Market Commentator (6 March 2015)

Murray Winckler – co-founder and portfolio manager at Laurium Capital, on favoured stocks, stock market drivers, the appeal of hedge funds and African opportunities.

Hanna Barry:

Welcome to this Market Commentator podcast, Moneyweb’s series of interviews with leading investment professionals. My guest today is Murray Winckler, co-founder and portfolio manager at Laurium Capital. Murray, thanks for joining us, tell us first about Laurium’s investment philosophy?

Murray Winckler:

Hi Hanna, thanks for having me on the show. On philosophy I guess what is Laurium about, the core fundamentals of what we do is focus on value, we’re fundamental value orientated, so that’s the core but around that we do a lot of different stuff. We are not deep value, we have a valuation bias, we will have growth stocks in our portfolio, we’re quite pragmatic, so we’ll look at where we think we’re going to make money but generally a valuation bias. So in our team we have eight on the investment side that are looking at stocks, most of them, seven of them are chartered accountants, seven of them have got CFAs. So the fundamentals are pretty solid but we will look at stocks from a technical point of view if we think they’re going up, momentum, sometimes we’ll play those stocks as well.

Hanna Barry:

So to give us some colour to that philosophy, what stocks do you like at the moment?

Murray Winckler:

Well, the stocks that have been doing fairly well is anything but resources, we’ve had a very small portion of the portfolio in resources, we’ve had Billiton has been our choice, which is the lowest cost producer of the resources, so the margin of safety is the highest. The stocks that have done well, we’ve been a Naspers fan for – I guess we’ve held it in the portfolios – for the last six years since we started up, that’s very much a growth stock with valuations quite full, if you look on a normalised PE but the growth looks still pretty exciting going forward. Old Mutual has been a big stock that we’ve held over time in the life insurance space, it’s one of the cheapest, it’s back now to one times embedded value, relative to something like a Sanlam it is very attractive. Other stocks, we’ve been in Discovery for a long time as well, we think the management is exceptional, that’s more of a growth story, valuations aren’t that attractive I guess but if you’re a value investor there is lots of upside. Then the areas where we have been negative on have been on a lot of the retail stocks and in our hedge funds we are short them, things like Clicks, Mr Price recently and Truworths we were short for quite a while, and Shoprite as well. So we think that the valuations on those stocks, multiples of 20 to 25 times for growth rates of 10% to 15% they are definitely not that attractive from a valuation point of view.

Hanna Barry:

And, of course, we could see them come under pressure should the inflation outlook change and the Reserve Bank feel the need to raise interest rates retail stocks would certainly come under pressure in an environment like that. Sasol was a favoured stock of yours, I’m not sure if it still is, that share price is down about 30% over the year, are you still a fan of Sasol?

Murray Winckler:

Sasol has been quite a big holding for us up until the end of last year. The share price got above R600, we halved our positions, which was actually with hindsight was quite fortunate but we’ve still held into the collapse in oil. Oil was a big surprise, we didn’t think it would come back below US$95, so once we saw a bit of momentum, it was falling, we chopped our position size to about 25%, right now in our funds we are running positions I guess in our main long/short fund I guess of about 1% in Sasol, so very small. Then if we look in our flexible unit trusts we are running at about a 2% position in there. If you look at the weighting in the SWIX index or the All Share Index it’s close to 4% or 4.5%, so we’re pretty underweight the stock. I guess if you put oil spot in and the rand/dollar spot into models now on a rolling 12-month basis you’ll get earnings of about R38 from Sasol, which puts it on about an eleven times forward multiple. Historically it’s traded at around ten, so right now it’s priced pretty much where it should be but if you believe oil is going up over the next 18 months then it’s a good time to be buying Sasol.

Hanna Barry:

Let’s talk about that you mentioned the surprise in the drop of the oil price, also the rand/dollar exchange that is not looking great at the moment, are those some of the major factors that you think are driving stock markets or what are those factors that are driving the markets? h3.articla-sub-heading Murray Winckler: p Well, from a global perspective it’s cheap money, so we’ve seen it in the States, the S&P performing really well over the last five years and that has now moved to Europe. So with quantitative easing we’re likely to see the European stocks increasing in value we think quite significantly. That’s in euro terms, now you’ve got to offset the fact that the euro is likely to be weak, which we’ve seen a lot of that’s played out already this year, we’re getting pretty close to parity, dollar/euro. I think if you look out over the next two years we’re likely to still see a fairly strong dollar from these levels. Short term it does look like the elastic band has been stretched quite a lot and you could quite easily see a little bit of a snap back that the dollar actually weakens a bit because it seems to have moved very quickly, way quicker than we thought. h3.articla-sub-heading Hanna Barry: p Absolutely and here in South Africa would you say cheap money is also the driver of the All Share Index? h3.articla-sub-heading Murray Winckler: p We correlate obviously very closely to the US S&P, more than 50% of our earnings come from offshore, so when the currency does weaken we get a bit of an uplift. Our valuations on our market are pretty demanding, if you look relative to history, I guess if you strip out one or two stocks you get a normalised, probably about a 15 times multiple and historically we’ve tended to trade around a 12 times multiple. So our stocks do look expensive but I think the trick is that I think over the years cheap money, negative real rates, low bond yields are very supportive for stocks. So I think that underpin is still very much there, particularly globally and I think, as I said, Europe still looks quite decent from that point of view. The States has probably still got reasonable upside but the big returns have been had. The US market is sitting on a forward multiple of around 17 times, relative to history it looks fair but then bond yields are a lot lower than they have been historically. So you’ll probably get over the next three years total returns from the US, we think for what it’s worth and forecasting is always fraught with risk, total returns between 5% to 8% in dollars from the S&P over the next couple of years, which beats ten-year bonds at 2%. h3.articla-sub-heading Hanna Barry: p So we’re not necessarily going to see a market correction anytime soon at least here locally?

Murray Winckler:

No, we will always see corrections in the market…

Hanna Barry:

Significant market correction.

Murray Winckler:

Markets over time go up and they have corrections along the way and it’s just how big is that correction each time. So forecasting that we’ve basically got no chance, all we can say is markets do look expensive now and at some stage you’d expect some sort of pullback but I think the tone is set from global markets. Once rates start rising in the US, which could be as early as mid this year, we’ll see probably a bit more money shifting back from emerging markets into the US, which will put a bit of a dampener and a headwind onto our markets. So our view at the beginning of this year was that total returns out of the SA market we’d see a return of somewhere between 5% to 10%. We’ve had pretty much close to that already in the first few months, so the markets have performed fairly well. So it is in fairly high risk territory but we’re not advocating a big fall down or anything like that.

Hanna Barry:

You mentioned, and I’m going to get to what one can do to hedge against markets being expensive or potential pullback, but you did mention offshore and the fact that about 50% or more than 50% of your earnings come from offshore, there seems to be this ongoing debate as to whether investors should be investing locally or get all their money out, get all their capital out because South Africa is going to the dogs, as some writers like to argue. What’s your view, do investors need to have significant offshore exposure or is 20%, 25%, some offshore exposure purely for diversification purposes sufficient?

Murray Winckler:

I think for diversification purposes around 25% is a decent slug of your money to be offshore. On our exchange you have the choice of…you’re effectively buying a lot of offshore companies as well, you’re buying your Richemont, you’re buying your BATs, you’re buying your Mondis, which are 90% offshore, you get Aspen, which is close to 50% of its earnings from offshore. So there are a lot of counters, SABMiller, which the bulk of the earnings is offshore, so a lot of the companies on our exchange are actually offshore global companies and offshore, so you are protected already, you are getting global exposure, so you don’t need to have that much more than 20%, 25%, in my view, in other international stocks.

Hanna Barry:

Let’s talk about hedge funds, okay now Laurium has a couple of those and I saw a tweet the other day from an asset manager depicting hedge funds in one picture, saying they’re very expensive, they don’t work very well and rich people love them [laughing]. Now we were talking just before this and globally hedge funds have underperformed most equity stocks, certainly in the US, locally that’s not been the case but what for you, Murray, is so appealing about hedge funds?

Murray Winckler:

Okay, I think what you say is absolutely right, globally if you look over the last five years hedge funds, and there is probably more than $2trn in hedge funds globally, there are a lot of different strategies but hedge funds over the last three, four years when markets have been performing particularly well, the US, hedge funds have performed quite poorly. If you go back the ten years before that hedge funds globally did quite well. It depends which type of strategy, if it’s a macro strategy, if it’s a market neutral, if it’s a merger arbitrage or long/short equity, which I guess is more like the basic long only funds out there, more similar, let’s say that. So absolutely, fees in hedge funds are high, one in 20, internationally two in 20, so there’s a big headwind and I think that a lot of markets that it pays to be in just your passive, if you look at the S&P 500 index funds are not a bad place to be because it’s very competitive and efficient in those markets. I think there is definitely a place, there are hedge funds that do extremely well, I think the South African hedge fund industry which is very small, we are literally now probably R60bn, tiny compared to unit trusts of $2trn, being small, not running huge amounts of money, the opportunities to go long and to go short, which is most of the funds in South Africa, long/short is the predominant hedge fund strategy. The managers have done extremely well, if you look at the top ten hedge fund managers over the last I guess let’s take the last six, seven years, I think almost all of them have beaten the All Share Index with volatility close to half the market volatility. So hedge funds in South Africa have done extremely well and those are after fees which are one in 20. They do have a hurdle that you need to give an investor over 12 months, a cash return before you take your fees, but net of fees most of the players have actually generated returns ahead of the All Share Index.

Hanna Barry:

When you say one in 20 is that 20% of the fund’s performance?

Murray Winckler:

That’s right, ja. So we charge a 1% management fee and then as long as the investor gets a cash return, which is called STeFI, which is most of what the funds do, on a 12 month basis they need to get at least, STeFI at the moment is around 6.5%, as long as you give them at least a 6.5% return you will then take 20% of the performance.

Hanna Barry:

Which is quite high considering that the All Share Index has done far more than 6.5%, not last year but in years prior to that. Did Laurium’s hedge funds outperform net of fees in the last three, five, ten years?

Murray Winckler:

Well, we started the business myself and co-founder, Gavin Vorwerg, six and a half years ago, we started six weeks before the Lehmans crisis, so bad timing. That fund since then has generated a return net of fees of 15.6%, that fund alone is about R2.5bn, we run as a firm just over R5bn of assets. But that fund has gone at 15.6%, the total return in the market since we started is just nearly 2% per annum less than what we have done, so we’ve obviously covered our fees. Then if we look at our average net exposure has been 55%, so we’re running half the exposure of the All Share Index, plus cash, and we’ve still managed to beat the market. So far so good, there’s a long way still to go. So that’s our main long/short fund, we have an aggressive version that’s been going for a couple of years and that’s more than doubled the market every year since it’s been going, net of fees.

Hanna Barry:

Wow that is impressive and the numbers don’t lie I suppose. You mentioned long/short fund and that’s your major fund, something that has always fascinated me is when fund managers short a share, in other words they bet on the stock price falling and then sell shares they don’t own on the back of that bet. My question is does that not artificially drive share prices, so that by shorting a share you do in fact ensure that that share price falls. h3.articla-sub-heading Murray Winckler: p If you’re a very big player you’re absolutely right, so I think we’ve seen internationally every now and then a couple of hedge funds get together, seem to act in concert, focus on a stock and tend to drive the price down by shorting. h3.articla-sub-heading Hanna Barry: p Financial engineering at its best [laughing]. h3.articla-sub-heading Murray Winckler: p Ja, I’m afraid there is some of that stuff that takes place, it takes place in investment banks everywhere, so there are definitely incidents of that that happen. As mentioned in the South African market hedge funds are…we are very small, so the ability really to have a big influence on knocking a share down unless it’s a smaller cap, which is dangerous shorting smaller caps anyway, we tend to play in the liquid top 80 stocks if we put shorts on and generally small sizes as well because it’s all about risk management and what you do. So in the SA market I can’t think of any instances where that’s really been the case. h3.articla-sub-heading Hanna Barry: p Some new hedge fund regulation coming into effect on April 1 this year, for one hedge funds will be declared collective investment schemes, so essentially will be regulated like any other unit trust and then there will be stricter regulation for retail hedge funds I think as a way of getting more retail investors into those, is this regulation going to change the game for hedge funds? h3.articla-sub-heading Murray Winckler: p Hedge funds have been held back I guess from the regulatory framework, South Africa has been quite far ahead of the game in terms of regulating the managers and now in this latest move to product. So the move to have hedge funds under Cisco and have the product regulated is obviously going to be quite a big game changer to change and to grow the assets going forward. Pension funds do have an issue with fees obviously but there are some that have been keen to come into hedge funds, there are some in hedge funds already but there are a few that have been waiting for the regulations to change to see that the product is actually regulated as well. So that I think we will see quite a lot of new money coming in and then in the retail space as well understanding hedge funds for the retail investor is quite difficult, it’s fairly complex to understand the mechanics and generally it’s been high net worth individuals that have gone into hedge funds, I guess almost all of our clients on the individual side that have come in their minimum investment has been R1m. But with having the product regulated now the amounts are going to be a lot smaller and it will open up to a lot more investors out there. I think hedge funds…because we run…our nets aren’t, it’s a lower risk generally, most of the funds run about half the volatility of the market, with markets being fairly full, long-only funds are a lot more vulnerable to pullbacks and drawdowns. So generally on hedge funds we would look and we say, and obviously nothing is ever guaranteed, but generally we would look if the market pulls back one third drawdown is what we would look at, you try and capture two thirds of the upside, one third of the downside, that would be a low risk fund in the hedge fund space or very moderate risk and that’s what one tries to do. h3.articla-sub-heading Hanna Barry: p Do you think Laurium will make available some offerings to retail investors that don’t, say for argument’s sake, have R1m to invest but would like to get into hedge fund investing or is it going to be too expensive to offer those kinds of products? h3.articla-sub-heading Murray Winckler: p a, we will be going into the retail space, so we are busy setting up, our existing product already fits into it in terms of the gross, the nets and the position sizing. So we already fit into exactly the framework for the retail product, so there’s nothing we need to change of our existing main fund, so it’s really just changing some of the regulatory requirements at the top but the fund will be running exactly the same and I guess in the next few months smaller investors will be able to come into that. h3.articla-sub-heading Hanna Barry: p Finally, Murray, Laurium views Africa as the continent of opportunity but we have seen a number of key economies in Africa come under pressure because of the fall in commodity prices, oil comes to mind, particularly countries like Nigeria and Angola, is Laurium still fairly bullish on the outlook for the continent? h3.articla-sub-heading Murray Winckler: p Hanna, the longer term outlook I think for Africa is extremely positive, so if you take a five to ten-year view the opportunities are huge. The economies, if you look back over the last ten years, have grown on average, let’s exclude South Africa, between 5% and 6% GDP. If we look out at the next ten years I think that the growth rates are going to be 5% plus in most of the economies out there. So without a doubt the outlook is very positive on a longer-term basis, shorter-term commodities are having quite a big hit on the markets, Nigeria and Angola, as you mentioned, in particular. In Nigeria we’ve seen the currency, the naira, come under huge pressure, going from 150 to 200 now. There are elections coming up on March 28, after the elections a lot of people are expecting the naira to weaken further, probably by 10%, some people say as much as 20% from here but a lot of that is priced into the market, so we’ve seen the markets come back significantly. The consumer is under quite a bit of pressure in Nigeria at the moment, yet you still have stocks like Unilever, Nestlé, Nigerian Breweries trading on multiples of 30 plus times, so internationals still buy the story longer term, we think that some of those stocks have been priced way too expensively but people believe in the story. So longer term, without a doubt, very positive. Shorter term I think there’s a lot of turmoil, once we get through the elections and with our view that oil will rebound, if we look 18 months out we think that oil will be back at 85, I think it’s going to be a great buying opportunity. Probably Nigeria is the most attractive, get through the elections now, a lot of noise, it’s probably going to be the biggest upside if you take on a two-year view from where the prices are now. Kenya on the other hand is an importer of oil, so that economy this year will grow at around 6% or so and the stock market has been doing very well, valuations have got quite full there but the economic growth in Kenya is looking very strong and the infrastructure investment going in will drive that economy for the next five years or so. h3.articla-sub-heading Hanna Barry: p You mentioned earlier some changes, while we were talking off air, to the Nigerian Stock Exchange being able to short shares, can you talk us through that? h3.articla-sub-heading Murray Winckler: p The big opportunity in Africa is that it’s under-researched, whereas in South Africa you might have ten, 15 analysts looking at a stock here, you get into Africa some of the stocks, you have one person covering a stock or two people, so it’s under-researched, so there are a lot more opportunities. Stock exchanges aren’t as efficient, you can arbitrage from one exchange to the other, we’ve done a few of those before where there’s 50% upside in a trade from one exchange to another. So it’s getting out there and looking for opportunities and it’s under-researched. So there’s the beta story but if you’re covering those markets, Zimbabwe is another one, we’ve been in Zimbabwe running a fund there that we started up five years ago just after dollarisation and Zimbabwe is struggling at the moment, it seems to be grinding to a halt, probably flat GDP growth now but it grew for a couple of years at close to 10% per year. So coming back to the shorting side, in fact a lot of the markets don’t allow shorting but it is opening up, the Zimbabwe exchange allows shorting but there’s been one short done in the last ten years, which we worked with the stock exchange and we did a short on the exchange, just a test trade, so we did do a short, that was two years ago. h3.articla-sub-heading Hanna Barry: p And in Nigeria, can you short shares there? h3.articla-sub-heading Murray Winckler: p In Nigeria by using access to banks you can do access products, so it’s not on the exchange as yet but they will be bringing that in in time as these exchanges develop more, so that is the plan. But right now there are ways that you can synthetically short by doing access products with banks, so it took us about six months to set some stuff up with a couple of banks and we have actually been short for the last nine months or so five consumer stocks that we have put into a basket and we’ve been short, which has worked out fairly well. Oil did, as I said before, we didn’t expect oil to come down like it has, so that has helped those shorts quite nicely in Nigeria. h3.articla-sub-heading Hanna Barry: p All in all Africa is still top of the pops or a good investment opportunity at least in the long term? h3.articla-sub-heading Murray Winckler: p Look, you’ve got to take a long-term view, volatility is extremely high, you need to be very careful with where you’re going and what stocks you are buying. That’s where fundamental research comes in pretty well, understanding the companies, looking at the balance sheets, looking at corporate governance, going for companies that probably have got global parents, where the governance is better. So you need to be careful what you choose. So unlike when we talk about index passive, you go with the S&P 500 Tracker Fund, if you buy the S&P 500 through Vanguard you’ll probably beat 80% of the fund managers consistently over time is what will happen. If you go into Africa you’ll pick an index, I think the opportunities in Africa if you do the research, are pretty significant relative to a basic index because there is a lot of rubbish listed on exchanges in the rest of Africa h3.articla-sub-heading Hanna Barry: p So choose wisely. There you go, that’s Murray Winckler, the co-founder and portfolio manager at Laurium Capital.