We’re in the longest uninterrupted growth cycle that we have on record … the further it goes the closer it must be to exhaustion.

Moneyweb Radio Market Commentator podcast with Adrian Saville from 2 February 2015.

RYK VAN NIEKERK: Welcome to this Market Commentator podcast, our series of interviews with chief investment officers, portfolio managers and investment professionals. Our guest this week is Dr Adrian Saville, he’s the chief investment officer of Cannon Asset Managers. Adrian, welcome to the show, we are currently seeing a lot of volatility in the market; how do you read this market environment?

ADRIAN SAVILLE: Thanks, Ryk. The market environment looks like it’s getting to a stage of what I would call exhaustion. For a number of years you’ve had this very easy money environment and the easy money environment has supported some valuations that have dislocated from financial and business reality. Now that we’ve got onto these very elevated valuations and we’ve been there for a little while, the question is perhaps where do you go from here and to see more upside in some of these valuations is really, really hard. So I think this might be a time where these elevated multiples are looking for downside rather than upside.

RYK VAN NIEKERK: There has been a lot of discussion or debate about momentum investment strategies, do you think we should rather then move more to a value-based type of investment strategy?

ADRIAN SAVILLE: Well, I’m hopelessly biased in that regard, it’s been incredibly frustrating, as it is for all active managers when the style that they bring to managing portfolios is out of favour it’s always difficult, they’re hard yards to walk but for the last five years value has been firmly out of favour. We’re in the longest uninterrupted growth cycle that we have on record, growth stocks have never had it better. What we also know from investment finance and the gravitational forces of economics is that what goes up can’t just keep going up and up and up. So at some stage this style will exhaust itself when it runs out of road and valuations get too silly or too extreme. So it has been going the way of momentum investors for a number of years and that’s been a lovely place to be because it’s emotionally easy and it’s financially rewarding. Financially rewarding because the momentum takes you to better places and emotionally easy because you are buying what others are buying. Whereas while value tends to have a disproportionate advantage in delivering better investment returns, it’s a much harder place to go and a much harder place to stay. That’s the long answer, my short perspective would be that I think it equips investors to recognise that styles are cyclical and that this is a very, very long cycle, the further it goes the closer it must be to exhaustion.

RYK VAN NIEKERK: But don’t you think the US quantitative easing process did inflate a lot of developing markets such as the JSE but do you think the European QE programme could have the same effect?

ADRIAN SAVILLE: It may well do, although I would ask if you’ve got a fairly mature, large cap business on a 35 times earnings multiple do you really think it can go much higher and if it does go higher is that speculation or investment because I wouldn’t pay 35 times earnings or even 25 times earnings for a mature business. So it may well be the case, this quantitative easing, of throwing more money at the problem does help valuations go higher but I don’t think that those valuations are investment-led, I think they are led by speculation. Any form of speculation is the best way to lose money, there is a yawning difference between speculation and investment. I think this is an environment in which you most definitely want to be wearing an investor’s hat because the risk to the downside is bigger than the opportunity to the upside.

RYK VAN NIEKERK: What is the mood in the investment community towards value investors?


RYK VAN NIEKERK: There are several so-called contrarian investors and they have invested in shares, they just did not show the same return as the momentum guys. Did you see outflows, what do you see from investors, are they prepared to wait for the inevitable rise in value stocks?

ADRIAN SAVILLE: Ja, there’s almost no appetite for value funds and value investors in the current environment. I would go a little further and venture that because of that lack of appetite you’ve seen a number of managers in South Africa drift to other styles. At Cannon we firmly believe in this investment philosophy, it works and its time will come. What you do when your style drifts or style changes is you try to time when you think sentiment will shift back for the whatever style it is that you’re applying to your portfolios. I think there are two challenges with that, the one is that I’m not sure how you in one environment describe yourself as a value manager and then in another environment you’re a growth manager, I think it’s philosophically quite difficult to reconcile. A second observation I would make is that whilst there is a huge seduction and thinking that we know just when the appetite will turn for a particular style, the evidence of managers to style time is atrocious and for that reason we think that the wisest thing to do is, whilst these are very hard yards to walk, the wisest thing to do is to do what we do best and that is exist as value managers and conduct ourselves as value managers, and we’ll wait for the style to come back in our favour. I think people like Ben Graham put this very neatly in his investment poem, The Intelligent Investor: Don’t try and second guess the market, buy good businesses at good prices and wait, the waiting is the hardest part.

RYK VAN NIEKERK: Are you currently buying or selling?

ADRIAN SAVILLE: So to go back to your comment about the QE in Europe, the place where we have seen fantastic opportunity for some time is in South-African facing businesses. For obvious reasons investors looking at the JSE have thought that South African companies aren’t going anywhere in a hurry, 1.5% economic growth, inflation was above 6%, interest rates were heading higher and that most definitely was the state of existence reality in 2014. We’ve had this gift that was given to the economy in the form of a collapse in the oil price, US$100 to sub-$50, silently that has parceled up a number of gifts to the South African economy that I’m not sure have been entirely recognised or priced. Our economic reading is that the collapsing oil price will take inflation from over 6% last year to as low as 3% through the course of 2015. The pressure on interest rates to rise has turned into a propensity to actually keep interest rates either stable or possibly even cut. Although cutting is a bigger call than recognising that we’re now back into a stable interest rate environment and the South African consumer has been gifted about R20bn and that R20bn is equal to the revenue of Mr Price. So we’ve just built another Mr Price for consumers in South Africa. That will translate into lifting economic growth by 1% that wasn’t there this time last year. Given that I think the environment has shifted in this way, inflation is going lower, interest rates are stable, the current account is going to improve by 1.5%, that might work in favour of the rand and economic growth is going 1% higher, all else equal. If South African-facing stocks have been overlooked and ignored and the environment has turned in their favour from what was in the price it might be a good time to look at these investment engines, which have got a fresh flow of oil, to try and coin a poor pun. Again, that’s a very long answer; I would be buying South African-facing industrials.

RYK VAN NIEKERK: Just on the commodity sector, you are invested in Anglo and Sasol quite significantly in the equity fund, what do you foresee in the broader commodity sector?

ADRIAN SAVILLE: Ja, the short answer on Sasol is wow, it’s hurt but Sasol has a long-established history generating return on equity close to 20% per annum. Whilst it is priced as a commodity business I think ultimately it’s a technology business and we expect in the fullness of time Sasol will continue to return that almost 20% per annum to investors. So we’ll stay with Sasol, notwithstanding the near-term pressure of the much lower oil price. Anglos is a really interesting story, I think Mark Cutifani has bought much-needed discipline and focus to the portfolio of assets, he’s set very clear hurdles on the required rates of return and anything that doesn’t meet that is being dealt with, and the portfolio quality is slowly improving. On top of all of this you’ve got some assets inside of Anglos that I think have been mispriced, it would be bold to say they’ve been entirely overlooked but a great case in point is De Beers, where De Beers whilst it is widely treated in the investment community as a diamond miner, the way we see De Beers is as a luxury goods business and if you take some valuation between London-listed diamond miners and luxury goods businesses De Beers can account for almost all of Anglo American’s market cap, which means you get everything else in this optionality. Now optionality doesn’t work unless it’s revealed or masked, so what I suspect you’re going to see is as part of Cutifani’s portfolio rationalisation I wouldn’t be surprised to see something like De Beers list or to see them unbundle some of their underlying assets that sit as portfolio assets. That’s going to unlock value in Anglos, it’s a good asset.

RYK VAN NIEKERK: Just lastly, the Flexible Fund did actually quite well, over the last year it actually comfortably beat the JSE All Share, tell us a bit about the fund?

ADRIAN SAVILLE: Ja, so the Flexible Fund has got a great strategy, it’s got all four of the major asset classes and tactically moves around in equal weighting in these asset classes from the benchmark position. Its equity exposure is to South African equities held through the Cannon Equity Fund in a similar format, so thematically the equity holding is very close to the Cannon Equity Fund. Property, of course, had a great year and that helped the property component of the portfolio. Cash, as always, was a drag, although given that the JSE did only 10% last year, cash was much more of a modest drag than it normally would have been. Bonds gave something similar to the equity return. So the lifting came from property and equities.

RYK VAN NIEKERK: Thank you. Dr Adrian Saville is the chief investment officer of Cannon Asset Managers.