RYK VAN NIEKERK: Welcome to this Market Commentator podcast – my weekly podcast, where I speak to leading investment professionals. My guest today is Piet Viljoen; he’s the founder and chairman of RECM, one of the few deep value or contrarian asset managers in the country. Piet, welcome to the show. I want to start with your performance of your funds over the past few years: your Balanced, Equity and International Feeder Fund performed exceptionally well and this followed a period of relative poor performance, did you change your approach during the past few years?
PIET VILJOEN: Thank you for having me on your podcast, Ryk, it’s a pleasure to be here.…RECM had a very good track record up until 2013/2014, around about there, and at that time or in the period leading up to that time, we started devolving responsibilities for fund management to some of the other people in the firm to reduce key man risk and I stepped back from the portfolio management process. At the same time I also stepped back from actually monitoring what process was being followed, with the result that in the time period 2013/2014 our process, which had always been one of taking smaller positions, very risk management, became one of taking high conviction large positions. So the process changed a bit.
The philosophy is still value; we are very much value investors and we still are, even today, despite the fact that nobody wants to be called a value investor, we are proud value investors. But our investment process did change somewhat and having said that, I think there’s a lot of research that shows that high conviction, large positions can work over time, as long as you can withstand the inevitable volatility that comes with those sorts of positions. Of course, in open-ended funds like unit trusts when you have large drawdowns, such as we did in 2014 and 2015, it has a very negative impact on your clients’ portfolios and their mindset. So we lost a lot of clients in that process and that’s one thing that we didn’t take account of at that time. So by the end of 2015 the firm had shrunk significantly and, of course, there was lots of turmoil within our client base and also within the firm.
And then I started taking back control of the portfolio management process, and over the last three years I have been managing all the funds according to the original RECM process of small positions, strictly risk-managed, diversified portfolios but based on the deep value investment philosophy. I think the results over the past three years speak to that. So that’s a very long-winded way of saying yes, for a while our process did change – our philosophy didn’t but our process underwent some subtle shifts – but we are back on track now.
RYK VAN NIEKERK: Of course, as you said, you saw an outflow of funds. How quickly does a good performance lead to an inflow of funds?
PIET VILJOEN: No, it doesn’t come quickly. Once you have lost credibility with a client, it takes a very, very long time to build it up. That’s what they say, ‘trust is something that is earned over a long period of time but you lose it in a short period of time’. So we’re in the process of rebuilding our trust with our clients and with potential new clients. So far I think the team has done a fantastic job of that, but these things take a long time to build up again. But day by day we are busy with that.
Decision-making at RECM
RYK VAN NIEKERK: Just the way you do research, in many other firms you would see an investment committee and several fund managers would work together on a whole portfolio. From what you said earlier it seems like you’ve taken back control. How do you actually within the team decide what to invest in or is it basically your decision?
PIET VILJOEN: One of the fundamental tenets of RECM has always been single-point responsibility, I think as soon as you have a committee making decisions, individuals abrogate responsibility and everybody looks at each other when something goes wrong – it’s nobody’s fault. So we believe very firmly in single-point responsibility. So I take responsibility for all the fund management decisions and I have a team of three analysts who help me with that. We sit together and we chat about these things. We talk about them, we analyse them but I make the decision and I manage the money and I stand by those decisions.
RYK VAN NIEKERK: Let’s talk about the local market; we’ve seen interesting trends develop over the last year or so. Let’s start with the mid-cap sector, which was absolutely hammered last year. The Alsi (JSE All Share Index) went down 11% but many companies actually dropped significantly more than that. How do you view that sector and the opportunities offered in it currently?
PIET VILJOEN: I think a lot of companies in the mid-cap sector had become market darlings for a while, as more growth-oriented managers attracted more money in the 2015/2016 period and bought those companies. They were seen as almost infallible, good managers with good businesses and I think the view was that it didn’t matter what price you paid for the shares, you would make money because they are such good companies, managed by such good people. But in the end those things don’t work out and I think a lot of those stocks have come back down to earth with a bang.
So we are starting to see some opportunities there, one or two, but we do think that it’s still too early to get involved in those ex market favourites, if I can put it that way. We think that there’s an alternative grouping of stocks in that mid-cap space as well, which were never market favourites before, but are hated even more now, and those are the SA industrial companies, exposure to basically only South Africa and maybe a bit of sub-Saharan Africa, but predominantly South Africa.
Nobody wants anything to do with South Africa; nobody wants anything to do with those businesses and at the same time the economy is going through a very tough stage, as it does every five or six years, so the earnings powers of those companies are under pressure. So you have earnings, which are coming out quite badly, you have negative sentiment and all that adds up to some very, very low valuations on those SA-focused companies and that’s where we’re seeing more opportunity now.
‘We like to invest when times are bad’
RYK VAN NIEKERK: Your equity fund, your Global Flexible Fund as well as your Balanced Fund are quite heavily invested in HCI, Hosken Consolidated Investments. Obviously that is one of those SA Inc stocks. The share did not perform well last year, why do you like it so much?
PIET VILJOEN: Mainly because it didn’t perform so well last year, I’m just joking. There are a couple of arrows in this quiver. First of all we think HCI is managed by one of the top capital allocators in South Africa, Johnny Copelyn. Over time he has created tremendous value for shareholders with the transactions he has done; he doesn’t overpay and he generally buys good assets. So we have an investment company that is run by a tremendously good capital allocator.
The second thing is the assets that HCI owns are all top-quality assets: Tsogo Sun is probably the best hotel group in the country. eMedia is a top media business: it has gone through a tough time but it is a strong business; it generates good cash flows. You can go through the balance sheet, they own a whole bunch of really good businesses. All of them are unfortunately focused on South Africa, but when the economy turns these things are going to fly.
The third thing here is you are getting all those qualities, good businesses run by a good capital allocator, at a massive discount to the underlying intrinsic value and those three things to us add up to a very good investment proposition.
RYK VAN NIEKERK: But that strategy is hedged on the performance of the local economy. Now, many economists are not too bullish about accelerated growth in the short- to medium term. When do you think the local economy will fly, to use your own words?
PIET VILJOEN: The economy is always a tough thing; I think economists always tend to extrapolate current conditions into the future. A couple of years ago, four or five years ago when things were going fantastically well in South Africa, all the economists said that it would continue to go well. So you’ll always have this extrapolation by economists and we don’t know about that, we don’t understand how they come to their projections. All we know about the economy is when things are bad, in a few years’ time they will be much better and when things are good, in a few years’ time they will be much worse.
So we like to invest when times are bad because that’s when assets are cheap and nobody wants them, and then when times are good we’ll sell out of it and then we don’t listen too much to what the economists say.
RYK VAN NIEKERK: But it seems to be a game of patience – you’re not going to see SA Inc stocks probably run in the foreseeable or the near-term future. Do you have a patience horizon?
PIET VILJOEN: Not a set horizon, but we think it pays to be patient. We think that the market is increasingly, not only locally but internationally, driven by short-term oriented participants. It’s like I’ll give you one marshmallow and if you don’t eat it I will give you another one and you can have two, but the market always eats its marshmallow way before it can get its second marshmallow. Immediate gratification is the way of the world and it’s becoming stronger and stronger.
I think one of the investment edges one can have is to be happy with delayed gratification and we think that’s an edge that not many people can replicate, so that’s something we focus on.
As I said, there’s no set time period, but we think if you pay a low enough price for an asset, over time you will be rewarded – you just don’t know when. I think Clover is a great example: it’s a stock that went sideways for five years and then out of the blue there’s a bid for it and it’s up 50%, and you’ve made 10% a year for five years, which is better than the market, which is great. But you had to be there at some point over those five years and sit with it and wait and wait and wait. I think that’s a classic example of the payoff to delayed gratification. That’s something at RECM that we are very good with, delayed gratification.
‘Last year our funds didn’t lose money’
RYK VAN NIEKERK: That is interesting, but it means that investors should not expect a linear performance of, say, 10% per year every year. You need to be patient for a while and stomach sideways or even negative performance and wait for a big jump. Do you think investors appreciate this?
PIET VILJOEN: I think that’s always a problem because most investors want to see regular gains, but in the process they give up outperformance. We’d rather pay a little bit away while we wait and then get the big returns over time. So it’s a very different profile of performance and one that you can only get if you are patient. So that’s the way we prefer to do things and we think it does make us very different from other fund managers and we think that it pays off.
Ideally what the term profile looks like is when everybody else is making money we’re making a little bit of money … but then when people lose a lot of money we tend to not lose. If you put those two periods together, making a little bit when everybody is making a lot and then when everybody loses a lot and we make a little, that is strong outperformance.
At the end in markets it’s the one who loses the least who wins. If you’re going out for regular gains every year, and every year you are taking more and more risk, at some point that all comes crashing down like it did last year for many investors. One of the reasons our funds did so well over the past three years is because last year our funds didn’t lose money – they were flat or slightly up. That’s the sort of outcome we want and that’s the sort of outcome we think our clients want.
RYK VAN NIEKERK: Let’s look at the political environment. We are in an election year: we will probably see a rollercoaster ride and we’ll see a lot of propaganda. How do you think this will impact investment decisions?
PIET VILJOEN: How will it impact our investment decisions? Not at all. It won’t impact anything we do. To the extent that prices move up a lot, it might cause us to sell some assets and to the extent that prices move down a lot in reaction to politics it might cause us to buy other assets. But we only react to the cards as they are dealt to us – we don’t try to anticipate what happens.
As to what happens with politics, I have no idea. It’s like economics: I just have no idea, I can only react to what the price signals tell me to do. I would remind your listeners that living in South Africa for the past 30 years we have gone through major highs and lows, which nobody could forecast and even if you could forecast them, you couldn’t forecast the impact on share prices and I think this year will be much more of the same.
I don’t think you need to worry about politics or economics. All you need to worry about is, is the price you are paying low enough to give you a margin of safety against adverse outcomes?
That is what one has to worry about, not exactly what those adverse outcomes are, because they’re unpredictable, but is the price paying you to hold the asset, even if bad things happen?
RYK VAN NIEKERK: The local market has also performed poorly over the past several years, relative to what we have seen on international markets. Do you think that this disparity could normalise in the near future?
PIET VILJOEN: That’s an interesting question. I think it’s a question that exercises the minds of most of us. I think if the Zuma part of the ANC was still in charge I would say yes, it would carry on and we would go down the Zimbabwe/Venezuela route and in that case you had to make sure that you had no exposure at all to the South African equity market or asset market at all because there’s a good chance it would go to zero. I think that there is a chance that that might not happen; I think that there’s a non-negligible chance that that might not happen. What probability would I put on it? Not a high probability. I’d give them about a 20% or 30% chance of getting the economy back on track and to that extent I think it warrants some exposure to South Africa.
I think the assets here are cheap; they are discounting a very, very bad outcome and that outcome might not happen. In that case you could make a lot of money from South African assets the way they are priced right now. So I think a diversified portfolio warrants at least some exposure to Africa. Should you have all of your assets outside of South Africa, like many people tend to believe today, I don’t think that would be wise, I think there are many markets offshore that are quite expensive. There are currencies like the dollar that are quite expensive and I think you are exposing yourself to different risks if you do that. So I think a sensible portfolio today would have some exposure to Africa, depending on your risk tolerance, more or less, but at least some. I think one should be very careful about where you move your money offshore. It’s not clear to me that obvious alternatives like America, the US dollar and some other places are the best places to have your offshore assets in. So I think one needs to be, as always, very cautious.
RYK VAN NIEKERK: We’ll have to leave it there. Thank you, Piet. That was Piet Viljoen, the founder and chairman of RECM.