Anthony Sedgwick of Abax Investments, Portfolio Manager of the Nedgroup Investments Rainmaker & Entrepreneur Funds, talks about their approach to limit the downside of Covid-19.
Domestic South Africa
From an investment perspective, it’s been a pretty challenging and exciting time and we’ve certainly been more active in both funds over the last couple of months. The South African domestic equity market has been a tough place for South African investors for a considerable period with the All Share Index back at its 2014 level of 50 000 after many years of moving sideways. The extensive selloff following the virus outbreak saw the All Share Index falling 30% from the peak to its trough. What’s interesting to note is how far it has recovered relatively speaking.
Post Covid-19, we saw massive dispersions in returns illustrating just how much domestic South Africa has underperformed. The weakest example is SASOL down 85% since January 2019, the All Share Index down 5%, general retail index down 54% and the banks index down 45%. In contrast, what’s pulled the market up is Naspers, which is up 50%, British American Tobacco (BAT) up 50% and gold up 240%. The Nedgroup Investments Rainmaker Funds’ largest position, 1/3rd of the portfolio, is in Naspers, BAT, Reinet and Prosus and we have another 4% in gold, which is slightly underweight.
Learning from the mistakes we made during the Global Financial Crisis (GFC), we acted very aggressively while monitoring how long lasting this impact was likely to be. We have seen a very aggressive economic response to the virus from a monetary and fiscal perspective, which happened much faster than with the GFC. Our focus has been on the financial health of all our underlying businesses. We wanted to move quickly against businesses where debt levels are higher and where cash flow could come under pressure as a result of contracted activity. In South Africa, we’re getting used to the new normal of a substantially weaker Rand, higher bond yields and the possibility of rising inflation in the future.
We have maintained a substantial Rand hedge component unless we felt that the underlying prospects for those businesses was diminishing. We have continued to hold very substantial positions in Naspers, Prosus, BAT and we have bought more Reinet. In contrast, however, we have been concerned about the impact on the profits of Richemont, ABI Inbev, Bidcorp and Mondi, despite the fact that they are all high quality businesses with strong balance sheets, with the exception of ABI Inbev. We’ve sold out Richemont and Bidcorp completely and substantially reduced ABI Inbev and Mondi. On the domestic side, we’ve rotated into more defensive SA holdings and have sold out of Barloworld, Motus, Imperial and Truworths. We’ve also been looking for wholesale selling of stocks that would enable us to increase our exposure to quality businesses and in this respect have added more AVI. We’ve also looked to rotate into more defensive holdings and have bought Santam, Spar, Reinet, BHP, Anglo Gold and Absa. We continue to have strong holdings of Naspers, Prosus and BAT, which cumulatively make up 34% of the Nedgroup Investments Rainmaker Fund and 20% of the Nedgroup Investments Entrepreneur Fund.
Sectors that worry us the most
We have a healthy degree of scepticism about the long-term attractiveness of banks as they continue to be de-rated by the markets. Our preferred exposure has been through FirstRand. Pre-Covid, SA banks looked good value relative to emerging market peers on a relative price to book basis, and were de-rated to the lowest point they’d been for almost 7 years with an absolute PE below 10X with attractive dividend yields. Even though we had very sanguine expectations around profit growth, in February we had a combined bank exposure of 13% of the portfolio. Covid-19 materially de-rated the businesses again and they have barely bounced off their lows. For many businesses, dividend decisions are being deferred in favour of accumulated cash to weather the storm. We’ve never seen valuations like this before, even at the trough of the GFC. We’ve already seen a very constructive intervention from the Regulator, softening their stance on loan loss accounting and offering the sector flexibility with liquidity and capital buffers. We’ve also seen substantial interest rate cuts, which will help businesses with their borrowings under these circumstances.
It’s interesting to note that the capital positions of the banks are substantially higher than in the 2008 crisis, despite a backdrop of no inflation, lean growth, relatively low interest rates and very low credit demand growth. The banking sectors and its clients have gone into this crisis in a relatively better position than in 2008. The banks’ valuation levels are unprecedented in history and while we’re nervous, we continue to hold a fairly large exposure to the sector, but is the area we’re applying a lot of focus and we’ll be fairly nimble with how we adjust that portion of the portfolio. Despite the weakness in the Rand in the short term, we’re not reducing our exposure to our major Rand hedges and believe that the valuations of the underlying businesses remain attractive.
Entrepreneur Fund insights
Our conservative stance has been supportive with very strong performance in the last month or two. We are super defensive in short-term insurance with 10% of the Fund in Santam and RMI (Outsurance). We’ve maintained limited Rand hedge exposure through Naspers, BAT / Reinet, Oceana Fishing and have traded the platinums that are available to us. We maintain our focus on balance sheet quality and the opportunity to acquire quality businesses at a discount, including AVI and Adcock Ingram. We have looked to limit our discretionary consumer exposure as far as possible. We have sold down Truworths and Italtile and bought some Pick ‘n Pay. We have sold out of Barloworld and remain worried about our positions in CMH, Hudaco and Reunert, which are 8% of the portfolio.
Our defensive positioning has been effective at limiting the downside and we will remain nimble and use market opportunities to add value relative to what’s available.