it wasn’t from our perspective a special statement at the time of selling Anglo. We have a monthly document that goes to clients, which we call the Equity Spotlight. So each month – and these things are on our website – each month we talk about one of the stocks that we own or perhaps used to own, maybe a new acquisition, maybe something where there has been news flow that’s interesting, and we want to update clients. So we always talk about this. It’s very easy for investors – we also have 20 stocks in this portfolio, and other names, and dividend growth. We’ve probably got 30 names that we can pick and write something about in any given month. And it’s always interesting to write about the new deal, the exciting prospect, that sort of thing.

But when we eventually sold out of Anglos after a fairly rigorous process and some soul-searching on our part, we decided we needed to share with investors what we’d been through as an investment house and our thoughts at the time in terms of selling it. As you say, a lot of people are saying this is the bottom and, clearly, if you look at the historic share price over the last number of years, it looks like a bottom on the one hand.

On the other hand, if you look at what’s been happening n the world, if you look at economic growth coming out of China, if you look at the commodity cycle for all the base metals which are relevant to Anglos, then you have to ask the question – it may be the bottom, but how long will it be before you get a decent return from these levels? And what kind of pain might they go through before the stock really turns? From our perspective we think there is a realistic chance that the dividend will be cut. In fact, if you look at Anglos today, it is trading, I believe, at a dividend yield of something like 9%, approaching that. Now, normally when shares trade at a dividend yield north of about 6 or 7%, it doesn’t really tell you anything about the dividend. …. I may be wrong, but it looks like the dividend is likely to be cut. In addition, there is a chance they may want to do a rights issue at some point in time, which frankly is unlikely to be good for the share price. So the long-term prognosis for a company like Anglo American might be bullish, but how long is the long term? Is it months away or more years away? Time will tell. And ultimately, as I say, we made a painful decision to cut at a point in time and rather deploy that money, and we wanted to explain that to investors because that is unfortunately one of the value detractors we’ve had.

I just want to balance that by saying that we’ve had a number of other good investments for the same clients. We bought into something like Prudential four years ago and since we bought it the share price has doubled. I mentioned the AutoZone example earlier. So in the end, as long as your good calls outnumber the bad calls, you are likely to add value to client portfolios, but unfortunately this was one of the ones that we did sell.

RYK VAN NIEKERK:  Thank you Deon. That was Deon Gouws, the chief investment officer of the London-Based group Credo Wealth.

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