By Alwyn van der Merwe, 18 December 2013
I spoke with Alwyn van der Merwe, director of investments at Sanlam Private Investments, earlier today. The SPI business had its quarterly briefing a few weeks ago where it really gives us the opportunity to zoom out and look at things in perspective.
I asked him what expectations are for returns on the market in the next 12 to 18 months, given earnings forecasts that exist and that high rating on the market, plus we've had a few very good years in terms of returns.
I think expect the rating to come off. What it does mean, as I said right from the outset, your total return number is a function of a combination of the change in the rating of the market and of course the change in the earnings number. And it's very tough to forecast that over a one-year period. So what we've done is we've just assumed that the market rating would go back to the kind of the north.
We assumed consensus earnings growth for the market over the next three years and, if you put that number through your computer, ultimately you get an expected capital return of just over 6% per annum over the next three years. And then you’ve got to add the dividend yield of about 2.5%or so. And that gives you an expected total return, capital plus income, of about 9% per annum over the next three years for the South African market.
Alwyn, where’s the alpha going to come from if the market gives you 9% a year, roughly, over the next three years? How are investors going to be able to outperform that number?
Well, the first thing is that the only way you can outperform is to actively manage a portfolio. And if you speak about a particular asset class, as you say, then we talk about so-called alpha – so that is the outperformance relative to the market. It is a question that we deal with on a daily basis.
What we have seen is that there’s huge divergence in the performance if you just look at the broad sectors within the South African equity market. The industrials outperformed the mining shares by a significant margin and also outperformed financial shares. So if you purely look at valuation, then I think at some point you need to migrate from arguably more expensive industrial shares into the arguably cheaper mining shares. But you do know that you buy cyclicality if you do that. So I think you’ve got to have a strong stomach and you’ve got to have a slightly longer-term view when you make that rotation. It is always very handy if you were correctly positioned, which is essentially a call that we had.
Then I think within the financials space we certainly see a bit of value. On the banks side it's not that you see huge upside potential, but I think that the banks are fairly valued. I think most of the major banks are well provided, the capital structures are in place. So I think some of those financial shares are also likely to provide alpha to us.
But the migration from the safe, non-cyclical shares to let’s call it the more cyclical shares is not something I think you must just go there boots and all. I think one’s got to be very selective if you make that particular call.
Have you been making that slow and deliberate rotational switch on the alpha client?
Yes, indeed. If we can be stock-specific here. At the beginning of the year we added to Billiton, and later on in the year we added to Billiton again. We have also added to Anglo American. And both those counters, if you just look at them valued on a price-to-book basis, they are significantly cheaper from those very elevated levels we saw early in 2008. We also think that those management teams will address the capital allocation in a far more shareholder-friendly fashion, and you can see those management teams are very cost-conscious. So what you do need, however, is commodity prices to behave properly. And I think then you should get a decent performance.
What did we sell? Late in this year we started to sell Richemont – but again from a very overweight position, and it's still a quality counter that I think one needs to have in your portfolio. But we've also trimmed Nasionale Pers after having had the privilege to have a significant exposure to Nasionale Pers. I think for me the forecast risk in terms of Tencent in particular just becomes very elevated at this particular point in time. It is trading under a very high price/earnings multiple. I think the historic multiple is about 33, 34 times, so you just know that your again, if I may call it, margin of safety has been diluted in a significant way. And again, it's got nothing to do with the quality of the counter. It's just a call on the price and locking in some of the outperformance that we had.