The recipe for success
South Africa equities
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If we had any illusions that 2022 would finally give us some respite, those have been shattered in the past three months. Russia’s invasion of Ukraine, persistently higher inflation and growing fears about stagflation are all raising uncertainty. One point of relief is that both the rand and South African equities have held up very well during this period. The Alsi is up about 1.5% when most of the world’s leading markets are in the red. In this special Citywire supplement, we examine the current views on the South African equity market, and how allocations are likely to shift with the increase in the offshore allowance. We also speak to two leading fund selectors about how they go about identifying the managers for their South African equity allocations. Enjoy the read!
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AllianzGI research has found that sustainability-focused strategies are more stable generators of alpha. Here, the firm explains how it is positioned for this
South African fund managers are finding value in the local equity market, with resources and banks preferred, as well as a few defensive shares and opportunistic businesses
Chapter one
CONTENTS:
Patrick Cairns
Editor, Citywire South Africa
With changes to Regulation 28, balanced multi-asset funds can now invest more offshore. Over time, some will, but local equity won’t be abandoned
Chapter TWO
How two multi-managers take different approaches in their South African equity allocations.
Chapter Three
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Local asset managers are bullish on the opportunities on the JSE, but add that it is important to be selective. ‘We think the economy is healthier than people think and the headlines show,’ says Meryl Pick, head of equity research at Old Mutual Investment Group. Sandile Malinga, a multi-asset portfolio manager at M&G Investments, adds: ‘There are many excellent businesses in South Africa like banks, retailers and miners that have demonstrated solid long-term profitability. Many have the potential to deliver strong results going forward, with earnings and dividends showing a robust return to growth over the medium term.’ Citywire + rated Evan Walker, portfolio manager at 36One, says he would be disappointed if the JSE doesn’t deliver double-digit returns this year. Sanlam Private Wealth head of equities David Lerche is feeling reasonably comfortable about local equities, particularly compared with the rest of the world. However, he says there is pressure on the consumer, and investors must be quite specific about what assets they invest in.
words by Patricia Holburn
Cherry-picking the SA sectors with value
chapter one
The economy is healthier than people think
Banking bull, despite higher interest rates Along with resources, banks are also a favourite in the local equity market. ‘We see quite strong earnings growth in banks over the next 12 to 24 months,’ Pick says, ‘driven by three key factors.’ Lending is picking up, which Pick says was quite depressed in Covid-19. ‘Early indications are that banks are starting to open the credit taps again after a bit of a hiatus.’ The second driver is the better bad debts Covid-19 experience. ‘The bad debts worst case did not play out and there are still provisions that can be released.’ The third driver is higher interest rates, which should be a positive on the income side for local banks. ‘Banks benefit from a rising interest rate cycle as long as its pace and extent remain relatively moderate,’ Malinga says. ‘South Africa’s Achilles’ heel is oil and its impact on inflation,’ says Urvesh Desai, portfolio manager at Old Mutual Investment Group. ‘But inflation in South Africa has not been demand-driven, so we are still positive as there are no domestic excesses.’ He added that South Africa may also benefit from emerging market inflows as the country is a more investable emerging market than others such as Russia and Turkey. This should be supportive of the rand, which is another positive for banks.
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chapter two
chapter three
Content from: Allianz Global Investors
The big resource bull and its side effects ‘Even though resource stocks have already benefited from higher prices, they are still cheap and yielding massive returns,’ Walker says. He says positives for resources include lost supply due to tensions and conflict in Eastern Europe, as well as ending globalisation. This is leading to more companies repositioning critical operations onshore, which requires resources. ‘We are overweight resources in our funds,’ Walker says. ‘Many mining companies continue to experience elevated revenue and earnings as the prices of commodities remain at high levels, helping them strengthen their balance sheets as well as enabling large dividend payments to shareholders,’ Malinga says. ‘We are currently overweight Northam Platinum for its relatively high quality, as well as Anglo American, Glencore and Sasol (the latter a fairly long-held preference).’ Resources are also set to benefit from decarbonisation. ‘With the Euro block countries accelerating the pace of renewables, there is a need for copper and nickel,’ Walker says. And decarbonisation doesn’t yet mean the end of oil. Citywire AA-rated Pick says they have a constructive view on oil and oil-related stocks. ‘Oil supply is falling and will be falling ahead of demand. Long-term decarbonisation is a theme for almost every country, but demand will still fall quite slowly and incrementally over the next 20 to 30 years, whereas supply will fall in the short term because of a lack of investment and sanctions. ‘Stocks directly and indirectly exposed to oil such as Sasol, Kap and Nampak – producing oil or plastic derivatives, will benefit. Oil-producing African countries and their economies will also benefit. Nigeria is an example, which is why we like MTN.’ Pick doesn’t think oil prices will retreat to the lows of two years ago. ‘There is still a significant upside for these counters.’ The side effects of a resources boom offer another positive for some South African shares. ‘A healthy mining industry tends to be good for the wider South African economy,’ Lerche says. Pick says this is evident in construction companies that benefit from mining capex projects.
The selective opportunities
Reopening economy Walker says 36One is seeing value in the post-Covid reopening theme, particularly in hospital shares such as Netcare, Mediclinic and Life, which will be a beneficiary of this theme, and won’t be as affected by decreases in discretionary spending as the cost of living rises.
The well managed With a weak consumer, retail stocks are not universally in favour. But Pick says we shouldn’t gloss over some stock-specific stories just because the macro picture is not strong. Examples include TFG and Transaction Capital. ‘They have good management teams and are proving to be quite resilient. We saw TFG make opportunist acquisitions and Transaction Capital bought We Buy Cars.’
Diversification ‘We believe it’s important to have a widely diversified portfolio within South African equities because of the higher than usual market uncertainty,’ Malinga says. ‘We are holding defensive shares such as British American Tobacco, which is one of our largest absolute and relative positions.’
Meryl Pick Old Mutual Investment Group
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Balanced funds can now hold a maximum of 45% in offshore assets, in any jurisdiction, according to changes announced in the 2022 Annual Budget. The move has been welcomed as it increases the opportunity set for these funds. However, there isn’t likely to be a broad rush to invest in offshore assets. There are also some good reasons to continue holding local equity.
SA still a crucial piece of the pie
A lot of our clients are South Africans who live off the 4% to 5% they draw from these funds. If all your assets are offshore and the rand strengthens you can have a large mismatch
Asset liability matching Investing in offshore assets can bring added currency risk, which can have a dramatic effect on total returns – and it isn’t always positive. ‘Greater offshore investment allows the ability to have greater diversification, but this cannot come at the expense of returns. Currency volatility can be extreme and one has to factor in both the return potential of the investment being made in its own currency and how this potentially translates into rand returns over time,’ Chester says. ‘We have to consider an asset-liability mismatch that can occur if you have too much offshore,’ Williams says. ‘A lot of our clients are South Africans who live off the 4% to 5% they draw from these funds. If all your assets are offshore and the rand strengthens you can have a large mismatch.’ ‘An appropriate allocation to local assets is important in ensuring asset and liability matching,’ Chester says. Ninety One’s Chetty says the rand is a very important driver of risk, but should be seen separately from the decision to invest in offshore equities. ‘Often the decision to go offshore isn’t separate from the decision on the rand. But you should divorce those decisions,’ he says. He added that the regulations give you the ability to hedge currency moves, even though annual movement in the rand is quite slow when viewed over longer time frames. ‘Aside from shocks, the annual range the rand moves in is around 2-6% per annum.’
Not using it – yet Although managers are enthusiastic about the change, they’re unconvinced that now is the best time to invest more in offshore markets. ‘We were always batting our heads at the top end of the 30% allocation before the latest volatility in the market. Over time, given our expected return, we will increase the offshore component in our funds. But with the most recent volatility, we haven’t made any significant changes,’ Chetty says. Ninety One may have been at the top end of the offshore allowance, but Coronation Fund Managers and Centaur Asset Management were not. ‘Local equity remains a key building block in our multi-asset strategies,’ says Neville Chester, a portfolio manager at Coronation. ‘Prior to the relaxing of the offshore allowance, we were below the Reg 28 limit, and we will not currently be moving more assets offshore given relative valuations.’ ‘We are not looking to move beyond 30%,’ says Roger Williams, managing director and chief investment officer at Centaur. Although offshore market returns have been strong for the past eight or nine years, Williams is not sure that global markets are the place to be now. ‘We are facing a possible inflection point in the markets. We had exceptionally low interest rates globally and it is changing, while the rand is slightly undervalued.’ He says Centaur decreased its offshore holdings from 30% to about 24% in the past year. ‘We do occasionally see great offshore stock picks, when a share looks good value with great management, such as Dell and Stellantis. We are excited about these opportunities – but when we comb the world, we don’t find many right now.’
The world just got bigger ‘We are very excited about the increased offshore allowance,’ says Sumesh Chetty, portfolio manager at Ninety One. ‘The previous requirement didn’t appropriately represent the investment opportunity for our clients.’ The South African equity market makes up less than 2% of global equity markets, well below the allocation balanced funds hold. Chetty believes the local market has an overconcentration of certain sectors, such as banks, insurers and resources. However, outside those sectors, the local options are limited, he says. ‘Take tech, for example, where the local options are limited to Naspers and Prosus.’ Having more offshore allows for greater diversification across asset classes. ‘The 30% offshore allowance was so valuable that you were trying to allocate it as far as possible to equities, given the lower returns in South Africa. The 45% allowance opens up more opportunities.’ He uses the example of offshore bonds, which despite not offering the best expected returns right now, may provide a better opportunity in the future alongside diversification benefits.
Home turf information advantage Another good reason for keeping local equity in a portfolio is better information and knowledge for local managers. Centaur’s Williams says being more familiar with the South African market gives them an information advantage when investing locally compared to offshore. ‘We see management, we see the products, so we are very in touch with South Africa,’ he says. ‘Globally, we are not as in touch and there are often unexpected idiosyncrasies in global shares.’
We were always batting our heads at the top end of the 30% allocation before the latest volatility in the market
Sunesh Chetty Ninety One
Roger Williams Centaur
Talk to any fund selector in South Africa and they will tell you that this country has some outstanding fund managers. But how do you get the best blend of them into a multi-managed portfolio? The Southern Charter BCI Balanced fund uses four local active managers and one passive fund for its general South African equity allocation. The portfolio is run by Ursula Maritz and Mark Thompson, who were named as the best managers in the Mixed Assets – Balanced ZAR category at the 2021 Citywire South Africa Awards. ‘We like having a blend of different managers,’ Maritz says. ‘At the moment, we use 36One, which has a value bias but trades pretty actively. Aylett is more value-oriented, and one of the few managers that doesn’t hold Naspers or Prosus. ‘We have a long-term holding in M&G and have added to that recently. We like its exposure to banks, MTN and some resources. And we use Ninety One because we like its four-factor approach,’ she says. ‘What’s also done very well for us is the Satrix Divi Plus ETF. We also have a long-term holding there. It’s defensive with a high dividend yield.’
words by Patrick Cairns
Finding the right multi-manager mix
We like to mix up our managers, over a two- to three-year period, if they are not delivering expected returns relative to their own benchmarks, we will sell out
Notably, Southern Charter also uses two specialist resources funds: the Coronation Resources fund and the Ninety One Commodity fund. ‘We identified in 2017 that that part of the market looked very cheap,’ Maritz says. ‘It had high cashflow yields, and valuations looked cheap relative to spot prices. That was a theme we wanted to get exposure to. We have taken profits along the way when our exposure breaches our risk tolerance levels and remain constructive on our commodity theme. That is something we look to do, rather than being purely driven by manager styles.’ Southern Charter is prepared to be active in allocating to new managers, but Maritz says it’s not an objective of the strategy. ‘We like to mix up our managers,’ she says. ‘If they are underperforming, we do another due diligence. We give them time, understand where they are doing wrong, but over a two- to three-year period, if they are not delivering expected returns relative to their own benchmarks, we will sell out and identify a different manager to put our money in.’ Maritz says that she and Thompson are also conscious of how much they are allocating to different managers. ‘The fund has also grown exponentially, so we are very conscious now of how much we have with each manager. We’ve had to get more managers to reduce the risk of having a large holding with just one manager. Particularly if you want to sell out quickly, you don’t want that sale ringfenced.’
Contrasting styles The differentiated approach used by Southern Charter is quite different to that employed by PPS Investments. The PPS Equity fund currently only uses three managers – Fairtree, Ninety One and Truffle Asset Management – with allocations split equally between them. ‘For us, fewer is better,’ says portfolio manager Reza Hendrickse. ‘We try to not overdiversify and only include managers where we have very high conviction, maintaining a fairly concentrated group.’ ‘Currently, it’s three, at some point it may be four, but that is probably the maximum we would reach. It’s important to get the manager mix right, then we equal-weight them rather than try to guess which manager will outperform’. This approach is guided by the firm’s view of how the local market functions. ‘The South African market is idiosyncratic,’ Hendrickse says. ‘We are faced with concentration issues, where a few shares dominate the index. You also have a small universe, with a little over 100 investable companies. ‘So, in our local equity strategy we focus on managers that are not too style-specific,’ Hendrickse adds. ‘We want managers with fewer constraints and less cyclicality of performance.’ Size is also a factor. ‘Ideally, we want managers that are not too large and can still be nimble in moving in and out of opportunities. We want them to be able to change their minds if need be,’ he says.
We try to not overdiversify and only include managers where we have very high conviction, maintaining a fairly concentrated group
‘On top of that, given that global macro factors have a big impact on our market, we prefer firms that are good at deciphering the macro backdrop. We look for managers who demonstrate not only a bottom-up but also a top-down skillset, which provides an edge locally.’ PPS is not averse to making changes in the portfolio. Seven years ago, it used an entirely different set of managers in Absa, Prudential (now M&G), Kagiso and Coronation. However, Hendrickse says that the process has since evolved. Ideally, they would prefer never to switch managers. ‘In reality, things do change, either on our side or the managers’ side,’ he says. ‘It’s important that we maintain confidence that these businesses or strategies are working well. For example, key decision-makers change, and that could be impactful, particularly if there isn’t a clear succession plan one is comfortable with. ‘But we tend to make changes quite infrequently. We added Truffle about a year ago, and Fairtree three to four years ago. We do a lot of work upfront and prefer to invest for multiple years.’
Ursula Maritz Southern Charter
Reza Hendrickse PPS Investments
