• Paul Bosman, PSG Asset Management

Perils Of Perception’ – And Keeping Clear Sightlines

South Africans are most likely to think things are worse than they really are

This is according to global market research specialist Ipsos Mori, who ranked the country top – or ‘most wrong’ – in its latest Misperceptions Index. The index is constructed based on the outcome of the company’s annual ‘Perils of Perception’ survey. In 2017, it revealed that out of the 38 countries surveyed throughout Europe, the Americas, Asia and further abroad, South Africans most consistently overestimate the size of their problems. While survey topics ranged from murder statistics to general health to smartphone ownership, we would venture that the trend might also hold true for negative assessments of the local investment environment.

When investing, perception is a double-edged sword

Acting on perception can be a costly mistake, but acting on the back of others’ misperceptions can get the odds in your favour. To place our clients on the right side of this dynamic, our process focuses us on the facts. We believe that this is the only way to discern between perception and reality, and to effectively gauge the odds of various outcomes. Blindly relying on perception (yours or others’) is likely to cloud your vision.

A recent (mis)perception: South Africa is headed for collapse

In the afterglow of the ‘Ramaphosa effect’, it is difficult to imagine that a year ago, sentiment towards South Africa was clouded by fear and negativity. Political instability, worsening fiscal metrics and credit rating downgrades had spooked local and foreign investors alike. But was the situation as bad as the market was pricing in?

At the time, our funds were invested in South African government bonds, and holdings included several domestic-facing companies (both positions we largely maintain). This was not because we were predicting the opposite of what the market was predicting – or in fact, any specific outcome at all. Rather, we believed that market prices reflected the certainty of a negative outcome, when several facts indicated that this was not a foregone conclusion.

The facts reminded us that South Africa remained a functioning democracy, with an independent judiciary and independent central bank. In addition, our public debt remained well structured, both in terms of currency and maturity. Furthermore, although the size of this debt was unhealthy in relation to GDP, it was not as dire as credit markets suggested.

However, news flow, sentiment – and therefore security prices – were all fixated on the worst possible outcome. This was especially visible in the prices of local government bonds and banks. Since mid-December, the 20-year government bond delivered a total return of 15% to end March 2018, and the local banking index 25%. While we are very careful of referencing short-term returns, this might prove to be a fundamental re-pricing. A ‘wait-and-see’ approach that limited exposure to South African-facing securities may therefore have come at a cost.

Current (mis)perceptions?

“South African industrials have rallied and run their course. There’s no further upside.”

While the prices of South African-centric stocks have recovered from the lows seen in 2017, many remain on very reasonable multiples of low profits. These profits were generated in a time when activity levels and confidence in the South African economy were very low. In fact, gross fixed-capital formation was lower than in 2014, when adjusted for inflation. There is therefore a reasonable chance that the market is underestimating the future potential profits of these companies (and multiples tend to follow profits higher).

“The rand is strong and likely to weaken.”

Predicting the movement of any currency is difficult, especially in the short and medium term. Furthermore, perceptions of a currency’s strength or weakness are often the result of its recent direction of travel. This is a dangerous over-simplification.

There are several scenarios under which the rand could strengthen further – and perhaps dramatically – from current levels. (Lyle Sankar writes more about this in his article). Positioning a portfolio with a strong bias towards rand-hedge assets based purely on exchange rate predictions may therefore be problematic. As long-term, bottom-up investors, we believe in evaluating each security we consider on its individual merits – and not on macroeconomic or currency views. Our portfolios therefore include South African bonds and industrial stocks (which will benefit from a stronger rand), as well as international stocks, which could detract from fund performance if the rand strengthens. We don’t predict currencies.

Diversified portfolios of quality, undervalued instruments should continue to serve investors well

We believe that perception is a powerful force that favours the most informed – so we make it a priority to be well informed. We aim to achieve this by, firstly, always doing our own homework: we rely on original sources rather than second-hand, ‘packaged’ research. Secondly, our team-based approach encourages debate and critical thinking. Finally, the investment checklists we’ve developed from our prior experience and learnings act as a final risk overlay, ensuring that facts – and not perceptions – remain at the forefront of our process.


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