The Allan Gray Balanced Fund’s performance over the past quarter was helped by overweight positions in Standard Bank and Impala Platinum, and by underweight positions in SABMiller and MTN. It was hindered by being overweight British American Tobacco and Reinet, and by being underweight Anglo American and BHP Billiton. (All positions quoted are relative to the FTSE/JSE All Share Index).
During the quarter we bought Naspers, Sasol and Old Mutual. We sold SABMiller, as well as gold miners Sibanye, Harmony and Gold Fields. We received the cash for our remaining SABMiller shares in early October. We had been positioning our portfolios for this event, for example in the Balanced Fund we upped our equity exposure. As always, we will be on the lookout for opportunities provided by the market due to the index change and high volumes on the day.
Perceptions and reality
In recent months, a number of 'high-quality' stocks have disappointed. I use inverted commas because it is surprising how often perceptions of quality are mistaken. A high-quality stock can disappoint in two ways:
- Very high expectations are priced in: If the company fails to meet expectations – it might still do very well, just not as well as people expected – the stock de-rates.
- The company turns out to be an average company, or a lemon: It was flattered by some industry tailwind or by high levels of gearing.
Luxury goods company Richemont, which the Fund does not currently hold, has declined by 31% from its peak in rand terms and by 42% in dollars. It used to be described as a high-quality company, but it seems investors are wavering. We think the jury is still out on the quality of the business. Richemont has certainly benefited from a very strong tailwind in the form of Chinese spending on luxury goods, the company requires large amounts of working capital to operate, and there is implicit gearing in the leases. Despite the fall in its share price, Richemont trades at 24 times consensus forward earnings.
A look at British American Tobacco
In contrast, we believe that the Fund’s largest holding, British American Tobacco, deserves to be called a high-quality company because it passes the following tests: It has 1) a high conversion of profits to free cash flow, after all capital expenditure, 2) a high return on equity, 3) stable and high profit margins, 4) moderate gearing and 5) management with a track record of good capital allocation.
The next time someone labels a company ‘high-quality’, ask yourself whether they don’t just mean ‘share that has gone up a lot’.