Issue: December 2011 / February 2012
Expert Opinion

Delayed gratification

Rumbelow...managing the ‘new normal’
Cruywagen...where to find value
Gerhard Cruywagen, the Sanlam Investment Management (SIM) chief investment officer, is probably one of a few investment professionals who doesn’t have an iPad or price feeds on his cellphone. He doesn’t see a need to be caught up in the day-to-day financial markets, preferring to keep his eye on the medium- to long-term horizon for getting the most out investment portfolios.

You’ve now been at SIM for three years. What’s stood out for you the most?

When I joined we were in the midst of the US sub-prime crisis. Now we’re in the midst of the sovereign debt crisis. Both events, not completely unrelated, are likely to have a long-term impact on global political and macro-economic policies in the Western world.

Our role as asset managers is to determine the fair price of assets. We do this using the assumption that the current world economic order continues. What stands out is that for the first time in my investment career the validity of this assumption is being seriously questioned. A structural change, a change to the monetary system or the full-scale nationalisation of sectors such as banks, or even the dissolution of the European single currency union, has to be considered.

How do you sleep at night when markets are so turbulent?

One can easily get caught up in short-term price movements and can be influenced by news headlines. When at home I try to remove myself from investment/work-related issues. So usually I don’t know what happened in the financial markets from the time I leave work until the following morning. When on holiday, I normally don’t follow the markets.

What do you consider to be the key attributes of a successful investor?

Given that most opportunities in financial markets are presented by mispricing, based on human emotions and a generally short-term focus, a successful investor should be emotionally detached from short-term price movements in his portfolios. But this is easier said than done.

In essence, an investor should interpret the news of the day or week in the context of a much longer time frame. One technique is to read newspapers only a month after they have appeared. They would then prove a quick read as most of the stuff is irrelevant in terms of asset pricing.

Second is the ability to delay gratification. Often the available opportunities only bear fruit three to five years later.

Third, it helps if one is a bit of a contrarian or has a slightly cynical outlook on life. I don’t believe in the ‘wisdom of crowds’ when it comes to financial markets. Crowds seem only to be wise when independent individual decisions are aggregated. In the case of financial markets, there is a feedback loop; participants influence each other.

How would you describe SIM’s pragmatic value-investing philosophy?

We use the concept of normalisation over the medium to long term. This central assumption is applied to asset classes as well as individual assets.

Assets and asset classes that carry more risk in terms of loss of capital should generally offer better prospective returns. We use required real-return ranges for the asset classes in which we invest. These ranges are based on what has been historically experienced; what we call the ‘normalised’ levels.

For specific companies, normalisation typically would imply a basic assumption that the return on capital of companies should normalise over the long run. If the return on capital is very high, this is likely to be eroded by competition (unless there is a monopoly). If very low, it is likely to return to normal if the business model is intact. Often companies are not priced for this normalisation to happen. There lies the opportunity.

We call ourselves pragmatic to differentiate ourselves from the traditional dogmatic approach which might use typical rules; for example, buying only companies with price-to-earnings (PE) ratios of below 10 or price-to-book ratios of less than one. There are cases where we would buy high PE companies and high price-to-book companies as these might trade below fair value when compared to our normalisation assumptions.

What would you say sets SIM apart?

SIM is one of the largest asset managers investing in the SA market. It means that we own meaningful stakes in companies on behalf of our clients and can therefore have some influence in terms of corporate matters. This has enabled us on several occasions to add value to our clients’ portfolios.

Also, because of our size we’re involved in the unlisted credit markets and can access investment opportunities not available to clients of smaller managers. And due to the fact that we’re part of a big insurance company, our corporate governance processes are strong. It should also be a comfort to investors that SIM is owned by a strong parent with a strong balance sheet.

What, at the moment, does SIM’s bottom-up valuation process say about the different sectors and overall investment market?

The interesting opportunities are currently in the international markets. International sovereign bonds are trading at historically low yields. To obtain an appropriate real return from bonds, investors would require zero inflation or deflation over the next 10 years. If the current economic order continues, this seems unlikely given that central banks are targeting on average 2% inflation and are printing money hand over fist.

European equities are trading at extremely cheap levels based on long-run measures, such as price-to-normalised-earnings and price-to-book ratios. There are also specific sectors in the European markets that are, in our opinion, extremely cheap. Looking at long-run measures, the US equity markets are less attractive.

In SA there seem to be fewer opportunities. Fixed-income assets such as cash, inflation-linked bonds and conventional bonds appear on the whole to be expensive or fairly priced relative to our normalised required real-return levels. The local equities market does appear to offer some value, but not nearly as much as available in developed markets abroad.