Global market opportunities:
interview with Pieter Fourie

Interview transcript:

Joining me today is Pieter Fourie from Sanlam. Welcome, Pieter. Let’s start by discussing some of the current conditions in global markets, and some of the opportunities that are being presented.

This year has been quite interesting. Unlike the previous few years, the US stock markets underperformed. A lot of fundamentalists feel that for the US market, being the most expensive market in the world, the time was ripe to lag the likes of Europe and Asia. We’ve seen that happen this year, and fortunately for us we’d been buying, towards the back-end of last year, a few companies like Baidu and Yum China. Even though they’re listed in the US, they do their business in Asia.

So we’ve been quite fortunate that those businesses have performed very well for us. It does, however, leave us with a short-term conundrum if Baidu and Yum China move up by more than 35% to 40%. This would move it very close to, if not to, an over-valued territory versus intrinsic value. So we’ve taken profits in some of the names that have performed very well for us this year.

In light of some of these factors, can you tell us about the principles behind the Sanlam Global High Quality Fund that you offer?

We operate on the basis that we want to find great businesses. Typically they’ll have a wide economic moat and the ability to grow for many decades, if not for 50 to 100 years, by being very much in charge of their own destiny. What do we mean by this? Because of their wide economic moat, they have pricing power, which is very important in the deflationary world we live in.

We therefore seek businesses that are not in commoditised areas like financials, mining stocks, utilities, and so on. We end up with businesses that typically trade at slightly higher valuations than the market, but not at excessive valuations. And we do have the ability to sell out of names sporadically if that opportunity exists. We feel that our 125-name universe gives us enough opportunity to switch dynamically between different stocks.

Can you give us a picture of how the fund has been positioned over the past three to five years?

Well, we haven’t had a great opportunity to invest in names in the healthcare division, for instance. Those sectors traditionally have been quite expensive, but this is an area to which lately – over the past year – we’ve been increasing our allocation. One of our top positions is Medtronic, one of the world’s leading medical equipment companies. This is an area we favour. We do have the odd drug company, but we try not to over-expose the fund to these because we feel the business-specific risk can be quite high in companies that focus only on a few core products.

Traditionally, we’ve favoured consumer goods companies quite a bit. Unfortunately, they’ve become expensive lately, so we’ve taken down the position size in names like Nestlé. Having said that, we also find that names like Reckitt Benckiser, a competitor to names like Unilever and Procter & Gamble, have become an interesting proposition for us, and we’re building a position in them.

Unlike the 2000s period, when technology stocks were trading at super-high valuations, this is an area in which we now have quite big exposure as well. So names like Alphabet, Microsoft and Oracle feature for us, but we find it very difficult to get ourselves comfortable with the valuations at which names like Facebook, Amazon and Netflix are currently trading.

Are there any sectors that you deliberately avoid?

Those sectors that are over-regulated tend to scare us away. Utilities is one that comes to mind. Another sector that we would typically avoid is financials – banks in particular. Our whole process is driven around return on invested capital. We’re looking for businesses that can achieve high return on invested capital without a lot of excessive gearing. Your typical bank would be eight to 12 times geared (loans versus deposits), so if we can find a business like Johnson & Johnson that does 20% return on capital with a very small amount of gearing, this to us is preferable to investing in a typical European bank, which might be up to 30 times geared in the case of Deutsche Bank.

You mentioned a 125-stock universe a bit earlier. Are you limited to the number of stocks that you like to hold ideally within the portfolio at any one time?

We try and stick to between 25 and 35 names. At the moment, the fund is towards the maximum end of that range. It’s an admittance that within quality sectors it’s very difficult to find disparities between sectors within the same universe today. However, we’re quite comfortable that volatility on a stock-specific level can be higher than an index on its own. So we feel comfortable that the opportunities will come for us if we stick to what we’re doing.

Typically, our 125 names that we look at don’t change that much. We believe great businesses are hard to find. It’s easy with the benefit of hindsight to say Facebook would have been a big business and a great performer, 10 years ago, but investors underestimated at that point the ultimate earnings power of those businesses.

If we can find that type of name, it’s always a real kicker for the fund. A name that we’ve discovered over the past few years is a company like NetEase, which focuses on mobile gaming. The earnings power of that business has been quite tremendous and vastly underrated by investors over time.

Pieter, you’ve mentioned valuations several times. What’s your current take on valuations in the markets that you participate in? How do you manage that sort of risk?

We can’t deny the fact that if you look at median valuations in the US, they’re not at 2000 levels, but they really are pushing towards the upper end of the valuation range. What we do find, however, is that we don’t have the stratospheric valuations in areas like technology that we had in 2000, so even though Microsoft might be on 18 times earnings next year to the end of June for their fiscal year-end, this is much, much less than the 45 or 50 time earnings it traded at back in 2000.

So we never want to anchor ourselves to previous valuations, which were in bubble territory, but that’s a good example of a stock that offers us a 5% to 6% free cash-flow yield. It’s very compelling. Yes, it is in technology, but we still feel there is upside, and we certainly aren’t looking at energy stocks at this stage. They already discount quite a large earnings recovery – the energy sector in the US is trading on 30 times earnings, and probably at quite depressed earnings levels. But we’d rather invest in those businesses that we understand and that do still trade at a discount to the market.

For retail investors looking to have an allocation to the Sanlam Global High Quality Fund, what can they expect?

When I joined Sanlam five years ago, I was of the opinion that, given starting valuations were for high-quality businesses and the fact that earnings growth still looked quite rosy going forward, you could expect 12% per annum dollar returns. That’s what we actually delivered over time, and it significantly beat the market over that period.

Going forward, I think the market is in a 4% to 6% return range, and we’re hoping we can do a little bit better than this. I think investors have to accept the fact that it will be a lower-return environment. For our businesses, earnings still look quite robust, but the valuations are unfortunately a bit higher than three to five years ago.

A final question – do you manage currency risk, or anything like that, within the fund?

Last year, for the cash that we did have in the fund, we favoured the US dollar. It worked in our favour – the dollar was up against most currencies. This year, it’s not working in our favour. Having said that, a weak dollar benefits many of our US names, whether it’s Philip Morris or Procter & Gamble. That’s really softened the blow, so to speak, for holding dollar cash.

Going forward I still prefer the dollar long term. I’m quite surprised by how strong the euro is. The euro strength this year is putting pressure on earnings growth for European companies that operate internationally. You’re starting to see the likes of Pernod Ricard notifying the market that the growth will perhaps not be as strong as it forecast before, because the dollar is very weak and is therefore putting pressure on its earnings, as it reports in euros.

So we still think in the very long term we want to have dollar cash, but we don’t hedge any of our positions. We feel that the underlying earnings growth of our businesses will ultimately be reflected in either currency strength or currency weakness depending on where they do business. If emerging market currencies remain relatively robust, that should be good for our companies, since about 25% of their earnings come from emerging markets.

Thank you very much for the discussion and for joining us this afternoon, Pieter.