December brought to a close what has been a very rewarding quarter for the Investec Value Fund, with the month’s 7% return bringing the quarterly return up to a substantial 21,59% — well ahead of the all-share index’s return of 11,8% and sufficient to place the fund as the top-performing value unit trust over the quarter.
After a disappointing second quarter, the strong finish to the year enabled the fund to end the year as the second-best value unit trust with a return of 41,56% — in line with the all-share index’s return of 41,2% and a good result when one considers that at mid-year the fund was about 10% behind the index.
Investors should also note that 2006’s return was sufficient to place the fund in position six out of 54 funds if compared with funds in the general equity sector. Over five years the fund remains the best-performing equity fund across all sectors with a 41,8% compound return.
Performance over the last quarter of the year was driven by the fund’s large positions in banks (+24% over the quarter), general retailers (+28%) and mobile telecoms (+35%), as well as our small positions in the underperforming areas of oil and gas (+3%), general mining (+3%) and life insurance (+4%).
The strong run-up in domestic interest-rate stocks over the last quarter was the main feature of the period and reflected the combination of a deeply oversold position at mid-year together with a moderation in the market’s panic with respect to rising inflation and interest rates (which in turn was due to rapidly falling commodity prices — especially oil — as well as the South African Reserve Bank’s slightly less hawkish comments at the back end of 2006).
The rapid fall in commodities had a “double whammy” positive impact on your portfolio, as it not only assisted in the rally in domestic interest-rate sensitive stocks (although we will argue that the sub 10 PEs that were applicable on a number of these stocks also assisted the rally), but also prompted profit-taking in resources in which we remain underweight.
Over the month we added to our holdings in Steinhoff, Ellerine, JD Group and Foschini, introduced a small holding in DRDGold, and took profits in Bidvest and Naspers. In addition, given the massive run-up in share prices and valuations over the last quarter, we have made the decision to up the cash holding in the fund to about 10%. As a result, we sold out our holdings entirely in four stocks that had reached our price targets, namely MTN, Telkom, Illovo and Barloworld.
Looking ahead, importantly, we emphasise that, given the fund’s more than 40% compound return over the past five years, returns over the next few years are expected to be substantially lower.
That said, the fair value of our holdings remains above current share prices. For the portfolio as a whole, we estimate approximately 15% upside to full valuations. It should also be noted that there is a very real possibility that the market overshoots fair value and so our advice is for unit holders to hold on, but with tempered expectations.
The average PE of the top 10 stocks (which make up nearly 60% of the portfolio) is still only 12 times — a 25% discount to the market and a reasonably low absolute level given the quality of the top 10 holdings.
With respect to stock selection, despite the strong outperformance of financial and industrial stocks over the last quarter of 2006, we are not tempted to switch into resources as all that has in fact happened is that financial and industrial stocks have recouped the ground they lost over the first half of 2006.
Given that resource stocks are not trading at a discount to the 12 PE of our top 10 holdings and that dollar resource prices are falling (thus resulting in some question marks with respect to resources’ 2007’s earnings) — in contrast to our conviction that the financial and industrial stocks we hold will continue to grow — we stick to our financial and industrial overweight and resource underweight.
Note that these good fundamentals for financials and industrial stocks are further enhanced by the rash of private equity buy-outs (which are currently focused on the Findi sector) as well as the fact that the 2010 Soccer World Cup with its associated euphoria is now only three years away.
John Biccard is a portfolio manager at Investec Value Fund