FUND REVIEWS

Kagiso Equity Alpha Fund, Nedgroup Investments Rainmaker Fund A, Old Mutual Investors’ Fund A, Prudential Equity Fund, Sim General Equity Fund

The general equity fund is the oldest, and was for many years the only, category of unit trusts. It now has R316bn under management or about 20% of industry assets.

Equities remain the asset class with the highest probability of giving the highest returns.

But in recent years the new money has moved into multiasset funds, which incorporate fixed income and property and which are better suited to investing for retirement as these funds are governed by Regulation 28 of the pension funds act. General equity funds not only face competition from multiasset funds, they could soon see index funds eat into their market share.

The funds reviewed below are among those that have the least to fear from index funds as they have produced strong alpha (outperformance) over their histories. You will often read very similar comments from these fund managers. All five, for example, hold Old Mutual in their top 10 holdings.

Prudential, for example, while describing its investment process, says its aim is to build a portfolio of high-quality companies (who doesn’t?) that are undervalued (nothing controversial there) but with earnings growth at least in line with the market.

In common with other large managers, Prudential uses quantitative screening. Then it does detailed fundamental analysis of the stocks identified in the screen. It believes in identifying the intrinsic value of a company on a “through the cycle” basis. It looks at the specific circumstances of the company and industry in which it operates to understand why the share is being undervalued.

The biggest debate among fund managers has been about Naspers, with four of the funds owning the stock and just one, SIM Value, leaving it out. There is certainly a view that it is too risky to leave Naspers out, given that it is 13,5% of the shareholder weighted index (Swix). Many of the fund managers have held the share for many years and believe that they are adopting a high-conviction approach.

The other differentiator has been the approach to commodities. Funds such as Old Mutual Investors, Prudential Equity and Rainmaker must be close to their lowest-ever resource weighting, particularly if paper company Mondi is considered to be an industrial. Sasol is also nowhere near as prominent as it was — it features in the top 10 of just two of the funds, Investors and Rainmaker, and in each case is close to the bottom of the tables. Just Kagiso has a hefty exposure to commodity shares, in its case platinum, and there has been a dent in its strong long-term track record.

The grouping does not include supersized monster funds Allan Gray Equity and Coronation Top 20, but incorporates two R14, 5bn-plus funds, Nedgroup Rainmaker and Old Mutual Investors. It also includes the R3billion flagship of Prudential Portfolio Managers, the Prudential Equity Fund, which is not big but reflects the house view of a R200bn-plus manager. Prudential is known for its highly disciplined, pragmatic approach and excellent risk control.

While these are all broadly styled neutral funds, using a blend of value and quality, SIM Value hangs it hat on its own definition of value.

It is also the fund that pays least attention to the benchmark. The fund is going through its own transition, as the fund managers, Claude van Cuyck and Ricco Friedrich, have left Sanlam Investments to start up Denker Capital. Van Cuyck says he hopes the gradual recovery in the world economies, along with more normalised interest rates, will lead to more rational capital allocation, which will help the fund. Kagiso Equity Alpha also claims to be a rational investor. Fund manager Gavin Wood says fluctuations have self-reinforcing cycles of enthusiasm or negativity often fuelled by an excessive focus on near-term data or news.

Will the market turn so that unloved sectors such as platinum and construction help drive returns? Or will the industrial large caps such as SABMiller and Steinhoff continue to drive the market? Certainly, if there is a speed bump at Naspers it will hurt most of these funds (though, of course, it will hit index funds just as hard).

There is also widespread support for the big banks, which might be one of the few remaining significant pockets of value as they trade at a discount of up to 30% against the market. But increased interest rates will affect the banks’ bad debts and may lead to reduced lending.

Fund managers have to make a call on these issues every day.

But at least they have the free lunch of diversification, which makes these risks far more controllable.

❛❛ In recent years the new money has moved into multiasset funds, which are better suited to investing for retirement

This fund was started in 2004 and was the number one general equity fund since inception until 2012. But the past year has been the first in which it has substantially outperformed the peer group — by a hefty 7%. Portfolio manager Gavin Wood says this does reflect the quality of the team, which continues to grow and includes the high-profile Abdul Davids as head of research.

Wood says the fund’s biggest mistake was to build a large position in platinum, particularly Lonmin.

“We believed that the supply of platinum group metals was so concentrated and the above-ground supplies so limited that this would help keep prices up. We certainly did not forecast the recent fall in the platinum price.”

The fund remains exposed to platinum though, mainly through the commodity exchange traded funds (4% for platinum, 3,7% for palladium) as well as Anglo Platinum (3,9%) which is the most mechanised of the houses (particularly after selling the Rustenburg mines to Sibanye). Wood says the house will no longer hold as high a position in a single metal again, now that it is more aware of the risks. It also had a U-turn on oil, reducing the holding from a high of 6%.

Kagiso has also had limited exposure to the high flying consumer industrials such as retailers, hospitals and SABMiller. For a value-orientated fund, however, it has a surprisingly large share in the portfolio — Naspers. Wood says the fund has always had a positive view on media companies and it has held Naspers since it had a much more modest market cap. He says the market focuses entirely on Tencent and does not put an adequate rating on its classified and e-commerce businesses in giant markets such as Russia and Brazil.

It sees the biggest value in the midcap sector where its exposures include AECI, ARM and Tongaat Hulett. It also has quite a healthy exposure to financials such as Old Mutual, FirstRand and Standard Bank. Though FirstRand looks expensive on a price-to-book basis, Wood says it is a high-quality business with strong operational momentum as well as returns on capital which justify its weighting. He says even though Standard Bank has nowhere near FirstRand’s return on capital they will improve once Standard has bedded down its expensive IT upgrade. Wood says the group’s African footprint remains an attraction in the long term. And Old Mutual (where he once worked as an actuary) has an excellent group schemes (lower-end) business and an improving UK wealth business but only an “average” local wealth management business.

Other financials in the broader sense include JSE-listed property shares invested offshore such as Capital & Counties and New Europe Property Investments.

It also has 17% in fully offshore equities. It looks at themes such as ageing demographics, the German consumer, the short-term insurance cycle and US technology. It owns a number of German residential property funds and two UK direct insurers (Esure and Admiral). He had a lucky escape as he sold his Volkswagen shares before the recent emissions scandal.

The Equity Alpha fund is a small fund but it has a strong long-term track record. It is a little over R400m after a hefty R600m withdrawal from a fund of funds manager. Wood says there has been limited investment into pure equity funds over the past 10 years, in which investment has been predominantly into multi-asset funds.

It also does not have a household brand name, which makes it a difficult sell to financial advisers.

The fund was associated for many years with its founding portfolio manager Tim Allsop. But since he stepped down more than two years ago the fund has been in the hands of Omri Thomas, his colleague at Abax. The fund has been comfortably ahead of benchmark over all periods. The fund is known for its excellent stock selection and for its risk control.

Thomas says the fund was fortunate to be on the right side of the commodity slump, with less than 5% in mining and the bulk of that in the relatively stable BHP Billiton. It had a further 4% each in Sasol and Mondi. A mistake he made was to sell out of retailers too early. He recently liquidated his position in Shoprite. He has less than 2,5% in the retail sector, through Foschini and Woolworths. The fund has a weighty 13% in Naspers.

Thomas says the fund, which has owned the share for more than 10 years, continues to take profits in the share but it continues to make up an ever-larger part of the portfolio. He remains a big long-term believer in the share.

A relatively high 20% of the portfolio is invested into shares outside the Top 40. Some winners for Rainmaker have included City Lodge, AVI and Oceana. There are 45 shares in total in Rainmaker.

The fund cannot invest outside the JSE but Thomas says that it has strong rand hedge qualities as 65% of the income is generated in dollars.

He says market sentiment is likely to remain extremely skittish. “We remain guided by a longer-term perspective in managing the fund’s positions and will look to take advantage of short-term volatility.”

Rainmaker’s inflows and outflows are broadly neutral. There have been switches into the multi-asset Nedgroup Opportunity fund, also run by Abax, as well as a regular drawdown of funds held in living annuities.

The fund is the oldest surviving fund in SA, having been created in 1967. It has more than R14bn under management and is the flagship of the Old Mutual Equities boutique. Fund manager Peter Linley says it has a valuation-driven approach but it also takes cognisance of three other factors: growth, quality and sentiment.

“Valuation is highly subjective,” says Linley. He says that Anglo American seemed to offer good value at R500, but as the earnings dwindled the price was not sustainable. It is now less than R150/share. “We aim to avoid such value traps,” says Linley.

He has little in mining other than a 3,5% holding in BHP Billiton as it is the most financially robust of the mining houses and could well have a forward dividend yield of

6%-7%. Its other resource shares are paper producer Mondi, which it considers to be an industrial cyclical, and a modest 2,5% in Sasol as it is cautious on the oil price, though Sasol is benefiting from the weak rand.

Every analyst in the Old Mutual Equities team has to provide a bull and bear case for their shares and to weight the probability of either materialising. The market’s earnings revisions are also taken into account, not least when they challenge the team’s perceived wisdom. Analysts also question each other’s methodology so that recently, as part of the stress testing process, small-cap analyst Brian Pyle and resources analyst Ian Woodley questioned each other’s assumptions and methodology.

Linley says the quality overlay is important and led the fund to take a (relatively modest) 3,5% holding in SABMiller, which would not have made it into the portfolio on valuation alone. The process also led the fund to buy Steinhoff at R22 as it showed every indication of being good value. It is now about R85. Steinhoff is one of the global cyclicals in the fund, such as Richemont, Steinhoff, Datatec and Mondi. It also invests in hybrid South African/global shares such as Investec, Old Mutual, MTN and Mediclinic.

Linley is sceptical about pure SA Inc shares though his fund holds Netcare, Remgro and Bidvest. The only retailer still in the fund is Foschini. Like Rainmaker, Investors’ Fund has a high conviction position on Naspers, which makes up 13,5% of the fund. It is now the biggest emerging markets e-commerce business, yet almost all of the value is accounted for by its 34% interest in Tencent and almost none by brands such as DStv, OLX and online travel agent Ibibo.

The fund owns Barclays Africa, FirstRand and Standard Bank as Linley believes there is too much specific risk in holding just one bank or even two.

Prudential is a value investor which has not gone down the same self-destructive path of other value funds. Fund manager Craig Butters says there are three factors which distinguish the Prudential approach: one is value or assessing the relative value of an asset by comparing its current valuation to alternative assets and the historical valuation range. But almost as important is quality or a bias towards value creators: ones that are capable of consistently delivering real growth in the underlying equity with more stability than the average company. The third leg of the process is risk consciousness: managing the risks and rewards of tilting portfolios away from their benchmarks.

“We quite unashamedly invest in a benchmark-cognisant way, paying as much attention to the shares we do not own as we do to those we own,” says Butters. “But you will find our portfolios are cheaper than the benchmark.”

Prudential has a chunky 7,4% holding in Naspers but, in line with its prudent approach, this is about half of the weighting in the less benchmark-cognisant Old Mutual Investors’ and Nedgroup Rainmaker. Butters says investors are paying for the indirect exposure to Tencent in China, with the pay-TV and Internet businesses elsewhere there for free. Unlike the classic deep value managers, Prudential has neither gold nor platinum shares. Its largest resource holding is 2,5% in BHP Billiton.

Based on valuations, the fund has a low exposure to retailers, through Pick n Pay, Woolworths and Foschini. Butters is more comfortable with the valuation of banks, which trade on a 25%-30% discount to the market, with visible earnings growth of 12%-14%. Standard Bank, FirstRand, Investec and Barclays Africa are all in the top 10 and make up 14% of the portfolio, with a further 4,7% for Old Mutual and smaller holdings in the JSE Ltd and Peregrine. In the global defensive category Prudential prefers British American Tobacco to either SABMiller or Richemont. BAT makes up 5% of the fund. Recently it has detracted from performance, along with MTN and Old Mutual, while Datatec, Steinhoff and Pick n Pay have helped performance. The fund has 16% invested offshore, either through exchange traded funds such as the iShares S&P 500 ETF or through funds run by sister company M&G in London.

The fund is used primarily by fund of funds managers as financial advisers and direct retail clients prefer its more aggressive sister fund, the Dividend Maximiser.

The SIM fund is now run by Denker Capital, the new breakaway manager in which Sanlam has a 49% stake. But it is still run by the same team of Claude van Cuyck and Ricco Friedrich. This is more of an unconstrained nonbenchmark-cognisant fund than it is a true value fund. Its top 10 has just one resource share, Anglo American. Van Cuyck says the fund will invest in shares whose return on invested capital is notably higher than the cost of capital — such as Spur and AdvTech — but also shares which trade on a deep discount to intrinsic value, such as Altron, which it expects to narrow.

The largest share in the fund is Steinhoff followed by Standard Bank, a share in which the price arguably does not reflect earnings potential. Next is Anglos, followed by Old Mutual — a favourite position in most general equity funds. The other big SA holdings are Barclays Africa, MTN and Investec. On its valuation basis, the fund cannot find any compelling logic to own Naspers.

Van Cuyck says the market may be expensive as a whole but certain stocks remain attractively valued. It has been slowly increasing its exposure to platinum shares, which now make up 5% of the portfolio.

Van Cuyck says the aim of the 25% international portion is to exploit opportunities that cannot be found locally. It owns seven shares, six of which are owned in the Global Best Ideas fund also by Denker. These include American International Group, Oracle and Samsung. Retailer Urban Outfitters is the seventh share. The fund also has a 3% direct interest in the Sanlam Global Best Ideas Fund.

The fund has R3, 6bn under management. Van Cuyck says several things set the fund apart. It has an unconstrained approach, its risk management is focused on the loss of capital over the long term and, because it is relatively small, opportunities are broader than its competitors. The fund has a lower exposure to large caps than the all share index (52% vs 83% in the Alsi) and it has a much higher exposure to small caps (10,5% vs 3% for the index) The small caps it owns have a dividend yield of 4,8%. The fund has a one-year forward p:e of 10,7 compared with 15,2 for the index but it also has expected earnings growth of 16,6% over two years compared with 14,7 for the index.