South Africa has a history of political uncertainty. The 15 months since the removal of Nhlanhla Nene as finance minister in December 2015 have been a stark reminder of this, culminating in the cabinet reshuffle announced at the end of the recent quarter. We disagree with recent decisions and are concerned about the negative impact they will have on South Africa’s future.
Our investment philosophy is to build diversified portfolios of undervalued investments from the bottom up, so as to maximise the probability of real returns while limiting the risk of permanent capital loss. This philosophy has protected our clients’ wealth through similar periods of uncertainty and we believe will do so again.
High uncertainty increases the need for an ongoing assessment of relative risks and returns. This has resulted in some positioning changes within the Stable Fund over the last 15 months. The most notable has been a reduction in SA gross equity exposure from 29.6% to 24.4% and an increase in SA net equity exposure from 17.8% to 21.5%. Hedged SA equity, the difference between gross and net equity exposure, has fallen from 11.8% to 2.8%. This highlights our view that there are fewer valuation disparities in the market today. The mining and financial sectors were particularly attractive in January 2016 relative to large cap industrials such as Richemont, MTN and Steinhoff that we felt were overvalued. This gave us confidence in alpha opportunities that influence the return from hedged equity. Similar disparities are less obvious today.
However, we are still finding attractive investment opportunities, and have increased the Fund’s SA net equity exposure. Our estimates of intrinsic value for most of the Fund’s holdings have increased but Standard Bank is the only share in the Fund’s top 5 holdings of which the price is higher today that it was in January 2016. We have thus added to existing holdings, mostly funded by the cash received from AB InBev’s acquisition of SAB.
Some of the larger additions have been in Naspers and Remgro:
- We have invested many hours analysing the long-term value of Chinese internet company Tencent, which accounts for most of Naspers’ value. Risks certainly exist but we are increasingly confident of Tencent’s cash flow potential as it monetises its user base. Naspers’ management is also focused on unlocking value from their other investments. If successful, we believe Naspers investors gain exposure to Tencent’s potential at an attractive valuation.
- Two-thirds of Remgro’s current value comes from its holdings in Mediclinic, FirstRand/RMB Holdings (RMH) and Rand Merchant Investment Holdings (RMI). We believe these companies have above-average management with track records of building shareholder value. They all have challenges: Mediclinic is facing regulatory pressure, FirstRand is exposed to a weak SA consumer, and RMI’s life insurance businesses (Discovery and MMI) are struggling to generate cash. However, we believe these risks are priced in, particularly with the further discount one gets from investing via Remgro.
Since December 2015, bonds and cash have increased from 39.8% to 48.2% of the Fund. Bond exposure was added at attractive yields, but the majority of fixed interest exposure remains in short duration money market instruments. These offer yields in excess of inflation at low risk, making them appropriate for the Stable Fund in the current environment.
Since December 2015, the foreign portion of the Fund reduced marginally from 26.8% to 25.2%. We converted some foreign exposure into rands at attractive levels in early 2016. Since then, the performance of the Fund’s foreign holdings, managed by Orbis, has been good in dollars but offset by the stronger rand.