The In­vestec Eq­uity Fund: Why an earn­ings re­vi­sion strat­egy works

Finweek English Edition - - INVESTEC - 1 YEAR

While growth and value in­vest­ment st yles are widely known, earn­ings re­vi­sions may be less familiar to the in­vest­ing public. Earn­ings re­vi­sions oc­cur when in­vest­ment an­a­lysts’ ex­pec­ta­tions of a com­pany’s fu­ture prof­its change. This leads them to ad­just their earn­ings es­ti­mates up­wards or down­wards. Share prices con­tin­u­ously re­act to changes i n t he f un­da­men­tal prospects for com­pa­nies, which are partly ref lected in changes to fu­ture earn­ings ex­pec­ta­tions.

We strongly be­lieve that be­havioural bi­ases cause in­vestors to over- or un­der­re­act to new in­for­ma­tion as sen­ti­ment and emo­tion cloud their judg­ment. Some in­vestors tend to cling to their orig­i­nal earn­ings fore­casts even though new in­for­ma­tion has come to light. As a re­sult they only move away from their orig­i­nal ‘an­chor’ po­si­tions in small in­cre­ments over time. When a com­pany is do­ing bet­ter or worse rel­a­tive to cur­rent ex­pec­ta­tions of prof­itabil­ity, in­vestors typ­i­cally need time to un­der­stand why this has oc­curred. They are there­fore slow to re­act to in­for­ma­tion while they re­frame their views.

When an­a­lysts at­tempt to fore­cast the fu­ture earn­ings and cash f lows of listed com­pa­nies, they are tempted to look at the es­ti­mates of other an­a­lysts as this in­for­ma­tion is read­ily avail­able. It is there­fore no sur­prise for earn­ings es­ti­mates to ‘clus­ter to­gether’, as some­how it al­ways feels more com­fort­able to fol­low the herd.

We ex­ploit th­ese be­havioural bi­ases in the In­vestec Eq­uity Fund and be­lieve that buy­ing sus­tain­able earn­ings re­vi­sions at a rea­son­able val­u­a­tion within a dis­ci­plined in­vest­ment process has helped us to de­liver mar­ket-beat­ing re­turns. The fund has out­per­formed the FTSE/ JSE All Share In­dex over one, three and five years, and is in the first quar­tile over all th­ese pe­ri­ods:

25.3%

14.8%

13.4%

1

23%

20.1%

16.7%

1

18.5%

17.2%

15.0%

1 The­o­ret­i­cally, the value placed on any listed com­pany should be in equi­lib­rium with the mar­ket’s per­cep­tion of the com­pany’s fu­ture earn­ings prospects. In­vestors will typ­i­cally pay a pre­mium for com­pa­nies that are per­ceived to have high growth prospects, while com­pa­nies with low growth prospects trade on low val­u­a­tion mul­ti­ples. We be­lieve it’s there­fore only when ex­pec­ta­tions about

PORT­FO­LIO MANAGER, IN­VESTEC EQ­UITY FUND fu­ture growth prospects change that the shares of the listed com­pany should outor un­der­per­form the broader mar­ket.

Within the con­text of our in­vest­ment phi­los­o­phy, we are cur­rently pre­sented with a fairly nar­row in­vest­ment uni­verse – the do­mes­tic econ­omy is strug­gling, elec­tric­ity short­ages and industrial ac­tion are ham­per­ing the lo­cal man­u­fac­tur­ing and min­ing sec­tors, while com­mod­ity prices re­main un­der pres­sure. As a re­sult, the port­fo­lio is fairly con­cen­trated rel­a­tive to his­tory, with a num­ber of large core hold­ings. It’s po­si­tioned to cap­ture the benefits of an im­prov­ing global econ­omy as well as mit­i­gate risk from a strug­gling do­mes­tic econ­omy and an un­der-pres­sure re­sources sec­tor.

In terms of in­dus­tri­als, we main­tain our un­der­weight hold­ings in com­pa­nies with large ex­po­sure to the do­mes­tic econ­omy. In con­trast, we hold over­weight po­si­tions in those with large or ex­pand­ing off­shore op­er­a­tional ex­po­sure. This has been driven by com­pany-spe­cific rea­sons and not by sweep­ing top-down themes and is largely a re­sult of our po­si­tion­ing in Mondi, Naspers* and Stein­hoff In­ter­na­tional.

Fi­nan­cials re­main our core ex­po­sure. On av­er­age, banks and in­sur­ance sec­tors are re­ceiv­ing the strong­est pos­i­tive earn­ings re­vi­sions in SA, while re­main­ing at­trac­tively val­ued.

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