FUND RE­VIEWS

Financial Mail - Investors Monthly - - Contents - STEPHEN CRANSTON

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.

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