The impact of the current crisis on managing a local equity portfolio
Please click below to listen to a web-based meeting we held at the end of April 2020 on the impact of the current crisis on managing a local equity fund, specifically our Denker SCI Equity Fund. A summary of the main points is listed below.
What we’ve learnt from previous crises
Director and portfolio manager
- Our research shows that there have been eight market manias over the past 50 years. While each started for a different reason, they all presented incredible buying opportunities.
- The average sell-off from peak to trough was roughly 14 months, with an average decline of 41%. The shortest lasted four months after the 1998 Russian crisis and the longest was 28 months following the collapse of the Bretton Woods System in 1975.
- Investing in the three months after the initial sell-off yielded exceptional results over the subsequent 12, 24 and 36 months.
- It is not possible to time the bottom in a period of extreme uncertainty and it’s not easy to buy when the news is bad and everyone else is selling…but buying at these low prices is a great opportunity.
- The South African market initially fell 35% from its January peak and has subsequently bounced 26%, leaving it down 18%. Research by Gavekal tells us that rallies rarely happen in a straight line. In 15 bear markets over the past 50 years, only one did not see the initial major low being tested within three months. So, we do see further buying opportunities in the coming months. The bounce we’ve seen reflects perhaps a little too much optimism.
Critical factors in analysing which businesses to avoid
Claude van Cuyck
Director and portfolio manager
- Given that the future is impossible to predict, it’s important to stick to an investment philosophy.
- For us, there are certain key factors that we consider when making an investment decision. These are good business economics (strength of business models or moat and strength of balance sheet); the quality of the management team; and investing with a margin of safety – we make sure that we aren’t overpaying for the value we are receiving by understanding the intrinsic value and the range of possible outcomes.
- The ideal scenario is for all of these factors to be aligned when allocating capital but this is not always possible. Therefore, it’s important that we understand the risks companies face so that we diversify against them and invest with a margin of safety.
- If valuation is the only reason to buy then it is probably not the right buy – you need to consider other factors in conjunction with value.
Will domestic small caps survive?
- When fear and greed dominate, market participants seek the liquidity that large caps offer. So small caps have lagged, which is normal in times of crisis. However, it’s important to focus on the long term.
- In the last three years the small caps in our portfolio have outperformed the FTSE/JSE Shareholder Weighted Index by around 15%.
- In the medium- to long term the companies that have strong balance sheets, strong business models and strong management teams will survive.
- We see significant opportunities in the small cap sector, now and before the crisis hit.
How the Denker SCI Equity Fund is positioned
Director and portfolio manager
- In March we sold some of the defensive companies in our portfolio that held up well (Pick n Pay, Dis-Chem, Shoprite and Mediclinic). We bought MTN, Northam, Mr Price, Capitec, Sasol, Curro, FirstRand and Naspers).
- In April we have not made many changes to the portfolio. Stocks have recovered quickly and to some extent we think this optimism is premature.
- There are good opportunities to buy great quality businesses at bargain prices. We are sticking with our investment philosophy and are attracted to companies that are not just resilient, but anti-fragile. We see an anti-fragile company as having a growing profit pool, being a great capital allocator, having a strong track record of financial health and culture as a sustainable competitive advantage.
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