What’s in 36ONE’s portfolio?

Negotiating the current market conditions.

CAPE TOWN – In a low-growth world, finding attractive assets in which to invest is extremely challenging. It is very hard to identify where one might secure decent, reliable returns.

For the manager of the 36ONE Equity Fund, Evan Walker, this situation is not likely to improve in the near term either. The outlook for the global economy is very muted and so is the likely return from equity markets generally.

“We’re still in a world of significant over-capacity fuelled by China,” Walker says. “China has the highest savings rate in the world, and it is accelerating. That money has to go somewhere and it is going into more investment into businesses creating more widgets, and that is leading to deflation.”

At the same time, central banks in many major economies are still engaging in quantitative easing programmes and keeping interest rates low.

“We’re in an environment where growth is benign and I think it’s just going to get worse,” says Walker. “It’s difficult to see what pulls us out of it.”

The Brexit vote in the UK has only made this worse. In an already lacklustre European economy investment is now likely to reduce further.

“In this environment companies are going to look to cut costs even quicker, which will lead to job losses, which means that the environment doesn’t improve,” Walker says. “For the next 24 to 36 months that is our prognosis for the world economy.”

Given these conditions 36ONE has adopted a very cautious approach in its portfolios, particularly towards equities.

“The prize assets in this environment are big scale companies with a lot of clients or users or applications that combine that scale with big specialisation,” Walker says. “That’s why we have a big position in Naspers because of its holding in Tencent.”

Walker argues that with over 500 million users, Tencent has the kind of scale that will give it huge advantages in monetising its offerings. The same is true of the likes of Google, Facebook and Amazon.

“Where growth is limited, we like companies that can leverage scale through technology,” says Walker. “Even though they are expensive we think this still has a long way to play out.”

Big pharma is another sector where 36ONE sees a similar theme. These are big scale companies that are able to add specialisations through new drugs and new technologies.

He however acknowledges that it’s not so easy to find these kinds of companies listed on the JSE.

“You can’t just have Naspers,” Walker says. “If we only had highly-priced, specialisation models that would also create a portfolio with a very high price-to-earnings ratio, which in a downturn would be a risk. So we are also looking at companies just below this that have big scalability on their balance sheets that gives them leverage to make acquisitions where the cost of capital is low.”

Steinhoff is a good example. Even though it has been hurt by Brexit, Walker believes its ability to use its balance sheet to its advantage over the long term makes it compelling.

36ONE also likes big companies that are able to leverage their cost base to drive efficiencies, particularly in the tobacco and brewing industries.

“For example British American Tobacco gets more and more efficient every year,” he says. “These big businesses still have a lot of efficiency to extract, which we think will be beneficial.”

AB InBev offers a similar proposition.

“We like the scalability given that we think there will be big cost cutting at SABMiller in the next few years which will give incremental growth,” Walker says. “We are cognisant of the price we have to pay, but overall we like that thesis.”

36ONE has built the core of its current portfolio around these kinds of companies, which it believes will offer the most secure growth going forward. However, that doesn’t mean it is completely ignoring other opportunities.

Walker points out that he also holds the likes of Blue Label Telecoms and Pioneer Foods, which are smaller companies with compelling prospects.

“The scale theme is a big anchor for the portfolio, but we are not saying this is all we are buying,” Walker says. “Around 20% of what we own will be companies that we think will still do well or transform their businesses to perform relatively well in a tough environment.”

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