Investec Value comment - Jun 13 - Fund Manager Comment06 Sep 2013
Market review
South African equities ended almost unchanged in the second quarter, but volatility was high during this period. The sector laggards remain mostly confined to resource stocks with gold (-33.5%), platinum (-23.9%), coal (-10%) and diversified miners (-10.8%) all experiencing double-digit losses in rands. Year to date, the resources sector is trailing the overall market by 19.4 percentage points. Industrial stocks mostly held their ground over the quarter and defensive stocks, on average, achieved strong absolute returns. Financials lagged, with banks down 6.2% and life insurers flat for the quarter after a particularly weak June.
Portfolio review
The portfolio continued to underperform over the second quarter of 2013. We have underperformed the benchmark for seven consecutive quarters and the length and quantum of this underperformance now exceeds the 2007/08 period when we held no commodities at the height of the commodity "super cycle". The second quarter of 2013 was characterised by our worst absolute and relative performance since the period of underperformance began. Large-scale capitulation by investors holding gold and platinum shares caused these stocks to experience sharp losses over the quarter. The 23% fall in the dollar gold price during the review period prompted a wholesale liquidation out of the gold mining sector. Given the slide in bullion, it is not surprising that the biggest two detractors were our holdings in AngloGold and Gold Fields, which fell 35% and 28% respectively over the quarter. Our holding in Anglo American Platinum (-23%) also detracted significantly from returns. These three stock holdings, which constitute the majority of our long gold and platinum position, represented more than two-thirds of our underperformance over the quarter. This commentary focuses on why we continue to hold these stocks. The Investec Value Fund's offshore holdings continued to contribute meaningfully to performance, with the offshore portfolio rising 6% in US dollars and 15% in rands over the quarter, bringing the 12-month performance for these stocks to 50% in rands. The offshore holdings added approximately 4% to performance over the second quarter.
Portfolio activity
Over the quarter, we added to our AngloGold, ArcelorMittal and Anglo American Platinum positions. This was funded almost entirely by reducing our Sasol position.
Portfolio positioning
There was no change to our positioning over the quarter, and further underperformance resulted in additional small purchases of gold and platinum shares. Our position is summarised by five major themes. We will briefly touch on the first four and then spend more time elaborating on our long gold position, as this position has been the major detractor from performance and is the most controversial:
1. Limited exposure to "SA Incorporated' shares" (approximately 32% of the index). These shares (retailers, food producers, industrials and to a lesser extent, banks), have led the market higher over the last five years and continue to appear very expensive to us on an average historic price earnings ratio (PE) of 16x. This all-time high rating seems unrealistic, given South Africa's unimpressive GDP growth rate and rising socio-political risks. The recent increase in South African bond yields, on the back of a more hawkish outlook for rates, is especially worrying for this group of stocks trading on such high ratings. We are amazed at how little these shares have fallen in the face of a rising discount rate.
2. No exposure to Naspers, SABMiller and Richemont (approximately 22% of the index). Our continued bearish view on the rand would suggest there is an investment case to be made for holding these three big multi-national rand hedges. However, we believe the current historic PEs of 30x, 24x and 20x respectively are too demanding.
3. Lower valuation rand hedges (approximately 20% of the portfolio). The portfolio holds meaningful positions in Steinhoff (a PE of 9x) and Sappi (trading at book value). These rand hedges have low valuations.
4. Long SA platinum shares (approximately 16% of the portfolio). In our view, South African platinum shares represent a text book case of a deep value opportunity. The sector is trading at the lowest price-to-book and price-to-replacement value in history. Investment history shows that purchases made on these multiples prove extremely lucrative over the medium term, unless the industry is in terminal decline (for example, Kodak). We do not believe that this is the case for the South African platinum industry. The outlook for platinum remains favourable. Platinum group metals (PGMs) are essential in the production of automotive catalytic converters. Currently, there are no substitutes and many countries require catalytic converters to be fitted to motor vehicles. In addition, 75% of the world's platinum supply comes from South Africa, and supply constraints remain.
5. Material exposure to gold shares (approximately 18% of the portfolio).
Investec Value comment - Mar 13 - Fund Manager Comment30 May 2013
Market review
South African equities recorded positive but modest returns in rands over the quarter, with the FTSE/JSE All Share Index closing 2.5% firmer. The rand weakened 9% against the US dollar and more than 6% against the euro. The resources sector's underperformance continued into the first quarter with gold (-17.9%), platinum (-13.5%) and diversified miners (-6.3%) ending sharply lower. The combined financial and industrial index rose 6.2% over the quarter, with industrials in particular performing strongly. There was a wide dispersion of returns within the broad industrial sector. Rand hedge global stocks saw double digit returns, with SABMiller and British American Tobacco rising 24.7% and 18.4% respectively. Meanwhile retailers, favoured amongst foreign shareholders, dropped nearly 10% despite a strong performance in March. Banks marginally underperformed the FTSE/JSE All Share Index, while telecommunications lost more than 7% and healthcare gained 8.8% over the quarter.
Portfolio review
The portfolio has underperformed the benchmark for six consecutive quarters. The extent of this period of underperformance now equals the 2007/2008 period when we held no commodities at the height of the 'commodity super cycle'. Performance was negatively affected by our overweight positions in South African gold shares (Gold Fields fell 28% over the quarter and AngloGold shed 18%). In addition, our exposure to platinum shares (Anglo American Platinum fell 14%) and our underweight position in SABMiller (+25%) detracted from returns. Our underweight position in both Anglo American and BHP Billiton benefited the portfolio. The fund's offshore exposure contributed meaningfully to performance over the quarter, with the holding in offshore stocks rising 11% in US dollars and 19% in rands.
Portfolio activity
Since most of our positions are in place, trading was limited over the quarter. We sold out of African Bank, Mondi, Reunert, Distillers and MTN and added to our holdings in AngloGold, Sasol, Sibanye Gold, Lonmin and Absa.
Portfolio positioning
Five major positions contribute to the bulk of our tracking error:
- SA gold equities (approximately 20% of the portfolio). Our case for SA gold shares is based on valuation and a rising dollar gold price. Gold Fields, AngloGold and Sibanye Gold are trading at price earnings ratios (PEs) of 12x, 10x and 3x respectively. Moreover, their relative valuations are the lowest they have traded at for over 20 years. Without the dollar gold price rising, low valuations will not matter that much. Our bullish view on the dollar gold price is based on the unprecedented level of debt in the developed world which, we believe, means that negative real interest rates will have to be maintained for an extended period to reduce the real value of the debt. We therefore see gold continuing to benefit as an alternative currency - a currency that holds its value in real terms and whose value cannot be eroded by central bank actions. In our opinion, the recent poor performance of gold shares cannot be attributed to concerns over mining costs, but reflects the current market view that the dollar gold price has peaked. We, however, expect the dollar gold price to rise, which could lift these shares from current depressed valuation levels.
- SA platinum equities (approximately 14% of the portfolio). We believe SA platinum shares are a textbook case of a deep value opportunity, which only occurs once in a decade. SA platinum shares have fallen between 70 and 90% off their highs of five years ago and now trade at the lowest ever price-to-book and price-to-replacement value. We believe that this indicates that the market is pricing in a structural change in the platinum group metals (PGM) markets. We do not share this view as we continue to see a reasonable future for PGMs. The global 'car park' is still growing and emission standards continue to be tightened. In addition, 75% of the platinum supply comes from South Africa and the supply outlook has materially deteriorated over the last five years as a result of the well-known problems in SA mining. We therefore see steady demand for a material with no substitute that is mostly found in South Africa. This should see the rand price of platinum increasing to a level at which SA platinum producers can make a return on capital. With a stock like Anglo American Platinum trading at half its replacement cost, this represents a major opportunity.
- Limited exposure to 'SA Incorporated' shares (approximately 30% of the index). We have limited exposure to domestic-oriented stocks (retailers, banks, food producers and industrials), with only small positions in Absa and Sun International. A massive rerating has occurred over the last four years, which has left domestic-oriented shares trading on an average historic PE of 17x. We believe this is simply too high a price to pay for exposure to a low growth SA economy whose growth has principally been driven by the extension of credit over the last five years.
- No exposure to Naspers, SABMiller and Richemont (approximately 21% of the index). Our negative view on the rand exchange rate would suggest that these three big multi-national rand hedges should be in the portfolio. However, they are simply too expensive as they trade on historic PEs of 26x, 23x and 19x respectively. Only SABMiller's earnings profile is defensive. Our gold and platinum shares as well as the stocks mentioned below give us our rand hedge exposure.
- Lower valuation rand hedges (approximately 35% of the portfolio). The portfolio holds meaningful positions in Reinet (a 27% discount to British American Tobacco), Steinhoff (a PE of 8x), Sasol (a PE of 9x) and Sappi (trading at book value and a forward PE of 12x). We believe these stocks are fundamentally undervalued and give us additional rand hedge exposure at a significantly lower valuation.
While 18 months of underperformance is obviously a difficult burden to bear, we remain committed to our views. We believe that when the tide turns, investors will be rewarded for their patience.
Investec Value comment - Dec 12 - Fund Manager Comment25 Mar 2013
Market review
The FTSE/JSE All Share Index (ALSI) ended the year at record highs, adding just shy of 27% in rands to the modest gains of 2011. The ALSI rose by 10.3% over the quarter. Resources lagged the general market, recording gains of 7.3% over the 3-month period and 3.1% for the year. The gold mining (-18.4%) and platinum mining (-7%) sectors were the weakest performers in 2012, while diversified miners added 10.9% over the quarter and 12.3% for the year. The industrials sector rose strongly, with general retailers (+50.2%), health care (+59.5%) and global luxury brand Richemont (+64%) - the only constituent of the personal goods sector - seeing exceptional returns in 2012. Mobile telecommunication increased by 32.6% over the year, with the fourth quarter adding 12.7% alone. Financials also saw market-beating returns, gaining 38.1% for the year. Banks closed up 11.8% over the quarter while the life insurance sector added 12.7%.
Portfolio review
The Investec Value Fund continued to underperform over the quarter, as the worst year of relative performance for our portfolio since 2008 came to an end. The trend of the past 15 months continued - the most expensive stocks (domestic consumer and defensive international stocks) got more expensive, and the cheapest stocks (gold and platinum stocks) got cheaper. Even though the quarter's returns were below benchmark, the portfolio recorded the strongest absolute return of the year. The largest detractors to performance in 2012 were our overweight positions in Gold Fields (-14%), Anglo American Platinum (-16%) and AngloGold Ashanti (-23%), as well as our underweight positions in Richemont (+65%) and SABMiller (+41%). Our underweight position in Anglo American (-10%) was a material contributor to performance. Our offshore equity holdings performed strongly over the quarter. Although the offshore component lagged behind the All Share Index, the returns from our offshore equities exceeded our domestic equity returns. Detractors to offshore performance were our holdings in Supervalu (-70% in US dollars) and RadioShack Corporation (-78%), which was partially offset by our holding in Enterprise Inns (+350% in pounds).
Portfolio activity
Since most of our positions are in place, trading was limited to adding to our Anglo American Platinum and AngloGold Ashanti positions, initiating a small position in African Bank and taking profits in Oceana Group.
Portfolio positioning
Despite 15 months of persistent underperformance, we believe our views will eventually be vindicated. We have built a high conviction portfolio of exceptionally cheap and out-of-favour stocks. The shares that have hurt our relative performance over the past year now trade at extremely attractive valuations. The top gainers of 2012 (Woolworths, Mr Price, Aspen, Richemont and Life Healthcare), which rose between 65% and 89%, now trade at respective historic price earnings ratios (PEs) of between 21 and 26x. These ratings allow no margin of safety and any negative earnings surprises will result in permanent capital loss. We therefore have almost no exposure to South African industrial and consumer stocks and continue to believe that the highly rated international stocks (SABMiller, Richemont and Naspers) are overvalued at historic PEs of 21, 21 and 28x respectively. The portfolio is almost entirely exposed to rand hedge shares. We are concentrated in just a few positions - domestic gold and platinum stocks as well as Steinhoff, Sasol and Sappi. Our offshore equity holdings are concentrated in the US, Japan and Europe. The rand's 4% depreciation against the dollar over the past 12-months was less than expected, given the dramatic widening of the trade deficit. We expect the rand to weaken further against the dollar. Our expectations are based on our belief that there won't be any further substantial foreign capital inflows into our markets to offset our large trade and current account deficits. Worsening political news could also weigh on the local currency. The unfavourable outlook for the rand, our continued bullish view on the dollar gold price and the fact that South African gold shares are trading at multi-year lows, encourage us to maintain a large weighting in Gold Fields and AngloGold Ashanti. Given US government debt levels, we believe that the US Federal Reserve has no option but to continue to supress US bond yields through ongoing quantitative easing. The level of debt that has been accumulated by the US government over the last decade means that negative real interest rates will have to be maintained for an extended period to transfer debt from the savers to the largest debtor, the US government. China's response to this situation is to rapidly increase its gold holdings. We therefore expect the 10-year bull market in gold to continue. Our large position in platinum shares (Anglo American Platinum, Lonmin and Aquarius) is motivated by the all-time low valuations of these stocks (lowest ever price-to-book and price-to-replacement values). We also like the long-term prospects for platinum group metals because of the regulatory nature of demand for these metals, an absence of substitutes, and the fact that South Africa remains the world's largest producer. The platinum stocks that we hold in the portfolio are between 60-90% below their all-time highs. We see substantial value in our current portfolio, remain committed to our positions, and will wait patiently for the catalyst to unlock the inherent value. Given that we hold out-of-favour shares with low valuations, we believe there is little downside to our stocks. In our view, any further underperformance would be due to our portfolio remaining flat while the market advances, as was the case over the past 15 months. In fact, while the market is at an all-time high, our stocks are on average 40% below their respective all-time highs, indicating substantial upside when the tide turns.