Anthony Sedgwick from Abax Investments, the portfolio managers for the Nedgroup Investments Rainmaker and Entrepreneur Funds, provides a mid-year update.
The ALSI in context
Since mid-2014, the South African equity market has been moving sideways with minimal returns for the last five or so years. It’s been a tough time for South African domestic investors with a massive divergence in returns between different sectors. The impact of the COVID crash, in the context of historic major market corrections, was the fastest on record. We’ve seen a tremendous recovery in a very short space of time resulting in a very volatile year thus far. There has been massive divergence in the year to date numbers in relative performance between our resource stocks and industrials, the latter driven mostly by some of the large Rand hedge stocks, particularly Naspers and Prosus, that dominate our index. In contrast, bringing up the rear are the financials where banks and property companies were particularly hard hit.
Rainmaker year to date overview
We have enormous exposure to the Naspers Prosus combination, which is effectively our interest in Tencent and is now more than 20% of the portfolio. We have started to reduce that holding slightly, but are still extremely positive about its prospects. British American Tobacco (BAT) and Reinet have pulled back a little in the short term and are cumulatively 10% of the Fund.
Our resource exposure, where our preference is the diversified mining houses, such as Anglo American and BHP Billiton, accounts for more than 10% of the portfolio. The prospects for iron ore and particularly copper, look very attractive in the short term. The relative valuations of the diversified mining houses are more attractive to us than the mining producers. For the first time in many years, AngloGold has been a top ten position in the portfolio at 4.5%, and we own 3.7% of PGM Producers.
We have almost no exposure to REITs other than a 1% holding in Growthpoint, and we are very cautious on discretionary consumer stocks, retail currently making up a very low proportion of the portfolio. What did hurt us was our exposure to banks who, despite going into this crisis with stronger balance sheets than leading into the Global Financial Crisis, have underperformed and remain a concern.
Our exposure to SASOL in Q1 hurt us although we did add to this stock and we’ve seen a substantial recovery, but, at R175 we think it looks quite full and have been reducing at that point. Some select domestic industrial exposure that we have in KAP and Bidvest also detracted from performance.
The early analysis in January was that COVID was relatively unimportant along the lines of SARS and bird flu. The COVID pandemic has, however, not been localised but has had a far-reaching global impact. We spent a lot of time and effort understanding the effectiveness that lockdown may or may not have and the impact on economic activity in the short and medium term. Given the degree of economic stimulus, both fiscal and monetary, that’s been applied to every economy around the globe, we needed to understand the extent to which that would offset the impact of the economic crisis caused by the pandemic. This was followed by analysing how human behaviour and economic activity, post lockdown, may be permanently changed. We also had to respond to the very rapid economic impact and liquidity concerns, so our focus has been on balance sheets, cash flow and business resilience and the ability of businesses to bounce back.
We maintained our Rand hedge exposure as much as we could unless we had concerns about the underlying prospects for the individual businesses and if valuations were very high. In that regard, we have completely sold out of Richemont and Bidcorp and substantially reduced our exposure to ABI Inbev. Mondi and SAPPI were also substantially reduced. We’ve increased our stakes into cyclical and more defensive South African businesses, while substantially increasing our mining exposure in BHP Billiton, AngloGold and the PGMS.
Our focus has been on balance sheets and an opportunity to acquire quality at a discount. While we’ve maintained our overall exposure to banks, we have rotated into the higher quality banks, so have reduced ABSA and increased our exposure to FirstRand. We balanced that by investing into stocks that we thought were particularly oversold, e.g. AVI and Santam, both very high-quality businesses at prices we haven’t seen in about a decade. We have continued to hold Naspers, Prosus and BAT, cumulatively making up 33% of Rainmaker and 22% of Entrepreneur.
SA economy pre-COVID
Our national debt is unsustainable and getting worse with no GDP growth or plan. We expect to be down somewhere between 7% and 10% GDP growth for 2020 with business confidence dropping to previously unrecorded lows. We’re concerned that the South African economy’s structural ability to respond to stimulus and recover is extremely constrained and limited. Interest payments as a percentage of gross tax revenue have increased from 8% to 15% with the latest forecast suggesting it will reach 20%. There is, however, very little desire and conviction to achieve any kind of cost cutting. We can only hope that the IMF has put stringent conditions in place that will force the government to be more prudent around expenditure. Our debt-to-GDP ratio is now heavily impacted by COVID and will cause it to accelerate to very worrying levels
Despite the fact that we’ve had very little growth and that the SA equity market has been moving sideways for the last six years, the market has de-rated from around 15 times historic earnings to pretty much single digits. Looking at PEs at the moment is largely irrelevant because there is so much uncertainty and very little confidence about accurately forecasting levels of profitability for large and small companies. We’ve focused on cash flow and balance sheet strength rather than the absolute level of earnings or dividend yield.
More than 55% of the portfolio is in basic materials (23%) and Industrial Rand hedge (32%) with quite a big exposure to financials at 23%. We have 3% in cash and near cash, 13% in domestic consumer and 6% in domestic other. As previously mentioned, the top five holdings are Naspers and Prosus (21.9%), BAT (8%), Anglo American (5.9%) and FirstRand at 4.6%.
Our principle has been to adopt a conservative stance in a worrying environment. We think short-term insurance will be able to weather the COVID storm, so we’ve increased our positions in Santam and RMI (Outsurance) to 10% of the Fund. We’ve maintained our limited Rand hedge exposure through Naspers, BAT/Reinet, Oceana and some mining exposure. There is clearly value in the mid and small cap space where we’re seeing opportunistic in M&A activity and have already been bought out of Assore and Peregrine. We expect more of this activity in this space and hope to benefit from it. Again, our focus has been on balance sheets and an opportunity to acquire quality at a discount.
Adcock Ingram and AVI are both positions that we’ve added to with weightings of 4.7% and 3.4% respectively. We have very limited exposure to discretionary consumer and have reduced this exposure by selling out of Truworths completely, reducing Italtile and buying Pick n Pay for the first time, which we think is more defensive. We’ve sold out of Barlows, but are worried about our just less than 10% exposure to domestic industrial exposed businesses via CMH, Hudaco and Reunert, even though the valuations are compelling. We’ve increased our exposure to Afrimat, an iron ore producer and run down our cash holding from 9% to 4%. The Fund has managed to weather the storm relatively well in comparison to the benchmark indices and we’re hoping to benefit from the ongoing upside with the performance of the last year relative to the peer group looking pretty attractive.