FUND RE­VIEWS

Financial Mail - Investors Monthly - - Contents - STEPHEN CRANSTON

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

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