This one-pager describes our thinking behind selected recent management actions in Global Balanced Mandates and provides context to their current positioning against the backdrop of their investment opportunity set. Our funds always consist of a diversified portfolio of opportunities and risks; please bear that in mind when evaluating my commentary about individual fund positions.
This month I am discussing our views on 5 current sources of important questions for investors.
We calculate ‘fair’ values for currencies using long term PPP. It is not expected or designed to be specifically correct and we never take investment actions in client funds at marginal currency differentials. Our model indicates a ‘fair’ exchange rate level for the Rand against the US Dollar of 9.50, which is also the number that our analysts use in their asset valuation models, for example in valuing businesses like Sasol or Richemont. The latest R/$ level of 10.31 therefore implies that we now consider the Rand to be slightly undervalued. It is fair to observe that the Rand has historically oscillated around intrinsic value, implying that it is possible that the Rand weakens further. Importantly, this does not mean that we will take an investment action that relies on such a highly uncertain and wholly unpredictable future event.
Property & Bond Price Declines
In my past year’s monthly fund commentaries I repeatedly pointed to the meaningful overvaluation, poor prospective return and return-less risk profiles of these two important asset classes in SA. May has not been a good month for owners of these assets, which does not include our clients. It appears to be linked to foreign sellers of South African assets, which typically would involve an unwinding of their related currency exposure. One or two poor months following a very long bull market does not imply or guarantee cheap asset prices, but we are keeping a close eye on price to value developments in these two asset classes. We are ready to act if and when acceptable margins of safety are offered.
In short; labour disruption and disputes are part of the fabric of the South African economy. To ever expect anything less and to price domestic assets as if there is no sovereign risk is pure folly. Just because it hasn’t happened for a while does not mean that it cannot happen. Our valuation models continue assuming reasonable and realistic levels for long term interest rates, sovereign, liquidity and equity risk premiums.
Other than our investment in JD Group, our funds carry very little investment exposure to the potential risks of a breaking bubble in unsecured lending practices. In JD Group’s case their lending business accounts for about 70% of our valuation appraisal following their business restructuring in 2012. As with any other unfolding problem that could turn into a crisis, we find ourselves drawn to the significant recent price declines in this area of the SA equity market. If there are any investment opportunities we will act on them. I hope to discuss these with you in due course.
Japanese Equity Market Rally
The Japanese equity market rallied very strongly year to date, coupled with significant Yen currency weakness against the US Dollar. Interestingly it has been a broad based rally across the small, mid and large cap spectrum, fuelled by speculative day-trading activities. We continue to calculate and expect decent prospective investment returns from the quality small and mid-cap equity segments in Japan; more specifically from your investments. In addition, the Yen has weakened to such an extent that we now consider it meaningfully undervalued on a PPP basis, in the order of 20%, which puts it on par with the investment opportunity it offered in 2007. In combination this makes investment in cheap Japanese assets particularly compelling from a US Dollar perspective.
The current RE:CM Global Fund exposure to Japanese assets is 10.9%, against the MSCI World Index weighting to Japan of 9%. This can be referred to as being ‘overweight’ Japan. We don’t spend any time worrying about whether our fund positions are ‘underweight’ or ‘overweight’ that of index constituents. We invest where we find cheap assets and thereafter we observe and comment on outcomes at the Fund level; if it makes sense to do so.