RYK VAN NIEKERK: Welcome to this market commentator podcast, where I speak to leading investment professionals. My guest today is Adam Ebrahim. He is the chief executive officer and the chief investment officer of Oasis.
Adam, welcome to the show. How do you juggle your responsibilities as CEO and CIO? Are they not both full-time jobs?
ADAM EBRAHIM: I think they keep the CEO job just as a title, because I started the business. You have the chief operating officer who takes all those responsibilities. My main focus is on investments.
RYK VAN NIEKERK: But let’s talk about investments, and let’s talk about the international environment, which is currently pretty volatile. What do you think of the current situation? What is driving international markets at the moment?
ADAM EBRAHIM: I think firstly we’ve got massive divergence in economic policy, monetary policy, massive divergence in growth rates. And with that divergence you then get volatility. But the big driver behind it is the moving wave of liquidity and quantitative easing in the US, which has done a couple of things.
One, it has made emerging markets more vulnerable, – and I’ll talk about emerging markets in slightly more detail.
Secondly, because emerging markets were big consumers of commodities, which are very oversupplied across the commodity profile, that was for commodity companies down.
And then thirdly the amount of debt that especially emerging markets have taken over the last couple of years. Whereas the developed world has been de-gearing, emerging markets have been re-gearing. And just as they’ve been re-gearing in the last six months interest rates and yield spreads have increased very dramatically.
So what you are going to have is you really have an emerging-market debt crisis. And you’ve seen that play out in greater volatility in financial markets.
RYK VAN NIEKERK: Can you just expand on that? In an emerging market debt crisis, how significant would it be, and how long do you think this could last?
ADAM EBRAHIM: If you look at our debt levels, in 2007 the developed markets peaked in their debt levels, and in the corporates in the developed market, especially in the US, there has been quite a significant run-down in their debt
And secondly what has happened is in 2008 emerging market debt was at a very low level. And you’ve almost swung around completely and emerging market debt is now at the same level as 1997/98. And so you remember in 1997/98/99 you had the emerging market crisis, where debt had to be repaid very quickly and abruptly. We do not expect as brutal a change in economic fortunes and also stock-market fortunes for emerging markets as we saw in 1997/98. But we do see a continued sideways movement and downward movement for the next couple of years. So we’ve been bearish on emerging markets for the last five years and we continue to be bearish.
So I’ll give you an indicator. The interest burden of the advanced economies in 2007 was 10.3% of GDP. In 2015 this had dropped to 5.7% of GDP. So nearly halved. Emerging markets in 2007 – remember, emerging markets would have slightly higher interest rates – their interest burden was 8% of GDP. In 2015 this grossed 12.1% of GDP. So much higher than the 10.3% for advanced economies in 2007. But this 12.1% of GDP could quickly rise to about 15%, given the much higher interest rates.
RYK VAN NIEKERK: What is the South African ratio?
ADAM EBRAHIM: I don’t have that ratio in front of me. I think South Africa is actually in a more favourable position, but deteriorating.
RYK VAN NIEKERK: I think the interest bill for government is around 15% of the total expenditure budget, so it should be around 7, 8% of GDP, which is still a rising number as you have said.
One development currently that is influencing markets is Britain’s possible exit of the EU. How do you think that will impact the broader market?
ADAM EBRAHIM: I think the probability of the UK exiting the EU is pretty low if you just look at the polls before. And the commentators spent so much time talking about Scotland exiting the UK, and when the vote actually came around it was very much in favour of staying within the UK. I actually think you are going to see the same focus. There is a lot of noise between now and the referendum and you are going to see – this morning 34 of the top 100 company CEOs came up in support of staying in the EU. So I actually think that this is going to create to create a buying opportunity. The pound is weakening and UK assets are becoming cheaper, and we view that as a buying opportunity. And at this point in time we’ve put a very low risk of the UK exiting the EU. If the UK exits the European Union, then I think the pound gets weaker for a short period. But then it strengthens from the medium to long term point of view – it strengthens very dramatically but in the short term it actually decrease quite significantly. But in the long term the reverse happens because it no longer will have to cover the burden of Greece and other countries that haven’t sorted out their fiscal and economic situation.
RYK VAN NIEKERK: Let’s look at the local market. The South African economy is currently not in the healthiest state it has ever been, but markets have held up relatively well, mostly due to companies that derive a big chunk of their earnings offshore. Where are you looking for value currently?
ADAM EBRAHIM: Firstly, if you look at the local economy, we see it as a stagflation economy – that means low economic growth and high inflation, and inflation will drift higher, most probably to the 7 and 7.5%. And you then have a budget tomorrow that is likely to be quite an austere budget in South Africa, which is likely to pull the economy lower. It may be very good for financial markets, bond markets and the currency, and you’ve seen the currency strengthen.
Thirdly you’ve got the local government elections, which is going to create a lot of noise. Fourthly you’ve got the universities creating a lot of noise at the kment. And fifthly you have the drought.
So in that environment the short-term outlook for the economy is quite ??…mistic…[7.54]. However. when you look at the weak rand, there are many, many industries that have suddenly become very competitive. So in the Western Cape and around the coastal areas throughout the country tourism is just taking off. Wherever you go, the restaurants are full and it’s all foreign tourists. You cannot get a flight in and out of Cape Town or most South African cities today because of the weak rand.
Secondly, we do have the short-term impact of the drought in most of the countries [companies? 8.36], but those companies that export deciduous fruit from the Western Cape are going to hit the ball out of the park and some of our fishing companies are going to hit the ball out of the park because of the weak rand.
Then again, speaking to somebody last night, the business-process outsourcing people – they are just going to fill up more and more jobs. So there are those sectors that are going to do not so well in the short term and there are those sectors that are going to do incredibly well.
If you take that to our beleaguered mining industry, if you analyse AngloGold’s third-quarter results, they were showing a negative $200m cash flow, negative free cash flow. Their latest results – and if you take the current rand/dollar and Aussie dollar and Brazilian real and Argentinian peso, if you take that effect they are running at a positive $800m of positive free cash flow. So suddenly those companies that were down 70, 80% have suddenly had a massive change in fortune. Now they have moved up by 40%, 50% from their lows, but they could double or triple from here on out. So I’ll spend a minute talking about the miners.
RYK VAN NIEKERK: Can we, just before we focus on that industry, I just want to ask you: the economic factors you’ve mentioned earlier, there is another one where South Africa may face a rating downgrade. Now, Pravin Gordhan has come out as the champion to try and evert that downgrade. But what should investors do in this environment? Is it prudent, maybe, to move some money to cash and be slightly more conservative?
ADAM EBRAHIM: You know, within this it creates a lot of opportunities. So selecting a great balanced funds with a good manager is a good way to take advantage of the opportunities that volatility creates. And so in this environment where there are so many factors, this is not the time to put money into index funds and ETFs and those managers who just track the stock market. They’ve had a fantastic time for the last eight years. These factors that we are talking about – stagflation and the divergence of economic policy globally and divergence of sectors within countries, really calls for stock-pickers and great asset allocators.
So if you kept taking your money and placing into cash when there was negative news, you most probably lost out on some of the biggest values in the stock markets and financial markets over time. So if you are very concerned, I’d put it into a low-equity balanced fund. If you are reasonably concerned, I’d put it into a medium-equity balanced fund. And if you are reasonably bullish I’d put it into a high-equity balanced fund.
RYK VAN NIEKERK: Well, this moves the discussion to performances of fund managers. And in the past not too many have actually beaten index funds. This could be an interesting time to actually see which fund managers have swimming trunks on.
ADAM EBRAHIM: Exactly.
RYK VAN NIEKERK: If you look at past performance, how seriously do these investors have to analyse those performances before choosing a fund manager?
ADAM EBRAHIM: I think very importantly. Say you could have a manager doing really well, so you’ve got to look at a couple of things. Firstly you’ve got to deconstruct that performance. How much market risk is the person taking, and how much is the manager adding through selection? So normally the market-related risk could be the beta, and the value-add through selection would be the alpha.
Now the managers have done incredibly well because the market has done well, and why the index funds do well in a rising market with low volatility is that that they have a beta of one. And many of the leading South African asset managers have a beta greater than one. Many of them have got a beta of 1.2. Okay? I’ll explain that later. And they actually have a zero or negative alpha over the very long term.
What we are looking for is a manager who is able to add value to having a very strong long-term alpha stock selection, and a lowish beta – 0.8. I’ve used the two examples. If you have a beta of 1.5, if the market goes up 10% you go up 15%. But if the market goes down 10%, you go down 15%. Now, if you’ve got a zero alpha you are going to have this massive volatility and that is in the home of the index trackers and the ETFs and those fund managers that are market-oriented. if you look at a company that focuses on the alpha, and if they have a beta of 0.8, if the market goes up 10%, they go up 8% or they go down. But now if they have an alpha of 5 or 8 or 10, just say 5, the market goes up that 10% and you get 8% on the market plus 5% alpha, that gives you a 13% return.
When the market declines and you only go down 8 but you get your 5 alpha, you only go down 3. You get an understanding of what to look for. The e first item is to look for the track record of stock selection over five, ten, 15 – preferably over a ten-, 15-, 20-year period because economic cycles last normally be five and seven years.
The second thing is to look at a five-, ten-, 15-, 20-year view on the downside correlation how much downside risk does the manager take.
Thirdly, the Sharpe ratio; fourthly the Solteno ratio. If you take all of those into account, you will choose the managers and you will have a greater chance of adding real value. And when you’ve chosen that manager, stick with that manager for the very long term.
RYK VAN NIEKERK: The time is running out. Just lastly, you did refer to the commodity sector. Are you actively buying in that sector? Is there still value or is there value elsewhere?
ADAM EBRAHIM: I think we are not actively buying. We bought towards the end of 2015, when they were ridiculously cheap. So some of the stocks that we bought were AngloGold, Assore, Pallinghurst, among others. But if you look forward, outside mining there are a couple of stocks we really like in South Africa, something like RCL Foods. Their results come out today, tomorrow. Yes, in the short term they’ll be affected by the drought, but they’ve got some of the best management, some of the best brands and very strong cash flow.
And then something like Reinet. Again, in a bearish market a company like Reinet will add significant value when the markets are under pressure. And, over the long term if you took a portfolio, besides investing with Oasis, in the long term if you took a portfolio of RCL, Reinet, Pallinghurst, Assore and AngloGold, and maybe a 50:50 weighting between the miners and the non-miners, or 45% to the miners and 60% to the non-miners, those five shares will outperform the Nationale Pers by an order of magnitude. it will outperform the Steinhoffs by an order of magnitude, it will outperform ridiculously overvalued stocks like NETP and Rockcastle, which are really, really overvalued, taking very, very high risk. You’ve said when the water goes up ??, not only will you see that they are not swimming in their trunks, but they are kind of seriously exposed.
RYK VAN NIEKERK: Some interesting bets there. Thank you, Adam. That was Adam Ebrahim, the chief executive officer and chief investment officer of Oasis.
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