Sometimes in investing, the best thing to do is nothing. In a presentation to advisers and clients via Zoom webinar, Duncan Artus examined the levels and valuations of South African financial assets in the context of the lockdown and discussed the actions Allan Gray has taken over the past few months. Watch the 16-minute recording here and key points are summarised below.
During February and March, we were active in both the equity and fixed income markets, believing many South African assets were looking attractive in the face of very negative sentiment. The hard lockdown announcement, and the subsequent expectation of significant harm to the economy, saw many prices continue to fall. We took advantage of the weaker rand to sell some offshore assets and used this to fund purchases of government long bonds and select South African equities.
We have been less active since early April: At this stage we think the portfolio is reasonably well positioned and are watching and waiting. We expect further volatility – and have cash available in the portfolio to take advantage of opportunities should they arise.
The news is undoubtedly bleak, and we expect the headlines to get worse. Cases of COVID-19 in South Africa are set to increase exponentially. This is expected and understood. Meanwhile, there is very little that can be done to stop the spread of the pandemic. This is the backdrop we have prepared for.
There is no shortage of risk. The most difficult risk to incorporate into our valuations and portfolios is the unpredictable actions of politicians, which may or may not be rational. This could lead to certain local sectors being placed under significant pressure and increased socioeconomic costs. We have tried to manage this risk from an overall portfolio view, by limiting exposure to certain sectors, as an example.
The fiscal situation is going to be dire – the government has had to spend a lot of money to prop up the economy during the lockdown and tax revenue is falling. The forecast increase in the government’s fiscal deficit has meant South Africa has had to pay high real interest rates to raise money at longer durations. Yet, at the same time, short-term interest rates have fallen significantly, putting pressure on savers seeking safety in money market funds. Over the long term, and assuming a return to more normalised conditions, many equities offer great value – but opportunities should be approached with caution as some businesses will not survive in their current form.
A focus on key holdings
Our two largest local equity holdings are Naspers and British American Tobacco (BAT). Thankfully, they held up well during the sell-off. We continue to think that both these shares are attractive.
First, the impact of the global lockdown on Naspers and BAT will be smaller than for the average company. In fact, Naspers may even benefit from the lockdown, due to its holding in Chinese internet company Tencent. Tencent generates much of its earnings from online gaming and various other online businesses, which are in demand in the current climate.
BAT, meanwhile, is doing well and indeed the closing of borders has reduced the illegal cigarette trade across the globe (excluding South Africa). BAT has a 16% global market share of next generation products, which will become a key driver of value as consumers increasingly move away from combustible tobacco products.
We have also been cautious buyers of selected local consumer shares, especially those with self-help stories, such as Woolworths and MultiChoice, who have the ability to create value independently of the economy. While hard to imagine currently, in a more normal world we think these companies offer exceptional value.
Where to from here?
In our view, putting a country into lockdown is relatively easy. Implementing and managing a successful exit strategy is far more complicated. No one knows with any certainty how this is going to be done. We continue to position the portfolio for multiple outcomes.
To view the Q&A session from this webinar, click here.