Ten years ago, optimism in South Africa remained high. SA had just hosted the FIFA World Cup in 2010, and we were barely three years in the presidency of Jacob Zuma.
The South African economy tended to track the median performance of other countries, but as Zuma’s presidency became increasingly associated with state capture and corruption, that link was severed. . SA’s economic growth slipped behind the median.
As economic growth slowed, the cost base increased. Major operating costs – such as electricity, tariffs, water and garbage removal – have increased at rates above consumer inflation, resulting in returns on capital mediocre own on the JSE. There has been a structural decline in South Africa’s business sector and it is only recently that stocks have started to wake up from this long winter of underperformance.
“Investing in this context posed obvious challenges. One of the big lessons we’ve learned over the past 10 years is that when you’re faced with two stocks with the same levels of upside and return, always look to the best deals, ”says Iain Power, manager of fund of the Nedgroup Investments Balanced Fund. . “In general, we think cheap businesses are cheap for a reason and it’s hard to discern what a value trap or a value opportunity is. “
The Nedgroup Investments Balanced Fund, which is managed by Truffle Asset Management, has maintained its best-in-class performance of peers over a turbulent decade. It did so by staying nimble, honing a research team ready to challenge the consensus point of view, making sound asset allocation decisions – and, perhaps more importantly, by making sound asset allocation decisions. avoiding losers.
In the 10 years to September 2021, the fund came first in its category, beating the High Equity category of Asisa (Association for Savings and Investment South Africa) by 3.4%.
Over three, five and seven years, the fund has consistently ranked in the top 10%.
“Our secret sauce has remained fairly constant and this made the performance reproducible. We’re looking for companies that trade for less than their intrinsic value, ”says Power.
“Where we’ve been more successful than others is in distinguishing between cheap stocks that have temporary issues and stocks that look cheap but are value traps. We were able to determine if these stocks have temporarily lost value, and therefore have a good chance of returning to the median, or if there is more fundamental value destruction in the company.
Future returns won’t look like the past
Some of the critical challenges that all research teams face are the likely impact of Covid, climate change, and ESG (environmental, social and governance factors) on business performance.
Covid will have lasting impacts on supply chains as the great sweep of globalization of recent decades now looks like a potential liability.
Many companies are looking for alternative supplies made locally. Critical freight backlogs have developed at key ports around the world, providing local suppliers with the best opportunity in decades to regain market share from overseas competitors and build the cost of international freight into their products.
“Covid, climate change and other factors have changed the behavior of people,” says Power. “From a research perspective, this has made some of the current trends more difficult to read. We say that future returns may not look like the past, and this is where some of our peers have struggled to understand the fundamental changes that are taking place.
One of those changes is the changing interest rate cycle as the era of super low interest rates comes to an end.
This will have a serious impact on over-leveraged companies. “Businesses fail because they can’t pay down debt, not because they can’t generate cash flow,” says Power.
One of the main reasons for the fund’s success is its ability to avoid many losers like Aspen, MTN, Brait, Omnia, Tongaat, EOH and others.
“We had some exposure to Steinhoff, but not very significant, and for us that was a good lesson well learned. At a fundamental level, we are business analysts trying to build strong portfolios and trying to spread our capital across as many independent business ideas as possible.
“We are looking for opportunities that are poorly evaluated. We are spreading our positions widely and we will inevitably be a little wrong, but we will get a lot more correctly, ”adds Power.
Question the inconvenience
The Truffle approach to research places a strong emphasis on questioning the drawbacks.
“We always ask ourselves if we are wrong, where and how will it impact us and permanently affect our capital? We are looking for dumped companies so if something goes wrong we can always get 100c back into the rand. “
The research process is rigorous, involving on-site visits to warehouses, stores and competitors. This allows the team to know if the reality of the management is reflected in the reality of the investment.
“We have spent a lot of time developing our team and our talent and we think we have a very solid bench. The reality is that we want to test ideas in the stoves of solid debate. If these ideas can come out of the debate unscathed, we believe it increases the likelihood of achieving returns and also highlights some of the downside risks. “
The challenges of the next decade
One of the big challenges South Africa will face over the next decade is youth unemployment, which in turn creates pressure on politicians to pursue more populist causes, such as wages. minimum, basic income allowances and free basic services.
None of these can be paid in the absence of robust economic growth and there is little evidence that this growth is being generated under the current administration.
It remains to be seen how well the ruling ANC will perform in the next local elections and what percentage of the electorate will bother to participate.
“The shift to populist policies is not unique to South Africa,” says Power. “It’s a global phenomenon. China is already moving down this path with fierce consequences for shareholders, but the risk is in execution. When you have well-established legal and administrative systems, the risks are not that high.
“The ANC needs to implement some form of reform and growth to get South Africa out of these challenges in a reasonable form.”
Presented by Nedgroup Investments.
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