Is there still value in SA’s general equity market?

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SIMON BROWN: I’m chatting with Rademeyer Vermaak, head of systematic solutions at STANLIB. Rademeyer, I appreciate the time today.

First question: Is there still value to be found in the SA general equity market? There are a lot of stocks looking cheap, but cheap doesn’t necessarily always equal value, as I understand.

RADEMEYER VERMAAK: Yes, Simon. Thank you for having me. I think, Simon, if you look at the SA general equity market there are to my mind two different realities playing out. The one is where the market is currently pricing our equity market, and it’s really pricing for a worst-case scenario. If you look at our valuations versus our emerging market peers and our developed market peers, they are really being priced for a worst-case scenario.

But I think on the other side of the coin the different reality that’s playing out is that South Africans in general and South African business in particular are quite a resilient bunch to my mind at the frontier of solving problems that the rest of the world is only starting to grapple with.

We are embracing alternative energy sources, becoming less dependent on state infrastructure, and there are numerous institutions building parallel solutions to the problems that we are facing.

I guess what makes me most positive is that our businesses are coming to the realisation that responsibility for a favourable business environment lies with themselves.

So, while I think there are some short-term profitability headwinds as businesses adjusts to this new reality with a sort of five-year hat on, and we are quite optimistic about the SA equity market.

SIMON BROWN: I take your point on that and certainly South African businesses are resilient; we’ve been through very, very tough times before.

Changing tack slightly to different investment strategies that SA equity managers would look to follow, I imagine this is broadly the sort of bottom-up versus top-down sort of strategies where you start that investment process.

RADEMEYER VERMAAK: Yes, I think that’s a fair comment. But I think even if you look specifically only at bottom-up stock selection strategies there, there are a number of different perspectives and approaches that South African equity fund managers tend to follow. So, for example, you find managers who focus specifically and exclusively on quality, but other managers that focus on valuation and other managers that focus on momentum and growth-type strategies.

I think the best analogy to explain what these different strategies entail is to shift the asset loss slightly away from peer equity to, let’s say, buy-to-let property. If you think about it, if you are a buy-to-let property investor, you can follow a number of different strategies.

One of these is to simply go out and buy quality properties. What are these? These are the classic location, location, location. They are the best properties in the best parts of town, with a beautifully manicured lawn, and a new kitchen and bathroom. But they are expensive.

On the other side of town is where you find your value properties. There are players that invest in value properties, and these are properties that need a lick of paint, which have never been renovated. But, given the rent that you can receive from this property and the price that you pay to acquire it, it’s a pretty good yielding investment. But it’s not without risk.

And then to my mind where the growth dimension lies is if you think about investing in the plot-and-plan where there’s a new development in town. You can’t really put a tenant in yet, but there’s potential in the future.

South African equity fund managers typically invest according to one of these different investment strategies. We think there’s an alternative way of investing at that intersection of quality – value and growth. Stocks that meet all the criteria [are] in the middle of town, so to speak, and we’ll delve into that maybe a bit more.

SIMON BROWN: I like that idea because as you were going through that analogy, I was thinking, well, hang on, why not get the fixer-upper on the Atlantic seaboard. In other words, blend those different strategies together and in an ideal world you end up with the best of all three.

RADEMEYER VERMAAK: Exactly. So we think that South African asset allocators diversify the risk to each of these different strategies by allocating to various equity fund managers from a top-down perspective. So they would buy into a quality manager, a value manager, and a momentum or a growth manager. We think that there’s an additional arrow in the quiver by buying an investment process that buys in the Atlantic seaboard – as you so eloquently put it, at that intersection.

The reality is that it’s very difficult to know when each of these different investment strategies is going to perform well. They perform through different parts of the macrocycle. To give you some context on that, when there’s stress in the macroeconomic environment, such as for example with the global financial crisis in 2008, we have what is colloquially known as a flight to quality. That’s when a quality strategy typically performs well.

So you want to have that in your portfolio. And then when central banks open up the spigots of monetary policy we have what happened in January of 2009 – a dash for trash. That’s when value stocks that are just simply cheap outperform. Valuations don’t matter any more.

So it’s difficult to know when these strategies will perform well, and that’s why asset allocators typically blend that risk and diversify that risk away [through] one of each of these different strategies.

We think that there’s an additional arrow in the quiver by also looking at this from a bottom-up perspective.

SIMON BROWN: I like that. You are sort of building – and I use the phrase – ‘a preponderance of evidence’. You’re getting lots of wind at your back. You’re not quite sure when it’ll blow, but it’s there when it does.

We’ll leave it there. Rademeyer Vermaak, head of systematic solutions at STANLIB, I appreciate the time.

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