Issue: September 2012 / November 2012
Why SIM doesn’t compromise on value investing
The current investing environment may be referred to as the ‘New Normal’, an environment in which the old market adages don’t count anymore. Yet there are some investing styles that aren’t new, but remain successful. And for the Sanlam Investment Management (SIM) team, sticking to its pragmatic value-investing style is not negotiable.
For them that means simply applying common sense when looking at a company’s past and believing that assets are likely to revert to their long-term average real returns. In other words, you are likely to make money if you buy assets that are selling for less than their fair market value, and sell them when they get close to their fair value.
According to Gerhard Cruywagen, chief investment officer at SIM, operating as value investors allows the group to avoid emotional investing and inaccurate forecasting: “All SIM’s investment decisions are firmly rooted in our pragmatic value philosophy. It enables fund managers to make rational, not emotional, decisions that are based on in-depth research conducted by our large team of analysts. This gives them insight into what an asset is truly worth, not what investors are willing to pay based on greed or fear.”
Value investors like SIM’s large team of investment managers therefore believe that financial markets are inefficient because they are driven by humans who make decisions based on emotions. Emotional investing leads to asset prices deviating from their fair market value. This is exacerbated by the actions of investors who have different time frames and liquidity requirements when they invest. When mispricing arises out of these situations, the value investor is in a position to make the most of the opportunity.
SIM also avoids relying on – or making – forecasts. Statistics show that analysts who attempt to make predictions about a company’s outlook three years into the future get it wrong 70% of the time. As a result, SIM managers prefer using current and available data to find those assets that are mispriced.
How do the SIM analysts go about finding the fair value of the asset, thereby knowing when it is mispriced? They use a fair-value framework based on long-term historical asset returns. They can then identify these pricing anomalies and exploit the difference between the share price and the fair value. Given that the next three years’ worth of cash flows account for just 15% of the value of that business, the group is willing to make the investment over the long term and not just focus on the following three years. “We are patient investors and are not swayed by short-term news flows,” Cruywagen says.
The truth is in the results. SIM’s own portfolios have delivered strong returns, even during tough economic times. Most of the group’s institutional portfolios (more than 80%) have outperformed over rolling three-year periods.
For the SIM team, however, it’s not only about performance: a crucial part of the strategy is to avoid potential disasters through strong risk management. That’s why, as part of the investing process, the SIM analysts ensure that clients enjoy a margin of safety. They achieve this by assessing the inherent risk of each business the team looks to invest in. Cruywagen says, “Managing downside risk is embedded in our investment philosophy.” So while risk cannot be summarised into a single number, for SIM it means avoiding a permanent loss of capital, or crucially, not keeping up with rising inflation.
How does the current market environment – one characterised by volatility driven by news of the economic crisis in Europe, and the ever-slowing recovery of the United States – affect SIM? The answer is: not much. Investing for the long-term empowers fund managers to ignore the short-term wobbles. It also means looking for quality value investment opportunities – buying those value stocks that have strong balance sheets and offer a good margin of safety.
For Cruywagen, this means remaining patient: “We’re convinced that by sticking to our guns in the long term and riding out volatile and uncertain periods when market prices move out of alignment with reality, we will be able to deliver consistent, compelling long-term investment performance for our clients.”