Reflecting on 25 years of the Denker SCI Equity Fund

Caylin Conradie:

I’m Caylin Conradie, Head of Marketing at Denker Capital. Today is the 27th of October, and it’s quite fitting that our 25th episode is about the 25th anniversary of the Denker Sanlam Collective Investments (SCI) Equity Fund. We are very proud to have reached this milestone, as not many funds in South Africa boast such an extensive track record. So, today, I’m chatting with Claude van Cuyck, Portfolio Manager of the fund, to gain his insight into what he’s learned over this time managing the fund, how the fund has performed for investors, and his take on the SA equity market. Welcome, Claude.

Claude van Cuyck:      

Thanks, Caylin.

Caylin Conradie:

Let’s start at the beginning. Why was this fund launched?

Claude van Cuyck:      

Caylin, the fund was launched, as you said, 25 years ago, and the real objective here is to compound real wealth for clients over long periods of time, and for us to be able to do that through an active management approach, but at the same time also providing a reasonable level of current income, and that’s via a steady flow of dividends from the fund.

By providing access to really good-quality management, well-managed businesses, good-quality companies at favourable valuations, this allows clients to really grow their real wealth and wealth well ahead of inflation.

Caylin Conradie:

So, you’ve been researching SA equities for over 30 years. You’ve obviously seen quite a lot in this time. I’m keen to hear your take on how the SA listed environment has changed over the years.

Claude van Cuyck:

Caylin, over the 31-year period that I’ve been involved in the markets, the SA listed space and the environment has changed significantly. In 2001, there were over 600 companies listed on the JSE. Since 2000, and the 2001 period where the IT bubble sort of burst after it’s boom in the late 1990s, we lost almost 250 listed companies on the JSE.

So, today, we have just over 300 companies listed, very much closer to what was listed in 1994, and we generally see these listing booms when the economy is really booming and global markets are booming. Then you have these behavioural factors, and in particular, greed, that really drive the listing booms as many private companies come to the market with players, hopefully your participants, hopefully trying to get rich fairly quickly.

We saw this run up to the IT boom in the early 2000s, and between 1997 and 2000. We had 240 new listings and when the bubble burst post 2000, we saw 290 de-listings between 2000 and 2003.

Caylin Conradie:

That is quite a change in listed companies over time. Has that created opportunities for you?

Claude van Cuyck:      

Yes, Caylin. More recently, we’ve seen quite a few de-listings in the SA environment. And, in particular, some really good-quality businesses that have delisted (Distell, for example). Not only Distell – Mediclinic, RB Platinum and Pioneer Foods a little while ago too. Very often, when you go through these delisting periods, these companies tend to be taken out at fairly significant premiums relative to the market. So, we’ve benefitted substantially from that over the last few years.

We were big investors in Mediclinic, we were large investors in RBPlats. We had Alviva, which is a small cap IT company that was taken private at a significant premium. It was taken out at R28, and we initially bought shares at R6. So, that does create opportunities to unlock value for our investors.

Caylin Conradie:

And how has that unlocked value over the 25 years?

Claude van Cuyck:

So, to talk a little bit about the performance of the fund over the last 25 years, the highest fee class of the fund (the R class) has compounded at a rate of 15.7% per annum, net of fees, outperforming its benchmark over that 25-year period per annum by a rate of 1.6%. These returns are as at the end of September 2023. In order to double your money over a five-year period, you need to generate a compound return of 14.9% per annum. So, that means over 25 years you would’ve had five opportunities to double your wealth over that period. Since the fund compounded at a rate of 15.7%, means that a R1 million investment invested 25 years ago would’ve grown to R38.3 million today. And that compares to if you were just purely invested in the market, your R1 million would’ve compounded to R27 million. So, the fund has generated wealth at a rate of 42% higher than that of the market.

If you had compounded at the rate of inflation, which averaged about 5.6% over that 25-year period, your R1 million would have compounded to just under R4 million. So, the fund has actually created ten times more wealth, in real terms, for an investor over that 25-year period.

Caylin Conradie:

And when you say market, what index are you looking at?

Claude van Cuyck:      

In the initial stages, over a large component of that 25-year period, the benchmark was initially the FTSE/JSE All Share Index. At a later stage, we changed that to the FTSE/JSE Capped Swix. Then, over the last number of years, because we were able to invest offshore, we included an MSCI global portion to that benchmark. So, as it sits today, that benchmark is 87.5% the FTSE/JSE Capped Swix and 12.5% the MSCI World Index.

Caylin Conradie:

So, it’s massive outperformance of the benchmark over time.

Claude van Cuyck:

Absolutely.

Caylin Conradie:

Obviously, we hope for investors to be invested for 25 years, but that’s not the case for everyone. So, if we look at shorter-term performance?

Claude van Cuyck:

So, over the shorter term, if we’re looking over the last one, two, three, and five years – the fund has outperformed its benchmark fairly consistently over that period. Over three years, the fund has achieved an annualised return of 16.4%, so slightly higher than the 15.7% compound rate over the 25-year period. Obviously, everything moves in various cycles – we’d love to be able to compound continuously at a rate of 16%. The fund is in the top quintile, top 20% of funds, versus its peers over one and three years, and in the top third over five years.

Caylin Conradie:

Well done on that performance.

Claude van Cuyck:      

Thank you.

Caylin Conradie:

Claude, this fund has been going for a long time, and you’ve been in the industry for a long time. What are some of the successes and challenges that you’ve experienced over your time managing the fund?

Claude van Cuyck:                  

I think let’s start with the challenges. So, it’s fantastic that the fund’s had great performance, but as I said earlier, it doesn’t all come in a straight line. There are periods where you do have challenges, and that’s why investors, I feel, should be invested for the longer term.

On the challenges side, I’ll talk specifically to 2015 and 2017. We had a fairly tough period of performance in late 2015, and that was at a time where we had a fairly large holding in SA banks, where we saw a significant amount of value. But if you can recall, in 2015 we had the Nenegate scandal, and that’s when Jacob Zuma decided to fire the finance minister, Nhlanhla Nene, in December 2015, which was a terrible Christmas present for us.

So, we’ve certainly learned over time that by avoiding mistakes, and particularly avoiding bigger mistakes, you’ve already won half the battle. We experienced some challenges in 2017, as well. We had a fairly tough period of relative performance, and that came down to a holding that we had in Steinhoff. We did react very swiftly to the news when it broke out in December 2017. We immediately sold our investment, because the whole investment case had changed, and we managed to exit at about R19 a share. So, again, that was not a very pleasant Christmas present. But, you’ve got to take the good with the bad and learn from those mistakes.

Caylin Conradie:

So, after two bad Christmas periods, what did you learn? Is there anything you did differently after those periods?

Claude van Cuyck:

Yes, we absolutely did. Although your investment philosophy never changes, or shouldn’t change, that should be embedded in your DNA, your process needs to adjust and needs to evolve to conditions that might change over time. So, through that period, we realised that consistency of performance is crucial to our investors.

As I said earlier, avoiding mistakes is a big part of winning the game I guess, in this environment. So, we brought in very tight risk controls in late 2017, early 2018, into our risk management process. So, we incorporated a proprietary risk management dashboard, or tool, that monitors various company-specific or idiosyncratic risks, as well as market-related risks. And we also incorporated ESG directly into the process in 2020, and that was really to tighten up our responsible investment framework.

Caylin Conradie:

On the risk management dashboard, Claude, what are some of the factors that you look at from a company point of view?

Claude van Cuyck:

So, Caylin, a lot of thought went into that process. And when we look at company-specific risks, and this is an important part of our investment philosophy, as well, is identifying companies that have really good business economics, that have competitive advantages, that are able to generate return on invested capital well above the weighted average cost of capital. Because, if you can identify those companies, you are able to grow the intrinsic value of your underlying investments over time.

So, a lot of time is spent on understanding the business economics, firstly, and the moat of a company. Secondly, we also look at the quality of management. We feel that very often the market underestimates the significance of a really good management team.

We rate our universe of 100 companies, that we follow, very actively across the JSE between an A-rated management company, which is a good-quality management team, and an E-rated company, which is a very poor-quality management team. So, we’ve got the quality of the business economics of a business, the quality of a management team. And then, a third very important factor is understanding the intrinsic value of a business, i.e., do you have a margin of safety when you’re allocating capital?

Caylin Conradie:

And how has looking at these specific factors in a business contributed to success in the past? So, apart from the risk management dashboard?

Claude van Cuyck:      

We’ve had a number of successes over the years. But, just to remind investors, we should never rest on our laurels with past successes. We clearly need to focus on future opportunities. We’re only as good as our last successful investment. Success is not only measured by what you earn in the portfolio. It’s also about what you’ve been able to avoid -avoiding some of the disasters.

To tie that back into the risk management process, if you are able to identify over-valued sectors or companies, or identify poor-quality businesses, you are able to eliminate that risk factor when you’re making your investment decision. So, if I go back to 2008, the run-up to the resources bubble where commodity prices were at extreme levels, driven by huge demand from China, we felt that the resources sector in 2008 was hugely overvalued.

At that time, resources were almost 50% of the FTSE/JSE All Share Index. We had less than 10% of our clients’ capital allocated to resources over that period. So, just by avoiding a significantly overvalued sector, you were able to really protect a fairly large amount of capital for your clients. So, I just wanted to contextualise that. It’s also about avoiding disasters.

Then, we’ve had other successful investments. So, I’ll talk about two in particular on the small cap side. Combined Motor Holdings, we’ve owned the company in the portfolio for many, many years. And over the past 15 years, it’s increased value almost 17-fold. It has had two of the oldest serving directors on the JSE. The CEO, Jebb McIntosh, was appointed in 1976.  It’s a simple business. It’s an auto retailer. It’s got a car hire business to it. It’s a fantastic business. It generates extremely high return on invested capital, certainly relative to its cost of capital, and it’s been able to compound a huge amount of value for us over the years.

I’ll also highlight another company, which is Altron, which unlocked significant value, where we took a very active approach to unlock value. We engaged with Value Capital Partners in early 2017, and together with some other shareholders, we were able to drive significant shareholder value creation. In March 2017, Altron’s share price was R7 a share. It had a market cap of less than R3 billion. Three years later, by Feb 2020, the share price had gone from R7 to R23, from a market cap of just under R3 billion to R8.5 billion. And then, subsequent to that Feb 2020 period, they unbundled Bytes Technology Group and listed that in the UK. And the current market capitalisation of Bytes Technology Group is R26 billion. So, you took a R3 billion investment in 2017 to well over R30 billion investment opportunity, which was more than a tenfold increase in value over that period. So, that also added significant value. And these are the types of opportunities, that we’re looking for.

Caylin Conradie:

When did you invest in Altron?

Claude van Cuyck:

We had invested in Altron prior to that. I can’t recall our exact entry level. But it probably was in the order of R8 or R9 a share on average when we invested. By the time we had exited that investment, it was almost a tenfold increase in value.

Caylin Conradie:

You spoke earlier about avoiding resources. It must take quite a lot of discipline to do the opposite to what everyone else is doing in times like that.

Claude van Cuyck:

Yes, absolutely. I think it talks to some of the behavioural factors of investing. The biggest mistake will be if you get sucked up into this sort of greed scenario where markets are performing incredibly well, there’s a huge amount of momentum, and you get sucked into that, and vice versa.

You need to have that discipline as a portfolio manager. When times are tough, that is when you have your best long-term investment opportunities. And when there’s a bubble emerging, you need to have the fortitude to say, look, I don’t want to get involved in that bubble. It can last for a fairly long period of time, so you need that discipline.

Caylin Conradie:

Obviously, discipline comes from experience, which is something that you and your team have. Could you tell us what else differentiates this fund from the rest?

Claude van Cuyck:

That talks clearly to what you believe your competitive advantages will be relative to your peers. So, there are three that we can clearly highlight.

As a smaller boutique asset manager, we have a much broader universe of stocks available to us to choose from. So, we actively cover 100 stocks. Many of your larger peers, purely from a liquidity point of view, will only be able to really invest in the top 40 stocks. So, that small- and mid-cap space is a significant differentiator for us, where we can tap into opportunities. So, our top ten relative positions often differ quite substantially from our peers. Over time, we’ve probably averaged about 30% of the capital allocated to that mid- and small-cap area of the market that is under-researched.

The second point, is the experience of the investment team. We’re focused and we’re passionate about generating great returns for our clients. I’ve been focused on local equities for a 31-year period. My colleague, Jan Meintjes, who I’ve worked with for many, many years has been in the market for 28 years, and we’ve got a great team of analysts that support us. So, with that, I think our clients can benefit from the stock-picking skills of the team across mid, large and small caps.

Thirdly, there are very few boutique asset managers that have an extensive and integrated global equity team available to them. We’ve run global equity funds for decades. Kokkie Kooyman’s been around for over 30 years. Our global equity team has managed funds for a long period of time. And now we are able to invest up to 45% of our assets globally. So, we need to be able to tap into really good-quality global opportunities. So, I think that is a significant differentiator for us, as well.

Caylin Conradie:

With all these skills in the team, what opportunities are you seeing at the moment?

Claude van Cuyck:

I think, Caylin, we’re seeing a lot more opportunity at this point in the SA equity market relative to global, just given the fact that there’s a lot of negative news, certainly in SA at the moment. And that’s a function of the obvious consumer pressures that we’re seeing on the back of high inflation, higher interest rates, our Eskom challenges which have had a dramatic impact on domestic SA.

So, long-term opportunities are generated, as I mentioned a little bit earlier, when the environment is fairly tough. You see the breadth of opportunities increase dramatically. You see a lot of good-quality businesses de-rating significantly and offering a lot of investment opportunities. So, if we look at the investment universe of 100 stocks that we have, the median price-to-earnings multiple of that universe currently is about 9.5x, with a median dividend yield of approximately 5%.

In the context of seeing pretty decent-value opportunities in SA, the likes of a Mr Price, Italtile, Pepkor, Hudaco, all of these companies are trading anywhere between a 7.5x price-to-earnings multiple to a 10x multiple. So, we’re seeing a lot of opportunity there.

I’ll give a few other examples. Sun International, we’ve built up a reasonable position there over time. They’re recovering post-Covid as consumers return to their gambling habits, as hotel occupancies are increasing. The likes of Famous Brands, consumers are now eating out a lot more post the Covid recovery. You’re seeing more travel. The quick-service restaurant environment is improving, people are dining out. So, those are some of the opportunities. The banks in South Africa remain relatively cheap, trading anywhere between 7x and 9x multiples.

We also have to look at our banks in the context of global opportunities because, as I mentioned, we can invest up to 45% offshore. So, we do see some opportunity in local banks, but we also see a lot of opportunity in Kokkie’s global financial fund, so we’ve got about 7% of the fund exposed to the Denker Global Financial Fund, which is very well diversified across developed and developing market banks, and insurers and asset managers.

Caylin Conradie:         

Well, I think we’re looking forward to seeing how these opportunities play out for investors. Claude, to finish off, I’ve got one last question for you. If an investor had to sit in on one of your investment meetings, what is the one thing you’d like them to take away from it?

Claude van Cuyck:      

Caylin, I think in line with our company vision, and it might sound a little bit corny, but our company vision is: to be our clients’ greatest discovery. And if a client was sitting in one of our meetings, I would like to convince them and show that we are able to create real wealth for our clients over time, and to do that by identifying fantastic investment opportunities that can compound wealth over time.

And we would do that with the robust debate that we have within the team. In all of our team meetings, we are focused on one thing at the end of the day, and that is identifying and searching for these great long-term investment opportunities. So, hopefully they’ll walk out of that meeting and realise that we are our clients’ greatest discovery.

Caylin Conradie:         

I’m not on the investment team, and it is very clear to me that the team is very passionate and skilled at what they do. Thank you so much for your time today. It’s been very interesting taking a trip down memory lane with you. We’ll chat again soon.

Claude van Cuyck:      

Thanks Caylin, and yes, thanks for the opportunity to talk about the fund.

Disclaimer:

Annualised performance since inception:

Source: Morningstar, 30 September 2023. Inception date: 1 October 1998. Returns are net of fees. Returns for periods longer than one year are annualised. The highest annual calendar year returns over the last 10 years was 24.4% and the lowest was –15.5%. The R class has an annual management fee of 1.55% (incl. VAT), a maximum initial advice fee of 3.45%, a maximum annual advice fee of 1.15% and a performance fee of 20%.

The information in this podcast belongs to Denker Capital (Pty) Ltd and Sanlam Collective Investments (RF) (Pty) Ltd. The information should only be evaluated for its intended purpose and may not be reproduced, distributed or published without our written consent. Although all reasonable steps have been taken to ensure the information in this podcast is accurate, Denker Capital and Sanlam Collective Investments do not accept any responsibility for any claim, damages, loss or expense – however it arises, out of or in connection with the information. No member of Sanlam gives any representation, warranty or undertaking, nor accepts any responsibility or liability as to the accuracy of any of this information. The information does not constitute financial advice as contemplated in terms of the Financial Advisory and Intermediary Services Act, No 37 of 2002 (FAIS). Use or rely on this information at your own risk. Consult your financial advisor before making an investment decision. Sanlam Collective Investments (RF) (Pty) Ltd is a registered and approved Manager in Collective Investment Schemes in Securities.

Collective investment schemes are generally medium- to long-term investments. Past performance is not necessarily a guide to future performance, and that the value of investments/units/unit trusts may go down as well as up. Changes in the exchange rates may have an adverse effect on the value, price or income of a product. A schedule of fees and charges and maximum commissions is available from the manager on request. Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. Forward pricing is used. The Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The manager has the right to close the portfolio to new investors in order to manage it more efficiently in accordance with its mandate. Performance is based on a NAV to NAV calculations with income reinvestments done on the ex-div date. Performance is calculated for the portfolio and the individual investor performance may differ as a result of initial fees, actual investment date, date of reinvestment and dividend withholding tax. Annualised return is the weighted average compound growth rate over the period measured. If the fund holds 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 fund may invest in other unit trust funds which levy their own charges and may result in a higher fee structure for our portfolio. All portfolio options presented are approved collective investment schemes in terms of Collective Investment Schemes Control Act, No 45 of 2002 (CISCA). The forecasts or opinions in this podcast are not guaranteed to occur.

Sanlam Collective Investments retains full legal responsibility for the co-branded portfolios. The portfolio management of the fund is outsourced to Denker Capital (FSP no: 47075), an authorised financial services provider in terms of the FAIS Act. For more information, visit www.sanlaminvestments.com