Last quarter, Seema Dala wrote about the importance of diversifying your portfolios by investing offshore. Australia is definitely offshore from South Africa, but there are also some strong similarities between the two economies. L J Collyer and JD de Lange, from Allan Gray Australia, examine whether investing in Australian equities makes sense for a South African investor.
Other than being fierce competitors on the sports field, South Africa and Australia have many other things in common. For the 112 years to the end of 2012, for example, South Africa and Australia had the best performing stock markets in the world, in real terms1. Both are resource-rich countries, and resource companies make up a significant percentage of both the Australian Stock Exchange (ASX) and the Johannesburg Stock Exchange (JSE). Furthermore, financial shares make up more than 30% of both the S&P/ASX 300 Index and the FTSE/JSE All Share Index (ALSI). In terms of contribution to global GDP, South Africa contributes less than 1% and Australia 2-3%.
Despite a similar make-up, the indices show stark differences in valuation
Since the 2008 global financial crisis, the South African market has rebounded, recording new highs in 2013. The Australian stock market, meanwhile, has not seen this type of recovery. Although last year was a good one for Australian stock market investors, there are still a lot of stocks trading below our estimate of intrinsic value. Graph 1 displays the performance of the two indices since 2000 in local currency terms (the ALSI on the left hand axis and the ASX on the right).
The valuations between the two countries are not aligned and the sectors where one can find value are also different. Compare Graph 2, which shows the relative performance of key indices in Australia, to Graph 3, which illustrates the South African story. Australia’s Retail sector has been trading at cyclical lows over the last few years due to cheap imports from China, growing online competition, a high savings rate and competition for capital from a Commodities sector that has excelled until recently. The picture is quite different in South Africa, where retailers (and other industrial shares) have been booming, while the Commodities sector has had a torrid time on a relative basis. These differences suggest a range of diversification opportunities for South African investors.
The Allan Gray Australia Equity Fund is typically contrarian, which in itself provides diversification
Looking at the sectors that have underperformed (as shown in Graph 2), readers who are familiar with our contrarian approach to investing will not be surprised that the Allan Gray Australian Equity Fund is very underweight Commodities and Financials (that together represent 55% of the ASX). As a result, the Fund has a very large exposure to the rest of the ASX. The current positioning of the Fund compared to the ASX 300 is shown in Graph 4. The Fund therefore offers South African investors a fair degree of diversification on a sector level.
In addition, a number of the top 10 shares held in the Fund are in sectors that provide unique opportunities to South African investors because they are lesser known sectors or similar opportunities are not available on the JSE. Examples of these include:
- Utilities – SP AusNet (7.7% of the Fund): A utility company that manages an electricity and gas network in Victoria, Australia, providing electricity transmission and distribution and gas distribution services to households and industry.
- Energy – Origin Energy (4.1% of the Fund): Australia’s largest energy retailer and one of the country’s largest electricity providers. It also has significant interests in liquefied natural gas (LNG) projects and invests in a number of renewable energy technologies.
Investing in Australian equities via the Allan Gray platform
One way for South African investors to access Australian shares is through an Australian equity fund, either directly through an Australian investment manager, or by investing in a fund via an offshore platform. The Allan Gray Australia Equity Fund seeks to offer investors an opportunity to benefit from higher long-term returns than the Australian stock market as measured by the S&P/ASX 300 Accumulation Index. It is a concentrated portfolio of shares listed on the ASX and may be appropriate for investors looking for contrarian-style investment exposure to the Australian stock market. Investors must be able to take a long-term view and endure shorter-term performance fluctuations. A minimum investment period of five years is recommended. Investors looking for investment exposure to Australia, without taking on equity market risk, should follow the same approach as they would when picking a local fund, and look for funds that are not as exposed to the equity markets.
The Allan Gray Australia Opportunity Fund invests in top-rated Australian bank deposits. In addition, analysts look out for investment opportunities in the Australian stock market where they have high confidence that a specific share will yield returns better than cash with limited downside. Over the long term the Fund aims to deliver a return better than the Australian Reserve Bank’s cash rate, rather than focusing on delivering returns relative to the stock market. Early indications are encouraging, with the Fund returning 7.4% per year in Australian dollars after two years.
The Fund does not gear or use derivatives and will never have a share exposure of more than 50%. In certain market conditions (when the market is overvalued) the Fund may have no share exposure at all with all money invested in cash deposits.
Over time, the aim is to have higher share exposure when many shares in the market are trading at a discount to our estimate of intrinsic value (and thus yield investment opportunities that should give good absolute returns).
The Allan Gray and Orbis philosophy and approach remains the same, irrespective of geography
Although the opportunity set available in Australia is different from that of South African investments, Allan Gray Australia’s investment philosophy and approach is the same as that of Allan Gray and Orbis. We focus on our discipline of assessing a company’s true intrinsic value and we only invest when the share price that we will pay is substantially lower than the value we are buying to ensure that we have a margin of safety for each share in our portfolio.
Is Australia the right diversification opportunity for you?
While the differences between South Africa and Australia currently outweigh the similarities, in a global context, the diversification opportunity may not be appropriate for everyone. However, if you are planning to move to Australia, or have family ties or business interests in Australia, it is probably worthwhile exploring. It is crucial of course that your investment decisions meet a specific need in your portfolio. If you need help with diversification, or investing in general, we encourage you to speak to a professional independent financial adviser.
The Allan Gray Australia Equity and Opportunity Funds are both available via the Allan Gray Offshore Investment Platform and have been approved by the FSB for marketing to South African investors.