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Investment views

Losing sight of the shore

10 October 2019
Author: Duane CablePortfolio Manager, Quality
“You cannot discover new oceans unless you have the courage to lose sight of the shore.” Andre Gide

South Africa is small in the context of the global investment universe, representing less than 1% of the respective global equity, property and bond indices. Today, more than 50% of earnings from businesses listed on the JSE are generated from outside South Africa. In the volatile world in which we find ourselves, it has become increasingly apparent that one needs to have a global perspective to navigate the choppy waters of investment markets. Being based in London for the last few months, has taught me how easy it is for investors to develop a home bias. These biases are natural, given the perceived edge gained from home court advantage and familiarity with local market trends. The reality is that global trends have a material influence on domestic markets and one needs to have a more balanced perspective when evaluating the attractiveness of investment opportunities – both locally and abroad.


Global depth and breadth

Investec Asset Management has a proud emerging market heritage, but the founders have invested for the long term and have built a truly global asset manager. Assets under management have grown to approximately R2 trillion, with an investment team of over 240 investment professionals based in Cape Town, London, New York, Hong Kong and Singapore. Since my arrival in London, I have been most impressed by the depth and quality of research at Investec Asset Management and the level of integration – both regionally and across capabilities. The ability to attract global talent, superior access to global management teams and improved local insights from being based on the ground, are just a few of the advantages that come from achieving global depth and breadth.


Tapping into China

I believe the opportunities and threats posed by China have become increasingly important for South African investors to grasp, given the impact on stocks like Naspers, Richemont and resource shares. Investec Asset Management has expanded its investment offering to tap into China’s growth opportunities. We now have approximately 30 investment professionals across capabilities with a Chinese focus, of which 10 are Mandarin speakers.

Tencent is a business which has great significance for South African investors, given that Naspers’s c.31% ownership stake represents more than 100% of the current market capitalisation of the internet and media giant. We have exposure to Tencent across multiple capabilities and we share ideas among teams. Within the Quality capability, our two Asian-focused specialists cover Tencent and its Chinese competitors. The scale of Investec Asset Management allows for regular access to Tencent management. What’s more, depth of coverage across the Chinese technology sector means we richly debate the merits of Tencent’s larger peers like Alibaba and Baidu as well as gaming rivals like Perfect World and NetEase. Of course, the lesser known investments within Tencent like Huya (live game streaming), JD.com (e-commerce), Pinduoduo (e-commerce) and Meituan-Dianping (platform) are also on our radar.


Too much reliance on consumer-led growth in China?

The booming Chinese consumer is having a disproportionate impact on the results of several sectors we follow. Looking at the luxury goods and prestige beauty sectors, Chinese nationals account for 30-45% of revenue for most stocks that we cover. It is easy to conclude these growth rates are not sustainable, and earnings estimates for these businesses are inflated, given the overreliance on the Chinese consumer. However, a closer examination of the current wealth disparity between China and the US, suggests that there is a long runway ahead for the Chinese consumer (Table 1).

Table 1: The current wealth disparity

  CHINA US
Wealth levels Income per day % of Total Cumulative % of Total Cumulative
High $50+ 0.8%   52.5%  
Upper middle $20-$50 9.7% 10.5% 36.5% 89.0%
Lower middle $10-$20 29.1% 39.6% 7.5% 96.5%
Low $2-$10 59.5% 99.1% 2.3% 98.8%
Poor < $2 0.9% 100.0% 1.3% 100.0%
  100.0%   100.0%  

Source: Chinapower.csis.org

Taking into account China’s 1.4 billion-strong population, one starts to appreciate the potential prize available to businesses that are able to tap into this market successfully. If the top wealth level in China increases from 0.8% to just 10% of the current total population, it will add almost 130 million new potential consumers of luxury and prestige beauty products. As illustrated in Table 1, the assumed 10% would still be a fraction of the highest income group in the US (c.53% of the current US population).


Avoiding the emotional allure of luxury brands

While the opportunities to tap into the booming Chinese consumer are abundant, they are not without risk. As long-term investors, we think carefully about the risks and make sure we understand the sustainable competitive advantage of each business we analyse. There is no guarantee that century-old brands will stay at the top of their game. As discerning investors, we need to understand what the true competitive advantages are for each business and whether they have enduring qualities that will help us to grow and preserve our clients’ capital over time. Prada is over 100 years old and used to be one of the most iconic leather goods brands in luxury, alongside Louis Vuitton, Gucci and Hermes. However, a lack of product innovation and digital distribution after the 2011 initial public offering, took its toll on revenue and profitability. Today, the business is a shadow of its former self. Investors who got caught up in the emotional allure of the Prada brand while ignoring some of the structural challenges, have paid a heavy price, with the stock having declined c.73% from its peak.

Another interesting case study is Gucci, which is currently one of the hottest brands in luxury. As long-term investors, it is important to consider recent trends within the historical context of a company. Gucci has had quite a volatile history with three creative directors over the last 25 years. The company’s creative directors have typically enjoyed impressive revenue growth at the start of their tenures, but inevitably they would have to vacate the creative ‘hot seat’ when they could not sustain performance over the long term. Allesandro Michele is the current creative director, and the Gucci brand is once again on fire. Has Gucci finally found the ‘magic formula’ to deliver more sustainable growth or will its past failures haunt it once again? These are the important questions to consider when building an investment case for these businesses.

While I am a believer in the longer-term structural growth drivers in the luxury sector, the reliance on China has increased volatility. Investors need to consider macroeconomic and geopolitical risks that are difficult to forecast. Besides these factors, the regulatory risks around daigou1 and new ecommerce laws are also key issues to ponder. The beauty of being a truly global asset manager is that we can tap into collective insight across the globe to manage risks and uncover the best investment ideas.


Home bias, risk and portfolio construction

A good example to illustrate home bias is Quilter, which happens to be listed on the JSE as a result of the Old Mutual restructuring. Its business operations are predominately in the UK, yet South African investors own more than 60% of its outstanding shares in issue. Do South African investors see something in Quilter which UK investors are missing? Within the Quality capability we have full coverage of the UK Wealth Management sector, which includes Quilter but also a range of competitors like St. James Place, Hargreaves, AJ Bell and Integrafin. We prefer St James Place, given its superior quality and growth prospects, and have reflected this view in our portfolios. We are able to adopt this globally integrated investment approach for all South African dual-listed stocks, which we believe presents a unique proposition to South African clients. Most local managers have outsourced their global allocations to global managers who typically construct the offshore component of portfolios without considering the overall portfolio (e.g. South African positioning, security correlations and overall portfolio benchmarks).

We often go about our daily lives ignorant of the risks involved in routine tasks. However, ignorance of risk is not advisable when it comes to managing client portfolios. While our job is not to avoid risk, the insights gleaned from our investment process allow us the ability to manage those risks through appropriate portfolio construction.

Robert Rubin, the former US Secretary of the Treasury and Goldman Sachs and Citigroup executive, summarises the dilemma we face when making investment decisions across portfolios: “Individual decisions can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision making will lead to better overall results, and more thoughtful decision making can be encouraged by evaluating decisions on how well they are made rather than on outcome.”

Over the long term, a good investment process should result in more successful decision-making. I am pleased that our flagship Quality portfolios, namely the Investec Cautious Managed, Investec Opportunity and the Investec Global Franchise strategies, have delivered first quartile investment performance over all meaningful periods as at the end of August, source Morningstar.


Conclusion

The last few months away from the shores of South Africa have taught me that the global asset management industry is operating in an increasingly competitive environment. What was once considered proprietary research a few years ago, has become standard practice in the industry as active managers battle to remain relevant. I have no doubt that these global trends will impact local active managers and we will either need to adapt or be disintermediated. Investec Asset Management is one of the few local managers that is able to offer a truly globally integrated investment solution to clients. We will ensure that we continue to work hard to stay ahead of global industry trends and guard against complacency. It is important to never forget that we are the custodians of our clients’ capital. We remain focused on generating world class investment research, which will enable us to construct portfolios that can deliver the targeted returns expected from our investors.

 

1 Daigou (pronounced ‘dye go’) is a form of cross-border importing in which an individual purchases goods such as luxury handbags or cosmetic products outside of China, for customers in China.

Duane Cable
Duane Cable Portfolio Manager, Quality

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All information provided is product related and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Past performance is not necessarily a guide to future performance. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. We endeavour to provide accurate and timely information, but we make no representation or warranty, express or implied, with respect to the correctness, accuracy or completeness of the information and opinions. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate. Any representation or opinion is provided for information purposes only. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management (Pty) Ltd is an authorised financial services provider. Issued by Investec Asset Management, October 2019.

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