ANGLES & PERSPECTIVES - PSG · 2017-01-20 · Table 1: Global companies ranked according to their...

ANGLES & PERSPECTIVESFOURTH QUARTER 2016

Contents

Patience is a virtue. The patient investor who has taken a long-term view and remained invested with us throughout the market cycle has been rewarded.

1. Introduction – Anet Ahern 1

2. Could 2016 be the inflection point in equity markets? – Greg Hopkins 2

3. Extrapolating your way to buying high and selling low – Kevin Cousins 5

4. Flawed incentives – how the market works against investors – Mikhail Motala 8

5. The PSG Global Flexible Sub-Fund 12

6. Portfolio holdings as at 31 December 2016 14

7. Percentage annualised performance to 31 December 2016 (net of fees) 17

8. Risk/return profile 18

9. Unit trust summary 19

10. Contact information 20

FOURTH QUARTER 2016 | 1

Despite the challenges of 2016, we believe equity markets may be at an inflection pointFor many reasons, 2016 has been described as a challenging and eventful year. At PSG Asset Management, we look back at 2016 as a year of opportunity and the start of what we believe may be an inflection point in equity markets. This is the topic of our opening article, in which Greg Hopkins, our CIO, expands on what appears to be the early phase of a trend away from the extreme valuation gaps between shares. This rotation is an indication of how strongly the market is valuing certainty and growth – and how much the market loathes anything cyclical.

The potential pitfalls of market dynamics and human nature are more evident than ever Greg leads the way for Kevin Cousins to illustrate how difficult the market and human nature make it for investors to be successful. It is all too easy to fall victim to behavioural follies such as extrapolation, oversimplification and overconfidence. Since we are all human, the only antidote is to have a solid, structured investment process according to which we make decisions. This applies to selecting funds and managers, choosing underlying investments, as well as setting and adapting an investment strategy, from a personal financial point of view or within the institutional space.

Mikhail Motala expands on the theme of how the market works against investors, who often tend to sell low and buy high. In this article, we explore the lure of new listings and the characteristics of the lead-up to going public. We specifically take a closer look at the recent listing of one of our household names, Dis-Chem.

The featured fund offers access to global opportunities The featured fund in this edition is the PSG Global Flexible Sub-Fund, which is modelled on the PSG Flexible Fund, but with a global mandate. The fund offers an attractive combination of equity-like returns at lower levels of risk by its ability to invest in markets outside South Africa. We offer a US dollar-denominated as well as a rand-denominated fund for this mandate.

Our disciplined investment process provides protection against the temptations of the marketWe believe that being sensibly contrarian is the most effective way to beat the market, which is full of tricks to prevent investors from being successful. At PSG Asset Management, we have built our process to withstand the temptations of the market. It is simple, disciplined and acts as a defence against our own cognitive weaknesses and biases. By taking a longer-term view and often being early in our positioning, we believe we will be able to continue delivering excellent returns for our investors.

A long-term focus remains key to successful investment outcomesEnjoying the benefits of being early and staying the distance is only possible with a long-term approach. It also requires views that are backed by research and process, free from short-term reactions to the daily overflow of news that can swing sentiment either way. Long-term investors in our funds who have been willing to adopt this approach have been handsomely rewarded and we commend you for your discipline and patience.

With more than a decade’s successful investing, we remain committed to our approach Our resolution for 2017 is to consistently keep doing what we have been doing with our investors’ savings for over a decade. While many other New Year’s resolutions are often abandoned quickly, we are committed to sticking to this resolution for a long time to come. We thank you for your support.

Anet AhernIntroduction

Anet has 30 years’ experience in investment and business management. After starting her career at Allan Gray in 1986, where she fulfilled various roles in trading and investment management, she worked as a portfolio manager at Syfrets, and later BoE Asset Management, where she was CIO and CEO. She also spent six years at Sanlam, where she was the CEO of Sanlam Multi Manager International, with assets totalling R100 billion in local and global mandates. Anet joined PSG Asset Management as CEO in 2013.

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Greg HopkinsCould 2016 be the inflection point in equity markets?

The current dominant market view reflects the behavioural biases of investors There is an entrenched way of thinking that currently prevails in global markets, which is illustrated in Figure 1.

This is understandable, since for the past five years the macroeconomic environment has been characterised by low economic growth, low inflation and low interest rates. On page 5, Kevin Cousins highlights the human tendency to place

greater emphasis on more recent information (in this case low growth, inflation and interest rates) and to extrapolate this into the future.

Markets are efficient at pricing in the available information that supports the prevailing view. As Mikhail Motala points out in his article on page 8, if you read about a theme repeatedly in the newspapers, it’s probably priced into the market already.

Greg is the Chief Investment Officer at PSG Asset Management and is the Co-Fund Manager of the PSG Equity Fund, PSG Balanced Fund and PSG Global Equity Sub-Fund.

Source: PSG Asset Management

Figure 1: The consensual view that has been dominating global markets

Quantitative easing is here to stay

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Graph 1: Valuations of cheap versus expensive equities (January 1990 - December 2016)

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The result is large discrepancies in valuationsWe observe the large divergence between shares with the highest and lowest valuations as measured by their price-to-book (P/B) ratios with interest. A P/B ratio provides an indication of what the market would pay for the underlying net assets of a business. A high ratio indicates that the market assigns a high valuation to the company’s assets.

Graph 1 shows the ratio of the stocks with the highest P/B ratio in a universe of 500 global companies to stocks with the lowest P/B ratios. This divergence is almost as extreme as it was during the dot-com bubble in the run-up to 2000.


Table 1: Global companies ranked according to their price-to-book (P/B) ratios

Company name Sector P/E ratio (forward) P/B ratio

Amongst the least expensive

A.P. Moller-Maersk Group Shipping 16.18 0.81

HSBC Holdings plc* Banks 12.72 0.83

Capital One Financial Corp* Banks 10.41 0.91

Glencore plc* Resources 9.00 1.20

Daimler AG* Automobiles 7.50 1.20

Average 11.16 0.99

Amongst the most expensive

Roche Holdings Healthcare 14.45 10.00

PepsiCo Inc Consumer staples 19.76 11.11

Starbucks Corporation Consumer discretionary 23.53 14.29

British American Tobacco plc Consumer staples 15.85 14.29

Amazon.com, Inc Consumer discretionary 53.76 20.00

Average 25.47 13.94

* Currently owned by PSG Asset Management Sources: PSG Asset Management, Bernstein

Table 2: South African companies ranked according to their price-to-book (P/B) ratios

Company name Sector P/E ratio (forward) P/B ratio

Amongst the least expensive

Impala Platinum Holdings Ltd Resources 8.20 0.56

Grindrod Limited* Industrial cyclical 17.00 0.58

Group Five Ltd.* Building and construction 6.50 0.68

Raubex Group Ltd.* Building and construction 8.20 1.20

Barloworld* Industrial cyclical 9.60 1.23

Average 9.90 0.85

Amongst the most expensive

EOH* Technology 15.00 3.40

Naspers Media 25.60 5.90

Pick n Pay Retail 20.10 9.00

Famous Brands Limited Consumer cyclical 21.80 10.00

Clicks Retail 21.70 12.50

Average 22.30 9.35

* Currently owned by PSG Asset Management Sources: PSG Asset Management, Bernstein

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The market has favoured ‘bond-like’ blue chip shares and shunned cyclicals A closer look at a selection of stocks in the most and least expensive buckets is quite revealing. Quality blue chip companies with ‘bond-like’ characteristics (perceived to be as safe as government bonds, but with higher yields) dominate the basket of most expensive stocks, while cyclical companies in the industrial and financial sectors are included among the least expensive stocks (as shown in Tables 1 and 2). This is not surprising. In an environment of ‘scarce’ growth, those companies that have demonstrated their ability to grow have seen their share prices being bid up by the market. Given that these low-growth conditions have persisted for some time, the market has been willing to pay incrementally more for these companies. We have even noted that some value managers have started to include more expensive quality companies in their portfolios in response to this trend.

Markets are valuing companies based on prevailing economic conditions On the other hand, companies whose earnings prospects are dependent on the economy (i.e. cyclical shares) are trading at low relative valuations (as shown in the tables). Since many global economies, including South Africa’s, have experienced low or even recessionary conditions, many of these companies are currently reporting low earnings. Therefore, many of these companies are trading on low valuation multiples on low earnings, as the market is expecting these conditions to persist for some time. A good example of extrapolation!

Signs of a market rotation prove that the market is challenging the dominant view As some of the leading indicators of global growth have started to recover, we have begun to witness a significant rotation in the market. Graph 2 shows the relative performance of an index of global banks compared to an index of consumer staple companies. The rotation began earlier this year and has accelerated in the wake of the recent US elections, as the move to more populist politics has challenged the dominant market view of perpetually low economic growth.

Is this the start of a multi-year cycle? Only time will tell Some of the current market conditions and investment behaviour remind us of a similar situation that existed in the early 2000s before the dot-com bubble burst. This time, we are potentially facing the bursting of a bubble of overvalued ‘bond-like’ blue chip shares and a rotation into cheaper cyclical shares.

During the early 2000s, we also witnessed a market that was poorly positioned and ill-prepared for the rotation that ensued. The current market environment, particularly in South Africa, can reward investors who avoid expensive shares and who can take advantage of a revaluation of cyclical shares. It is too early to say whether this is the start of a multi-year cycle. However, given the large divergence in valuations in the market, we believe the odds are in our favour. We believe our portfolios are well positioned to capitalise on this emerging shift.

Graph 2: Relative performance of the MSCI Global Banks Index versus the MSCI Global Consumer Staples Index (December 2010 - December 2016)

Sources: PSG Asset Management, Bloomberg

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Kevin CousinsExtrapolating your way to buying high and selling low

Kevin has 23 years’ experience in investment management. After working at BoE Asset Management from 1993 to 2002, he co-founded Lauriston Capital, a specialist hedge fund manager. Kevin then worked as part of the hedge fund management team at Brait (now called Matrix Fund Managers) until joining PSG as an Investment Analyst in 2015.

Projecting the recent past into the future is a risky approach to investing Human beings are poorly ‘wired’ as investors. We have behavioural or cognitive characteristics that – while they may serve us well in other areas of life – conspire to make us poor investment decision-makers. A good example is the fact that market participants tend to extrapolate the recent past when forecasting future outcomes.

What makes this dangerous is not that it never works; on the contrary, it can often be an effective mental shortcut. However, this results in investors becoming very confident in their expectations of the future. This means that at times when the recent past is a poor guide to actual future outcomes, this approach can be very costly.

Guarding against this risk is a lot more difficult than we may think If investors are aware of and understand the risk of projecting the recent past into the future, shouldn’t it be relatively easy for them to avoid this approach when evaluating investments? Unfortunately, it is in fact very difficult. This is because it does not merely come down to lazy thinking or inexperience, which could be easily corrected. If this was the case then diligent, experienced market participants would have been immune to extrapolation errors, which is clearly not the case.

We believe the best explanation for extrapolation-type errors comes from Daniel Kahneman, the 2002 winner of the Nobel Prize in Economics, in his book ‘Thinking, fast and slow’1.

‘Answering an easier question’When faced with hard questions on very complex matters, we often generate quick, intuitive answers by substituting an easier related question, and answering that instead. We do this subconsciously and we believe that we have answered the hard question. Kahneman calls this ‘substituting heuristic questions’. For example, the question, ‘how fast will Mr Price Group grow their earnings per share (EPS) over the next five years?’ is a very difficult one with many uncertainties. The answer relies on many key assumptions and clearly requires a lot of work. Even after our best efforts, it is still only an estimate.

Most investment analysts substitute this question with an easier related question: ‘how fast has Mr Price Group grown its EPS over the past few years?’ This can be answered quickly, easily and with a high degree of precision. It is a simple step to project this answer forward. As it is a subconscious process, the analysts are not even aware that they never answered the actual question.

Although this is already a concern, the true extent of the problem becomes evident when we consider two other points that Kahneman makes:1. ‘People are routinely overconfident and place too much faith

in their intuition.’2. ‘When people believe a conclusion to be true, they are very

likely to believe arguments that appear to support it, even when those arguments are unsound.’

This means an analyst is likely to intuitively expect growth rates to be similar to those achieved in the recent past (without even being aware of it), become very confident about these expectations, and believe any other research or information that supports this view.

How this plays out in the real world: Mr Price Group (MRP) as an example MRP has an excellent long-term track record of earnings growth, which it has funded internally by generating high returns on capital. Not surprisingly, the share price has shown dramatic appreciation. By mid-2015, MRP was trading at over R250 per share. EPS growth had been remarkably stable (as shown in Graph 1), and this growth was expected to continue (the dotted line in Graph 1).

It is entirely reasonable to assume that most of these forecasts were arrived at by extrapolating the recent historical growth record. Earnings, as represented by the Bloomberg consensus of analyst forecasts, were expected to grow to R12.36 by March 2017, which put the share on a two-year forward price-earnings (P/E) ratio of 20.2 times. As a quality company with a solid growth forecast, many would have considered MRP to be a low-risk investment in June 2015.

Although MRP is a quality company, it was a risky investment We are eager to own stakes in companies with good growth prospects, high returns on capital and proven and aligned management teams, i.e. quality companies. However, our process requires a margin of safety, which means that we buy at a price below our estimate of the intrinsic value of the company, even if it is a high-quality company. A few years ago, MRP had a very wide margin of safety. As Table 1 shows, in 2009 MRP was on a historic P/E ratio of 11 times and a forecast of 8 times based on 2011 EPS with relatively depressed operating margins.

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This is in strong contrast with 2015, when MRP had very high operating margins (which means it was unlikely to grow through further margin expansion), and was on a historic P/E ratio of 27.2 times at R250 a share. This premium rating meant that, should the forecasts that extrapolated the recent growth track record prove incorrect, MRP’s price could come

under pressure. There was no margin of safety, and therefore no means to weather any unexpected changes in the real economy or sectoral trend reversals. Contrary to popular belief, an investment in MRP in mid-2015 was fraught with risk. Yes, it was, and still is, a quality company, but at R250 in 2015 it was a poor investment.

March '09 March '15

Operating margin 9.6% 17.8%

Share price when results announced (June) R28.00 R250.00

Forecast EPS 2 years ahead R3.38 R12.36

Forward P/E based on forecast 8.3 20.2

Actual earnings or current best estimate R4.19 R9.66

Historic P/E ratio 11.1 27.2

P/E based on actual subsequent EPS 6.7 25.9

Table 1: Mr Price Group fundamentals (2009 versus 2015)

Source: Bloomberg

Graph 1: Mr Price Group share price and earnings per share (2008 - 2017)

Source: Bloomberg

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The dangers of extrapolationThe actual delivered EPS and current expectations are now 25% below the mid-2015 forecasts. In the last 18 months, the share price of MRP has declined more than 40%, a painful reminder that a premium rating and negative earnings surprises are a toxic combination for shareholders (as shown in Graph 2). The weak price action is evidence that many investors who viewed MRP as a low-risk opportunity with good growth prospects in 2015 have capitulated and sold their positions. Essentially, they ‘extrapolated’ their way to large losses by buying high and selling low.

Has the cycle now swung a full circle, and are investors unreasonably pessimistic about MRP? That is an important question to consider. The price decline has certainly improved the valuation. It is clear that projecting the recent past into the future works both ways, leading to both losses and opportunities.

We manage our cognitive biases through a disciplined investment processAs discussed, our ability to make consistently sound investment decisions is compromised by our deeply ingrained cognitive biases. Given that these biases often exert their influence subconsciously, which means we are not even aware it is happening, knowing their impact is not in itself an effective solution to countering them. It is an important first step, but it is crucial that this knowledge is then incorporated into the design of a robust investment process.

The disciplined implementation of a carefully designed investment process is therefore our sole defence against our cognitive weaknesses. Our process includes the following aspects that help guard against biases such as extrapolation of the recent past:• We consider several possible outcomes for a company,

rather than relying on a single forecast. These include the consideration of a bull case and a bear case, the latter often best done by a different person from the lead analyst on the stock.

• Our analysts make recommendations and then our Investment Committee provides a forum where an idea can be interrogated, drawing on a variety of viewpoints from across the team.

• All additions, conviction changes or removals from our buy list are decided by a formal vote in the Investment Committee. This dilutes the influence of any one individual on the process.

Finally, in addition to the above, our process always requires a margin of safety, an important and effective risk mitigation mechanism across all fund positions.

References:1 ‘Thinking, fast and slow’, (D. Kahneman), Penguin, 2002

Graph 2: Mr Price Group’s current share price and earnings per share

Source: Bloomberg

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Flawed incentives – how the market works against investors Mikhail Motala

Although the formula for investment success is simple, applying it is a challenge The formula for investment success is simple: buy low and sell high. The application of this formula, however, is difficult. Share prices are low when investor sentiment is poor, which is reflected in low valuation multiples. A bout of unexpected bad news easily spreads fear in the market. Distressed investors sell in a panic, driving share prices lower. At such times, the market tries its utmost best to scare investors away. In contrast, share prices are high when the outlook is rosy. Investors are enticed by the prospect of high returns and are willing to ‘pay up’ to share in company profits.

The market is configured to work against investors and make them feel uncomfortableBuying when others are selling and at a time when newspaper headlines reflect doom and gloom is uncomfortable. However, the market is quick and efficient at digesting bad news. Very soon all the negative sentiment is ‘in the price’. Investors can be handsomely rewarded by picking up quality shares on the cheap. The challenge is that it is only with the benefit of hindsight that the attractiveness of the opportunity becomes apparent. As the saying goes: the last crash always looks like an opportunity; the next crash always looks like a risk.

It is equally uncomfortable to sell when others are buying and market momentum is driving share prices higher. The fear of missing out often tempts otherwise rational investors to hold on for the ride despite shares becoming significantly overvalued. Whether the market is deterring investors when they should be buying, or luring them in when they should be selling, the market is designed to make investors feel uncomfortable and work against them.

Initial public offerings (IPOs) prove how the market persuades investors to buy high IPOs often present the best example of how the market tempts investors to buy high. It is important to first establish the primary objective of the IPO, which can include:• raising capital for strategic growth initiatives such as

acquisitions or expansions, • incentivising staff by paying them in shares that can easily

be traded, • adding credibility to the company, and/or • providing an opportunity to existing owners to sell their

stake, or a portion thereof, to the public.

Focussing on the last example, investors should exercise caution before rushing to participate in this particular type of IPO, for this simple reason: the sellers – the existing owners of the business – understand the value of the business much better than the buyers. No rational business owner would willingly dilute their stake at a price they deem to be unfavourable. Typically, they will sell at a fair price or, as happens all too often, at a price considerably higher than fair.

Although the share price is often not justified, investors believe it is To understand the IPO process in more detail, it is important to understand the roles of the key players in the process. On the one end are investors. On the other end are company management teams who are often the existing owners of the business. In the middle are the investment banks. In a typical IPO, a company would hire an investment bank to raise capital by marketing the business to prospective investors. These banks thrive on companies in ‘sexy’ sectors, which are characterised by defensive earnings, potential for long-term growth, and high returns on capital. This triple cocktail makes it easy to market the business to investors. Once the business becomes an easy sell, management and the banks only have to convince investors that the share price is fair or, even better, at a discount to fair value. Although forecasted cash flows almost always justify the share price, the problem lies in the assumptions behind those forecasts. Investors don’t scrutinise these assumptions hard enough and readily believe that the share price is justified.

Buying shares during an IPO is often the worst time for investors to buy IPO activity is indicative of the pro-cyclical nature of the market. It is no coincidence that valuations at the time of company listings tend to be elevated. History has shown us that the number of IPOs reach their peak in the late stages of a bull market (as shown in Graph 1). These are times when investors gobble up what the market offers, often irrespective of price. Most often this is the worst time for investors to deploy capital into the market. On the contrary, in the troughs of a bear market, no listings come to the fore. Yet, this is the best time for investors to deploy their capital.

Mikhail joined PSG Asset Management in 2015 as an Equity Analyst. He conducts research on both local and global companies across various sectors. Before joining PSG, he worked in the assurance division at Ernst & Young. Mikhail is a qualified Chartered Accountant.


Flawed incentives in the IPO process Both business owners’ and investment banks’ incentives are often flawed in an IPO. The existing business owners are incentivised to extract as much value as possible for their stake when selling to the public. They often take certain actions before a sale to place the company in a favourable light. Examples include underinvesting in capital projects to boost reported free cash flow, and increasing the dividend pay-out ratio to enhance the reported dividend yield.

Investment banks on the other hand are remunerated based on a percentage of the capital raised. Globally, these fees reach hundreds of billions of dollars per year in total (as shown in Table 1), which proves that this is a lucrative business. Since these fees are paid by the company that is listing rather than investors, the banks know which master to serve. The banks are therefore far more concerned about the fees generated upfront than the long-term investment outcome.

It is important to recognise that there is nothing inappropriate about management cashing in on a stake of a business they’ve built. Similarly, there is nothing unethical about management and banks seeking the highest price. Investors should merely be mindful of these factors.

Case study one: local IPOs reflect the economic cycle Graph 2 illustrates the pro-cyclical nature of IPOs in a South African context. Over the period 1 January 2006 to 31 December 2016 there have been 80 listings on the JSE. In 2007, the year before the global financial crisis, there were a record 30 listings. In stark contrast, there were no listings in 2009, the year when the crisis was at its height. It was not until 2015 that listings

reached double digits again. It is no coincidence that in 2015 the average price-earnings (P/E) ratio of the FTSE/JSE All Share Index (ALSI) was 23 times compared to the 10-year average of 16 times. Of the 15 IPOs in 2015, 7 were in the listed property sector, which has had an exceptional run – a topic that we have written about previously.

Case study two: hype around Dis-Chem’s listing pushed up the price to beyond fair value In 2016 there were a total of six listings on the JSE. The largest was the long-awaited floating of Dis-Chem Pharmacies Limited, with Dis-Chem’s existing owners selling a 27.5% stake in the business to institutional investors at a price of R18.50 per share. PSG Asset Management did not participate in the private placement. The shares started trading on Friday 18 November and closed the day at R21.48 per share. This price increase was a result of the interest shown by retail investors, who could not participate in the listing, and institutions seeking more stock than they were allocated. Since the stock was clearly in demand, the question is: why did PSG Asset Management not participate?

While Dis-Chem is a quality business, we believe the share is overvalued Dis-Chem is a high-quality business. Established in 1978 by the Saltzman family, it has become the largest pharmacy dispensary retailer (by market share) in South Africa. The pharmacy business is defensive – irrespective of booms or recessions, people get sick and need medication. Dis-Chem operates from 101 stores countrywide, generating a total of R15.5 billion annually in revenue. The growth potential for new stores is extensive, with management aiming to double the store count over the next

Graph 1: Global IPO activity (1999 - 2013)

Sources: Citi, Dealogic, Marathon Asset Management

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Year to date 2016 Year to date 2015

Investment bank Value $bn Number of IPOs Rank Value $bn Number of IPOs

JPMorgan 8.55 67 3 9.82 73

Morgan Stanley 8.17 61 1 14.35 91

Goldman Sachs 6.46 55 2 11.12 87

Citi 6.38 65 6 9.10 81

Deutsche Bank 5.66 50 5 9.11 72

Credit Suisse 5.28 52 8 5.94 65

BofA Merrill Lynch 4.83 43 7 8.81 70

UBS 4.36 35 4 9.48 57

Nomura 3.42 30 11 3.57 43

China Securities Co Ltd 3.34 19 53 0.78 9

Subtotal 56.45 82.08

Total 135.74 1 148 194.27 1 304

Table 1: Investment bank IPO rankings (2015 and 2016)

Source: The Wall Street Journal

Sources: Bloomberg, PSG Asset Management

Graph 2: Number of IPOs per year on the JSE (2006 - 2016)

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five to eight years. The business generates returns on equity of 54%, significantly higher than an average company. In other words, the triple cocktail boxes are all checked. It is therefore easy to see why four investment banks jumped at the opportunity to list the business, collecting R117 million in fees from the deal.

Our analysis of the pre-listing statement showed that Dis-Chem earned R550 million in net profits in the 12 months ending 31 August 2016. This equates to approximately 63 cents per share. The placement price of R18.50 therefore resulted in a historic P/E ratio of 29 times. It could therefore be argued that Dis-Chem’s growth potential was already priced in. Dis-Chem’s closest competitor is Clicks Group Ltd, another phenomenal business. At the time of writing, Clicks traded at a P/E ratio of 26 times. The market justified Dis-Chem’s premium based on the company’s faster growth profile. However, it can easily be argued that Dis-Chem deserves a discount to Clicks based on Clicks’ superior cash generation ability, better corporate governance and longer track record. The point is that it is dangerous to justify share prices on a relative basis. Although Clicks trades at 26 times earnings today, the long-term average multiple is 16 times (as shown in Graph 3). It is clear that the market has become far more enthusiastic in recent times. To us, this screams danger.

While there is no doubt that Dis-Chem is a great business, it is not necessarily a great investment at the current price. In our opinion, the risks are far more skewed to the downside than the upside. While the market may continue to bid the price higher in the short term, we will gladly miss out on this euphoria and avoid putting our clients’ wealth at risk of capital loss. We will however happily buy Dis-Chem when the price falls to levels we deem to be more fair.

Being contrarian is the most effective way to beat the market The market is configured to work against investors. It aims to scare them away when they should be buying and tries to lure them in when they should be selling. Contrarian investing is the surest way to get the odds in one's favour and beat the market. At PSG Asset Management, we have built our process to withstand the temptations of the market, of which IPOs are a good example. We are mindful of the flawed incentives that are inherent to certain IPOs and carefully evaluate the circumstances and primary objectives before acting.

Graph 3: Clicks’ price-earnings ratio (2000 - 2016)

Source: Bloomberg

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Greg HopkinsPhilipp WörzThe PSG Global Flexible Sub-Fund: an opportunity to generate long-term wealth

The fund aims to deliver equity-like returns but at lower levels of riskThe PSG Global Flexible Sub-Fund is a Malta-domiciled unit trust fund that is denominated in US dollars and invests in equities, debt instruments and money market instruments on global markets. The fund aims to achieve equity-like returns at lower levels of risk. It has a flexible asset allocation and equity holdings will vary depending on available opportunities. When there are few opportunities that meet our high hurdle rates, we will hold cash. When opportunities present themselves, we will deploy cash holdings. The fund aims to outperform US inflation plus 6% over the long term.

We look for quality companies that are mispriced The fund invests in global companies that meet our 3M investment criteria: Moat, Management, and Margin of Safety. This means we look for companies with a sustainable competitive advantage (a moat) that are being managed by quality management teams and that trade at large discounts to our conservative estimates of what we believe they are worth. Essentially, we want to invest in what we call ‘mispriced quality’ – an inherent quality business that the market may be missing. It really excites us when quality goes on sale, because it gives us the opportunity to buy above-average quality businesses at below-average prices. This typically occurs when there is fear and uncertainty in the markets, when the likelihood of finding mispriced stocks increases.

We prefer to hold a limited number of companies and partner with strong management teamsWe have been investing offshore since 2006. The first offshore company we bought was Berkshire Hathaway and it is still a large holding across our funds. We have one team and one investment process, which allows us to evaluate global and local stocks simultaneously. The holdings in our funds are typically quite concentrated, because we prefer to own a limited number of companies that we understand well. In addition, we can allocate more than one analyst to a specific investment idea so that we can increase our knowledge of the companies in the funds. We try to improve the likelihood of successfully investing our clients' funds by partnering with management teams that are ethical and transparent and who have proven track records of capital allocation. This means we assess the footprints that management leave behind and we evaluate their ability to buy

low and sell high. Management ownership is an important consideration for us, because managers who think and act as owners tend to have a long-term mindset and make decisions that are aligned with investors’ interests. Management teams of the top ten holdings in our funds own over $100 billion worth of stocks in their companies.

Investing globally provides access to the benefits of diversificationInvesting offshore provides exposure to a larger universe of potentially mispriced stocks. Investors gain exposure to sectors and companies that are not listed on the JSE. Examples include reinsurance (Berkshire Hathaway), technology (Microsoft, Cisco and Qualcomm), and alternative asset managers investing in infrastructure assets (Brookfield). In addition, investors are able to diversify their assets across a broader range of geographies and currencies, which reduces the risk that an event in any one country will result in permanent capital loss. Over the very long term, these investments can also serve as a hedge against the depreciating purchasing power of the rand.

The Sub-Fund invests offshore directly while the Feeder Fund is denominated in rands The PSG Global Flexible Sub-Fund is a dollar-denominated fund and invests in global securities. To invest in this fund, investors must follow the South African Reserve Bank’s process to move money offshore, since the investment is made in US dollars. Returns are also measured in dollars.

The PSG Global Flexible Feeder Fund is a rand-denominated fund and invests solely in the PSG Global Flexible Sub-Fund. Investors can therefore get exposure to global companies in rands via this feeder fund. Returns are measured in rands and will take the dollar returns of the underlying fund and the currency movement into account. It’s important to be aware that, over the short term, this can lead to greater volatility in returns.

The global investment universe offers promising opportunities for long-term investors The PSG Global Flexible Sub-Fund is appropriate for long-term investors with an investment horizon of at least four years. One of the advantages of being able to invest widely is that we can normally find a significant number of companies that we believe will be able to deliver the growth that our investors require over the long term. As Greg Hopkins writes in 'Could 2016 be the inflection point in equity markets?', there are currently good opportunities in quality global equities that are more cyclical than the average company. We continue to find above-average quality companies that are trading at attractive valuations coming off low earnings. Over the long term, investing in companies like these frequently offers a recipe for attractive returns.

Basic fund information:Fund name: PSG Global Flexible Sub-Fund PSG Global Flexible Feeder FundFund size: $99.1 million R524.4 millionASISA sector: Global – Multi Asset – FlexibleBenchmark: US inflation +6% Managers: Philipp Wörz and Greg Hopkins


Notes

14 |

Portfolio holdings as at 31 December 2016

Top 10 equitiesDiscovery Holdings Ltd

Old Mutual plc

Glencore plc

FirstRand Ltd

Super Group Ltd

Brookfield Asset Management Inc

Tongaat-Hulett Ltd

Grindrod Ltd

J Sainsbury plc

PSG Group Ltd

PSG Equity Fund


FirstRand Ltd

Old Mutual plc

J Sainsbury plc


Glencore plc

Super Group Ltd

Grindrod Ltd

Cisco Systems Inc

PSG Group Ltd

PSG Flexible Fund

Asset allocation


FirstRand Ltd


Old Mutual plc

Nedbank Group Ltd

Super Group Ltd

Colfax Corp

Berkshire Hathaway Inc

J Sainsbury plc

Glencore plc

PSG Balanced Fund

Asset allocation

• Domestic resources 3%

• Domestic financials 20%

•Domestic industrials 18%

• Domestic cash and NCDs 18%

• Domestic bonds 18%

• Foreign equity 23%

Total 100%

Performance

0

200

400

600

800

1000

1200

1400

PSG Equity Fund FTSE/JSE All Share TR Index ZAR

'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Performance

PSG Balanced Fund Inflation +5%

0

200

400

600

800

1000

1200

'00 '02 '04 '06 '08 '10 '12 '14 '16

Asset allocation

Performance

'15'04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14100

200

300

400

500

600

700

PSG Flexible Fund Inflation +6%

'16






• Foreign cash 1%

Total 100%






• Foreign cash 3%

Total 100%



FirstRand Ltd


Nedbank Group Ltd

Old Mutual plc

Top 5 issuer exposuresAbsa Bank Ltd

Republic of South Africa

Nedbank Ltd

Standard Bank of SA Ltd

FirstRand Bank Ltd

PSG Stable Fund

Asset allocation






Total 100%


FirstRand Ltd


Nedbank Group Ltd


Top 5 issuer exposuresRepublic of South Africa


Absa Bank Ltd

Nedbank Ltd

FirstRand Bank Ltd

PSG Diversified Income Fund

Asset allocation

• Domestic equity 5%




Total 100%

Top 10 bond exposuresAbsa Bank Ltd


Nedbank Ltd


FirstRand Bank Ltd

Capitec Bank Ltd

Imperial Group Ltd

The Thekwini Fund (RF) Ltd

MMI Group Ltd

Investec Bank Ltd

PSG Income Fund

Asset allocation

• Fixed rate notes 66%

• Floating rate notes 32%


Total 100%

Performance

50

100

150

200

250

'15'06 '07 '08 '09 '10 '11 '12 '13 '14

PSG Diversified Income Fund Inflation +1%

'16

Performance

PSG Income Fund STeFI Composite Index (ZAR)

60

120

80

100

140

'11 '12 '13 '14 '15 '16

Performance

PSG Stable Fund Inflation +3% over a rolling 3-year period

'11 '12 '13 '14 '15 '160

20

40

60

80

100120

140

160

180

16 |

Top 10 issuer exposuresFirstRand Bank Ltd

Nedbank Ltd

Absa Bank Ltd



Investec Bank Ltd

Capitec Bank Ltd

Land and Agricultural Development Bank of SA

Transnet Soc Ltd

Netcare Ltd

PSG Money Market Fund

Asset allocation

• Linked NCDs/Floating rate notes 30%

• Step rate notes 9%

• NCDs 48%

• Corporate paper 1%

• Bill 12%

Total 100%

Top 10 equitiesBrookfield Asset Management Inc

J Sainsbury plc


Cisco Systems Inc

Colfax Corp

Yahoo Japan Corp

Capital One Financial Corp

Glencore plc

Apple Inc

Qualcomm Inc

PSG Global Equity Sub-Fund

Regional allocation

Top 10 equitiesBrookfield Asset Management Inc

J Sainsbury plc


Cisco Systems Inc

Colfax Corp

Yahoo Japan Corp

Capital One Financial Corp

Glencore plc

JPMorgan Chase & Co

Apple Inc

PSG Global Flexible Sub-Fund

Regional allocation

Performance

PSG Global Equity Sub-Fund

MSCI Daily Total Return Net World USD Index

60

120

80

100

140

160

180

200

'10 '11 '12 '13 '14 '15 '16

Performance

PSG Global Flexible Sub-Fund US Inflation +6% USD

0

20

40

60

80

100

120

140

'13 '14 '15 '16

Performance

PSG Money Market Fund (ASISA) South African IBMoney Market Mean (Benchmark)

'00 '02 '04 '06 '08 '10 '12 '14 '160

100

200

300

400

500

• US 53%

• Europe 3%

•UK 13%

• Asia 13%

• Canada 9%

• Singapore 1%

• Africa 1%

• Cash 7%

Total 100%

• US 43%

• Europe 2%

•UK 11%

• Asia 11%

• Canada 7%

• Singapore 1%

• Africa 1%

• Cash 24%

Total 100%


Percentage annualised performance to 31 December 2016 (net of fees)

Source: 2016 Morningstar Inc. All rights reserved as at end of December 2016. Annualised performances show longer term performance rescaled over a 12-month period. Annualised performance is the average return per year over the period.Past performance is not necessarily a guide to future performance.

International funds

1 Year 2 Years 3 Years 5 Years 10 Years Inception Inception date

PSG Global Equity Sub-Fund A 18.92 0.76 0.60 6.19 4.28 23/07/2010

MSCI Daily Total Return Net World USD Index 7.49 3.23 3.80 10.41 9.45

PSG Global Flexible Sub-Fund A 17.78 2.11 1.47 4.55 02/01/2013

US Inflation +6% (USD) 7.69 7.10 7.18 7.20

Local funds

1 Year 2 Years 3 Years 5 Years 10 Years Inception Inception date

PSG Equity Fund A 25.06 8.21 10.20 17.03 11.52 19.00 01/03/2002

FTSE/JSE All Share Total Return Index 2.62 3.87 6.15 12.97 10.50 14.32

PSG Flexible Fund A 17.64 11.14 11.47 15.68 14.07 17.22 01/11/2004

Inflation +6% 12.61 11.71 11.75 11.65 12.36 12.04

PSG Balanced Fund A 12.54 8.69 9.58 13.51 10.36 14.69 01/06/1999

Inflation +5% 11.59 10.68 10.73 10.62 11.27 10.62

PSG Stable Fund A 8.91 7.94 7.77 9.93 10.15 13/09/2011

Inflation +3% over a rolling 3-year period 9.59 8.68 8.73 8.62 8.59

PSG Diversified Income Fund A 8.11 7.95 7.48 7.98 7.79 7.87 07/04/2006

Inflation +1% 7.59 6.68 6.72 6.62 7.27 7.27

PSG Income Fund A 8.54 7.44 7.12 6.36 01/09/2011

STeFI Composite Index 7.36 6.91 6.58 6.06

PSG Money Market Fund A 7.39 6.94 6.58 6.01 7.26 8.58 19/10/1998

South African Interest Bearing Money Market Mean 7.43 6.92 6.55 6.03 7.28 8.57

PSG Global Equity Feeder Fund A 3.46 8.95 9.50 16.69 14.68 03/05/2011

MSCI Daily Total Return Net World USD Index (in ZAR) -5.11 12.23 13.45 22.67 21.07

PSG Global Flexible Feeder Fund A 2.06 10.73 10.63 16.34 10/04/2013

US Inflation +6% (in ZAR) -4.94 16.43 17.14 20.16

18 |

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PSG Asset Management unit trusts

Local unit trusts0800 600 [email protected] Offshore unit trusts0800 600 [email protected] General enquiries+27 (21) 799 [email protected]

Websiteswww.psg.co.za/asset-managementwww.psgkglobal.com

Cape Town office

Physical addressFirst Floor, PSG House Alphen ParkConstantia Main Road Constantia, Western Cape, 7806

Postal addressPrivate Bag X3 Constantia, 7848

Switchboard+27 (21) 799 8000

Guernsey office

Address11 New StreetSt Peter Port Guernsey, GY1 2PF

Switchboard+44 1481 726034

Client servicesSA Toll Free 0800 600 168

Malta office

AddressUnit G02Ground floorSmartCity MaltaSCM 01RicasoliKalkara SCM 1001

Telephone+356 (2180) 7586

Contact information


Disclaimer: Collective Investment Schemes in Securities (CIS) are generally medium- to long-term investments. The value of participatory interests (units) or the investment may go down as well as up and past performance is not a guide to future performance. CIS are traded at ruling prices and can engage in borrowing and script lending. Fluctuations or movements in the exchange rates may cause the value of underlying international investments to go up or down. Where foreign securities are included in a portfolio, the portfolio is exposed to risks such as potential constraints on liquidity and the repatriation of funds, macroeconomic, political, foreign exchange, tax, settlement and potential limitations on the availability of market information. The portfolios may be capped at any time in order for them to be managed in accordance with their mandate. Excessive withdrawals from the fund may place the fund under liquidity pressure and, in certain circumstances a process of ring-fencing withdrawal instructions may be followed. The fund may borrow up to 10% of the market value to bridge insufficient liquidity. Unit trust prices are calculated on a net asset value (NAV) basis, which is the market value of all assets in the fund, including income accruals less permissable deductions divided by the number of units in issue. Fees and performance: Prices are published daily and available on the website www.psg.co.za and in the daily newspapers. A schedule of fees and charges and maximum commissions is available on request from PSG Collective Investments (RF) Limited. Commissions and incentives may be paid and, if so, are included in the overall costs. Forward pricing is used. Different classes of Participatory Interest can apply to these portfolios and are subject to different fees, charges and possibly dividend withholding tax and will thus have differing performances. Performance is calculated for the portfolio and individual investor performance may differ as a result thereof. All performance data for a lump sum, net of fees, include income and assumes reinvestment of income on a NAV-NAV basis. Income distributions are net of any applicable taxes. Annualised performance show longer term performance rescaled over a 12-month period. Source of performance: Figures quoted are from Morningstar Inc. Cut-off times: The cut-off time for processing investment transactions is 14h30 daily, with the exception of the PSG Money Market Fund, which is 11h00. The portfolio is valued at 15h00 daily. Additional information: Additional information is available free of charge on the website and may include publications, brochures, application forms and annual reports. Company details: PSG Collective Investments (RF) Limited is registered as a CIS Manager with the Financial Services Board, and a member of the Association of Savings and Investments South Africa (ASISA) through its holdings company PSG Konsult Limited. The management of the portfolios is delegated to PSG Asset Management (Pty) Ltd, an authorized Financial Services Provider under the Financial Advisory and Intermediary Services Act 2002, FSP no 29524. PSG Asset Management (Pty) Ltd and PSG Collective Investments (RF) Limited are subsidiaries of PSG Group Limited. Money Market: The PSG Money Market Fund maintains a constant price and targeted at a constant value. The quoted yield is calculated by annualising the average 7-day yield. A money market portfolio is not a bank deposit account. Excessive withdrawals from the portfolio may place the portfolio under liquidity pressures and in such circumstances a process of ring-fencing of withdrawal instructions and managed payouts over time may be followed. The total return to the investor is made up of interest received and any gain or loss made on any particular instrument. In most cases the return will merely have the effect of increasing or decreasing the daily yield but in the case of abnormal losses it can have the effect of reducing the capital value of the portfolio. Fund of Funds: A Fund of Funds portfolio only invests in portfolios of other collective investment schemes, which levy their own charges, which could result in a higher fee structure for Fund of Funds portfolios. Feeder Funds: A Feeder Fund is a portfolio which, apart from assets in liquid form, invests in a single portfolio of a collective investment scheme, which levies its own charges and which could result in a higher fee structure for the feeder fund.

Trustee: The Standard Bank of South Africa Limited, Main Tower, Standard Bank Centre, 2 Hertzog Boulevard, Cape Town, 8001. Tel: +27 (21) 401 2443. Email: [email protected]. Conflict of Interest Disclosure: The Fund may from time to time invest in a portfolio managed by a related party. PSG Collective Investments (RF) Limited or the Fund Manager may negotiate a discount in fees charged by the underlying portfolio. All discounts negotiated are re-invested in the Fund for the benefit of the investor. Neither PSG Collective Investments (RF) Limited nor PSG Asset Management (Pty) Ltd retains any portion of such discount for their own accounts. The Fund Manager may use the brokerage services of a related party, PSG Securities Ltd.

PSG Collective Investments (RF) Limited does not provide any guarantee either with respect to the capital or the return of the portfolio and can be contacted on 0800 600 168 or on e-mail at [email protected].

© 2016 PSG Asset Management Holdings (Pty) LimitedDate issued: 27 January 2017

The information and content of this publication is provided by PSG as general information about its products. The information does not constitute any advice and we recommend that you consult with a qualified financial adviser before making investment decisions. For further information on the funds and full disclosure of costs and fees refer to the Minimum Disclosure Documents on our website.

ANGLES & PERSPECTIVES - PSG · 2017-01-20 · Table 1: Global companies ranked according to their...

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