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Local investing

Balanced Fund update: Unloved stocks present buying opportunities

Investor sentiment towards emerging markets remains weak. This has left emerging markets at a valuation discount to developed markets. The MSCI Emerging Market Index trades at a discount of over 30% to the MSCI World Index – an index dominated by the US and other developed markets – on a price to earnings (PE) basis. Our offshore partner Orbis is taking advantage of this valuation disparity: 24% of the Allan Gray Balanced Fund’s foreign equities are listed in emerging markets.

A comparable trend is unfolding in South Africa. Domestic businesses exposed to the vagaries of local economic and political trends are trading some way off their highs or remain suppressed. This includes our construction (Aveng, Group Five), healthcare (Netcare, Life Healthcare) and industrial companies (Nampak, KAP), as well as our banks. Businesses exposed to Africa have fallen similarly out of favour (MTN, Nampak).

South African banks provide an interesting case study on the merits of investing during periods of poor prevailing sentiment. Our clients recently had the opportunity to invest a substantial sum of money in Barclays Group Africa (BGA) when Barclays PLC – the UK-domiciled parent company – decided to sell a large chunk of its shareholding in BGA. At the time of our investment, BGA’s dividend yield (7.8%) was marginally higher than its PE ratio (7.5x). This has only happened three times since 1987 and all these occasions were characterised by massive investor uncertainty: 1988 (South African state of emergency; political and economic isolation), 1994 (first democratic general election) and 2008 (the Global Financial Crisis). Importantly, on all three occasions, investors would have been well served to own the stock over the subsequent three years despite the uncertainty at the time.

Some of our biggest purchases over the quarter fall into this bucket of ‘unloved’ stocks: MTN, BGA, Netcare and Nedbank. We have also added to existing positions in Implats and Sasol – both of which are deeply unpopular mining stocks. We sold some of the more popular stocks like British American Tobacco, Capitec and Mondi to fund these purchases.

The net equity exposure of the Fund is up marginally on a quarter ago, which is indicative of the increased attractiveness of certain shares versus cash, bonds or commodities. While a higher equity exposure could introduce some more volatility (which should not unsettle a long-term investor), it is to some extent offset by a very conservative positioning in the fixed interest component of the portfolio with a duration of 2.3 years.


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