Value is getting harder to find
FOR those already invested offshore, the good new seems set to continue. As at 10 days ago, the MSCI World Index had over the prior period of one month gained 7.8 percent in dollars from its recent low (or nine percent in rands).
As to whether this can continue: historically 75 percent of the returns both on offshore developed markets and the JSE ALSI have come between November and April. So this is typically a fairly buoyant period.
Anet Ahern, CEO of PSG Asset Managers, says one of the more surprising elements of this month-long recovery has been the strength and resilience of the US economy.
“It shows the US is still relevant. Many people thought China would be the main driver of growth, but that is not so. Furthermore, international stock valuations are currently not unreasonable: a lot of well-established US companies are trading at very good prices.”
She says there is also opportunity in the EU for early investors: “Stocks tend to recover in advance of the economy. We saw that in the US where there has been a five and a half year bull market but we are only seeing the economy really recover now.
“EU valuations were again punished this year, but I suspect the worst is over and early investors could ride the same wave as we saw in the US.”
The JSE’s recovery since its blip in August and September has also been a pleasant surprise, says Ahern. “The problem with the JSE is new money coming into equity funds, and we see a lot of this going into already overpriced top 20 stocks.
“I can’t agree with this trend and at PSG we are not following suit as they no longer offer value compared to mid-cap, small-cap and offshore stocks,” says Ahern.
So far in 2014 the JSE Mid-Cap Index has risen 12.5 percent, while the JSE Small-Cap Index has done 14.6 percent, to reach a new record high. It is usual in a bull market that mid-caps and small-caps outperform big caps.
In the PSG portfolio (it has about 25-30 stocks, which have been relatively stable for several years) Ahern says the best returns are coming from its offshore equities followed by domestic equities, such as Steinhoff and Capitec.
She attributes the good domestic equity performance to the fact it is not positioned in the top 20 stocks, but in value stocks “of which there are still quite a few”.
“We are not bullish on listed property and remain concerned about bonds, even though we believe that inflation is more under control than many people think.
“Cash is not yielding much, but we remain underweight equities and overweight cash as firepower for buying opportunities as they present themselves.
“Although many analysts viewed the recent correction as an ideal buying opportunity, Ahern says PSG was tentative in accumulating – “one or two percent rather than 10 percent”.
In explanation, she says: “We’re finding it harder to spot new value opportunities in the current market.”
Many people are hoping for a stronger rand: after all, although the international oil price has fallen about 23 percent, we’ve scarcely seen any decline in the domestic price.
However, Ahern believes they may be disappointed: “The difficulty is that the US economy is recovering strongly and this could result in a strengthening US dollar.
“Emerging market currencies tend to suffer as a result. Structurally, South Africa is running too big a deficit – and this is a major reason why we believe investors should diversify their wealth offshore,” she says.
PSG favours developed market stocks over emerging market ones, primarily because developed market valuations are good and many companies have excel- lent histories of clean corporate data, sometimes as long as 30 years, “which is not always the case with corporates in emerging markets”.
For those contemplating investing their year-end bonuses, Ahern offers advice on where to put it: “If you won’t need to touch that capital for 5-7 years, then I would definitely suggest equities. If you have any concerns at all, I’d recommend you opt for a balanced fund.”
She points to a recent trend of investors following that advice. In the last Association for Savings and Investment South Africa (ASISA) quarterly report, there was a noticeable shift in volumes into general equity funds.
“The main volume by a factor of three or four times remains into balanced funds, but there is a systematic increase of capital flows into general equity funds.
“I don’t think you could go wrong investing into general equities, even at this stage of the bull market, but I would be concerned at investors choosing large cap stocks.
“They’re stretched, and it would require some deeper analysis of individual stocks if your adviser is recommending such stocks, she says.
For instance, the average price to earnings ratio (P/E) of 12.5 times for domestic equities in PSG’s portfolio is almost 6 points lower than the JSE’s average P/E of 18.
“However, investors do face a dilemma. Stock markets have gone up and the rand down. At these levels investors need to closely assess their appetite for volatility.
“We still recommend investors investing in equities, but only in accordance with how much risk you can stomach,” says Ahern.
Sumesh Chetty, portfolio manager, Investec Asset Management, agrees in principle with Ahern, saying: “South African equity valuations have been stretched while the underlying economy remains rather lacklustre.
“This is why we continue to use our full offshore allocation, as we see the best opportunities in high-quality, developed market equities.
“However, one has to bear in mind that the asset class is not homogenous, so careful analysis is required to seek out those businesses that will be able to deliver real growth.
“For example, in the Opportunity Fund, we are reticent to invest in some of the more capitalintensive parts of the market and we are also not interested in highly leveraged companies. Instead, we have material exposure to consumer staples and we are seeing some attractive opportunities in the technology area.”
Chetty adds: “These are companies with good business models we believe the market has underpriced. One of our preferred consumer staples is the global food producer Nestle.
“The company’s products are entrenched in the minds of consumers and it has returned more than 103 billion Swiss francs in dividends and share buybacks since 2001.
“In the technology space Microsoft is one of our favoured stocks – the software developed by the company is fully entrenched in corporates around the world and not wholly substitutable.
“This does not mean there is no more value left in the South African market – investors would do well to look to those companies with large exposure to offshore markets, such as British American Tobacco Steinhoff and Richemont,” says Chetty.
CEO of PSG Asset Managers.