RYK VAN NIEKERK: Welcome to this Market Commentator podcast, where I speak to leading investment professionals. My guest today is veteran investor Tony Bell, he is the chief investment officer at Vunani Fund Managers. Tony, welcome back to the show. When I spoke to you in March 2018 markets were in a bit of turmoil and you described it as a healthy correction at the time. It was also during the period where Ramaphoria started to fade and I think the rest of 2018 was a bit of a dog show. But since then a lot has happened in South Africa and around the world, and since January our market has bounced by about 8%, despite more negative news than positive. How do you reconcile this positive performance of the market in this environment?
TONY BELL: Ryk, thanks for inviting me on your show again. Yes, the market turned out to be a slightly healthier correction than I had anticipated and I think what went wrong in December, by way of introduction, is that the US caught a whiff of deflation. When I came back from the BTA Conference in Toronto in September 2018 there was a general upbeat perspective on the US economy; growth was strong, the labour market was strong and companies were still investing. The market had expected the Fed to raise rates twice in 2019 but inflation really wasn’t a major concern.
So I think what happened since our last discussion is the negative growth and the whiff of deflation that unsettled investors in December really caused the price-earnings multiple of our market and the S&P to be the major factor in the negative performance for the quarter.
We’ve done quite a significant amount of work on the decomposition of returns, both in the quarter and for the year as a whole, and unquestionably if you go back the derating of the market through the PE contraction was the major contributor.
So I think, with that as an introduction, to answer your question, what do I make of this market bounce?
I think a lot of the deflationary concerns have abated, the Fed has turned dovish, the dollar has stopped strengthening, the US bond market has corrected slightly upwards and I think investors have a renewed sense of optimism that EM [emerging markets] – China in particular – will engage in some form of stimulation, which will nudge growth in 2019 slightly higher, and with that the EM currencies have strengthened. The yields offered by many emerging markets have attracted investors, together with the stronger currency, and that’s really translated into more of a risk-on phase than we saw in December, where the market was decidedly risk-off.
RYK VAN NIEKERK: Political developments in South Africa are pretty interesting – we’re going to see an election later this year and we will see a lot of populist statements being made. How much notice do you take of these developments and their impact on the local market?
TONY BELL: Not a lot. I must hasten to add that I am not a political specialist by any stretch of the imagination. When I listened to President Ramaphosa’s State of the Nation [address] and Minister Mboweni [delivery his budget speech] on Wednesday, I’m starting to see encouraging signals.
I don’t think that I in my lifetime expected a president in South Africa to talk about preparing for the fourth industrial revolution – this is normally the prevail of dinner party conversation in high society in Europe. If you have a look at the work that has been done around the so-called fourth industrial revolution, it really talks to three pillars: it talks to energy sustainability, it talks to technology, and it obviously talks to the way in which the world around us is shifting from a consumer and behavioural perspective.
I was really encouraged when I listened to President Ramaphosa in the way in which he introduced the conversation, as well as Minister Mboweni, introducing the conversation around the structural changes that are needed. So I bring that up really as providing some context for the listener against the very emotional debate that often happens around the populist and political rhetoric, particularly at a time of electioneering.
I think we need to take our lead, as I have often indicated, from the markets. We’re in a little bit of a post-budget euphoria at the moment but we do have some hurdles to cross. Moody’s is a big hurdle in late March, and that might create a very strong headwind for the politicians in order for them to be able to have the basis for implementing the changes that are needed.
So I think both President Ramaphosa and Minister Mboweni are trying to walk a fairly fine line between appealing to an electorate that is kind of stuck in the past and a country that needs to move forward into the future.
RYK VAN NIEKERK: Let’s talk about the local market. Vunani has two equity funds, one active and one passive. Why do you have both options?
TONY BELL: Well, that’s an interesting question; the passive equity fund really is part of the historical evolution of the business. Before we were Vunani Fund Managers we were Peregrine Quant, and we had developed quite a significant capability back in 2002 in what is now commonly referred to as smart beta products, and that capability still exists but the market by and large has looked for active equity in the bull market of 2009 quite logically and so we find the two sit comfortably side by side. There’s obviously a cost advantage of going into more passive or beta-style products, and the active equity fund, I am pleased to say, has done reasonably well.
Top 10 holdings
RYK VAN NIEKERK: Tony, let’s talk about your actively-managed equity fund, it’s a very interesting one indeed. If I look at your top holdings, Naspers is right at the top, it represents 8.8% of the total portfolio value. Naspers, of course, is currently unbundling MultiChoice – what are your views on Naspers?
TONY BELL: I think Naspers has gone through the logical phase of expansion and consolidation, I think it’s still very much in the consolidation phase but we’re starting to become a lot more encouraged at current price levels, as if the market is not overexcited about the future growth that the company can deliver.
If you look at the scale of Naspers and the extent to which it’s gaining in traction in China, there is still quite a large economic base that can be monetised and tapped. So from both the global fund that I run and the domestic equity fund we see a natural crossover into that market, where, as China starts to initiate a reflation policy through the course of 2019, that entire ecosystem should improve as a result of the focus moving away from the contraction of credit in the economy towards policies that induce more consumer spending, and Tencent is well positioned to monetise that as we go forward. It is still one of the top three technology companies in Asia and I think, subject to the ongoing tussle between the US and China resolving itself adequately, we could find some of the growth start to be renewed in that market.
RYK VAN NIEKERK: The rest of the portfolio is also interesting – at number four is Vodacom. Now Vodacom hasn’t performed well in recent times, it’s down close to 30% over the past year. Why do you like Vodacom?
TONY BELL: Well, it’s one of those interplays between a nice high dividend yield in the market, where opportunities are scarce. The dividend yield and the ability of the company to deliver or generate cash to pay dividends has been quite attractive and particularly in both our multi-asset fund and in the domestic equity, we’ve looked to anchor a portion of the portfolio in, I guess in what one would just call boring high dividend yield stocks, as it has the ability to sustain the dividend yield and anchor the return. Part of the benefit has been to reduce some of the volatility in the portfolio but also to try and produce cash-like returns in a market where earnings growth was certainly not assured.
RYK VAN NIEKERK: Looking at the other top holdings, you are quite heavily invested in the banks – Standard Bank, Nedbank and Absa make the top 10. I know it’s one of the sectors that has always been mooted as one that offers value, but why do you have three banks in there?
TONY BELL: With the banking sector we try and get an entry point into different aspects of the financial services sector through the different holdings. Nedbank, for example, is more exposed to the corporate market. Standard Bank a little bit more to the consumer and penetration into Africa and other EMs. Absa really is a restructuring story around the potential to unlock some of its price-to-book relative to its competitors. You’ll notice an absence of FirstRand in the top 10 holdings, and it’s exactly the combination of the three that you’ve mentioned that gives us the broader coverage without exposure to theFirstRand Group, which we have always seen as a little bit on the pricey side, as with Discovery.
RYK VAN NIEKERK: Moody’s was not too impressed with the budget and South Africa’s fiscal position, of course they are the only ratings agency that still rates our international currency and debt as investment grade. Are you worried that we may see a downgrade this year and if we do, what do you think the impact will be on equity markets?
TONY BELL: Yes, I think it’s important to step a little bit into the technical aspect of Moody’s downgrade.
Moody’s itself really has to do one of two things for the rating to downgrade. If I look at the methodology, one of the following has to happen: it has to double-downgrade economic strength or it has to double-downgrade fiscal strength – it’s an ‘or’, it’s not an ‘and’.
I think while both President Ramaphosa and Minister Mboweni have gone a long way to addressing some of the concerns that Moody’s has expressed, I’m not sure, given the forecast that was presented in the budget, that Moody’s may be convincing us of the economic strength going forward. The fiscal strength has improved but by both metrics both are lower than they were at the time of the medium-term budget framework and so it’s hard to call like these things are to call, but it might tip Moody’s in the direction of moving to a lower rating with the consequences for South Africa being fairly unpalatable. I don’t think we can discount it as a zero probability but I wouldn’t put it as much as a 50% probability because of the methodology of needing a double downgrade on either.
So it’s a very difficult call, it’s very much at the margin at the moment. I have listened to commentators on Wednesday and Thursday and I don’t think any of us really know. I think it would be a best-guess estimate at this stage. Those discussions still have to take place, we don’t know what the outcome would be but if it did happen it would probably not be the best outcome that we could get at this time.
Actively mitigating risk
RYK VAN NIEKERK: Are you actively trying to mitigate that risk?
TONY BELL: Well, I think in the last six months every fund manager in town has been trying to actively mitigate a range of risks. In the multi-asset portfolios we run we have obviously got quite a lot of offshore exposure. In the global equity fund that I run I’ve recently switched a lot of rands into dollars and a little bit into pounds. Into the underlying investments one wants to make sure that you don’t sit with any potential blowout and credit risk spread, so we’re looking at all aspects of the portfolio.
I think, given the progress that’s been made, both in the budget and in the State of the Nation, it would be an unnecessary development if Moody’s did decide to downgrade because I think at this stage the balance of probability shows a structural change, reallocation of capital decisions and the renewal of the prospect of high confidence in investment. So if it did come at this stage it would be an unwelcome development.
RYK VAN NIEKERK: Tony, your global macro fund performed really well, you’ve won a few raging bull awards, congratulations on those. Currently we are seeing interesting developments offshore and especially in the US, where this fund has a lot of exposure. Tell us about this fund and what your philosophy is behind it.
TONY BELL: Ryk, thanks very much for the kind words. The fund was started about six years ago really as a result of demand from local investors who wanted a bespoke focused offshore fund and the clients in the Vunani suite of segregated funds that were looking for offshore exposure.
My primary focus here is to pick a portfolio of up to about 35 stocks, looking at the top 250 stocks in the world, and I really do it on a simple basis of trying to understand how companies may improve their earnings growth at present and into the future. So the approach is very much a bottom-up fundamental one where I try and understand how the earnings growth of the company might change and how much of that is captured in the price. As you can see from the fact sheet, the top 10 holdings are not particularly unfamiliar. At the top we’ve got companies like Procter & Gamble, Mastercard, Amazon, Boeing, Starbucks and Adobe, so they really are high quality investments with about 25 to 30 stocks in the portfolio that give the investor global coverage at a very modest price in South African terms.
RYK VAN NIEKERK: The asset allocation is also interesting – 65% in foreign equity, as you would expect, but then around 35% in cash, of which 20% is offshore. Where do you park the cash and what are your yields on those investments?
TONY BELL: We’re both discussing the January fact sheet. Being a flexible fund, one of the benefits that I’ve got is I can move very quickly and very dynamically between equity exposure and cash. What I started to do in October 2018, following the conference we were speaking about earlier in the interview, is I took the fund to nearly 40% in cash. Some of it I actually brought back into rands and I matched the dollar exposure with equivalent rand exposure. The fund benefitted nicely from that because I parked that money, so to speak, in South African NPV (net present value), picking up a very nice yield, plus the currency gain. But I’m back up at about 80% equity invested and while the fund itself benefitted significantly from not having significant drawdowns during the fourth quarter of this year, I’ve now picked up and benefitted from the rally that we’ve seen in the S&P since around late December last year when the Fed changed its position.
RYK VAN NIEKERK: But that’s a pretty aggressive change in the portfolio, how often do you actually change the composition and the asset allocation within a fund?
TONY BELL: Ryk, the short answer is not often but I do move quite aggressively when the market indicates a very strong risk-off position. I do it by both adjusting the cash weighting but also adjusting the position sizes of the stocks in the portfolio. So in a typical upcycle in the market my top positions would be between 4% and 6%. You can see from the January fact sheet that the top positions are between 2% and 3%. So I have significantly reduced in the last quarter of last year my active risk in the portfolio and I think that was consistent with both the macro environment change, as well as the volatility we were going through. It is a feature of the portfolio to be flexible and I think once one has given that mandate, although it is difficult to affect market timing decisions, I try and do it through progressively managing my risk positions in the portfolio and whatever cash results as a consequence of that is an end result, not an objective.
RYK VAN NIEKERK: Thank you, Tony. That was Tony Bell, he’s the chief investment officer at Vunani Fund Managers.