Is there still value in value investing for South African investors?
Perpetua is a specialised and disciplined value manager.
In the 6 and half years since our inception, Perpetua has steadfastly and consistently pursued a value-oriented investment philosophy. According to a 2017 Glacier manager research survey, more than 50% of the investment managers surveyed (representing the vast majority of equity managers in South Africa) described their investment style as “value” while only 7% described their approach as “growth”. These numbers, however, tell a somewhat confusing story as most of the funds of the same self-described “value” managers did not actually perform the way one would have expected a value-oriented fund to have performed, especially over the past 7 years.
“Value” as an investment style has sharply underperformed over the past several years
As shown in Graph 1 following a period of strong outperformance following the internet bubble bursting in 2000, the “value” investment style outperformed most other styles until 2007. During this time, we saw many previous “growth” managers drifting to “value” as a style. However, in the aftermath of the global financial crisis in 2008, the subsequent era of globally co-ordinated quantitative easing saw equity risk premiums compressing globally and along with that price-earnings (PE) multiples expanding and asset prices increasing tremendously. During this time the “value” style began to underperform sharply while quality, growth and momentum styles performed well. During the period 2012-2017, the greatest contribution to equity returns came from price-earnings multiple expansion and not earnings and dividends growth. This contrasts to the period 2003-2007 where most of the returns from equities was sourced from earnings growth. This prolonged underperformance from “value” as an investment style over this time resulted in many investors and clients losing faith in the approach.
There are certain factors that need to exist to be considered a true value investor
Value investing is much more about the process or act of computing a fair value for an investment or the valuation of an asset. It is also much more than simply purchasing stocks which exhibit value attributes such as low PE or price-to-book ratios. More than that, to be a true value investor, assets should only be purchased when they trade at prices that are at a discount to their fundamentally determined fair value or worth. At the very heart of it, true value investors acknowledge that the price of a company and its value are often not the same and it is this mispricing that offers the opportunity to invest.
The pendulum of investor behaviour provides the opportunity to invest
There are often multiple reasons for why a share would trade at a price that is at a discount to the fundamental value or worth of a company but one reason that is typically in place which creates the mispricing: investor sentiment. Value investors are often offered up the opportunity to invest in stocks when their prices are well below their respective true value, because investor sentiment is unjustifiably pessimistic in respect of the fundamentals of the company, usually due to poor nearterm news flow. To take advantage of this opportunity (when the majority of market participants are behaving in an opposite fashion) requires specific behavioural traits on the part of the value investor. These include conviction, a sense of patient confidence, discipline, courage and a long-term outlook.
The South African equity market is currently offering up several fundamentally undervalued investment opportunities
As reflected in the poor returns in 2018, the South African equity market experienced a year of recalibration in terms of asset prices. Weak earnings prints; a constrained economic environment; very poor earnings visibility; extraction of liquidity in the market and heightened geopolitical uncertainty have all been contributing factors to 2018’s poor equity returns, when the stock market experienced a meaningful de-rating in PE multiples.
From current levels, however, prospective medium to longer-term returns are looking particularly attractive. Perpetua’s value-oriented equity portfolio has a thoughtfully differentiated positioning, with over two thirds of the portfolio invested in stocks outside of the largest 20 in the market. We are particularly confident about the long-term attractiveness of several large businesses whom due to share price declines are trading as mid or small cap companies in terms of size. The projected four-year return from our equity portfolio is now the highest it has been since inception of our True Value portfolio. In addition, we can source this return from a wide and varied range of good quality, defensive and unindebted businesses, many of which are fundamentally undervalued, trading at some of their widest discounts over the past 7 years.
Given this opportunity in the SA market, the prospect for compounding and differentiated returns from a true value-oriented portfolio is particularly compelling.
At Perpetua, we feel confident that there is considerable value in disciplined value investing and that patience and discipline will be handsomely rewarded in time.