We’re looking for 12% to 14% three-year returns from here

From a growth perspective, it seems we’re now into an upward-trending business cycle, which would be quite positive for equities going forward: Shoaib Vayej of Afena Capital.


RYK VAN NIEKERK: Welcome to this market commentator podcast. My name is Ryk van Niekerk and my guest today is Shoaib Vayej. He is a senior portfolio manager at Afena Capital. Shoaib, welcome to the show.

We are currently seeing a lot of activity and external noise in markets – most notably in the US, where we may be at the bottom of a rising interest rate cycle and this could have a pronounced impact on emerging markets, including and especially South Africa. What do you see the impact will be?

SHOAIB VAYEJ: Thank you Ryk. Yes, events of the last week with the US presidential election certainly took markets by surprise – not just the result of the election, but the subsequent reaction by markets to that election result as well…. The end result with Trump winning wasn’t expected by most of the pollsters.

But then the strategists that we were listening to before were saying that, in the event of a Trump victory, we were likely to see markets sell off quite significantly. Estimates were about at least 5% down on the S&P. Whereas initially we may have seen that reaction in markets for the first hour or so, by the end of that day markets had recovered quite substantially on the back of some of his utterances around fiscal stimulus for instance.

RYK VAN NIEKERK: There’s a lot more risk in the US at the moment due to the unpredictability of Trump.

SHOAIB VAYEJ: Yes I would agree. So what Hillary would have guaranteed was more of the same and that’s probably why the US electorate chose to vote more in favour of Donald Trump, because he represented something different from the past. And if you remember, this all probably stems from the global financial crisis and the sort of quagmire that the world has been in with the lack of growth.

We’ve tried to the furtherest extent to stimulate a recovery through excessive monetary policy and over the last year or two there has been increasing recognition that we’ve come to the end of the road in that respect, to the most significant signal almost a year ago when the US Fed started raising interest rates for the first time. But even with the Bank of Japan as well as the ECB in Europe, there’s talk that there wouldn’t be further acceleration of monetary easing and the burden needs to shift towards fiscal easing.

RYK VAN NIEKERK: We have seen an outflow: a lot of hot money came to South Africa and the rising interest rates may pull some of that back. What do you expect will happen in the next few months and what could the potential impact be on the local market?

SHOAIB VAYEJ: Yes, there are quite a few factors at play at the moment which makes the situation quite volatile. On the one hand we have our own credit rating decisions coming up in the early part of December from two of the ratings agencies and at the same time we’ve got a potential Fed rate hike in December, which is pretty much priced into markets. A key factor is as a specific, if we do get downgraded we’re likely to continue seeing outflows and further sell-offs in the rand.

RYK VAN NIEKERK: Let’s look at the local market. It seems to be very volatile but it’s a sideways volatility and, from my perspective, there seems to be more of a downside risk than an upside risk. Do you agree?

SHOAIB VAYEJ: Just in terms of your comment on volatility, as you say pretty much sideways. But given the currency volatility we have seen, you must remember that in dollars our market has moved quite a bit.

There was quite a significant sell-off and subsequent recovery in dollars, so the rand has often cushioned the impact of the sell-offs that we’ve seen in South African assets and dollar prices are what matters ultimately.

In terms of our view of the local market, we actually think that the market is pretty much fair value at current levels so we are looking for returns in the order of 12% to 14% from here, based on some of the top-down as well as bottom-up work. However what is key for us as active managers is the dispersion within the market. So there is increased polarisation within the market where we have certain stocks and sectors that are highly overvalued and the opposite in others. So we think dispersion is quite high and that bodes quite well for active managers going forward.

RYK VAN NIEKERK: The 12% – do you expect that for this year?

SHOAIB VAYEJ: It’s difficult to pinpoint a forecast a year ahead, but that’s the sort of return we’d be expecting on average of a rolling three-year period from this point.

RYK VAN NIEKERK: And how far are we off that, currently?

SHOAIB VAYEJ: As I was saying that would be our expectation going forward for the next three years, so it would be sort of close to our benchmark return of about 14% that we expect from equities over the long-term.

RYK VAN NIEKERK: Don’t you think that is quite aggressive, given the current depressed state of the market?

SHOAIB VAYEJ: That’s what our bottom-up as well as top-down research reflects although, as I said, depending on where you’re positioned within sectors, the outcome could be quite different.

RYK VAN NIEKERK: What is your asset allocation currently? Where are you overweight and where are you underweight?

SHOAIB VAYEJ: We currently run mainly equity long-only funds, so we actually don’t take asset allocation decisions. Our main strength is our stock pickers…

RYK VAN NIEKERK: Investec announced [recently] that they are actually going long on the dollar currently which is, I would imagine, quite a predictable strategy to reduce a bit of currency risk. Would you agree with that strategy?

SHOAIB VAYEJ: If you look at the rand over the long-term, we still think the rand is quite undervalued or quite cheap at these levels. So over the long-term we should see a reversion of the rand. What’s quite interesting to me as a commodity analyst as well [is], we’ve had quite a strong rally in many of the commodities that we produce, yet we have yet to see the rand impact. I think that’s partly a reflection of what’s happening to the US dollar post the Trump victory, where we’ve seen a strong rally as well as into the potential FED hike in December, but also partly what’s happening in South Africa in terms of our own political risk and the risk of a downgrade that I mentioned earlier.

So in a way that’s quite beneficial for South African exporters and commodities companies, but I think ordinarily we would have seen a slightly stronger rand given where terms of trade are at the moment. On balance over the long-term I would say that the rand should strengthen from here.

RYK VAN NIEKERK: If you look at the JSE there are significant differences in valuations, as you’ve said earlier. Where are you seeing value?

SHOAIB VAYEJ: Currently we still – and you must remember that as I said we manage mainly equity long-only mandates, so the valuation that I talk about is more in the relative sense – and that valuation would be at the moment concentrated within the resource sector, particularly within the general miners and platinum miners where on the general mining side we’ve got quite strong cash flow yields on a spot basis, but the market doesn’t seem to be buying into those.

So as consensus starts to catch up we’re likely to see a re-rating of those stocks over time, if those prices don’t sell down in an aggressive fashion in the interim. On the platinum sector we’ve seen quite a sell-off in both gold and platinum on the back of this FED hike, the anticipation of this second FED hike. And we think that over time that that situation should normalise, especially as interest rates revert – which would be positive for precious metals including platinum. We also think that platinum prices at these levels are unsustainable, which demands higher valuations from those companies.

We’re also seeing quite a bit of value in the financial space, particularly the South African banks. Although they’ve rallied quite significantly post Nenegate, they’re still trading on quite attractive multiples in yields.

RYK VAN NIEKERK: Is there any specific bank you prefer?

SHOAIB VAYEJ: Currently we’ve got positions in all of the big four banks. We tend to avoid Capitec, which we think is quite expensive, despite its growth outlook. So it’s pretty much evenly spread amongst the big four.

RYK VAN NIEKERK: Looking at your individual funds for retail investors you have a limit of R100 000, which could be quite steep. Why do you limit the amount of which you can enter your funds with?

SHOAIB VAYEJ: It’s more just a practical consideration on our side, given that we’re not a large firm and smaller amounts would create quite a bit [of] an admin burden on the company. So it’s just more from that perspective. We’d rather have larger clients where we can cope with the admin burden, given our resources. The bulk of our assets are in institutional mandates.

RYK VAN NIEKERK: Your main retail offering is the Afena Capital Equity Fund. How big is it and what is your approach there?

SHOAIB VAYEJ: Firstly in terms of our investment philosophy we are valuation-focused, so we tend to buy undervalued companies. Our process has also been enhanced over the years, where we try to time our entry into those undervalued companies much better to avoid value traps. So we take quite a bit of consideration of both the prospects as well as the quality of the underlying investment, so that we don’t buy too early or sell too late.

RYK VAN NIEKERK: What are your main holdings in there?

SHOAIB VAYEJ: Currently if you look at our top ten holdings, one must also remember that it’s more driven by the benchmarks. Our top ten holdings would be Naspers, BHP Billiton, Richemont and Anglos, but from an active point of view relative to the benchmark, our top overweight’s would be Old Mutual, Hosken Consolidated, AECI, Netcare and Pan African Holdings. And on the underweight side, although our largest holding is Naspers, would be underweight Naspers, Sappi, Aspen, Anglo Gold and Capitec.

RYK VAN NIEKERK: There are many investors out there who are looking at the market and they’re very concerned, especially on the medium-term future of the market. You earlier said that on a rolling three-year basis, a good return would be around 12% per year. Are you concerned about the short- and medium-term outlook and the potential risks our market faces?

SHOAIB VAYEJ: As I said, I don’t think I’m that concerned now given the valuation. I think we have seen quite a sell-off in bonds lately given the changes in the US market regime, so to speak, which for us as value investors has actually been quite beneficial. So that’s tended to favour our investment philosophy and style and that’s led to some outperformance in the markets.

Also from a growth perspective, it seems that the bottom of the cycle was about a year ago, and that we’re now into quite a confirmed, upward-trending business cycle, which would also be quite positive for equities going forward. Especially some of the positions that we hold.

RYK VAN NIEKERK: So there’s not a lot keeping you awake at night?

SHOAIB VAYEJ: I wouldn’t say that. As we look into next year, there’s as much political risk – not just within South Africa but internationally as well: quite a few elections and referendums in Europe. So the way we try and manage that risk is through our goal positioning within the fund. I mentioned Pan African as the key holding, but we tend to stay around neutral in terms of exposure to the gold equities and trade around that, around events.

So even if we think that sector is particularly expensive, we’re unlikely to go significantly underweight given some of the risks out there. So that’s one of the ways of managing it. The other ways of managing it is to try and minimise your exposure to macro-factors and try and just bring out the underlying stock picking, rather than an exposure to any particular commodity price or interest rate or currency.

RYK VAN NIEKERK: Thank you Shoaib. That was Shoaib Vayej, he is a senior portfolio manager at Afena Capital.

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