Navigating the narrow global equity market

Nigel Barnes:

Hello everyone, and welcome Jacobus. Nice to see you. Thanks for joining me. I never say this as well, but welcome, Caylin – my wonderful producer who is, as normal, standing here with the mic and giving us directions.

Caylin Conradie:

Thanks, Nigel.

Jacobus Oosthuizen:

Morning, Nigel.

Nigel Barnes:

Jacobus, let’s talk global markets. How have things been going in 2023?

Jacobus Oosthuizen:

2023 has started off quite well for global markets, although it’s been a very narrow market. There have been a few big winners, and not all stocks have participated in the rally that we’ve seen so far this year.

Nigel Barnes:

Just unpack that a little bit, in terms of the narrowness of the market?

Jacobus Oosthuizen:

So, the top ten stocks in the US have basically driven all the positive performance the market has had. So, if you exclude the top ten stocks, the market has been pretty much flat.

Nigel Barnes:

I believe it’s the main large tech companies that have driven that?

Jacobus Oosthuizen:

It’s predominantly the tech stocks. So it would be Microsoft, Nvidia, Google, Amazon, the likes.

Nigel Barnes:

And if you take those off the table, pretty much a flat market?

Jacobus Oosthuizen:

Yes, that’s right.

Nigel Barnes:

That must throw up some challenges for you, but let’s get to that a little bit later. Let’s just remind the listeners, Jacobus, of the funds you manage for Denker Capital. It’s the Denker Global Equity Fund and the Denker Sanlam Collective Investments (SCI) Global Equity Feeder Fund. So, you’ve got a dollar-based fund and a rand-based fund.

Jacobus Oosthuizen:

That’s right, yes.

Nigel Barnes:

How has performance been so far this year?

Jacobus Oosthuizen:

As at the end of May, the Denker Global Equity Fund A class has given us 7.8% so far this year in dollars and its benchmark gave 8.5%. The Denker SCI Global Equity Feeder Fund A1 class has given 26% in rands and its benchmark gave 26.4%. While both funds underperformed their benchmarks slightly on a net of fees basis, they outperformed their peer group category averages (for the global fund this is the Morningstar Global Large-Cap Blend Equity category and for the feeder fund it’s the ASISA Global – Equity – General category).

Nigel Barnes:

Excellent, 26% in rand. So, based on the new 45% limits allowable for offshore investing, then that would be the fund that people could focus on here in South Africa. So, that’s great. We’re one of the few global equity feeder funds out there in the market.

In terms of your approach, why those performance numbers? What have you been doing? Maybe give us a couple of specific stock ideas – things you’ve been buying, things you’ve been avoiding. Maybe start with your approach.

Jacobus Oosthuizen:

In terms of our approach, our listeners are likely aware that we follow a fundamental approach to investing. We make sure that we invest in companies that, over time, can grow shareholder wealth by earning returns on invested capital that exceed their weighted average cost of capital. And where the management teams have a track record of good capital allocation and are aligned with us as investors. And we make sure that we remain very disciplined on valuation.

So, last year this time, we also had a bit of a talk, and we spoke about some of the semiconductor stocks that have been sold down due to the market’s concern about a recession. That was an area of the market where we saw some value, where we just felt that these are very decent companies with a very strong long-term outlook, but where the market has become too pessimistic in the short term about possible recession.

So, those semiconductor stocks have done quite well for us so far this year. Obviously, the AI frenzy has contributed to that, and we would be very cautious about the whole AI frenzy at the moment. But there very decent companies that have good products and good business models, that will benefit in the long term from the global need for semiconductor chips. So, yes, that would be one area that has done well for us, and where our approach has worked well.

Nigel Barnes:

Why would you be cautious about the AI development frenzy?

Jacobus Oosthuizen:

The difficulty with the technology sector and technology companies is the rate of disruption. You can see it now again with Microsoft coming with OpenAI and the risk that poses to Alphabet and Google’s business model, their whole search business model. Two years ago, you would’ve thought that Google’s moat is almost impenetrable, and here comes a new technology that just disrupts it.

The same applies for today’s winners. Apparently, the market is saying Nvidia’s going to be a big winner. The stock is up almost 160% this year. It trades at a P/E multiple of 45x. So, it’s extremely optimistic, and yes, I’m sure the company will do well, and the new chip that they have is very well positioned for AI.

But at Denker, we just believe if you pay that type of valuation for a company, you’d better be very sure that growth does come through and that there’s no disappointment. We saw that in 2022 with a lot of these growth tech stocks pulling back 30 to 40%, and that could easily happen again.

I think it’s very important to remember that we’re also still in a period of quantitative tightening, and liquidity is getting taken out of the system. That means that we could see extreme volatility in the coming months or years as the Fed progresses on this quantitative tightening path. You just don’t know how things are going to play out, so we have to be very cautious about paying 45x for any company.

Nigel Barnes:

Moving away from tech, what other areas have contributed positively to the portfolio?

Jacobus Oosthuizen:

Yes Nigel, I agree that it may be a good idea to step away from tech, because that’s been the big driving force this year so far.

If we just take a bit of a longer-term view of the last 12 months, one of the interesting companies that have done well for us is HCA Health Care, which is the largest private hospital group in the US, with dominant positions in Texas and Florida.

We’ve had benefit from a nice demographic tailwind with people semigrating to Florida and Texas, and people getting older and needing more healthcare. It’s a very well-run business, very reasonable valuation, ticks all the boxes for us. That’s been up, about 27% over the last 12 months.

Ferguson plc is also a very interesting company. It was listed in the UK for many years, and only recently moved its listing to the US, where they’ve actually got most of their business. It’s a plumbing supplies business (distributor): plumbing, heating and ventilation, aircon equipment, etc. A very well-run distribution company benefitting from infrastructure investment in the US. As homes are getting older, they’re needing new plumbing. That company is up  24% over the last year.

Boeing is an interesting one too, it’s up almost 56% over the last year. Everybody knows the Boeing story. One where you’ve had to be very patient due to the turmoil it’s been through. First it was 737 MAX, and then COVID. And they seem to be coming through all the crises. The 737 MAX is up and flying again. Global travel is recovering quite rapidly. We’re almost at pre-COVID levels. The East is not quite there yet, but the US has recovered. And there’s a massive demand for aeroplanes.

Nigel Barnes:

So, that order book’s looking good.

Jacobus Oosthuizen:

Order book is looking very good. The biggest challenge for them is just the supply chain, and getting the supply chain up and running again, and being able to manufacture enough planes to fulfil the demand. And they’ve also got a challenge on the balance sheet side. So, as they are delivering stock that’s sitting on their inventory, we expect the cashflow to improve, and that should lead to a big improvement in the balance sheet.

Nigel Barnes:

That’s consistent with your approach of bottom-up thinking thing. Finishing off, Jacobus, what do you expect in terms of the rest of the year? Anything keeping you awake at night? Maybe if we see a pause in the Fed raising rates, what the impact’s going to be. Any thoughts?

Jacobus Oosthuizen:

Nigel, what’s keeping me up at night is quantitative tightening. We alluded to it previously in the conversation. It’s just that we’ve never been through a period like this. We’ve never seen a Fed with a $9 trillion balance sheet. We’re trying to wind that down to $8 trillion. It means there’s almost $100 billion of US treasuries that they are allowing to roll off every month. It’s a massive withdrawal of liquidity from the system. So, I think there’s a lot of unintended consequences that can come from that.

And so, for me, from a risk management point of view, I think it’s important for us to look at companies where the balance sheets are strong. We just mentioned Boeing. That’s one of the examples where the balance sheet is stretched, and we have to have a very strong view on which direction things are going. But generally, the portfolio is invested in the companies where the balance sheets are very strong, where they should be able to withstand a liquidity crunch.

This environment obviously also comes with a lot of opportunities. An example would be the regional banking sector in the US, where we’ve seen a big sell-off so far this year. And luckily, we can leverage off a world-class financials team for our financial stocks, so we think there are opportunities in the regional banking sector. I think ‘the baby has been thrown out with the bathwater’, and there are strong regional banks that are totally mispriced at the moment.

Yes, I think that would be the main risk for me: liquidity, and just to be aware of what that could do to your companies, and also the portfolio overall.

Nigel Barnes:

Jacobus, thank you. It’s been great to catch up. As you say, everything has been driven by tech this year, and the AI frenzy.. There has been great performance, especially from the Feeder Fund (up 26% this year, the A1 class in rand), which hopefully will appeal to a few listeners. And yes, a nice portfolio. How many stocks are in the portfolio at the moment?

Jacobus Oosthuizen:

Around 55.

Nigel Barnes:

Okay, so a concentrated portfolio, 55 companies – with strong balance sheets, able to sustain any sort of liquidity crunch that might come, and then you’re rifle-shooting some opportunities in areas like regional banking, etc.

Jacobus, thank you for your time, nice to see you, and keep it going. We’ll chat later in the year.

Jacobus Oosthuizen:

Thank you, Nigel, look forward to it.

Disclaimer:

Annualised performance over the last 10 years:

Source: Morningstar, 31 May 2023. Returns are net of fees. Returns for periods longer than one year are annualised. The highest annual calendar year returns since inception for the Denker Global Equity Fund A (USD) was 24.4% and the lowest was –15.5%, and for the Denker SCI Global Equity Feeder Fund A1 (ZAR) was 30.7% and the lowest was –10.4%. These are based on a calendar year period over 10 years.

The opinions expressed in this podcast are those of the participants and do not necessarily represent those of Denker Capital. This podcast does not take the circumstances of a particular person or entity into account and is not advice in relation to an investment. Please do not rely on any information without appropriate advice from an independent financial adviser. The value of investments may go down as well as up, and past performance is not a guide to future performance. Denker Capital is an authorised financial services provider in South Africa (FSP number 47075). The opinions expressed are not guaranteed to occur.

This information does not constitute financial advice as contemplated in terms of the South African Financial Advisory and Intermediary Services Act of 2002 (FAIS Act). Use or rely on this information at your own risk. Independent professional financial advice should always be sought before making an investment decision as not all investments are suitable for all investors.

The Denker Global Equity Fund is a sub-fund of Sanlam Universal Funds Plc, a company incorporated with limited liability as an open-ended umbrella investment company with variable capital and segregated liability between sub-funds under the laws of Ireland and authorised by the Central Bank. The Manager of the fund is Sanlam Asset Management (Ireland) Limited (Beech House, Beech Hill Road, Dublin 4, Ireland, Tel + 353 1 205 3510, Fax + 353 1 205 3521) which is authorised by the Central Bank of Ireland, as a UCITS Management Company, and an Alternative Investment Fund Manager, and licensed as a Financial Service Provider in terms of Section 8 of the FAIS Act. Sanlam Collective Investments (RF) (Pty) Ltd is the South African Representative Office for these funds. Deemed authorised and regulated by the Financial Conduct Authority. The nature and extent of consumer protections may differ from those for firms based in the UK. Details of the Temporary Permissions Regime, which allows EEA-based firms to operate in the UK for a limited period while seeking full authorisation, are available on the Financial Conduct Authority’s website (notes 1, 3 and 4). The A class is the most expensive class with an annual management fee of 1.5%.

The Sanlam Universal Funds Plc full prospectus, the fund supplement, the minimum disclosure document (MDD) and the KIID are available free of charge from the Manager or at www.sanlam.ie. This is neither an offer to sell, nor a solicitation to buy any securities in any fund managed by us. Any offering is made only pursuant to the relevant offering document, together with the current financial statements of the relevant fund, and the relevant subscription/application forms, all of which must be read in their entirety together with the Sanlam Universal Funds Plc prospectus, the fund supplement the MDD and the KIID. No offer to purchase securities will be made or accepted prior to receipt by the offeree of these documents, and the completion of all appropriate documentation. A schedule of fees and charges and maximum commissions is available on request from the Manager.

The Manager of the Denker SCI Global Equity Feeder Fund is Sanlam Collective Investments, a registered and approved Manager in Collective Investment Schemes in Securities. This is an equity fund, which means prices will go up and down. Funds that hold assets in foreign countries, it could be exposed to the following risks regarding 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 A1 class is the most expensive class of the fund with an annual management fee of 1.0%, a maximum initial fee of 2.9% and a maximum annual advisor fee of 1.0% (these fees excl. VAT). A feeder fund is a portfolio that 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.

Changes in exchange rates may have an adverse effect on the value, price or income of a product. Actual investment performance of the portfolio and the investor will differ depending on the initial fees applicable, the actual investment date, and the date of reinvestment of income as well as dividend withholding tax. The Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The performance of the portfolio depends on the underlying assets and variable market factors. Performance is based on NAV to NAV calculations with income reinvestments done on the ex-div date. Lump sum investment performances are quoted. For more information visit https://www.sanlaminvestments.com/.