The Investec Equity Fund: Why an earnings revision strategy works
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:
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.