Built to take the pressure
RE:CM’s investment director, Daniel Malan, responds on behalf of the Flexible Equity Fund
A SENSIBLE perspective on the divergent relative equity performance of managers in South Africa can be gained by studying the graph of price-tobook multiples of the JSE All Share index and its three key broader sector constituents — financials, industrials and resources.
In the graph, they have all been rebased in comparison to their long-term averages, represented by the straight dotted line. A few things struck us as interesting.
First, the magnitude of the boom-and-bust cycle of the resources sector in 2007-08. A clear valuation divergence from the rest of the market occurred when resource shares were very popular investment holdings, based on commodity super-cycle theories (can anyone even remember that?).
It is quite clear that the inevitable coming back to earth was indeed a harsh reality for many. It is our experience and observation that this sort of rapid bear market outcome is, in fact, to be expected of significantly overvalued assets.
In comparison, the price declines in the fair to undervalued industrial and financial sectors during mid-2008 were much more muted from an absolute perspective, and simply brilliant from a relative perspective.
Again, this is to be expected. Assets that are unpopular tend to outperform in bear markets owing to their lack of broad institutional ownership and inherent level of absolute cheapness.
The valuation divergence today between expensive industrials on the one hand and cheap resources on the other is clear and, indeed, also wide.
The “comfortable” ownership of late 2007 in very expensive resource shares ended in permanent capital losses for investors. The “uncomfortable” positions in cheap financials ended up performing well. The lesson is clear: one has to be extremely careful of popular, overvalued assets and carefully consider investing your capital in unpopular, cheap assets.
Of course, over short periods of time such as the past year, owning resources while their prices continued declining implies accepting significant levels of discomfort. No one enjoys mark to market losses on their portfolio, but it is a necessary evil of true value investing.
The discomfort of owning what goes down is made much more painful when the owners of popular assets are posting mark to market gains. The reason value investing works is because most investors cannot stomach the extreme pressures they experience at times in their performance cycles when the market presents significant valuation dislocations.
RE:CM is designed and structured in such a way that it can withstand these pressures comfortably; indeed, we welcome them, strangely enough.
Our firm consists of a partnership between its three key stakeholders: our clients, employees and shareholders, all of whom share a single longterm value investment philosophy.
Our shareholders and employees are significant investors in our own unit trust funds, paying the same fees as our retail clients. This represents a true alignment of interests.
We are heavily incentivised to do the right thing for our clients, because doing so directly affects all our own life savings.