An alternative view to the conventional wisdom around perceived “safe” and “risky” assets
John Gilchrist, deputy CIO and Portfolio Manager of the PSG Stable Fund, and
Shaun le Roux, Portfolio Manager of the PSG Equity and Flexible funds
At current multiples and yields, we believe the consensus ‘safe’ assets are actually very risky destinations for capital. In addition, extrapolating past economic trends may be a poor guide to what lies ahead, especially regarding inflation, interest rates and currencies. Our alternative view of risk reveals a rich opportunity set of underpriced assets in South Africa and globally.
There is a massive bifurcation between the price levels of those assets generally perceived as being low risk and everything else. Many commentators have highlighted the extreme outperformance of the growth factor over the value factor, but this is just one of several ‘themes’ highlighted below.
Table 1: The matrix of conventional wisdom: around Q3 2020
What was considered ‘safe’ two quarters ago has since become much riskier. Applying our alternative view of risk has enabled us to identify a rich opportunity set of underpriced assets, both in South Africa and globally. Focusing our research efforts on uncrowded or unloved regions and sectors raises our odds of finding ‘quality on sale’ with one of the areas being South African small- and mid-caps.
Exploiting the opportunity in small- and mid-caps
While we do not view ourselves as small-cap managers, many of the opportunities meeting the attractive valuation criteria highlighted above fall within the ambit of the JSE small- and mid-cap universe. While shares with smaller market capitalisations tend to outperform their large-cap peers over the longer term, they have underperformed over the last 10 years, primarily due to substantial underperformance over the last three years.
This underperformance has been driven primarily by a relative derating of smaller cap shares, hence the attractive opportunities and high prospective dividend yields we are seeing in this area of the market. Potential reasons for this being such fertile ground for mispricing are:
- Globally, there has been a protracted bias towards growth over value shares. In most cases, South African small- and mid-cap shares are regarded as value shares, given the lack of economic growth.
- Emerging markets have been out of favour and South Africa has not been spared.
- South African small- and mid-cap shares are perceived to be entirely reliant on the local economy. However, many of these companies are more diversified and resilient than perceived and often earn a significant amount of their profits in hard currency.
- There is very little broker research coverage of the small- and mid-cap universe.
To put it bluntly: South African smaller cap value shares are the most unloved part of an unloved market within an unloved investing style.
In conclusion, as we enter 2021 we find that areas of the market offering the most potential remain very out of favour. The widespread capitulation out of emerging markets and economically sensitive shares by both local and foreign investors has yet to normalise in any meaningful way. Capital flows and positioning continue to suggest a remarkable degree of crowding into areas which have worked well until now. South African assets (apart from the well owned large-cap shares) stand out as being particularly unloved. We believe a differentiated positioning in carefully selected companies will become an increasing valuable component of an investor’s portfolio going forward.
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PSG Asset Management Holdings (Pty) Ltd is regulated by the South African Financial Sector Conduct Authority as an authorised Financial Services Provider with a Category I, II and IIA license, issued in terms of the Financial Advisory and Intermediary Services Act, 2004 (FSP 29524).