Investors’ biggest risk

CAPITULATION: PULLING OUT AT LOWS WILL RESULT IN BIGGEST LOSSES

Annualised returns after low points average 24% for three years.

The last five years on the JSE have been one of the worst periods in the last four and a half decades. Poor returns are only part of it. Local investors are worried about the country. The economy’s battling to register positive growth, consumers are under pressure, there are ongoing corruption revelations, state-owned enterprises are under severe financial strain, and business confidence is at a 40-year low.

Safety in cash?:

Given this environment, asset managers are being asked whether investors should get out of the market and wait it out in cash.

However, PSG Asset Management’s Greg Hopkins believes investors must look at these tough conditions from a different perspective.

“When we look out to the future we think the biggest risk to investors is not what happens in the election in a few months’ time, in our economy or the global environment, but investors’ capitulation.”

It’s understandable for investors to feel despondent. But looking back at what has happened in the past following similar troughs, there’s a clear pattern (see figure 1).

“Subsequent annualised returns from those low points averaged 24% for the next three years. The highest was around 40% returns from 2003. That was a standout period where you earned 40% a year for three years.”

This was following the 2001 and 2002 dotcom crash.

“A lot of conditions in the market now remind us of that period in 2002 and 2003. Fear, uncertainty and poor visibility are often associated with low prices. And low prices bring opportunities.”

Asymmetry

Often the best time to be a buyer is when things appear to be at their worst. Because of the weak environment, there are many good companies that aren’t being recognised by the market. This has increased the chances for investors to find “above-average quality companies at below-average prices”.

Hopkins says a basket of SA-facing shares in the PSG Flexible Fund is currently sitting on a 16-year low price-to-book multiple. On this metric valuations are lower than they were during the global financial crisis. This is creating an asymmetrical return profile (see figure 2).

“It seems to us there is less downside risk, because prices are already so low, and significant optionality if things just get a little less bad,” Hopkins says.

The companies in this basket include Old Mutual, Hudaco, Reunert, Super Group and AECI.

“Hudaco has a fantastic track record of compounding shareholder returns at 20% a year over the last 20 years, far exceeding the average company on the stock exchange. Yet it is trading at around 11 times earnings, which is a large discount to the average company at around 16 times earnings.”

Reunert’s trading at the lowest price-to-book it has since 2000; it’s at a dividend yield of around 7%.

“Super Group is a company we’ve owned for a number of years, with a great management team,” says Hopkins. “It is now approaching valuations we last saw in 2012 when we first started buying it.”