A time for cool heads and cautious optimism

RYK VAN NIEKERK: Welcome to this Market Commentator podcast, where I speak to leading investment professionals. My guest today is Shaun le Roux of PSG. He’s the fund manager of the PSG Equity Fund. He has been in this job for a while, since 2002, and he’s also the fund manager of the PSG Flexible Fund. Shaun, welcome to the show. We’ve seen some interesting news this week out from the US – we will see a more aggressive interest rate adjustment this year, while the ECB [European Central Bank] will also maybe taper their quantitative easing programme. How does this affect markets and especially emerging markets?

SHAUN LE ROUX: Ryk, it’s a pleasure to be with you. I think we need to get our heads around the fact that interest rates have been extraordinarily low for a very long time and rates in the US are starting to rise and, as you suggest, the ECB has indicated that their extraordinary levels of stimulus, the buying of bonds, is coming to an end. We’re seeing rates rise in the US – it’s 200 basis points higher than it was two years ago – and this is going to have a significant impact on financial markets, and we think asset prices are just starting to get their heads around what this actually means.

RYK VAN NIEKERK: Well, asset classes, in an article you wrote not too long ago, you state that you believe some asset classes will outperform others and that there will be a lot of pressure on especially some equity asset classes or equity sectors. Can you maybe expand on where you see opportunities and where you expect lower than, say, inflationary growth?

SHAUN LE ROUX: If I flip that over and say where would we be cautious – in that environment of very low interest rates, very low global bond yields – we think valuations within equity markets, and particularly within the more crowded sectors in equity markets, are very elevated, so we think we’re looking at low returns from those parts of the market. But then on the other side of the spectrum, if we look deeper within markets, we think there’s a significant anomaly where the uncrowded, less popular stocks and sectors that are out of favour are trading at very attractive valuation levels. We think this is a global phenomenon and one place where it is indeed very prevalent is on the JSE. If we look into some of the SA Inc stocks and particularly not the most liquid SA Inc stocks, so outside of the Top 40, we think significant value exists and that long-term investors will be well rewarded if they are prepared to look through some of the shorter-term noise that accompanies things like rising interest rates and the sell-off that we are currently undergoing in emerging markets. So we are seeing very good opportunity within markets that are broadly expensive.

Small counters offering real value

RYK VAN NIEKERK: Daniel Malan, a fund manager at Perspective, said a few weeks ago that his investible world amounts to around 210 shares and that more than 50% of those shares are down around 20% over the past six months, which definitely relates to your comment that there are some of the smaller counters that are actually offering real value. Can you maybe mention a few that you would think offer real value?

SHAUN LE ROUX: I can indeed;. We would agree with that view. A lot of people have been disappointed with the returns on an index level on the JSE, where for four years we haven’t kept track with inflation but returns have still be positive. But the fact is if you look a bit deeper into markets, and on a broader basis, returns have actually been quite poor for some time and we think the SA Inc mid-cap, small-cap space has become severely neglected. What we’ve done, as we always do, we’ve used the opportunity when they’re out of favour, when prices are very low, to quietly go about accumulating a number of stocks and it’s been a story of months and years, and we’ve always found that it pays best to accumulate these stocks when they’re out of favour, when there are sellers around and we’ve been buyers. If you go through the shareholder register, you’ll see that we at PSG now own more than 5% of stocks like AECI, Super Group, Sun International, Tongaat, Grindrod and Hudaco – you can get a sense for the type of companies that we think have got extraordinarily cheap. We think the PE ratios are low and, importantly, those PE ratios have been struck on what we consider to be low levels of earnings. In the past when we’ve bought good businesses on low PEs, on low earnings, our clients have generally been rewarded over the long run as a consequence.

RYK VAN NIEKERK: Your biggest shareholding in your equity fund is Old Mutual, the second-biggest is Glencore, two internationally-focused companies in many ways. Why Old Mutual, what is your position currently, are you accumulating or are you selling off?

SHAUN LE ROUX: We would still be buyers of Old Mutual currently. We think there is a mispricing evident in Old Mutual. We think, as you’ll be aware, that there’s a lot happening there with the separation of the businesses. But what we think you’re seeing in essence is this anomaly where a stock with essentially an emerging market business is listed in the UK and, as a result of a misunderstanding and a fear around emerging market assets, we’re seeing a significant mispricing, and we think that mispricing is highly likely to be reversed in this environment of them separating the various businesses. When we look into the underlying businesses we think they are decent businesses and we can buy them for our clients incredibly cheaply under the current circumstances, so we would still be buyers.

RYK VAN NIEKERK: Your third-largest investment is in Brookfield Asset Management, which is a Canadian asset manager. Why are you attracted to Brookfield?

SHAUN LE ROUX: We think this is one of these global gems that’s just really fallen through the cracks. They are the world’s second-largest manager of alternative assets, [and] their focus is more on real assets, so property, infrastructure, renewable energy type assets. But they fall out of the indices, they’re not in the indices. They’re a company with an outstanding track record, a management team we regard very, very highly and a business that we’ve owned for a long period of time that we think is still under-recognised and undervalued and underappreciated by the market, so we expect to be long-term holders. Again, it speaks to the kind of opportunity that’s available if you’re prepared to look a bit outside of the mainstream and look into some of the less crowded parts of the market, the kind of stocks that can still give you excellent long-term returns, even in a relatively expensive market.

RYK VAN NIEKERK: But it hasn’t performed all that well. Looking at the graph, the performance over the past few years was pretty flat. Obviously there’s a difference, and that’s the big debate between an excellent company producing quality results and the share price that remains under pressure or the share price performance isn’t correlated to that business as operating performance. How do you marry those two?

SHAUN LE ROUX: The point of departure here is that we wouldn’t be looking at one or two share price performances being particularly relevant. As I said, we’ve been long-term holders and it’s done well for our clients. And if you look at the long-term compounding ability, at both earnings and share price level, this has been an exceptional company. It’s a business that has compounded shareholder returns in the order of 20% per annum for over a decade, and we might be going through a shorter-term lull on share price performance, but that normally means it’s getting cheaper and you can expect us to start accumulating positions under those circumstances, so we remain very positive.

Differentiating between PSG funds

RYK VAN NIEKERK: Your flexible fund owns pretty much the same larger shares –  Old Mutual, Brookfield again, Glencore, the top three – how do you differentiate between the two funds?

SHAUN LE ROUX: At PSG Asset Management we essentially run a buy list that is a result of a team-based process and it’s really us cherry picking the best opportunities that we can find anywhere in the world. Typically you are going to see those stocks that are on our buy list will appear across all of our funds. So there is and always will be a huge degree of commonality. And, as I suggested, it is a team-based approach, so at the end of the day it’s going to be the same stocks across both our equity and multi-asset funds.

RYK VAN NIEKERK: An absentee is Naspers. Do you own Naspers because the company has performed really well this year and obviously for the last few years?

SHAUN LE ROUX: No, we don’t own Naspers and, frankly, we have made life very difficult for ourselves by not owning Naspers over the last few years. We’ve actually managed to beat the market without Naspers, but obviously we’ve had to work quite hard to do that. We’ve felt for a while now that we can find better opportunities at significantly lower risk for our clients, and that’s purely a function of what we think is priced into Tencent at this stage. We think Tencent is a marvellous business with an outstanding franchise, but when we back out the growth rate on a per-share basis that is implied by Tencent’s current share price, we think that to be an owner of Tencent here and, hence, Naspers, you are ostensibly taking a view that Tencent’s growth rates will exceed what is baked into the share price. We think that’s a long stretch, and we think that it doesn’t take into account any of the risks that are prevalent within China, within the shareholding structure and so on. So we’re looking at a global universe, thinking [that] we can just find far better opportunities, both on the JSE and abroad, than Tencent and/or Naspers.

RYK VAN NIEKERK: Do you own and Google, Facebook or Amazon?

SHAUN LE ROUX: We don’t currently and, again, we would argue similarly – they are fantastic businesses, but we like to own businesses where we believe there’s a margin of safety and we’re being compensated for any future risks, unforeseen or risks that one could think about. In the case of those companies, again, we would argue right now that the way we value them they look pretty much priced for perfection.

RYK VAN NIEKERK: They’ve performed phenomenally well, as did Naspers. It’s actually a very big decision to take. How robust is the debate within PSG, the fund managers, about a decision like that – to rather follow the value route, as opposed to the momentum route?

SHAUN LE ROUX: I think it’s a very good question. There are two aspects to that. The one is [that] you have to be very clear on what your own philosophy and process is, and you have to be true to that and apply it consistently. So that concept of preferring not to own stocks that you think are priced for perfection is true to our philosophy. But on the other hand you can’t be lazy about it, so you can’t be not owning these companies for the wrong reasons. And what we try to do is ensure that we’ve at least applied our mind to each of these businesses to try and work out if there is some element of the business that is being under-represented in the share price. We look back, and with the benefit of hindsight, we’ll look at a business like Tencent and say that five years ago we could have been smarter in terms of our analysis of Tencent and recognised that the addressable market in China was … or is the size of that, and what that would mean from a monetisation perspective. We do look at these stocks currently, but we’re comfortable that what is being priced-in is aggressive.

Growth stocks versus value stocks

RYK VAN NIEKERK: In your article you also include a very interesting graph that compares growth stocks to value stocks – where, since 2006, it’s very evident that the growth indices and counters have really outperformed value. Do you foresee this trend continuing?

SHAUN LE ROUX: It’s near impossible to say what is going to happen, but I think what we should be mindful of is [that] if we’ve had a more than decade [of] outperformance by growth, that will give rise to a set of circumstances under which more money would be flowing towards growth strategies and away from value strategies. We think that one of the consequences of that is that stocks that would typically be more orientated towards a value strategy would be out of favour and, hence, a lot cheaper. We think that’s at play in the world. So we think that if you are prepared to shop in the unloved, more value part of the market, as it is traditionally configured, we would see better opportunity than if you were buying stocks that are well-owned within the growth strategies, which is where a lot of the money has been flowing in recent times.

RYK VAN NIEKERK: The markets are volatile, they are nervous, some commentators have described them as yucky. What would your advice be to retail investors in this market?

SHAUN LE ROUX: Again, I think one should be preparing yourself for elevated levels of noise and volatility. We spoke about rising interest rates, [and] there’s a lot happening on the political front, both in South Africa and abroad, so I think you should be careful of allowing the headlines to drive your investment decisions. We think it’s a time for cool heads. Be cognisant of the fact that markets broadly are expensive, but be prepared to take a longer-term view and look for some of the opportunities that do arise in this kind of environment. So cautious optimism would be our general tone.

RYK VAN NIEKERK: Many fund managers do always beat the long-term drum. Has your approach to investing changed since you started managing the equity fund in 2002, and the way you do now?

SHAUN LE ROUX: Our approach hasn’t changed. We like to believe we’ve gotten better at what we do, and that our process has incrementally improved – and that’s really orientated towards making fewer errors. But the reality is we still continue to make errors, but the one thing that we are unwavering on is that, as far as our philosophy is concerned, the only way we can look our clients in the eye and say with confidence that we can deliver what they would like from our respective funds is as a result of taking a longer-term view. We think that taking a longer-term view is the one edge that you have within equity markets because if you look at the way equity markets are configured, most participants are short term in nature, and if you can be contrarian in that fashion, we think that it speaks to the fact that you can generate alpha [additional return relative to the benchmark index] over the long run. We’ve managed to achieve that and we don’t see any reason why that should change.

RYK VAN NIEKERK: That was Shaun le Roux of PSG.

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