CAPITEC went through a stressful period in 2013 and 2014. However, having done their homework, the PSG team believed Capitec was a good-quality company with a strong management team that was undervalued.     Dylan Jacobs African News Agency (ANA)
CAPITEC went through a stressful period in 2013 and 2014. However, having done their homework, the PSG team believed Capitec was a good-quality company with a strong management team that was undervalued. Dylan Jacobs African News Agency (ANA)

The value of holding the line

By Martin Hesse Time of article published Feb 26, 2020

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Last year was a relatively decent year for the JSE – the FTSE/JSE All Share Total Return Index (Alsi) delivered 12.05%. The previous year it delivered just 3.32%.

Of the 170 collective investment schemes (unit trust funds and exchange traded funds, or ETFs) in the South African equity general sub-category, 35 matched or bettered the Alsi after costs in the 12 months to December 31, 2019. The majority (135) fell short: the popular Allan Gray Equity Fund, for example, returned 6%.

Surprisingly, considering their track record, the worst performing funds in the sub-category were two funds in the PSG stable: the PSG Equity Fund (–6.85%) and PSG SA Equity Fund (–13.01%).

The PSG Equity Fund has been a consistently high performer since its inception in 1997 and holds more than R4 billion in assets, according to its January fact sheet. Its managers, Shaun le Roux and Greg Hopkins, are among the most experienced in the industry and widely respected.

In 2016, the fund returned 25.1% against the Alsi’s meagre 2.63%, and until then had consistently been among the top five performers in the sub-category. But a bad year in 2018 – all equity funds had a bad year in 2018 – and another one last year have pulled down its long-term averages. Over 10 years, its annualised return is still a respectable 10.21% (Alsi: 10.76%) and it lies in 18th place out of 62 funds, according to data provider ProfileData.

So what happened last year, when the top 20 equity funds returned more than 15%?

A lot has to do with the performance of one corner of the stock exchange: the platinum miners. Despite the disruption of Eskom outages, miners of the platinum group metals (PGMs) had an excellent year, boosting the annual performance of the FTSE/JSE Resources 10 Index to 25.32%.

Over the 12 months, platinum went from about $800 an ounce to just under $1 000 an ounce, a rise of 25%. Another PGM, rhodium, went from $2 300 to $5 580 an ounce, a massive jump of 142%.

If you didn’t get your timing right on platinum shares – or didn’t have any in your portfolio – you would not have benefited from this windfall. While the PSG funds did hold platinum stocks, they cashed out a little too early.

As any savvy equity investor knows, and as I have mentioned repeatedly in this column, it is impossible to time the markets; so the funds that did cash in on the PGM boom from bottom to top were simply lucky. The best you can do is to have an established process of when to buy and when to sell. Such a process – and this applies to all investment styles – is not designed to deliver positive results all the time; it is designed to beat a benchmark (in the case of most equity funds, the Alsi) over the long term, ideally at lower risk than the benchmark.

At a PSG Outlook session for advisers and investors last week, Hopkins, PSG’s chief investment officer, and assistant fund manager Mikhail Motala explained PSG’s investment process, which follows the “value” style (as does Allan Gray’s). In such a process, you buy a share when it is undervalued (trading below what is considered its fair value, which may be calculated using various measures) and sell when it rises to above fair value. However, two things can happen to dampen short-term performance: after buying an undervalued share, it can stay low for longer than expected, and/or the share can continue to rise after you sold it.

Hopkins quoted the guru of value investing, Jeremy Grantham. He said: “Grantham says investment cycles follow specific patterns but it is very difficult to try to time the market. You know you’re buying low, but you just don’t know where the bottom is. He says no one rings a bell when a share hits the bottom.

“Grantham says you then go through a ‘suffering’ phase, when the share price stays low or goes down further. Importantly during this phase, you’ve got to hold the line. If the facts change, you can change your mind, but if the facts haven’t changed and you’ve done your homework, you’ve got to hold the line – you cannot panic at this stage. And then you win, and often win big.”

Hopkins said that, among some of the best opportunities out there, the shares are going through this suffering phase, and often the longer the suffering phase, the bigger the win afterwards.

He said the best chance of finding undervalued shares of quality companies was when an company or industry sector was under stress. Citing Capitec, Hopkins said the bank went through a stressful period in 2013 and 2014, around the time of the African Bank collapse. However, having done their homework, the PSG team believed Capitec was a good-quality company with a strong management team, which was simply undervalued.

Although the “suffering” period was prolonged – the bank faced a number of setbacks and negative headlines in the media – the fundamentals were improving, and the share ultimately re-bounded.

Hopkins said there were a lot of parallels between Capitec and what was happening now more broadly in South Africa. While the headlines on the economy remain negative, on the ground fundamentals are improving. There are well-run businesses that are doing well despite the gloom and others in a good position to benefit from a turnaround.

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