This article was taken from Mastermind, the official monthly newsletter of Sanlam Private Investments, a division of Sanlam Ltd. Visit the SPI Website
By Alwyn van der Merwe, Director of Investments
Investment fashions come and go but following the fashion pack normally does not provide long-term solution.
Just as the sales of clothes are driven by fashions and fads, the performance of assets and asset classes are often driven by trends.
However, we know that fashions change and that dandies sometimes inadvertently still follow the previous season’s fashion, raising the eyebrows of those in the know. Investments are very similar. Fads and trends change regularly, but unlike the world of fashion, these changes are not announced in advance in the pages of glossy magazines. Sometimes an investment fashion craze may be popular for a long time, and in other cases it can have a very short shelf life.
At present we find ourselves in a relatively prolonged period where fashions are dictated mainly by two factors.
First, investors find themselves in an environment where interest rates are low and interest rate expectations are regularly adjusted downward. Artificially low interest rates prejudice savers and favour those looking to borrow capital. Consequently, savers are now looking for alternatives to augment their low income yield. The alternative is to be found mainly in shares paying high and sustainable dividends, and, secondly, listed property shares with similar characteristics are drawing substantial investments.
Those who have spotted this trend would certainly have benefited since both categories have returned excellent investment yields over the past couple of years. Unfortunately, as in the world of fashion, this craze has caused sharp increases in the price of assets in these categories, and value investors have become sceptical about prospective investment returns of these assets. Since investment fashions change unannounced, the risk increases and we are of the opinion that this risk has to be managed in portfolios.
The second, and not unrelated factor is sluggish global economic growth together with geopolitical risks that are commonly associated with sluggish growth. Uncertain economic prospects create uncertainty about companies’ profit growth. Investors, therefore, are paying a premium for certainty of profit growth, while companies with a cyclic profit pattern or uncertain short-term profit prospects will certainly not feature on the front pages of investment magazines. The result is that so-called growth companies are trading at high valuations whereas cyclical companies are trading at very reasonable valuations.
In short, because of the current fashion crazes, property shares are expensive, growth shares are trading at a premium and cyclic shares are unpopular and cheap. We know that, over time, more substantial investment yields are produced by paying attention to valuation. We also know that fashion crazes – we are talking about context – have to be in mind when constructing portfolios. When relative valuations are skewed, as they are at present, we cannot ignore it.
Against this backdrop, we purchased unpopular shares, such as Anglo American last year, and we slightly reduced the highly popular name, for example, Naspers, in the portfolios. So far this decision has not worked well and clients – given the price movements over the last six months – are justifiably critical about the decision. But remember, Anglo American is unpopular in the current macro-environment, but it remains a company with excellent assets that can now be acquired at a huge discount.
We believe that – just like in 2007 – these companies will again, and for the right reasons, grace the front pages of investment magazines and will reward clients for their patience.
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