How far is ‘offshore’?

RYK VAN NIEKERK: Welcome to this Market Commentator podcast. My guest today is Karl Leinberger, he is the chief investment officer of Coronation Fund Managers.

Karl, we spoke in July last year when you said markets all around were very expensive and that Coronation was turning a bit defensive. A lot has happened since then; what are you doing now?

KARL LEINBERGER: Our portfolios were very conservatively positioned; we felt and had warned for some time that markets had done very well and expectations were too high. What you found subsequent to that is markets sold off quite significantly: just looking at the market here there was a more than 10% selloff in the lead up to January this year where markets troughed. In that period and particularly in January we significantly increased our exposure to growth assets, being primarily equities and property stocks, to such an extent that we would consider ourselves today to no longer be conservatively positioned. We think we have above-average exposure to growth assets in all of our asset allocation funds at the moment.

RYK VAN NIEKERK: But we’ve seen a massive devaluation of the exchange of the rand since December last year when this political turmoil we are in started. How did this impact your decision making?

KARL LEINBERGER: I think that’s a key point. We tend to focus too much on the rand returns of the major asset classes and not recognise what the rand has done over the last few years. The rand has halved from its highs a few years ago and, therefore, the decline that I spoke about earlier, of 10% to 15% in our market in rands was, in fact, much more than that in any hard currency. Hard currencies are relevant because today two-thirds of the value of the JSE sits in hard currency assets. So, in fact, our market had sold off a lot more than what was apparent if you looked at it in rands. That’s why we think that you’re getting better value in risk assets and growth assets than you have for many years. The currency’s flaws and Achilles heel, which we’ve all known about for a long period of time, have been exposed over the last few years and I think the only protection that investors can avail themselves of, to the loss and the purchasing power of their money, is to buy stakes in businesses and in real assets. Hence, the view that you need meaningful positions in property and equities if you want to protect yourself from inflation that’s coming in the years ahead.

Offshore investing

RYK VAN NIEKERK: But whenever the rand dips, like it did since the end of last year, the investment theme is ‘invest offshore’. It may be too late now, but what would your advice be to investors?

KARL LEINBERGER: I think you are absolutely right; for five or six years we have been strongly urging clients to increase offshore exposure and in the beginning the message was not well received. But what we’ve found more recently is that clients are prepared to increase offshore exposure. Today it’s a much more difficult call, the rand has been very weak and in addition to that a lot of SA Inc businesses have performed very poorly in the market – stocks like our banks, some of our clothing retailers, a lot of the domestic businesses out there have done really poorly. So I think it’s a much more difficult call than it has been. My message to clients would be that if you’re fundamentally underexposed offshore then I think more than ever South Africans need that diversification that comes from offshore. If your exposures are appropriate I think it would be a big mistake to go too high offshore; the currency is very weak today. So I think it’s all about your positioning in portfolios. There are clients who have got very little money offshore – 5%, 10%, 15% offshore – I think that’s too low a number, but if you’re sitting at the appropriate prudential levels I think that this would probably be the wrong time to increase your offshore exposure.

RYK VAN NIEKERK: There are many investors invested via RAs (retirement annuities), who are now being forced to move money back to South Africa, due to Regulation 28. What is the impact on those investors?

KARL LEINBERGER: I think whenever there is regulatory management or supervision of one’s investing activities, people experience frustration. So I think we must all bear in mind that the offshore limits have been increased materially. When I joined this industry I think it was around 10%, 15%. Today you can have 25% offshore and then there’s an allowance for Africa in addition to that. So I think we must be cognizant of the fact that those regulations have been relaxed materially over time. Not only have they been relaxed over time but today if you breach the 25% you’ve got 12 months to rectify the situation and bring the money back, which greatly reduces the risk that you are forced to sell it at an inappropriate time. So we all feel those frustrations from time to time, but I think the savings industry is in a much better place than it was when I joined this industry and I think we would do well to remember that.

Foreign investor movements 

RYK VAN NIEKERK: An interesting change in the market dynamic seems to be foreign investors taking money out of South Africa, do you think that impacts the market negatively?

KARL LEINBERGER: I think it definitely does. First of all it’s an additional buyer. Second of all, if you watch their behaviour in the market they are happy to pay up if they buy in positions or to sell out at discounts; they value liquidity and they want orders executed in a very short period of time. So I think they have a very big impact on our market. South Africa runs a chronic current account deficit and it’s a material deficit – we spend more than we produce; we don’t save enough for our investment needs in our economy and for that reason we depend on foreign capital to balance out or balance of payments. So South Africa will always need foreign capital: it has always needed it, since democracy we’ve run a chronic current account deficit. That’s the reason why investors around the world are so nervous around what we’ve seen in South Africa in the last year or two. We can’t afford, as a nation, to scare off foreign capital – we need that money to balance our books, to fund investment in the economy and so how they view South Africa is actually crucial to the country’s long-term success.

RYK VAN NIEKERK: But if foreigners are selling out, who is buying those shares?

KARL LEINBERGER: Foreigners own about 40% of our market – it’s a big number. That was very low 20 years ago, a couple of percent. So they’ve been big buyers of our market over the last two decades and the selldown we’ve seen has not been material. There’s been a lot of shifting of deck chairs; they’ve moved from one sector to another but that overall ownership hasn’t come down too much. If it were to do so it would have a devastating impact on the market. The only buyers for those assets, if foreigners sell, is locals and that would have big implications for price. So I think it remains crucial that we continue to attract foreign capital to our market.

Coronation equity funds

RYK VAN NIEKERK: Coronation launched a new SA equity fund in September last year; why did you launch a fund then?

KARL LEINBERGER: Coronation has two equity funds: we’ve got the top 20 equity fund and we’ve got our equity fund and they both were domestic-only equity funds; they’re invested on stocks listed on the JSE. What has happened over the last three or four years is that the market and our clients have increasingly moved in response to a regulatory relaxation into equity funds that have the ability to invest in global equities up to around 25% of fund. Initially we resisted the market trend because we felt that clients who invested in that fund should want domestic equity exposure but we absolutely put clients first in the way we run the business, and the overwhelming message from clients over the last two to three years has been that they would like for the fund to invest in global equities, as well as domestic equities. For that reason we listened to our clients and we launched the fund in September, although retaining the ability for clients to invest in purely JSE-listed shares, either in our top 20 equity fund or in the SA equity version of our equity fund.

RYK VAN NIEKERK: If you look at the underlying investments they are very internationally focused: Naspers, Steinhoff, British American Tobacco and MTNare the main counters in that portfolio, but that seems to be the theme in most of your equity portfolios?

KARL LEINBERGER: The overwhelming majority of our SA equity portfolios are invested in global stocks that happen to be listed on the JSE, you mentioned three of them. The reason is that we think they offer better value than your classic SA domestic business. However, I must say that those stocks that you mentioned have done well and domestic stocks have come under a lot of pressure and we are starting to buy some of those domestic stocks, which we think do offer long-term value, and selling some of those global stocks that have done well for us over the years.

Resources

RYK VAN NIEKERK: Having said that, you are actually quite exposed to the resources sector: 23% of this equity portfolio is invested there, and that is a good call, the resources sector has been the top-performing sector this year.

KARL LEINBERGER: Ja, the resources position in our portfolio detracted in 2014 and 2015, and while we completely agreed with the market in its view that the outlook was very tough for those businesses, as long-term investors we felt that many of these shares were trading at fractions of what they were worth. Some of those shares at the bottom like Anglo American, Exxaro and Impala, we felt were worth three to four times the share price at their lows in January this year. As a long-term investor we feel that regardless of difficulties in the short-term outlook for those businesses, if you can buy a business for 25c, 30c in a rand you need to put a position on the table. So that was the thinking behind our position; it certainly wasn’t a view that the short-term outlook for these stocks is any better than others thought, it’s staying true to our investment philosophy, which is buying the most undervalued assets in the market and investing for the long term.

RYK VAN NIEKERK: Are you buying into this sector now?

KARL LEINBERGER: No, no, a lot of the resource shares in our portfolio have doubled or tripled from their lows in January; in fact there’s been some selling of those positions as they’ve come closer to our assessment of fair value.

RYK VAN NIEKERK: What are your most preferred stocks in this sector?

KARL LEINBERGER: In resources we like the platinum stocks. We are cognizant of the very long-term challenges presented by disruptive change in the automotive industry – being principally electric vehicles and batteries – but we think over the next decade PGM (platinum group metals) markets are likely to be in significant deficit; we think the market is complacent about those deficits. They believe supply will always be there; they believe that there’s enough above-ground stocks to meet those deficits. We suspect not and we think that there is a very decent risk or possibility that prices need to increase meaningfully in response to those deficits in the years ahead.

Financial sector

RYK VAN NIEKERK: A sector that is offering value is the financial sector. Are you active there?

KARL LEINBERGER: Yes, I think financial stocks sit in the eye of the storm that South Africa is facing today. Financial stocks move most closely to the rand and to foreign sentiment about South Africa. They are bellwethers of the SA economy: they depend on the economy to grow; sovereign downgrade would have implications for funding costs, so banks and financial services in general really are good indicators of sentiment in South Africa. They’ve come off a lot. We’ve got big well-run banks in South Africa like Nedbank trading on seven times what we think they will earn next year on 7% dividend yields; those are very compelling numbers and they discount a lot of risk. So we do own significant positions in some of those stocks and we have been acquiring. Another example would be Discovery, which has been a great performer, both as a business and stock over long periods of time. It’s come off more recently and we think it presents an opportunity to buy a very good company at a fair price.

Coronation’s institutional outflow

RYK VAN NIEKERK: Coronation reported results and there seems to be an outflow of money, especially from institutional investors. It followed your closure of some of your funds for new investments – would you revisit this strategy?

KARL LEINBERGER: We are a long way from revisiting the strategy, we announced the closure of most of our institutional products to new clients almost four years ago and expected at the time to experience outflows for as long as the products were closed, and the reason for that is the institutional market in South Africa is shrinking and the retail market is growing. So we knew that it would result in outflows; we expect it, we don’t think it’s a bad thing. We think that the most important thing for ourselves, as an independent manager, is to beat the market and to do so meaningfully and in meaningful amounts and over meaningful periods of time, and if we do that our shareholders will be well served. So our message is that we’ve expected outflows, we don’t think they’re unhealthy. Coronation manages in excess of R600 billion and for us what matters is how we perform in the funds we manage. We think that that will define our success over and above anything else one may look at.

RYK VAN NIEKERK: Did you see an outflow on the retail side?

KARL LEINBERGER: Yes, we did, that also was anticipated. Coronation experienced inflows for three or four years, way in excess of our natural market share. We always commented to the market that we expected some normalisation retail flows. The flows we’ve seen in the retail market haven’t surprised us and we think that they are actually fairly healthy. A lot of our clients were very overexposed to us and we would far rather have a sustainable allocation to Coronation from our clients that can be held with us through good and bad years, than to have an unhealthy allocation from our clients.

Outlook

RYK VAN NIEKERK: Just lastly, what is your outlook for the short and medium term? Last year you were defensive; you are looking now for new opportunities. How active will you be in this market?

KARL LEINBERGER: As I mentioned earlier on, I would describe us as no longer being defensively positioned. We think that South Africans face the grave risk of seeing the purchasing power of their money decline materially in the years ahead in response to what’s happened to our currency and our exchange rate. We think that the way to protect yourself from that is through the purchase of stakes in businesses and earnings streams and in the purchase of real assets. We think that to sit with very high cash weighting might well be a mistake and that’s the reason for the significant change in our asset allocation funds in the last year, as you referred to.

RYK VAN NIEKERK: Thank you, Karl. That was Karl Leinberger, the is the chief investment officer of Coronation Fund Managers.