PSG Stable comment - Jun 17
Headlines around issues like land expropriation, the new mining charter and the independence of the South African Reserve Bank (SARB) ' accompanied by a continuous stream of leaked Gupta-related emails ' do not make for peaceful bedtime reading. Investors are understandably concerned.
'Be fearful when others are greedy and greedy when others are fearful.' - Warren Buffett Have you spoken to any South Africans recently who are fearful? One of the world’s greatest investors says this is the time to be greedy.
In investments, ‘being greedy’ means that you should be a buyer when fear is driving the prices of securities (shares and bonds) lower. There are various human biases that cause irrational selling. One of these is confirmation bias: once we reach a certain conclusion or develop a specific narrative, we search for or interpret information in a way that confirms our preconception. For example, once someone has decided South Africa is going the route of Zimbabwe, they will only see information that confirms this theory. Such a person would be a hasty seller. We would like to point out three possible reasons why we believe that ‘greedy’ investors currently have better odds:
1. Plenty of bad news has already been discounted in to the prices of securities. We can currently buy quality companies on the JSE at price-earnings (P:E) ratios in the high single-digit to low double-digit range, which is a standout opportunity. The weighted average P:E ratio of the JSE-listed companies in the PSG Stable Fund is currently 13.4. These are all companies that have some form of competitive advantage and are managed by very capable teams. There are many future scenarios under which these companies fare well and will reward brave investors handsomely.
2. Uncertainty and daunting prospects reduce competition, which is the most important driver of profits.
If in the year 1900 you knew which political developments would take place in South Africa over the next 117 years, would it be your investment destination of choice? Probably not. However, a recent study by Credit Suisse found that since 1900, South African stocks have generated higher US dollar returns than any other geography. Similarly, consider the tremendous social and regulatory pressure the tobacco industry has faced over the last 20 years. Despite this, an index of listed US tobacco companies has returned an annualised total return of 15.4% over this period - significantly more than the S&P 500 Index, which has returned 7.1% when measured on the same basis.
Why these unlikely outcomes? We believe that lack of competition was a significant contributor in both cases. In South Africa, sanctions and generally daunting political conditions kept new entrants at bay. In the tobacco industry, banned advertising made it impossible to enter the market.
Current domestic uncertainty is scaring off competition – both from outside investors and from many South African companies that are allocating capital offshore rather than competing locally. According to SARB figures, South African companies invested R300 billion outside our borders over the past five years.
3. There are numerous facts that don’t support the failed state thesis. If you live in a country with extreme income inequality and unemployment of close to 30%, should you be surprised to hear populist rhetoric from time to time? However, the process of moving from rhetoric to legislation is long and rigorous - and significantly easier said than done. Over and above parliamentary processes, we also have an independent judiciary and a constitution that is widely regarded as one of the most progressive in the world. And ultimately, we have a functioning democracy that gives the public the ability to hold politicians to account. The change of power in key metropoles in 2016 serves as an example.
We don’t know the future for a fact, but we do believe that odds are currently better for buyers of undervalued South African equities than for sellers. We remind existing investors in our unit trusts that to enjoy the benefits of our process, you need to invest for the long term – even when it is very hard.
We continue to have a large portion of the portfolio invested offshore (17%) in high-conviction global ideas, along with a small hard currency holding. We have also actively been allocating capital to our higher-conviction domestic ideas, which continue to offer compelling value. The real yields offered by South African government bonds are above our required rate and the portfolio currently has an aggregate exposure of 15% to these instruments. Cash levels remain high and we are able to deploy 29% of the fund if new opportunities arise. We think it is a good environment for long-term stock picking, and have a track record of generating good returns for our clients in tough times when fear is prevalent (such as in 2003, 2009, 2011 and 2015). Subsequent average five-year outperformance for our funds over these periods (including 2015 to date) was 6.6% a year (5.4% excluding 2015).
The PSG Stable Fund will seek to generate a performance return of CPI + 3% over a rolling three year period, while aiming to achieve capital appreciation with low volatility and a low correlation to equity markets through all market cycles. In order to achieve this investment objective the securities normally to be included in the portfolio will primarily consist of a mix of debt securities, money market instruments, bonds, inflation-linked securities, listed equities, listed property, preference shares, and other high yielding securities. The fund managers have applied a constraint on the mandate of this fund to ensure this fund complies with Regulation 28.