South African Equity Market Amidst Covid-19, Michael Dodd, Head of Equity at Old Mutual Multi-Managers

Covid-19 has required Fund Managers to adjust their sails and take a different approach to how they think about markets and in particular, how they position their portfolios. In this Market Matters Podcast @Michael Dodd, Head of Equity at Old Mutual Multi-Managers, discusses the performance of the South African equity market amidst Covid-19 and how we’ve faired against the global market. He also provides insight into what we can expect from markets in 2021. For more information visit www.ommultimanagers.co.za

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Ian Fraser  00:01

This year is definitely one for the record books. 2020 has indeed been a turbulent time on many fronts, given Brexit, the COVID-19 pandemic, and the US elections, to name but a few. As we approach the end of the year marked with many challenges and uncertainties, there might be a widespread reluctance to make firm plans for 2021. 

In this Market Matters podcast series, we explore the most prominent economic themes with investment analysts from Old Mutual Multi-Managers. They help us make sense of the equity, property, and fixed interest markets, and also share insights on how diversification could be the key to survive next year and beyond.

Ian Fraser  00:43

Today, we're talking to Michael Dodd, he is the Head of Equity at Old Mutual Multi-Managers at the investment team there. Michael is responsible for the management of all Old Mutual Multi-Managers investment funds and strategies, it's a big job. And as the Head of Equity, also mainly responsible for the asset class and manager research. Michael is also involved in the investment team decision making processes around managers selection and asset allocation.

It's a bit of a mouthful to get going. I hope that I've got that right for you, Michael. Welcome to the podcast. It's great to have you on. 

Michael Dodd  01:15

Thanks, Ian. Thanks for having me. Mostly right, very flattering, thanks very much. 

Ian Fraser  01:20

Let's jump right in first of all, and break that down just so people have context as to exactly what you're doing with the team. And then we'll drill down and get a bit more granular with the equities and stuff. 

Just a side note as well. This podcast is being recorded at the end of November 2020. It's been a heck of a year. So, let's go back quickly and just talk about your role and tie us in so we can get down to it. 

Michael Dodd  01:45

Ja, thanks. So, like you said, I am Head of South African Equity Manager Research within the Old Mutual Multi-Managers investment team. But I think you know, rather than, you know, I can't take credit for everything, as much as I would like to. You know, what we do is very much a team-based effort. 

So, while I am, I suppose, the lead person on the equity manager research, there's a whole team that is behind this, there's a whole load of us that are doing the work behind the scenes. And the way that we tend to operate is, you know, even though equity is what I specifically look after, you know, we try to employ a bit of a generalist approach as well, where we all sit in on each other's meetings. It's important to have an opinion on things like fixed income, the global equities, because ultimately, when we're putting the whole funds together, it's important to have that kind of context as well. 

Ian Fraser  02:43

Well, forgive me for stating the obvious, but I mean, you can't just put equities into a silo. It all works together, doesn't it, really? 

Michael Dodd  02:49

Exactly, ja. 

Ian Fraser  02:50

Let's jump right in then because been an interesting year, looking back over 2020. And I know you must have spoken about this many times. But I think there's a little bit of sunshine on the horizon with the turnover into 2021. 

How has the equities market, the locals, the South African equities market, fared over the past 11 months? Let's start from the beginning of this year, what's going on? 

Michael Dodd  03:15

Ja, well that's, I mean... as, I don't even need to, I don't need to reference the equity markets to tell people that it's been a rough year. You know, obviously, the year you can probably split up into a few different pieces as we have in our own lives where we're all sort of working from home and enduring lockdowns and living with the pandemic. 

The equity market itself, the South African equity market, had a pretty torrid time in the first quarter of the year. And as did, you know, most global equity markets. But our market in particular was particularly hard hit, had a pretty rough first quarter. And then I think from there, particularly in the second quarter, that was when the rebound started. And, you know, we saw a bit of a recovery in our markets from what were pretty extreme low levels. And where we sit today, towards the end of November, we are having a bit of a better month. 

As things stand for November, it's going pretty well, so far. A few days left to kind of hang on to the gains that have been made so far. But, you know, even with the recovery that we've had, and in particular what's happened this month, our equity markets still, you know, depending on the index that you're using, haven't yet had time to recover. So, the equity benchmark that we use on our side is called the capped SWIX. As things stand, the capped SWIX is still negative for the year so far, down by about three odd percent or so. Some of the other indices in our market are marginally positive, but I think you know, we've had the recovery but still haven't quite got our heads above water. 

And if you compare that to, particularly some of the global markets, which are now, you know, strangely quite positive and bombing on for all-time highs again, ja, our market has generally lagged the global recovery.

Ian Fraser  05:17

Interesting though that I was reading an article earlier on today, actually, that was talking about some sectors within our local market. And I mean, some of the tech firms have done incredibly well, you know, the reliance on this lockdown has made tech firms boom, internet connectivity companies, MTN was one that came to mind. Whereas, you know, you look at the restaurant industry, you look at the entertainment sectors, etc. they're at the bottom of the pile. 

So, without getting into it, really, you have to see there's been booms in some areas and others, there's just been a complete flop, hasn't there? 

Michael Dodd  05:45

Ja, that's right. And the market recovery has not been broad-based, and it has not been equal. And as you point out, there have been what we call COVID beneficiaries and COVID casualties through all of this, and the tech sector, as you point out, the South African market has a very limited tech sector. It's basically Naspers and Prosus. But you know, you compare that to the global markets and what the tech companies have done there, they've generally held up quite well. 

And as you quite rightly point out, some of the companies that are more consumer facing and rely on a normally functioning economy where people are moving around, and people are going to offices, and people are going to shopping malls. That particular segment of the market has continued to struggle. So, looking at, you know, in particular, your property companies, things like your banks, some of your retailers, you know, that area of the market has continued to struggle. 

Ian Fraser  06:45

If we talk about the global markets, you alluded to them a few times now in the last few minutes. Let's just talk about that, the composition of our market compared to global markets. 

Why are they seeming to do better than ours? 

Michael Dodd  06:57

Well, I think there's a few factors behind it. I think our market looks very different to what global markets do, in terms of its makeup and its composition. And there are a few sectors in our market that are quite heavily weighted, you know, when you compare us to the global markets. 

I think the one standout in the South African market, in particular, is the resources sector. So, I mean, as you would imagine, you know, the South African market and the South African economy has been built on things like mining and the resources that the country has. And resources make up about 26% of our local equity benchmark. But if you compare that to the global equity benchmark that we use, and the MSCI or countries, which is that particular benchmark, the resources sector, which for the purposes of industry classification gets called materials, actually only makes up about 5% of that market. So, the resources composition is a bit of a standout. 

And we touched on it earlier, but, you know, one of the areas where the South African market is underweight, I guess relative to the global markets, is the tech sector, where we've really got Naspers and Prosus. Depending on your classification that might not even be classified as a tech sector. We've seen this year in particular over the last few years, the rise of some of these technology companies, particularly in the US. The rise of the FAANG stocks, or the FANMAG stocks, or whichever acronym you're leaning towards, and whichever acronym people are using nowadays. 

But also, in particular, if you look at the emerging markets index, the technology sector there dwarfs the tech companies that we have in our market driven by, in particular, some of the tech companies that have grown within China. So, ja, I guess [laughs] long answer to the question, but I think a number of factors in the makeup of the South African market versus the global market. 

Ian Fraser  08:56

Gotcha. 

Michael Dodd  08:56

Ja, globally, having probably more of those companies that have held up a lot better. 

Ian Fraser  09:03

So, you gotta extend a hand of sympathy to the equity managers in South Africa at this stage. I'm giggling out of sympathy really, because I'd love to know their position right now. What's going through South African equity managers' heads? 

Michael Dodd  09:16

Ja, so, you know, the South African equity managers and how they're positioned. I mean, our managers have actually done reasonably well through this period. But how the managers have started to think about our market and in particular, how they position their portfolios is, they tend to think in terms of Rand hedges versus what they call colloquially SAInc, so your Rand hedges being the companies that, you know, aren't necessarily reliant on the success of the South African economy and all of that to generate their earnings growth. Whereas the SAInc companies being your more domestically focused. 

In general, our managers still prefer in terms of their exposure within the portfolio, the offshore earners over the SAInc companies. Although I think it's probably worth pointing out as well, yeah, we've had a few conversations with our managers over the course of the last few months. And in that we've seen, and we have noted that there has been some selective buying of some of the domestic companies on a more opportunistic basis. Because, you know, in reality, some of those companies are actually very, very cheap, at the moment.

At a sector level, you know, the favourite stock sector within our market remains the technology sector. Our managers still like the growth story of Naspers and Prosus, which is, you know, in particular linked to the growth story of Tencent. But I think also, in addition, there are some underlying businesses within those companies, such as the classifieds and the, in particular, the food delivery businesses within the Prosus stable, which has been a beneficiary of some of the lockdowns around the world. As you know, people have been staying at home, restaurants haven't been open, and the trend around food delivery has really accelerated within the last year, and they see potential for particular earnings growth within those companies. 

And then within resources, I think in general, our managers are marginally underweight that sector at the moment, but within that sector, it's important to look through and understand which parts of the resources sector you are, you actually have positions in and where you are overweight and underweight because it's a big catch all term. But there are many different areas within that sector. So, in particular, the managers being overweight, some of the diversified miners and the platinum miners, so favouring companies like Anglo American, Impala Platinum, Northern Platinum. Then within that, and where the underweight comes from, is that our managers have a fairly large underweight to the gold miners and the gold companies within that sector. 

I think lastly, maybe just to touch on the SAInc exposure, and why the managers remain underweight there. And that largely comes through from a general underweight to financials. I think of all of the sectors in our market, that is the one that is probably the greatest proxy for the South African economy because it includes the banks, the insurance companies, the property companies, the ones that are effectively bearing the brunt of lockdowns and consumer activity. And, you know, the managers, I think, in particular, struggle to find some value, particularly in the property area of that sector.

Ian Fraser  12:41

Interesting. Very interesting. So, rough year, looking forward, as we were talking about the New Year dawning. Where's it going? I mean, I'm asking you to look into your crystal ball here:

• How are we going to assess that 2021 scenario? 
• What's our local equity market gonna look like? 
• How's the global market gonna affect us? 
•  What do you think's gonna happen?

Michael Dodd  13:06

Ja, I mean, as you'd say, we love a crystal ball. [laugher] To know the answer around all of those things. 

Ian Fraser  13:11

I always feel bad asking that question. Because, you know, you're going "How must I know?", but based on what you do know, let's start there.

Michael Dodd  13:20

No, you know, it's obviously a very important question. Because in particular, the role that the South African equity market plays in our lives and also the role it plays within our portfolios and the return targets that we're trying to hit. It's an important generator of, you know, returns, we ultimately needed to do well. And I think in terms of assessing the prospects, we need to - we look at that through a number of different lenses and a few things that we kind of focus on. 

The first of those is we look at the prospects for earnings growth within those companies. And the consensus view is that, you know, the outlook for earnings growth in 2021, is obviously a lot better than what earnings have delivered in 2020. So, there's what we call the "base effect", of, you know, a very poor year in 2020 is sort of translating into a bit of an earnings rebound off very low basis, going into 2021. So, the expectation is that next year, the earnings, there'll be a return to some sort of earnings growth, the earnings picture will look a lot better than it did this year. But then looking out beyond that, that's where things start to get a little bit more unclear and a little bit more uncertain in terms of what happens 2022 and beyond. 

But generally, you know, the backdrop for earnings looks reasonably positive in 2021. One of the other things that we pay attention to, and I think what has become clear in the last few months to us as well, is that there has been large amounts of I think excess pessimism that's been priced into the South African market. And, you know, in recent conversations that we've had with some of the asset managers that we use, there's two areas that they've kind of flagged. 

The one has been the positive trajectory on earnings revisions. Now, what that is effectively saying, is the consensus builds in certain return expectations for various companies. And, you know, as time progresses, they adjust those either upwards or downwards. And there's been generally a bit of positive momentum in some of the earnings revisions, which means that people are revising their earnings estimates upwards, and maybe an acknowledgment that they were previously a little bit too pessimistic. 

Ian Fraser  15:42

Right.

Michael Dodd  15:42

And that was, I think, echoed by one of our other equity managers in one of the conversations we had where they actually pointed out that they were monitoring all of the updates and all of the results that various companies were coming out with, and generally that those things came in a little bit better than what they expected. 

Ian Fraser  15:59

Right. 

Michael Dodd  16:00

So, I think an acknowledgement that - it would suggest that companies have been holding up a little bit better than expected during the crisis. And then finally, I think just to round it all out, one of the important things to take into consideration when assessing the prospect for returns is what we call valuation. And valuation is important because it's a cornerstone of our investment philosophy. It's basically, in other words, assessing how cheap or expensive a market is relative to other opportunities that you may have. And I think the fact is that no matter which way you slice it, at the moment, the South African equity market currently looks very cheap. 

That is, cheap relative to its own history, cheap relative to what, you know, valuations look like in developed markets, cheap relative to what it looks like in other emerging markets. And that is, you know, whether you include or exclude Naspers, whether you look at it on a standalone basis, or whether you look at it relative to other equity markets around the world, our market currently does look fairly attractive. And I think, in terms of a guideline for future returns, valuation does give you a very good signal as to what your future returns could look like maybe sort of five years down the line. 

As much as we'd love to sit here and be able to tell you, you know, this is going to happen in the next year because this is where valuations are, unfortunately, it doesn't work like that on a one year basis. But if you have more of a medium to longer-term mindset, history has kind of said that if you buy at the levels that markets are currently at, within sort of five years or so, you've generally been rewarded with decent returns when you buy it at current levels. 

So, ja, I think in summary, still quite cautious on the outlook for growth, particularly for the South African companies. And I think the challenges to the growth outlook, I think, are fairly well known within our market. But, you know, the asset class itself does look reasonably attractive. One of the things you do have to balance up, is how does it look relative to some of the other asset classes, and, you know, within a South African context, every South African asset class, with the exception of perhaps cash, currently looks quite cheap. And so, you are competing for attention with the bonds and the property market, which also look quite attractive at the moment.

Ian Fraser  18:26

So, potential buyers potentially not licking their fingers just yet, but maybe in the next few months might be, as you say, getting quite a good deal, provided you hang on for a five-year term. You're looking pretty good to get an upside to any stock that you might buy.

Michael Dodd  18:44

Ja, I think just looking at the market as a whole. But I think, as our managers have pointed out, there's a need to be selective, I think, as well. You don't want to fall into, you know, what managers often call value traps.  

Ian Fraser  18:57

Right. And that's where you'd come in, which is a perfect way to end it really, for the people in the know and who've dealt with us and who deal with us all the time. That's a fantastic way to wrap it up. Michael, thank you very much for your time. Nice insight. A nice sort of dipstick into what's happening, the year that has passed. May 2021 bring you a little bit more of a smile, as opposed to the dreadful year that we've had so far. I hope that things get better next year.

Michael Dodd  19:24

Ja, let's hope so. Thanks very much, Ian. 

Ian Fraser  19:27

Great, thank you.

 Old Mutual  19:32

 Old Mutual Multi-Managers are a specialist investment boutique within the Old Mutual Group, South Africa's largest and most established financial services company. They offer affordable investments that blend together the best of South African and offshore asset managers. Old Mutual Multi-Managers is a division of Old Mutual Life Assurance Company (South Africa) Limited, a licensed financial services provider and life insurer.