By: Philipp Wörz
“The PSG Angle is an electronic newsletter of PSG Asset Management.”
The PSG Angle: Opportunity returns to global equity markets – but selectively so
Despite an overall positive macro backdrop, we have expressed concern about the generally elevated levels of global equity markets for some time. These concerns have been founded on high valuation ratios (relative to historical levels) and extreme investor complacency. Conversely, we have been increasingly positive on domestically focused South African companies. Here, political and economic uncertainty has kept prices low, despite the inherent quality we see in these businesses.
On the back of extended valuations, cash levels in the PSG Global Flexible Fund increased
Prevailing market conditions resulted in us finding fewer high-conviction opportunities across global markets. As such, offshore equity allocations across our domestic funds have not been at full capacity, and cash levels in the PSG Global Flexible Fund steadily increased throughout 2017. In fact, after the strong start to global equity markets in 2018, the fund’s cash exposure reached a record high of 37% in late January.
As we often emphasise, the inherent value of cash is seldom evident in times of exuberance. However, we consider it one of the most uncrowded and under-appreciated global asset classes. This is especially true when yields are low and appetite for risk is high – as has recently been the case. The true value of cash tends to show itself when volatility rises, prices fall and liquidity is in short supply. It is then that it serves as valuable firepower to capitalise on market mispricing.
Recent market pullbacks have provided opportunities to deploy some of our cash reserves
Global markets have recently pulled back somewhat; a development we welcome as we believe that the prolonged lack of volatility provided limited market-specific opportunities to acquire quality assets at attractive prices. It may be long forgotten by some, but the S&P 500 Index rose for a record 15 consecutive months to end January 2018.
Lower prices increase our pool of opportunities to deploy capital and are necessary to sow the seeds for attractive long-term returns. Indeed, over the past two months, several areas of the markets have presented excellent global investment opportunities for both our domestic and global funds. One such area has been the US retail property sector, where historic overbuild, department store issues, fears of online cannibalisation and higher interest rates have driven valuations to low levels. People tend to paint specific sectors with the same brush and while mall traffic has been under pressure for some time, this doesn’t apply to top-quality, Class A retail properties, which remain sought-after assets. Consequently, we have been buyers of the US-listed Simon Property Group, the world’s leading retail Real Estate Investment Trust (REIT) and owner of 325 properties, including five of the US’s top 10 malls. The company has compounded its distributions per share by 8.5% per year over the past 16 years and currently yields 5.1% – a spread of 2.3% over US Treasury bonds. We have also found company-specific opportunities in Japanese financials, agricultural commodity producers and energy services.
We have therefore utilised some of the cash our funds built up last year to take advantage of these opportunities, as shown in the chart below. As at end March, cash in the PSG Global Flexible Fund stood at 28%. Similarly, we have increased offshore allocations in our domestic funds.
PSG Global Flexible Fund – Cash level, price/earnings (P/E) ratio and MSCI World Index P/E ratio
Sources: PSG Asset Management, Bloomberg, MSCI World and company data
Despite the recent declines, overall market valuations remain high
Investors should bear in mind that although markets have declined by approximately 10% from recent highs, overall market valuations are still elevated when compared to history. In fact, many stocks are only back to where they were a few months ago. Fortunately, for bottom-up stock selectors like ourselves, the global investment environment remains one characterised by extremes. The differences between the prices paid for expensive stocks that dominate indices and those paid for cheap, out-of-favour stocks are at levels last seen during the dotcom bubble.
Uncrowded parts of the market continue to present the most compelling opportunities
As an outcome of our process, many of the investment opportunities we have recently allocated to tend to be in areas of the market characterised by higher levels of uncertainty. It is in areas such as these that general sentiment results in the mispricing of attractive individual opportunities. We are confident in the investment fundamentals of the recent additions to our portfolios, and positive on the long-term returns these companies can deliver. By consistently applying our 3 M criteria – looking for companies with a sustainable competitive advantage (Moat) and good Management that are attractively priced (Margin of Safety) – we believe we can continue to extract value from cheaper, uncrowded opportunities. We still have a significant amount of cash at our disposal to do so.
Philipp Wörz is the Fund Manager of the PSG Global Equity and PSG Global Flexible Funds, and the PSG Global Equity and PSG Global Flexible Feeder Funds.