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 Shaun le Roux, he is a fund manager at PSG and he has been one since 1999 so he’s seen a lot. And he currently manages the PSG equity fund as well as the PSG flexible fund. Shaun, thank you so much for joining me. We are in lockdown and you are at the office. What does that say?
SHAUN LE ROUX: Apparently it says I’m a part of the essential services, but, currently looking at the market maybe I wish I was in lockdown on a desert island.
RYK VAN NIEKERK: So what are you looking at? We are seeing a lot of volatility. Is that just noise or does it send a message?
SHAUN LE ROUX: Look, we’ve gone into a very uncertain world and in many respects, we’re in unchartered territory. If you and I had been having this conversation literally a few weeks ago, it would have been very different. But I think what we need to acknowledge is that we are seeing a very, very pronounced economic shock on the demand side globally and in South Africa. The market’s really struggling to price what that means. We don’t know what the next few weeks and months hold. So everyone’s grappling with the same issues. There’s very heightened fear obviously at an individual emotional level, but also from an investment perspective and naturally one should expect opportunities to arise in that environment. But everyone’s trying to make sense of everything. And you know, the asset managers like ourselves are looking at our investments and trying to assess whether they still good investments and just really trying to be focused on what are going to be the best investments in this kind of environment.
RYK VAN NIEKERK: That is the narrative, of course, that is also the advantage of having an active fund manager, an active manager because you can do things. Are you actually actively doing things? Are you changing the portfolio to try and mitigate some risks?
SHAUN LE ROUX: Well, we have a very disciplined process through which we look at all the stocks in the market, our 3m process that many clients will be familiar with. So what you shouldn’t be expecting from us is any kind of big philosophical departures. But we do believe it appropriate under the current circumstances when, if you look at what the weeks and months ahead hold, there’s a case to be made that it’s, in the case of some companies, there’s going to be very large permanent impairments in value. And in the case of other companies, there won’t be a permanent impairment of value. But we’ve seen these massive drops in share prices. So what we would be doing is, is in a very disciplined fashion going through both the stocks we own and the stocks that we don’t own and trying to make sure that our portfolios are appropriately positioned for the current set of circumstances. And what that means is we are tilting our funds towards companies which have an inherent resilience that the market is not thinking about at the moment, but importantly that are priced for Armageddon. And, uh, we think the current environment is very, very conducive to that. But on the flip side is to be open to companies where there is the potential for, uh, impairment of value, where there is some vulnerability that the share price is not compensating you for. So on the margin, uh, we definitely shaping our portfolios towards the stocks that we like that are incredibly cheap and we think that the market is missing the resilience that will come through in time.
RYK VAN NIEKERK: So you are actually buying in this market. Can you tell us which shares you are actually buying and where you see the value?
SHAUN LE ROUX: Yeah, I mean, again, I won’t [talk] too much about which shares we buy, but I think when you see these kinds of share price declines, there must be incredible opportunity within that. We run a global process, so we’re looking globally and what we are really looking for is companies where the economic impact is on a through the cycle basis, is likely to be a lot less than what the share prices have told you in the last few weeks.
So a good example would be an Anheuser-Busch, you know, the brewing company is listed on the JSE. Um, we see no reason why the value of this company should be permanently impaired and I see no reason why the profits next year should not be in line with where they were last year. Um, and yet the market by virtue of both backed the fact that people would be drinking less beer this year. And also by virtue of the fact that they do have some debt on the balance sheet, which we think is actually incredibly well structured, uh, the market would be panicking in a, in a stock like that. So we see that it’s a great opportunity to buy high-quality business at an exceptional price.
RYK VAN NIEKERK: Are you looking at the so-called SA Inc stocks? Because we are probably going to enter a very protracted recessionary period, probably a deep recession. Are you looking at local stocks in that context?
SHAUN LE ROUX: Yeah. Unfortunately, we came into this, this Covid experience owning a lot of SA Inc stocks and they’ve had a tough time as you know, as I suggest upfront there will be vulnerabilities. But at the same time, just like the example I used of Anheuser-Busch there are going to be domestic companies where the value won’t be permanently impaired, yes, earnings are going to take a big knock. But we’re going to be buying those companies at generational opportunities.
So we equally excited about the opportunities on the domestic front. But at the same time, there will be companies where debt levels will increase materially.
And yeah, when that happens, it can have the propensity to wipe out some of the value attributable to equity holders. So we have to walk carefully, but on behalf of our clients, we absolutely must be harnessing opportunities both abroad and locally. And you know, this is the kind of environment in which the next bull market is created.
I can’t help you with when and from what level, but I can tell you that there are exceptional opportunities out there.
RYK VAN NIEKERK: That’s always the case when there is some turmoil in the market, but some of the fundamentals in South Africa are changing. We are seeing an aggressively lower interest rate environment. I don’t know how sustainable that is. We are also seeing the Reserve Bank starting to enter the bond market to try and inject some liquidity into the market. Do you think that will have a long-term impact?
SHAUN LE ROUX: We think it should. I mean there’s a lot of noise at the moment and what you’re seeing is an unprecedented policy response globally, uh, both from governments and central banks. And they’ve moved well beyond monetary policy into the realms of fiscal intervention as well. And that is happening in South Africa as well. But the issue we’ve got locally as we came into this crisis within a much more fragile position than certainly the developed markets, which makes it trickier here. But that said, uh, we think one does need to be cognisant of the fact that we do have a lot of room to cut interest rates. And we’ve seen last week’s move already.
And I think that will just be the first of more to come if we look at just how steep, uh, you know, our bond curve is, and the Reserve bank coming to the party. Uh, just to make sure that if the market’s panicky from a liquidity perspective, things don’t come unhinged. Uh, it’s an environment where there’s a lot of fear, and if you look into some of the fundamentals, and as you reference interest rates coming down, and I talk about the fact that our bond yields have spiked, um, it’s an environment where prices are starting to reflect, uh, a very, very bad situation. And if we move beyond the panic, I think we’re gonna almost certainly look back and say there was, there was great opportunity within that.
RYK VAN NIEKERK: That is very interesting. Let’s look to the US, they have their own problems at the moment, but they are throwing a lot of money at that, at those problems. Do you foresee the US being able to overcome the challenges the virus brings?
SHAUN LE ROUX: Again, I think to make predictions here is dangerous, but what we can observe is that there’s a very, very big hole that’s being, uh, left by this massive retrenchment and demand from both a corporate and consumer perspective. And there the government seems to be prepared to plug the hole by spending. So I think one should expect, as a consequence, that once we’ve seen the impact of the virus, um, hit its peak and remember the markets will typically, turn before then, what you’ll see is your environment, which is set up for significant reflation. So we would expect the policy and interventions to have a dramatic impact. And
we also think that investors need to be really, really cognisant of the impacts of the inflationary exercise of this or reflationary exercise of this magnitude.
And you know, one of the questions we are often asked is, you know, the value stocks have underperformed for more than a decade now under what circumstances do cheap stocks start outperforming expensive stocks. And, uh, we would make an argument that in an environment where you are throwing a lot of money at your economic problems and significant reflationary exercises are underway, because it’s quite a fertile ground for, for value stocks and it’s something we should be taking notice of.
RYK VAN NIEKERK: How have your clients responded? Have you seen outflows? Have you seen people who assume there would be opportunities coming into the market? How did your clients react?
SHAUN LE ROUX: You know Ryk, I think everyone is so shell-shocked. I think everyone over the last few weeks has reacted a bit like a deer in the headlights and it’s an incredibly difficult environment to be making decisions in terms of what to do with your investment portfolio. So there haven’t been significant moves. But what really, really worries us is when clients are sitting in lockdown over the weeks ahead and start getting their statements on how their portfolios [are performing] and it doesn’t matter pretty much where you invested in March and often investors would have the tendency to panic under those circumstances and that really troubles us.
Because what we look at is, when we look into the market, we’ve seen a very, very dramatic drop in share prices. And we think if clients panic now and capitulate like a lot of them did towards the latter end of 2000 and 2008, it can have very, very dramatic negative implications for your long-term investment return.
So our strong advice is to try and stay calm under these circumstances, not to knee-jerk in any shape or form.
And as I suggested, the opportunities will arise and, and this kind of environment will sell the seats for the next bull market.
RYK VAN NIEKERK: Yeah. But it’s easy to say, many people have life savings entrusted to many fund managers and you see a hell of a lot of capital erosion currently. It is natural to say, listen, why don’t I just sit on the sideline, I can get a real return even at the interest rates we are currently seeing. Uh, it is difficult to do is a lot of behavioural psychology going on here.
SHAUN LE ROUX: And that’s exactly the case. So, uh, all the empirical evidence shows you that if you behave on the back of some of those behavioural traits, and if you do fall foul of, of your emotion, your investment returns suffer as a consequence. And our key point here is that we say yes, we see some cases where values in the stock market had been permanently impaired or will be permanently impaired. But if you look at them, what the share prices have done, we think it’s almost certainly the case that in many, many cases, in fact, most cases share prices have overreacted. And if you going to run to cash now and the market stages their recovery that capital that you’ve permanently lost, you don’t give yourself the chance of recovering that. So yeah, our advice is to stay calm.
Our advice is to invest with trust, with fund managers you trust.
Um, and we don’t think you will serve by a knee jerk response in the current circumstances
RYK VAN NIEKERK: You only realise the loss when you sell. On several of our shows over the last week or so, we’ve spoken to some senior economists and many of them predict a very, very deep recession, a prolonged recession, some even have used the word depression and that will have a long long-term effect on the South African economy. Now the stock market is not a barometer of the economic environment, but how do you think local stocks should perform in an environment like that?
SHAUN LE ROUX: Yeah. As you suggest that the South African economy has come into this environment with fragility. And that is something to be significantly concerned about. But you referenced some of the mitigating factors. I mean, the fact that our currency can give us some breathing space in terms of weakening. You also mentioned the fact that interest rates have been cut sharply. All prices are extremely low and it’s an environment in which some of those structural reforms might be able to be pushed through. So yes, it’s going to be really, really tough going. Um, but I think it’s a case of battening down the hatches at being invested in the right places and being patient and good things will come.
But I’m not for one moment suggesting that the next, next few months aren’t going to be incredibly difficult for all of us. But for those of us that are looking into asset prices and stock markets, uh, the stock exchange is quite good at pricing a lot of that. So I think we need, we can’t look at the economy or the months that lie ahead. In the absence of looking at what’s priced into individual securities.
RYK VAN NIEKERK: So if you are in the market, sit on your hands, what do you recommend? If someone else they have some cash in the bank, do you think you should enter the market at these levels?
SHAUN LE ROUX: I certainly think you need, I think prices are low enough, the sentiment is poor enough. And every time in history when you’ve had that combination, it’s been a very good buying opportunity. It could feel uncomfortable for a while, prices could decline further. Uh, but we think people that are in the fortunate position to have cash, and a lot of our funds have been sitting with cash for exactly that reason. Uh, this is the kind of environment in which we think you need to be thinking about employing that cash.
RYK VAN NIEKERK: Shaun, thank you so much for your time. And good luck with the rest of the lockdown and hopefully you’re not at the office too often.
SHAUN LE ROUX: Same there Ryk. Thank you very much.
RYK VAN NIEKERK: That is Shaun le Roux. He’s a fund manager at PSG and he currently manages the PSG equity fund as well as the PSG flexible fund.