Beware those concentration risks | Fin24
 
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Beware those concentration risks

Mar 13 2018 15:16
Schalk Louw

Whether you’re an avid gamer or not, when I mention the name Angry Birds, I’m sure most readers will know exactly what I’m talking about. 

This game, with its tiny birds flying through the air screaming, caused such a fuss that it not only triggered the production of actual toys and branded food products, but also a big-screen film. 

In fact, it was so big that the creators of the Angry Birds trademark, Rovio Entertainment, listed on the Helsinki Stock Exchange in September 2017 at an entry price of €11.50 per share. 

As with most trends, however, both children and adults lost interest in Angry Birds, and Rovio released a profit warning on 22 February, which caused an almost immediate 50% decline in the share price (to €4.90, a 57% decline in total since its listing five months ago).

Indeed, the Angry Birds and Pokémon GO heroes of today may easily become the zeros of tomorrow. 

You may wonder how this is relevant to this issue’s subject and investors in South Africa specifically. 

I would like to tell a cautionary tale about some of the less obvious risks, like concentration risk, when it comes to investing in the stock market. 

Now, unlike Rovio, local giant Naspers* doesn’t keep most of its eggs in only one basket. 

But despite a well-diversified portfolio of holdings, the largest portion of Naspers is made up of its stake in Chinese internet giant Tencent (which equals 150% of the Naspers share price). 

The latest data at our disposal shows that Tencent’s turnover for the third quarter of 2017 has grown by an incredible 61% year-on-year to $9.8bn, while its profits increased by 67% over the same period. 

This growth was largely driven by its online games department, which contributed 41% of the total turnover. 

Although these figures can largely be attributed to the success of games such as Honour of Kings, a few new titles were also released to help reach future growth targets. 

My Capetonian friends will understand the wine barrel concept. Each barrel has a hole at the top and the bottom.

As long as you keep filling up the barrel with wine, it will remain full enough, but if something goes wrong, all the wine will drain out the bottom hole and you will be left with a completely empty barrel. 

And it’s this concept, when applied to a company like Naspers, that makes me nervous. At a price-to-earnings ratio (P/E) of 95 times, standard fill-ups won’t be enough to keep the barrel full, simply because investors want so much of it. 

Obviously, this concept doesn’t only apply to Naspers. Like most trends, exchange-traded funds (ETFs) have also gained massive popularity over the past few years. Some of the main benefits of ETFs are:

- They are well diversified.

- Costs attached to ETFs are considerably lower than those attached to unit trust investments, for example.

- ETFs are listed on the JSE, making them highly tradable, while offering investors the benefit of liquidity.

- ETFs are transparent – investors know exactly what they are invested in at all times.

Even when we take a look at the performance of ETFs, at first glance, it looks like a no-brainer. 

Of the 175 equity funds available in South Africa, only 22 managed to beat the FTSE/JSE All Share Index (Alsi), for example, which is something that ETFs managed to do well (before costs). 

But the fact remains that the recent success of general equity ETFs can largely be attributed to their passive shareholding in Naspers, which grew by 52% over the 12-months ending (22 February). 

Remember, while active investment management focuses on the management of shares on behalf of clients, as well as risk, passive management focuses more on the equity weightings held within their chosen index or benchmark. 

The average shareholding in Naspers for all listed ETFs in the general equity unit trust sector was a whopping 16% as at the end of January 2018. 

If we focus only on ETFs that used the Alsi, Top40 Index and Swix Index as a benchmark, the average shareholding in Naspers jumps to 23%.

That means that nearly a quarter of these funds’ total weight consists of one share – Naspers. (One way to mitigate the Naspers concentration risk is to buy equally weighted ETFs.)

I’m not saying that Naspers is a bad company in any way, and I certainly see a place for ETFs in most well-balanced portfolios.

It’s Tencent and the size of it within Naspers that makes me uncomfortable, and if I have learnt anything from recent events surrounding certain shares, it’s that a too-large shareholding in one company, even if it’s a top-notch company, can be very dangerous.

Schalk Louw is a portfolio manager at PSG Wealth.

*finweek
is a publication of Media24, a subsidiary of Naspers.

This article originally appeared in the 15 March edition of finweek. Buy and download the magazine here.

investment  |  portfolio  |  naspers  |  tencent
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