Over the last few months, there has been significant debate around how cheap South African stocks are.
“In my opinion, you can fill a room with the smartest people you can find. You can give them six months to go out there and go and kick the tyres and see every management team and visit every business in South Africa, you’d never get away from the million-dollar question which is: is South Africa going to pull itself right?” Karl Leinberger, chief investment officer at Coronation Fund Managers, told advisors at the Investment Forum 2019.
No amount of work will provide this answer, he said.
During a presentation on the trade-offs between risk and return, Leinberger said Coronation’s investment team agonised over this, because if South Africa can pull itself back from the abyss in a meaningful way, there are incredibly cheap domestic stocks available.
Challenges may outweigh the case for recovery
Due to the risk that structural challenges may outweigh the case for cyclical recovery, it currently has very low exposure to domestic, economically sensitive assets.
Speaking more broadly, Leinberger said there is a massive emphasis on short-term performance in the industry, but very little focus on the risk taken to deliver those returns.
While textbooks often define risk as volatility, Coronation regards it as the probability of a permanent loss of capital.
“I firmly believe, after 20 years in the industry, that a manager reaching for return at the expense of risk could get away with it for much longer than any of us realise.”
But ultimately, they will be exposed, he said.
No one knows what the future holds
Managing retirement money is not a game. The first rule of investments is never to lose money. The second is that in an industry full of smart people with intimidating IQs and enormous confidence in the future, you shouldn’t forget that no one knows what the future will hold.
“We all need to fight hubris on a daily basis. The world is extraordinarily complex and uncertain.”
Coronation believes that risk matters more than return, he said.
“I cannot tell you how many shares on the JSE that we look at today [and] that we think are extremely cheap that we do not own in your portfolios. There are many stocks out there that we think could go up three, four, five times in the next five to 10 years and yet we don’t own them.”
One example is construction shares. Leinberger says Coronation doesn’t own construction shares even though one or two companies could deliver fantastic returns – the risks are just too high.
The same goes for gold shares.
“The world doesn’t need South Africa’s gold. We have marginal businesses with low quality reserves, high cost bases, unstable labour forces. We fundamentally think – although we could build a case around those shares doubling – we think they could just as easily halve and for that reason, we aren’t going to go there.”
While South Africa has a long list of worries, with load shedding currently top of mind, Leinberger also cited rising social tension and economic populism as a real concern.
“Almost every business we speak to is shrinking the number of people they employ. Large numbers of South Africans are being left without work, left behind by the economic system. We are seeing rising levels of frustration – far too many people in South Africa have nothing to lose.”
Leinberger said his biggest long-term concern is education.
Only 37% of people in South Africa who start school get a matric, while only a quarter of grade four students grasp what they are reading.
But even though risk abounds in South Africa as well as internationally, there is opportunity.
“Certainly in the domestic market valuations are much more attractive than they were five years ago, where generally markets were bullish about domestic assets – and we are finding opportunities as much in the equity market as the property market as the bond market.”