LESSONS FOR INVESTORS
AFTER A YEAR OF SURPRISES

David Lerche, Chief Investment Officer:

Buying well is not enough – you also need to sell well.

The most crucial aspect of managing a portfolio is to buy well, since over time, markets go up. Over long periods (more than 30 years), most of the returns come from relatively few stocks, however, which is why at Sanlam Private Wealth we have a quality bias in our investment philosophy. This means that while holding on to the few long-term winners, you’ll occasionally need to sell stocks effectively to realise gains and recycle cash into fresh ideas.

On the JSE, we have a greater proportion of cyclical stocks and fewer true growth businesses, so selling well is even more important in our market than for global investors. But this is one of the toughest things for most managers to do. Human minds are pattern recognition machines, so we tend to struggle to identify when a trend has reached a turning point. This is where valuation discipline comes in.

Two examples of where we believe we sold successfully in 2023 were the reduction in our holding in AngloGold in late April at R483 per share, and halving our Richemont holding in two tranches with a weighted average price of over R3 140. At the time of both sales, the story around these shares was particularly positive, meaning it took a lot of fortitude to act.

As a result of our philosophy at Sanlam Private Wealth of investing our clients’ money for the long term, our portfolios show far lower turnover than those of most of our peers. However, we are firm believers in the value added by active management, and will thus not only look to buying great businesses at attractive prices but also selling them effectively at the right time and price.

Renier de Bruyn, Head of Asset Allocation:

When markets don’t behave as expected, it’s even more important to maintain a well-diversified portfolio appropriate for your risk profile.

At the start of 2023, most investors anticipated a challenging year for global equities as tighter monetary policy was expected to constrain economic growth. Although the market had to revise expectations for interest rates even higher throughout 2023, global equities still managed to provide above-average returns. While many economies outside the US did experience slowdowns, and most of the equity market returns were driven by a few stocks, the lesson remains that financial markets did and will continue to move in unpredictable ways in the short term.

With the benefit of hindsight, one can easily identify the factors that contributed to the outcome being different than the market’s initial expectations. Loose fiscal policy, high household savings balances and a high proportion of fixed-term debt in the economy all contributed to slowing the impact of tighter monetary policy, especially in the US.

It should be remembered that the market is a complex system – there are too many variables to predict outcomes accurately. There will always be an ‘unexpected’ move of one or another variable. For this reason, investors should avoid relying too much on forecasts. It’s more important to ensure you maintain a well-diversified portfolio appropriate for your risk profile – one that can withstand unanticipated outcomes and remain resilient in different market cycles.

Christiaan Bothma, Investment Analyst:

If a business generates cash, it has intrinsic value. However, beware of falling into value traps.

This year has seen a significant shift in capital towards entities benefiting from artificial intelligence, and many of these companies are exceptional businesses deserving of a premium rating. However, it’s important to bear in mind that US$1 of dividends received from a fast-growing tech company holds the same monetary value as US$1 from a less glamorous industrial counterpart. It’s often the seemingly unexciting businesses that offer the most future upside for investors, not the stocks that are currently generating the most hype.

However, it’s also of critical importance to assess the sustainability and potential growth of any cash flow stream. If, for instance, a ‘mundane’ industrial company ceases to exist over the next decade, due to either product irrelevance or an inability to produce at a competitive cost level, the seemingly high current free cash flow yield can be very deceiving. It’s therefore crucial that when looking at an attractively valued business, you ensure you understand any potential existential threats as best as possible and consider whether you might not be benchmarking to a previous operating environment that no longer holds much relevance.

Gary Davids, Investment Analyst:

Use a wider lens of scenarios when considering a share, and look through the hype and ‘noise’ of the day.

Emotions can sometimes drive poor investment decisions as fear and greed distract investors from their long-term investment strategies. These behavioural impulses can lead investors into buying at the peaks and selling during the troughs of the cycle – in other words, at exactly the wrong time.

In a constantly changing environment, it’s essential to discern the risks associated with an investment through frequent scenario testing as well as understanding the main drivers of valuation in order to take the appropriate action. In addition, investment theses may require more time than initially anticipated to realise, demanding patience from investors.

Dumisani Chiume, Investment Analyst:

Share price movements present opportunities, but total returns pack a punch.

Stocks with buybacks and/or special dividend programmes provide gradual growth and are a good way for management teams to create value for shareholders. This is especially true when the market discounts or undervalues a stock, for whatever reason. Sometimes this is justified, but more often than not there is a psychological element at play – there may be pessimism around selective elements of a business, or silos that are not needle-movers.

An example of this is Barloworld. The company’s Russian exposure has been below 20% of earnings (even at its peak earnings contribution). After the invasion of Ukraine and the subsequent sanctions, the Barloworld stock price derated close on tangible net asset value levels – the market therefore discounted far more than just Russia and continues to do so. The rest of the Barloworld business hums along with strong delivery in many quarters and return on invested capital is now sustainably above 15%.

Management transitions within segments of the business have been bedded down relatively seamlessly and there is a proven ability to execute in tough environments. The business is sitting on large order books in sub-Saharan Africa and has good optionality in Mongolia. Notwithstanding lead times within operational cycles, the business is very cash-generative. Importantly, it has a consistent strategy around returning capital where feasible to shareholders.

The special dividends and buybacks over the last while have led to Barloworld outperforming the JSE All Share Index despite a cratered share price, which is mostly off the back of the Russia/Ukraine concerns. While Russia is a wildcard, on a risk-adjusted basis, the market will in time reward Barloworld with a share price rerating more commensurate with its track record and capital returns.

Pieter Fourie, Head of Global Equities, UK:

2023 was a year during which global equity investors enjoyed very good double-digit returns after suffering a sizeable drawdown in 2022. However, even with last year’s drawdown, the Sanlam Global High Quality Fund still saw a 14% annualised return over the past decade, justifying the risk of being invested in equities.

The most valuable lessons we’ve learnt in managing the Sanlam Global High Quality Fund include:

• Don’t get too emotional when equity markets go down. Last year was highly frustrating for equity investors, yet this created buying opportunities for capital allocators like ourselves with a multi-year investment time horizon.
• In a volatile environment, be prepared to lean against the trend. Last year we bought new positions that suffered severe drawdowns in 2022, but they turned out to be big winners this year – for example, Intuit.
• Active management is important. We exited names like Edwards Lifesciences and YUM China earlier in 2023 based on our valuation discipline, and both names provided us with the opportunity to reinvest at significantly lower levels later in the year.
• Patience should be rewarded. Compelling investment ideas often take time to be recognised by investors. This year, companies like NetEase, SAP, Novartis, LSE Group and Intercontinental Hotels performed very well after lagging for quite some time during the pandemic years.