Coronation Smaller Companies Fund, Investec Emerging Companies Fund, Nedgroup Entrepreneur, Old Mutual Mid & Small Cap Fund, Sanlam Small Cap Fund
T here has been a lot of academic literature that shows small caps outperforming large caps over time.
But the theory is little comfort for investors in the here and now. Over the past five years, large caps have outperformed by a comfortable 1.1% a year, 7.8% against 6.7%. Fledgling shares have a lot more runway than mature shares with large market shares.
But there are stumbling blocks. One is that the JSE puts most of its effort into the top 40 shares and institutional clients — the thriving private client culture which supports small caps in many other markets is not entrenched.
More recently, quality small caps have looked for other ways to raise capital, such as private equity, or they simply rely on debt, realising that equity is the most expensive form of finance in the long run. The tide could turn with the new stock exchanges such ZAR X, which will focus more on small caps.
On the demand side there has been limited appetite for building block funds, which has affected the industrial, financial and resources funds as much as small caps — even pure general equity funds have shown limited growth.
And there is a reputation for volatility — not necessarily deserved — in the small-cap funds. Yet these are often great for diversification. They will have limited stock overlap with traditional general equity funds and they will perform contracyclically to a large extent.
The funds had limited exposure to mining historically, though that has changed as these groups have struggled, AngloGold Ashanti is now the largest share in the mid-cap index, Imapala Platinum has slipped even below that. It also has no exposure to the banks (including Investec and Capitec which are also large caps) so it needs to find creative ways to access the financial sector, such as Peregrine, Sygnia or even, for those with strong stomachs, Brait.
The small- and mid-cap sectors are more focused on the domestic economy, with the rand hedges sitting primarily in the Top 40. A stable or recovering rand will help the sector but above all economic growth will be a necessary catalyst to the recovery of the sector.
There are differences between the funds. Investec Emerging Companies has an unusually large mining exposure and operates as a subfranchise of the Investec value team headed by John Biccard. Andrew Joannou, an Investec retread who worked for Afena in between, now runs the fund.
Old Mutual Mid and Small Cap is more of a one-man band run by the shrewd and wily Warren Jervis (not that his recent performance shows him in the best light). Nedgroup Entrepreneur would probably be the blue chip of the sector if you had to pick just one fund. Fund manager Anthony Sedgwick is a protégé of Abax Investments founder Tim Allsop and runs a predominantly mid-cap portfolio. Coronation puts very little marketing spend behind its smaller companies but it has a veteran manager in Alistair Lea and is full of shares that seem to make sense, though some are sceptical of Altech’s prospects.
The Sanlam Small Cap Fund has more shares than its peers that are below the radar but that is the strategy of fund manager Vanessa van Vuuren. Perhaps in the long term it will produce the most outperformance, but the sweet spot for this fund is the same as it is for the private equity market. Perhaps investors can make more money that way, without worrying about the pesky, irrational stock market.
There is less than R7bn in small caps out of the industry total of R2.2-trillion. Investors need to think again and reblend their portfolios to give local small caps a chance.
The shop may be one of the two largest unit trust managers in SA, but it has only been able to raise a paltry R165m for this fund, even though fund manager Alistair Lea is small-cap aristocracy; he managed Entrepreneur in its early years.
The fund has a pattern similar to the peer group, with about 7% in basic materials — focused on Northam Platinum and Pan African Resources — and 28% in financials. It focuses on high-quality companies, though there are always unexpected events. It has a hefty 5.5% in Famous Brands, which has an excellent business case in SA but has suffered from its badly timed purchase of Gourmet Burger Kitchen in the UK. Lea says he still prefers it to the alternatives: Taste is uninvestable and though Spur has held up well in the short term it does not have Famous Brands’ runway.
Famous Brands is the biggest blemish in its top 10, in which most of the shares would qualify as quality businesses. They include Spar, Distell, education group AdvTech, Altech (OK, that would be in the recovery category), Hosken Consolidated, advertising and media group Adcorp, insurance conglomerate Rand Merchant Investment Holdings (RMI) and fertiliser group Omnia.
Lea believes that Distell’s hard currency earnings, for products such as Amarula Cream liqueur, provide an underpin. The fund isn’t dominated by the large mid caps which might be in the top 40 in different circumstances. Only Spar, Netcare and Life Healthcare are in the grey area between large and mid cap. Steinhoff Africa is its only predominantly clothing retailer.
The fund has a particularly high 4.5% holding in Sygnia, the niche investment and administration group, and has even bravely held on to a 2% holding in Brait.
Other financial holdings are Ethos PE Capital and Coronation itself. Lea says he is not a big supporter of investment holding companies. He has not bought African Rainbow Capital, for example. But he has made an exception for RMI, Brian Joffe’s Long4Life and PSG’s Zeder Investments.
This was once the largest fund in the unit trust market when it was run by Rhett Hammond. And with R2.2bn it remains, with Nedgroup Entrepreneur, one of the two giants of the sector.
Under previous manager Daniel Sacks, it acquired a bias towards mining shares, quite a different profile to its peers. Under Andrew Joannou, manager for the past two years, it has rebalanced back to industrials.
Joannou says the mining bias is dominated by two stock-specific holdings which make up 13% of the fund: Impala Platinum, the troubled precious metals group which still has some good assets; and low-cost gold producer Pan African Resources.
Joannou calls Impala significantly mispriced as it gives no value to the developing Impala lease area. And the supply of platinum is in decline, which can only help the metal price. The precious metals theme is continued with holdings in Sibanye Gold and African Rainbow Minerals. But mining certainly doesn’t dominate, with holdings in Combined Motor Holdings, Hudaco and Metrofile increased and packaging group Nampak brought in.
It is actively managed, and Netcare, Tsogo Sun, Hyprop, Lewis Group and Sun International were all recently disposed of.
Like his peers, Joannou calls his fund defensively positioned, with a balance of rand hedge stocks, interest rate-sensitive businesses, precious metals producers and strong local industrial stocks. He says the fund was wary of buying into the SA Inc story too aggressively, preferring shares with specific recovery prospects such as Altech and financial share Peregrine, which has a sticky customer base through its Citadel private client business.
Massmart is the largest industrial holding, Hosken Consolidated the largest financial. Unusually for this sector, the fund has a 10% exposure to real estate, which was increased by recent purchases of Octodec, Rebosis and Stenprop to augment the holdings in Investec Property Fund and Vukile.
At the height of the Ramaphoria boom in SA Inc shares, fund manager Anthony Sedgwick received an unusually high number of inquiries.
By the nature of their universe the midand small-cap shares are focused primarily on domestic industrial counters. Unfortunately these inquiries did not turn into hard cash inflows.
Nedgroup Entrepreneur has a similar approach to Nedgroup Rainmaker — both have the stamp of Abax, which manages the funds on behalf of the bank. Abax is now a large manager with R90bn of assets.
Entrepreneur’s competitors will tell you that the fund is not true to label, as it has a number of large-cap shares, which it bought before it entered the all share index top 40. But now this makes up just 11% of the fund, with Naspers, British American Tobacco and Sappi. Naspers might be the largest share on the JSE, but it still fits under the “entrepreneur” label as it has a reputation for innovation.
Sedgwick says Entrepreneur has been defensively positioned in reasonably priced, highly cash-generative mid caps that occupy defendable positions as players of scale in their niches. Core holdings include biscuits, coffee and fishing group AVI, shortterm insurer Santam, Rand Merchant Investment Holdings (for its holdings in Discovery and Outsurance), industrial conglomerate KAP and Italtile.
Late last year when the market was in a slump, it rotated into the depressed retailers such as Massmart, Pick n Pay and Truworths. Only the Truworths position has been retained.
There has been activity in the third quarter, as the fund has sold out of packaging group Mpact, automotive parts group Metair, Massmart and Alexander Forbes. Sedgwick says the team had become disillusioned with Andrew Darfoor’s strategy as Forbes CEO. There were no entirely
new holdings, but enhancements were made to hospital group Netcare, which has flipped in and out of the top 40 (it is now outside), PSG Konsult, JSE Ltd, Truworths, Afrox, Merafe, Wilson Bayly Holmes, Barloworld and Reunert.
The fund has been a holder of Howden for many years and hopes to see some value from the proposed buyout of minorities by the main shareholder Colfax of the US.
It’s an industrially focused fund, with less than 9% in basic materials — just Afrox, Merafe and Sappi. There is 20% in financials, though this includes the 3% held between Reinet and Zeder.
The fund is highly leveraged to economic growth and has battled more than its peers to preserve value. As well as the local recession, the sector has been affected by the fall in emergingmarket shares and the overall move by investors to reduce risk.
Warren Jervis has been at the helm for most of the fund’s 21 years. He can’t be accused of taking a closet index approach, but the converse of this is that some of his larger holdings have bitten deep.
Invicta and Consolidated Infrastructure make up almost 10% of the fund and both have been in trouble. And he says that the Tongaat Hulett share price has been pushed down by perceptions that its land development programme will be held up by the danger of expropriation without compensation.
The fund has a modest 18% exposed internationally, primarily through Reinet, which recently exited the top 40 and trades at a 36% discount to the sum of the parts, mainly British American Tobacco. Other rand hedges are Trencor and Datatec. The fund might also benefit from a weak rand through increased tourism through its holdings in Tsogo Sun and City Lodge, particularly if visa restrictions are sufficiently relaxed.
Jervis says he regrets selling out of Assore, a highly volatile share, as well as Exxaro and African Rainbow Minerals. The only resources share in the fund is fertiliser producer Omnia.
The fund has 20% in financials excluding tobacco share Reinet. Coronation, Rand Merchant Investment Holdings, Discovery, PSG, Santam and JSE Ltd make this up. Jervis has also invested in small-cap favourites such as Italtile, Distell, AdvTech, Pioneer Foods and Afrimat. Its main broad retail exposure has been through Massmart. Among the former large caps are Telkom, Barloworld and Life Healthcare.
If there is going to be a move to serious infrastructure development then Barloworld’s capital equipment sales are bound to benefit. Telkom will always look like a value share, Jervis says, given the long-term decline of its fixed-line business, but it is making the right noises by improving customer service and not overspending on its mobile operations.
Jervis says it is important that the fund remains liquid, and tradability of the holdings is crucial. Recent acquisitions include Reunert and Clover.
This is the most true-to-label fund in the sector, but as a purist small-cap fund it has battled more than its peers in a market where lack of liquidity has pushed shares down.
But fund manager Vanessa van Vuuren remains focused on shares below the radar as they are not the subject of institutional research — shares such as AdaptIt, which she bought at R2 and now trade at R6.80, or Bowler Metcalf (BowCalf), consistently a highly profitable business. BowCalf sold its soft drinks business at an unexpectedly high R600m, making the remaining plastics business look extremely cheap.
She says the fund takes a 10- to 15-year view, which can work as there are limited inflows or outflows and just a hard core of true believers left in the fund.
Many people might not realise that some of her holdings are listed companies, such as Cartrack and Trellidor. Perhaps the most controversial share in the portfolio is Curro, the education group, which at times has traded on a p:e ratio approaching 100, but it has a strong long-term case.
Other core holdings are Namibian Breweries, the producer of Windhoek Lager, and HomeChoice, which Van Vuuren calls both her most and least favourite share. It has an excellent franchise in consumer goods for LSM 4-8 black women, but it has such a small free float it has been unable to get much traction in its share price. The fund has moved tactically into mid caps — over the past year it has made opportunistic purchases of Glencore and bulk mineral shares such as Exxaro and South32.
Van Vuuren also bought some Super Group shares but missed the run in Barloworld. She has taken some pain from Dis-Chem but regards it as one of the few genuine quality shares in her investment universe. Tactically it has moved in and out of TFG and Truworths.
Sanlam was also hit by the recent poor trading update in Rhodes Foods, but she is confident that as a much nimbler, less bureaucratic business than its food producer peers it will get through.
The fund includes a mixed bag of niche financial shares such as Peregrine, Sygnia, Ethos PE Capital and Brait. In property she holds home builder Balwin and the UKbased Atlantic Leaf fund.
Warren Jervis … shrewd and wily Picture: HETTY ZANTMAN
Anthony Sedgwick … predominantly Picture: HETTY ZANTMAN mid-cap portfolio