It’s hard to believe that markets priced by imperfect humans can be perfectly efficient.
Picture this: You are an energetic, inspired investor eager to begin the hunt for the next opportunity – the overlooked jewel, or the mispriced business with a bright future. But no matter how long you burn the midnight oil, or how far you venture into previously unknown territories, you end up disappointed. You discover that every potential opportunity has already been taken and is already properly priced and fully appreciated by a perfectly efficient market. No matter how hard you crunch the numbers, the market price simply doesn’t provide the investment opportunity you were hoping for – it’s always too close to your estimate of intrinsic value. This kind of investment world reflects the EMH story quite well.

The real investment world, however, is run by human beings who daily experience a host of emotions such as inspiration, joy, fear and greed. These imperfect beings are the ones making prices (for now, anyway), participating in markets, and making judgements. It is them we must thank for exceptional and rare opportunities.

Let’s explain this in more detail.

There are three types of investment opportunities that can potentially offer exceptional returns.
1. Businesses that have a competitive advantage that is stable and therefore hard for others to mimic.
These are companies with ‘wide moats’, according to popular financial jargon. They are perhaps the investments that make our job as investors most enjoyable. Who wouldn’t delight in discovering and then understanding the resourcefulness, the fresh thinking and the pioneering instincts that invariably produce enterprises with unique propositions? It’s literally studying human ingenuity in action. After all, these are the organisations that help drive progress. Examples of such businesses are ASML and Nielsen, both of which are held in the Sanlam Global Best Ideas Fund.
ASML is a Dutch company that is currently the largest supplier in the world of photolithography systems for the semiconductor industry. The company manufactures machines to produce integrated circuits. It has developed unique instruments for integrated circuit miniaturisation.

Nielsen remains the industry standard in market share and audience measurement technology.

2. Businesses that haven’t been discovered by the market at large.

These businesses have been neglected either because of their small size, their geographical remoteness, or because they are pioneers in completely new and poorly understood endeavours. Many of the financial holdings in the Sanlam Global Best Ideas Fund are of this variety. The fund and its investors are able to leverage off the research of Kokkie Kooyman and his team, who are masters at uncovering these kinds of companies.

Credicorp, a Peruvian financial services group, is a good example of this type of business that has helped to enhance the performance of the Sanlam Global Best Ideas Fund. The company commands a dominant position in the Peruvian banking sector, which is characterised by low penetration, high market concentration and strong profitability. Credicorp is engaged primarily in commercial banking, insurance, investment banking and pension fund businesses.

3. Businesses that are so unpopular that they are priced for a bad (but statistically unlikely) future.

These businesses have gone through a bad patch and are now seen as permanently damaged, despite overwhelming evidence that most of such company lows are cyclical. Some of our better performers in 2017 have come from this class of uncommon investment, such as homebuilders NVR in the US and Taylor Wimpey in the UK, and the online trading platform IG Group.

IG Group’s share price almost halved in December of 2016, after new regulations were proposed for retail traders in the UK. The market took fright, but this panic turned out to be an opportunity for investors who kept their cool about the likely effect of such regulations on IG’s bottom line. On a total return basis, the share price has since risen by well over 100%, and by some 89% over the last year.

Figure 1: Examples of exceptional businesses that have recently enhanced fund performance 

Source: FactSet (31 March 2018)

Exceptional companies are often priced incorrectly by less-than-perfectly-rational humans.  
To identify these companies for inclusion in our investment universe, we are required to be more rational than the people who are currently making the price. It’s not easy, but we hope that we’ve proven that it’s possible. The important thing is to consistently apply the discipline of unemotional, fact-seeking, objective thought, together with a strong dose of patience. We use this discipline to discover exceptional businesses where others may only see what the current mood of the market allows them to see. In fact, exceptional, rare businesses will invariably present themselves if you are able to ignore the herd’s opinions of the day.

Disclaimer

SCI stands for Sanlam Collective Investments. SIM stands for Sanlam Investment Management.

Denker Capital is an authorised Financial Services Provider, and an appointed investment advisor to Sanlam Investment Management (Pty) Ltd an authorised Financial Services Provider. The information in this communication or document belongs to Denker Capital (Pty) Ltd (Denker Capital). This information should only be evaluated for its intended purpose and may not be reproduced, distributed or published without our written consent. While we have undertaken to provide information that is true and not misleading in any way, all information provided by Denker Capital is not guaranteed and is for illustrative purposes only. The information does not take the circumstances of a particular person or entity into account and is not advice in relation to an investment or transaction. Because there are risks involved in buying or selling financial products, please do not rely on any information without appropriate advice from an independent financial adviser. We will not be held responsible for any loss or damages suffered by any person or entity as a result of them relying on, or not acting on, any of the information provided.

The fund’s risk profile is aggressive, so if you are an existing or potential investor: You can afford to take on a higher level of risk (i.e. will have a greater exposure to equities in your portfolio) because of your investment time horizon, or your appetite for risk. You know that in taking the risk, you need to be patient if you want to achieve the results. So you are willing to invest for the long-term and are prepared to tolerate some volatility in the short term, in anticipation of the higher returns you expect to receive in five years or beyond.

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