A significant valuation gap has been developing in equities between the retail sector and resources. According to Alexander Forbes's Global Large Manager Watch, this has resulted in large disparities in returns among fund managers – more than 10% in the past year – that have been steadily growing over the past few months.
The report shows that if asset allocation among the funds is stripped out, sector selection accounts for a 20% difference in returns. In other words, the fund managers who stayed with rising retail shares have, on an equity basis, outperformed those who invested more heavily in resources by 20%.
Foreign investors, who traditionally have viewed the JSE as a resource playground, have bought heavily into South Africa's retail and consumer stocks. This has continued the drive for stocks such as Massmart, Foschini, Truworths and Shoprite, which have outperformed the FTSE World Index by between 20 and 30 times over the past 10 years.
The profits of some of the listed retailers have grown more than 15 fold since 2000 and continued to grow throughout the 2007 to 2009 global financial crisis. This drew the attention of global investors, who now make up 40% of shareholders on the JSE.
Historically, South African managers have maintained relatively low weightings of resource shares relative to the index. This and their bias towards domestically focused shares helped them to outperform the index when resource share prices were suppressed. However, this has changed and many local fund managers have adopted a value-orientated investment strategy since the financial crisis.
According to the Alexander Forbes report, "a large segment of managers have piled into the undervalued mining shares to an extent that has not been seen in a decade or two. Unfortunately, this is also the segment of the market that has performed the most poorly."
Year on year, resources have declined by 9.9%, whereas the financial and industrial index is up 21%.
Although foreigners have maintained the price momentum in retail shares, the Alexander Forbes report questions whether the sheer weight of their presence will keep upward pressure on these shares for some time to come, or whether events in Europe or a prolonged global financial crisis will trigger a quick but devastating sell-off.
Managers such as Allan Gray and RE:CM have preferred undervalued resource shares to retail stocks in the belief that they will deliver superior returns over the next few years. But Foord Asset Management has been riding the crest of the retail and industrials wave and has outperformed its nearest rival by more than 10% over the one-year period, according to the Alexander Forbes report.
It states that Stanlib has also benefited from its underweight position in resources and Sasol. Prudential has also made good sector and asset allocation bets, which has placed it among the top performing large managers at different times.
Nick Balkin of Foord said it was not going to sell out of its position in retail stocks any time soon.
"The allocation to retail shares remains a good diversifier in our clients' portfolios and offset the risk associated with rand hedge shares, including commodity companies. When we bought them five years ago, they were cheap. The share prices played catch-up with the earnings over the last five years," said Balkin. He added there was no reason to sell them because they had run and outperformed the market.
Balkin said the management teams in the domestic retail sector, and clothing in particular, were among the best in South Africa and it would be difficult to replace themwith equivalents should Foord decide to sell off these holdings.
"We continually assess the merits of our investments and still believe retail shares have a role to play in clients' portfolios," Balkin said.
But Allan Gray remains firm about its decision to sell out of retail shares. Simon Raubenheimer of Allan Gray said although retail companies had shown significant profits, the good news had already been captured in the value of the stocks.
"It is very dangerous at this point to extrapolate from the past decade, which really has been exceptional," he said. Consumer-focused companies also had the tailwinds of falling interest rates and a relatively stable currency, which kept imports affordable.
Over the past 10 years households drew on credit, driving household debt to disposable income from a low of 50% to nearly 80%. But the increased income had been driven by social grants and high real wage increases in the public sector rather than increased employment levels.
"All of this is unfortunately unsustainable. A decade ago, investors were extrapolating from the poor conditions that prevailed at the time. They are doing so again – this time to the boom conditions."
Raubenheimer said consumers were stretched and debt servicing costs were high, despite record low interest rates.
He said retail stocks were not only expensive locally, with price-earnings ratios in the 20s, but also globally. He cited the example of Abercrombie & Fitch, a well-known global fashion brand, which had four times the revenue of Truworths and double the number of stores, yet the market value of Truworths was double that of Abercrombie. In other words, you could buy the entire Abercrombie & Fitch company twice for the price of Truworths.
"Unsurprisingly, we see no value in domestic consumer-focused stocks. They are expensive relative to their offshore peers and also relative to their own histories," Raubenheimer said.
Most fund managers have once again missed out on the listed property run – they delivered 26.3% over the one-year period compared to 9.3% from on the All-Share Index. This was on the back of declining interest rates and a growing pool of investors seeking yields in less volatile markets.
Despite this return, according to the Alexander Forbes report, the average managers were holding only 2% of listed properties in their portfolio.