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Simon Raubenheimer is one Allan Gray’s four portfolio managers – the men responsible for generating returns on hundreds of billions of rand in savings. He came over to the Biznews.com studio yesterday for a wide ranging discussion. Among the areas covered were Simon’s favourite stocks – both local and international – how he keeps perspective when investing huge amounts of money numbers and why he believes the argument between active and passive managers is over-simplified. Intelligent insights that will help any investor, professional or private.- AH
SIMON RAUBENHEIMER: Markets are high. I mean, it’s a fact. You can look at the ALSI over 55 years. We show charts going back to 1960 and markets are high, driven by valuations that are high, and so profit levels are high. Valuations are high. You’re looking at historic multiples, price-to-earnings multiples of 17.5 times, and that doesn’t even account for the high level of earnings on the JSE. If you look at valuations, there’s not that much to get excited about. Our message is pretty clear and has been for a while – I guess we’ve called this really, really early – is that markets are expensive and that investors should moderate their expectations about what level of returns to expect from this level, going forward.
ALEC HOGG: As a value investor, you’re always a little early….
SIMON RAUBENHEIMER: We typically tend to be early. In fact, it’s interesting. If you look at our various Unit Trusts, we generally tend to buy and sell early. What that’s resulted in is that our Equity Fund has actually lagged – the All Share Index. Since we’ve sectioned the equity fund over the last 15-odd years (say, since 2000) we’ve had about 170-odd months of being in the market and in 100/105-odd months where the market was up, our Equity Funds actually lagged the All Share Index by more than half a percent (by point-seven percent). Our long-term returns are entirely attributable to the fact that in down markets, we are able to preserve the capital that our clients have given us slightly better than the average manager or an Index-tracking Fund, for example. Our outperformance was generated in down markets, not in up markets and that’s really, a result of the very strong emphasis on risk management, and capital returns. When markets are higher, we do move into fairly defensive assets and places that we think safeguard investors’ capital better.
Listen to the full interview:
ALEC HOGG: Again, a typical value investor. Rule number one: don’t lose money. Rule number two: don’t forget rule number one.
SIMON RAUBENHEIMER: Don’t forget rule number one – exactly.
ALEC HOGG: Getting back to the South African market, where are you seeing opportunities?
SIMON RAUBENHEIMER: Let’s take our Balanced Fund. Our Balanced Fund is now R100bn so it’s a massive Unit Trust Fund in the context of South African Trust Funds. In our Balanced Fund, we probably have about 44 to 45 percent of our balanced fund invested in shares. Clients often ask us ‘given the fact that you think markets are high, why is it not a lot lower than 44 percent’.
We can, for example, drop our Domestic Equity exposure down to 30 percent and keep ten percent offshore, for example, which would give us a 40 percent share exposure. We’re currently running about 55 on that because of the fact that we can still find opportunities in South Africa, which, over the next four to five years, we think would beat cash and bonds. An example of the sector that we are currently overweight in, would be banks, for example. Financial services in general, so insurers plus banks, but banks even more so.
You’d therefore see Standard Bank as our second or third biggest holding. We like the fact that the banks are trading on historic dividend yields of over four percent. They generate tons of cash and they’ve demonstrated that over the very long-term, they’re able to compound that cash for shareholders.
ALEC HOGG: Standard Bank’s an interesting one though, Simon, because there is a view that FirstRand is running away with the local market.
SIMON RAUBENHEIMER: Absolutely.
ALEC HOGG: Is this a value play with Standard Bank, or do you think they’ve just been forgotten a little in the FirstRand mania?
SIMON RAUBENHEIMER: We own all the banks. We own some FirstRand banks. We own some Absa banks. We own FirstRand, mainly through Remgro as well. If you recall, one-third of Remgro is in FirstRand and our clients are one of the biggest investors in Remgro. Then we own Nedbank through Old Mutual as well, which you’d see in our top ten, too, so we do own all four banks.
I would say there’s not that much in it on a valuation basis. The reason we’ve picked Standard Bank is we think Standard Bank might have more optionality. Standard Bank have dropped the ball a little in the past years by allocating capital into markets elsewhere in the world, and that hasn’t quite generated the returns that they certainly would have hoped. Over the last few years, you’ve seen that they’ve exited their Russian and South American operations.
They are scaling down their U.K. operations and bringing money back to redeploy into their primary operations in South Africa, as well as in Africa. Africa is a second reason why we like Standard Bank. Currently, 25 percent of Standard Bank’s profits are generated in Africa (mostly driven by corporate investment banking) so they have an incredibly strong CIB franchise in the rest of Africa, which we really like.
The company as a whole in Africa…Standard Bank Africa, ex-South Africa, ex-the rest of the world… If I look only at Africa, it already generates an ROE of just north of 20 percent and that’s with a retail bank in Africa really not doing anything yet. They’re almost fighting with one arm behind their backs and they’re generating 20 percent ROE’s.
Certainly, when we look at the incremental leads on their retail business it certainly is getting better, and I think that’s a fantastic opportunity for management to redeploy cash – lazy capital currently sitting in London, for example – into Africa.
ALEC HOGG: So again, taking a nice, long-term view on it.
SIMON RAUBENHEIMER: Look, it’s not going to be a short-term thing. Standard Bank… This is something that’s going to happen over the next four or five years. The ROE’s in South Africa are low. The South African Bank only generates an ROE of, let’s say, 13.5/14-odd percent.
You mentioned FirstRand. FirstRand are currently shooting the lights out. They have a fantastic management team, but we would think FirstRand’s results have been boosted a little bit by very buoyant consumer expenditure in South Africa up until now. Their Wesbank business for example, has been pumping. FirstRand’s ROE’s are in the mid-twenties. Standard Bank’s is at 13 so I don’t think it’s too much of a stretch to imagine Standard Bank going to 17/18 percent, in which case you’d have quite a nice upside.
ALEC HOGG: Hence your optionality.
SIMON RAUBENHEIMER: That’s right.
ALEC HOGG: Outside of the banks…
SIMON RAUBENHEIMER: Some of the characteristics that we like in the companies we currently own… If you look through our top ten, they really are companies that I think, generate cash. Very strong emphasis on cash, especially in an environment where markets are high, and so we like companies that can generate and compound cash over the long-term, which is why it’s not surprise that you’ll note companies like BAT for example, are our biggest or second biggest investment.
In fact, if you look through Reinet, 70 percent of Reinet accounts for BAT. If you look through Reinet, BAT would be indirectly – plus directly, on a ‘look through’ basis – our biggest investment. It’s just a juggernaut. The company generates tons of cash. It’s on a four percent plus historic dividend yield. That’s four percent in Pounds, and historically, that has grown in the double digits. BAT has demonstrated to us that they are able to…
This is an environment that, after the last decade or so, with a lot of litigation, smoking bans, and plain packaging in Australia and elsewhere in the world as well. Despite all these ‘headwinds’ that BAT’s facing, they’ve demonstrated that they can grow their cash flows to shareholders over the long-term.
We would see that as lower risk investment in a market, which is currently very high so BAT, Sasol (another example of a company that’s grown its cash over 35 years – well in excess of the market)… Sasol’s grown its dividends by four or five percentage points faster than the market, every year, and you are starting with a dividend yield higher than the market. On all these investments… In fact, Standard Bank, Sasol, and BAT’s starting dividend yields are well in excess of the All Share Index’s dividend yields.
In addition, they’ve demonstrated that they can grow over the long-term in excess of the market, which is why we are quite optimistic about these shares and why we think these shares can probably beat cash or bonds over five or six years, even if their growth rate slowed down massively.
ALEC HOGG: Simon, coming back to where we started the conversation (on the exchange rate), both of the stocks you’ve mentioned (excluding Standard Bank, of course) – Sasol and BAT – are very strong Rand hedges. Is that part of the attraction?
SIMON RAUBENHEIMER: Yes, that would certainly add to it. Calling the Rand is really difficult. If you asked five people at Allan Gray what their view on the Rand are, you’d probably get seven different answers. We would think that if you looked at the long-term Rand/Dollar, we think the Rand is probably currently on its trend line.
Even if I do think a fair Rand to the Dollar is somewhere between 11 and 12, it doesn’t stay there for long so it overshoots massively, it corrects, and it undershoots again so who knows where the exchange rate goes. However, if we can find a similar company, which is a Rand hedge on a similar multiple – assuming all else is constant – we’ll probably take the Rand hedge.
It’s just great for… The South African market is really small in a global context – one percent of the global stock markets in the world – and for clients (to have in our equity fund) that have 100 percent of their assets invested in South Africa so we quite like companies with operations elsewhere. Just from a diversification point of view, it makes sense.
ALEC HOGG: But you make an interesting point and before we started this podcast, you also said that Allan Gray… You’ve signed a 35-years lease on your premises in Cape Town. You’re not getting distracted by the noise that one hears so much about at the moment, about political developments in South Africa.
SIMON RAUBENHEIMER: Yes. There is so much political noise, not just in South Africa, but globally. If you look at what Central Banks are doing… The whole world seems to be following, hanging on every word that Janet Yellen says or whatever happens in Japan, Europe, or elsewhere.
Look, I think we put our heads down and we focus on valuation. We’ve done numerous studies in many markets around the world and the most important determinant… For you as an investor, the most important determinant for your returns, going forward, is the valuation today.
It’s not what happens to GDP, what happens to inflation, exchange rates, interest rates, or what happens to unemployment. Those things are all really important and I find it fascinating to follow. It’s almost like a soap opera. It’s addictive. However, at the end of the day, how constructive is it really?
We hope to put our heads down, focus on one thing, which is one thing we’ve historically been good at, which is valuation and ‘what are the subsequent returns from here’ and that’s really, what we do. We’ve looked at research. In fact, one of the slides we show on this roadshow is some work that was done by GMO in the U.S.
They’ve looked at the relationship between starting valuations and subsequent returns, and the predictive nature of valuations is actually, really high. Interestingly, the longer your holding period, the more important the starting valuation is to your returns going forward, and not the macroeconomic variables. The difference…the GDP to subsequent returns or exchange rates/subsequent returns relationship is a really tenuous one so we focus on the things that we think are important.
ALEC HOGG: And in the international markets, given that you are eliminating all of the noise… Where are you seeing opportunities there?
SIMON RAUBENHEIMER: It’s quite interesting. Orbis’ portfolios have changed quite a lot. They’ve had a high portfolio turnover over the last nine to 12 months. They’ve had a fantastic year last year. They owned many cyclical stocks – companies like some of the banks.
They owned companies like Micron, for example (a semi processor/semi-conductor/manufacturing company) and last year, the cyclical companies rallied really hard and they found that that’s run its course. This year, they’ve switched in to the more defensive names. For example, global, big, stable, defensive-types of companies and funnily enough, in many ways similar to the characteristics of the companies we like in South Africa. Orbis, independently of us, have found that they are attracted to similar metrics.
ALEC HOGG: Cash generators.
SIMON RAUBENHEIMER: Cash generators, long-term slow, steady compounders of cash: these are often macro, huge, large cap companies. Companies such as Samsung for example, are companies that Orbis currently finds attractive so they’ve traded out of many of the smaller, small cyclical companies into the more defensive, larger cap names whose valuations are currently much lower than some of the more cyclical ones are.
ALEC HOGG: What about the tech space? We see many of the American investors getting terribly excited about the new social media stocks, but outside of that, Google has almost become a value investor’s play.
SIMON RAUBENHEIMER: Yes. Those are exactly the opportunities that Google or Microsoft… Those are companies that (in the case of Microsoft), you can almost buy them very low – double digits PE’s. These companies typically have 25/30 percent of their market caps in cash, often $40/$50bn of nett cash sitting on their balance sheets, which is not even in the valuation at all.
If you took that off, you’re paying a very low multiple for the enterprise value of the company to the profits that the company generates. Really, cash flow generative companies and people really find the sexiest, smaller, faster-growing stuffy really attractive, where we’ve taken a rather contrarian view as we would, and are sitting in the larger cap/more stable and defensive type of companies that generate tons of cash flows. Despite the fact that admittedly, these companies don’t grow very fast, they generate tons of cash.
ALEC HOGG: Over the years, we’ve seen Allan Gray grow and the momentum has really been strong. Are you finding though, that in the last couple of years – given that you can’t be on top of the pile indefinitely – you are losing some of that dominance that you had in the past, particularly with Coronation?
SIMON RAUBENHEIMER: Yes. Coronation is bigger than we are, interestingly. There’s no denying that it does become more difficult to manage money the bigger you get. I think that when we look at the equities we manage, in 2003 we managed about R70bn of money in nett equities in South Africa.
Remember, on the Orbis part, on the Foreign Equities, on bonds, on cash, and on all other asset classes we are a tiny, tiny little fish in a massive pond. The limit and where you start running into problems on sizes, really, around domestic equities… What we do is we add up across all of our funds and all of our clients. All the equities are in those mandates.
If we add all those up, then in 2003 that was R70bn. It’s currently R250bn so admittedly, it’s grown a lot. However, when we look at the All Share Index, the All Share Index in 2003 had a free float to market capitalisation of just over R1.5bn…R1.7bn and that’s grown to R7bn.
One should remember that the market in fact, has grown a lot and this is just the free float market cap of the companies on the JSE that excludes BAT, or it only includes a small part of BAT (and BAT’s R1tr plus company). Glencore is R700bn/R800bn. These are large companies, which aren’t in the free float market cap of the Alsi. If I include those, the market’s grown by even more and when I look at the assets we manage as a percentage of the market, it’s in fact the same now as it was in 2003.
ALEC HOGG: So it isn’t that much more difficult.
SIMON RAUBENHEIMER: We think that size isn’t that much more of a constraint than it was then, despite the fact that our assets are much bigger. Remember, back then you couldn’t take much off shore. We can now take 25 percent off shore and some of our asset allocation mandates have grown fast so we do have much bigger bond portfolios, cash portfolios, and others.
It’s a number we look at, so we’re currently at about three percent of all the shares we can potentially buy. All our Domestic Equities combined, are three percent of the total. I would say that it starts getting difficult at about four, maybe so if we grow by one-third from here, we’d start running into slight problems.
ALEC HOGG: Maybe capped funds or closed funds…
SIMON RAUBENHEIMER: That’s something we’ve done in the past. We’ve capped/soft-closed some of our funds in the past when we thought we were getting too big, so it’s definitely something we would do.
ALEC HOGG: Simon, there are four of you. Yourself, Ian Liddle, and Duncan Artus: you play around. No doubt, you see a lot of each other. You must look at equities. Do you fight a lot about what you decide to invest in?
SIMON RAUBENHEIMER: It’s funny. Many people don’t actually know this, but how we manage money and always have managed money in South Africa is that we have this multi counsellor approach, where you have four managers who each manage their own portfolios independently of the other three. I manage my portfolio. I co-manage our equity and our balanced funds in South Africa, so I have an equity pool that I look at and I have a balanced pool that I look at. Similarly, Ian, Duncan, and Andrew (my colleague) have two or three separate pools of portfolios that they manage completely autonomously and independently of each other, and so our client gets the average of the four of us. We throw everything into one pot and then slice and dice it across…
ALEC HOGG: Is there competition between you?
SIMON RAUBENHEIMER: Absolutely. That’s something we monitor very closely – how the performance is, with each of the four – and we often have different views on various asset classes. One of our managers might be really bullish on gold shares, where one or two other managers might think ‘geez, our gold shares are all going to nought’, and so the client would see the average of the four holdings. One or two of us might hold ten percent of their funds in gold. One, two, or three might hold absolutely nothing.
What the client sees is the average, and so we think it makes for quite a rigorous debate. Of course, we’re incentivised, not in the performance of our portfolio, but in the performance of the total of the client’s portfolio. I would therefore not do something that jeopardises the total portfolio if it’s at the expense of the client, if it means that I gain an edge over my colleagues.
We always want to make sure we keep each other in check, but we’re competitive people by nature so we don’t want to compete, we do want to beat each other, and it’s something we look at really closely.
ALEC HOGG: And this argument of ‘active versus passive’. We know that passive funds are much cheaper, that they beat half of the active managers before they even start because of pure arithmetic. How do you…?
SIMON RAUBENHEIMER: It’s a difficult debate. We can debate this philosophically. We almost do the opposite of what the passive manager does. If you look at various shares in the benchmark, a passive manager would buy more of the shares that go up a lot. For example, a share that goes up, and up becomes more expensive and a passive manager would buy more of it because it’s a bigger part of the benchmark.
They have to replicate the benchmark so they buy more of an expensive share where, by nature almost, we do the opposite. We would sell that share as it becomes more and more expensive, and buy a share that becomes smaller and smaller because that share, assuming again that all else is constant, to us, as it falls, becomes more and more attractive so philosophically, we’re almost at that other end of the spectrum of a passive manager.
On the fees: I don’t know. Is there that much of a difference in fees? On big, institutional mandates, our fees are fairly competitive, we think. We are in the process (and this isn’t quite public knowledge yet). We’ve gone out this week on the roadshow and announced to some of our IFA’s.
We are looking at reconsidering the fee on our Allan Gray Equity Fund and lowering the base fee to one percent, and that’s one percent at benchmark performance. That one percent fee is based on performance after fees so we’d actually have to beat the benchmark by a little bit to get our fee, so that the client would get the benchmark’s performance.
ALEC HOGG: That’s a good competitor with a passive fund.
SIMON RAUBENHEIMER: If you took what most passive funds that we look at (around South Africa) charge for retail investors – charge between 75 and 85 basis points. What passive funds wouldn’t tell you either, is that they’ll say half of active managers underperform the market.
That’s pure maths and you can’t argue with that. What they won’t say is that 100 percent of passive managers underperform the market, nett the fees. They have to. I think that at benchmark performance, our fee is probably very similar to the 80 basis points for a retail investor on our platform, and so it’s not too different to what a passive manager would pay.
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