PSG giving there views of what the goings on are at the moment.
"We have spent much of the last two weeks on a roadshow to clients on how we see investment markets and how our process has been configured to produce reasonable and consistent returns whatever the future holds. I thought it would be worthwhile sharing some of the main issues discussed.
An uncertain world requires a rigorous process.
We keep reminding investors that the future is always uncertain. And, while the world currently faces some very real and pressing issues, it is important to focus your investment process on trying to protect your clients from losing capital whilst at the same time taking advantage of the opportunities that an uncertain world pitches.
We like to keep our investment process rigorous but simple. This involves having a value-based approach which sees us buying companies for less than we think they are worth. And while we acknowledge that we can’t value companies with precision, a contrarian mindset is useful; buying when the market is fearful and selling off raises the margin of safety. Fear is generally pervasive and the instinct to flee or sell indiscriminately is where the best opportunities are created. It is clear to us the recent concerns around the collapse of Europe were a good example of pervasive fear.
Contrarian ideas.
Some of the better global ideas that we have at the moment originate in areas where markets are fearful or where the outlook is perceived to be uncertain. Within global equities we highlight the following opportunities:
Old tech
US healthcare
Financials
European cyclicals
Materials
We select stocks on a bottom-up basis. Our stock selection screens have identified numerous opportunities within the above sectors. Our portfolios include stocks from each of these areas and in each case we only own the stocks because we have been able to discharge our margin of safety requirement.
SA is fertile ground for Compounders.
We segment our portfolios into 2 types of stocks: compounders and mean-reverters. Compounders are companies that are able to progressively generate increasing cash flow every year. They tend to have less competition and as a result are highly profitable. Their ability to reinvest in opportunities to grow their business results in what we refer to as the lucrative equation.
It is our view that South Africa has been fertile ground for compounders. Competition has generally been benign, primarily due to historic and geographic isolation, and many industries see monopolies and oligopolies dominating. And, returns to shareholders in quality companies in these sectors have been very good.
We highlight the domestic clothing retailers as an example of an industry that has enjoyed the benefits of being able to aggressively grow their footprint without excessive competition. And, the SA private hospital groups are an example of an industry with massive barriers to entry for competitors and very strong pricing power; returns on assets are very high when compared to global peers. In both cases, shareholders have seen spectacular returns over the past decade.
When we derive a fair value for compounders we attempt to determine a value for future growth. For companies with sustainable competitive advantages in a high growth industry this value of future growth can comprise a material part of our intrinsic value.
On this basis we consider many of the SA compounders that we have owned in the past to be too expensive at this point. We think it is well possible that you could incur future capital losses if you bought many of the higher quality companies on the JSE at current valuation levels.
We see significantly better opportunity to acquire selected global compounders in the US and Europe. Not only are valuations much more favourable, but we are looking at some of the world’s leading companies in terms of quality of management and past track record.
Mean-reverters.
The second type of stocks that we own, mean-reverters, are generally lower quality businesses with limited competitive advantage or pricing power. We are happy to own mean-reverters when the margin of safety is large, for example when we are buying a rand’s worth of assets for fifty cents.
The uncertain macro-environment has resulted in defensive higher quality compounders trading at a significant premium to the mean-reverters. We have increasingly tilted our portfolios towards mean-reverters in some of the sectors highlighted above. For example, within the materials sector we have been buyers of Anglo American which trades at an attractive discount to what we estimate to be the value of its assets.
Two opposing forces at play in global financial markets.
Investors need to be aware of the two massive opposing forces at play in global financial markets. On the one hand, the consequence of excessive debt levels in the West is a painful process of de-leveraging. The worst pain is being felt in peripheral Eurozone countries where monetary union impedes some of the remedies for bloated sovereign debt: currency devaluation and default. But, global central banks have demonstrated a willingness to intervene in order to prevent a disorderly spillover to financial markets.
Central bank balance sheets have ballooned and much needed liquidity has been provided to the banking system when required. Given the very unattractive rates available in fixed interest markets, in the absence of further deterioration in the global economic outlook, it is possible to foresee a flow of money out of bonds into more risky and higher yielding assets like equities.
How we are positioning our portfolios.
We have been finding fewer opportunities on the JSE and have sold most of our larger cap JSE compounders in favour of: global compounders, small and mid cap compounders and mean reverters.
We are generally cautious of bonds, particularly global bonds.
We sit with higher than normal cash balances that we are happy to put to work as and when opportunities arise. "
REF : PSG - Shaun le Roux
"The PSG Angle is an electronic newsletter of PSG Asset Management. To subscribe or read more, please go to to www.psgam.co.za".
Steven
Steven Morris Chartered Accountant (SA)
3 Bickley Road
Sea Point
Cape Town
8005
Mobile :+27 83 943 1858
Facsimile : 0866 712 498
E-mail : steven@global.co.za
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