Biznews interview 21st February 2018


This special podcast is brought to you by Ranmore Fund Management.

Hi, I’m Sean Peche, I’m a Portfolio Manager, and CEO of Ranmore Fund Management and the fund I manage is the Ranmore Global Equity Fund.

Sean thanks for chatting to us today. Now you started out at Old Mutual Asset Managers in South Africa quite some time ago and then you left the country in 2001. Can you give us a brief overview of your background?

I qualified as a chartered accountant in South Africa and then I spent a few years at Old Mutual Asset Managers where I worked on small companies. The benefit of that is that I’ve seen many different companies and industries. Then I left and joined a company called Decillion early in 1999, and we started a hedge fund there called the Big Rock Fund. I was one of six and the Big Rock Fund did extremely well.

In 2001, there was an opportunity, because Decillion had an operation in the UK in London, and Richard Pitt and myself left. We came over to the UK to launch an international hedge fund. It was a challenging time because we were actually on the marketing trip to see prospective clients during 9/11, so we had very volatile markets. And then in 2002, the market was down some 22%. We managed to preserve capital, but the seeders needed their money back. So, after a very brief period at Coronation, I joined Orbis in 2003 and had the privilege and pleasure of working with the late Simon Marais and I was at Orbis for a fantastic five years.

You now run Ranmore Fund Management just outside of London. Can you tell us the genesis of this venture and what it focuses on?

I left Orbis at the end of 2007 and teamed up again with Richard Pitt, who was, at this point, back in South Africa and involved at BlueAlpha Investment Management. What we wanted to essentially do is get the show back on the road. BlueAlpha had a small hedge fund, which we ran through 2008, during the financial crisis. So again, it was a wild time, but we survived and actually returned around 16% in 2008.

But about halfway through the year, given the volatility of the market, we started to see real value emerging in some of the equities we were looking at. We then thought, well, this might be a great time to launch a global equity fund, because unlike a market neutral fund or a hedge fund — where you short shares — we were seeing more opportunities on the long side. So, that we did and we actually launched in mid-October 2008. We’re coming up to our tenth anniversary this year.

You now offer a fund which has a global equity mandate. Can you tell us more about what this fund offers investors and how does it differ from other similar funds?

Yes, I’d spent five years at Orbis in a global equity fund environment and I really became convinced of the merits of a global equity fund mandate for a few reasons. The first reason (if you think that your primary objective is growing your wealth) is that the best way to do that is to get access to the best investment opportunities out there. And they’re not always located in the same region. For example, the best information technology companies may be in the US. You might want a European consumer staple or an Australian miner. Therefore, I wanted to have a fund where I could access the best investment ideas that I thought were out there, no matter where they were in the world and not limiting oneself to an individual index. Being in the UK I could have  launched  UK fund but today the UK has less than one percent in information technology companies in terms of the FTSE 100 index constituents, some 7% in tobacco shares and 14% in oil shares. Also, there are no oil companies in the German DAX, there are no mining companies in the French CAC and so, I didn’t really want to limit myself to a single market or index.

The second benefit of a global equity fund (and one that I wanted exposure to myself) is that it gives you the flexibility to move between regions and that’s very tax efficient because you do that within the fund structure as you find value.

For example, today I could be selling US equities and then using those proceeds to buy Japanese equities but the unitholder or the shareholder in the fund doesn’t pay capital gains tax on these transactions. This is because all the profit taking and moving around takes place within the fund. But if I was an individual and I sold US equities or I sold a US fund and then waited for that money to clear and used that to buy a Japanese fund or Japanese equities, it would trigger off a couple of things. Firstly, I’d be out of the market for a few days while the funds are clearing and secondly, I would incur capital gains tax (assuming I’d used up my capital gains allowance) if I made a gain on those proceeds. Thirdly, I may have the hassle of all the forms involved in subscribing and redeeming. So, I think these are some of the significant benefits that I saw in launching a global equity fund that I wanted for myself and for my clients.

It was Warren Buffett who said, “Rule number one, don’t lose money and rule number two, don’t forget rule number one”. And a very important part of limiting your losses is diversification and a global equity fund offers diversification across currencies, countries and companies and currencies. One only has to look at the performance of currencies such as the Brazilian Real, the Turkish Lira or the Peso. These are not insignificant countries out there but their currencies have had tough times over the last 30 years. So, currencies are very important and the benefit of a global equity fund is you get diversification across currencies.

What kind of companies or assets are you investing in? Can you give us some examples and which countries they reside in?

To give you an example, today I think some of the best IT companies, happen to be in the US. One example is a company like Google. If you think about Google, essentially, it’s a monopoly with Google search and YouTube being the two largest search engines in the world. Amazingly, Google bought YouTube for only $1.5bn a few years ago. Now over the last four quarters Google has earned $29bn in operating income, and that is after they have expensed f $17bn in research and development. Normally, monopolies with a high level of profitability attract competition. But how on earth do you start a business tomorrow to get the returns on capital that Google receive when you’re up against them spending $17bn in research and development?

The odds of you or I coming up with a better idea and being able to execute it better than them is pretty remote — and so that’s the first point. The second point is the end-user of their product gets it for free. We don’t get invoices on a daily basis for having searched on Google or YouTube and so you can’t compete on price. And so here you have a business, which essentially is a monopoly that is very difficult for anybody else to compete with and generating very high returns on capital. Their property plant and equipment on their balance sheet is only $42bn and over the years that they’ve been operating, they have amassed $102bn of cash on their balance sheet.

Then you say, “Well, that’s a great business, but how much am I paying for that?” Well, you’re paying 18 times earnings next year if you strip out the cash. So that’s really an average multiple for a way better-than-average business and it might interest your listeners to know that there are some tobacco companies on higher forward earnings ratios just for comparison. But that’s an example of one company and then in another region, we also hold BMW. We have a position in BMW which today sells for less than eight times forecast earnings. Is it a very exciting business? No, but I think that BMW, is essentially a bank. But I think it’s better than a bank for a few reasons.

The first is that it’s far less geared than a traditional bank, so you have less risk. The second is they only finance their product, which they know well. The third is that most banks overseas are limited in what they can charge customers, whereas BMW’s “bank charges” essentially are the cost of servicing the vehicle and they are a price setter in that regard. If your bank starts charging you too much you just move banks, but if you’re already locked into a BMW contract it’s harder to do that and here’s a business that actually is growing, albeit slowly. They just reported their best ever January sales, which were up 3.8% and their electric vehicles are up some 37%. BMW’s targeting to sell 140 000 electrified vehicles this year and, just by comparison, Tesla sold 30 000 last quarter.

So, BMW, in terms of the market cap, is slightly more than Tesla, but BMW sold 170 000 cars just in January. That is another example of what I think is a great investment opportunity, a nice dividend yield, but they happen to be in Europe. This is very different to Google. Moreover, when I look around and try and find the best oil companies that I might want, I think they happen to be Chinese. So, a company like Sinopec I think is attractively priced and it’s a massive company with some 30 000 fuel stations. Those, then, are some of the ideas. It’s a global fund and so we have some Japanese, European, US, and Chinese equities etc.

Sean, do you have any South African equities perhaps?

We have one position where we own some Investec PLC and we built that position after they disclosed that their exposure to Steinhoff was only three percent of operating income. We thought well, here’s a great franchise. It is a huge asset manager with some fantastic performance and £150bn of assets under management and if you look how asset managers charge their fees, they are based on the market value of assets under management (and markets have gone up). So assets under management have gone up and here’s a share that is quite dislocated from that.

So that’s been a good investment for us, but we are very diversified, so we don’t bet the house and that would be the only South African exposure that we have. It’s really interesting, because when I first came over here to the UK, the South African market was trading somewhere around eight times earnings and it took some getting used to looking around the UK market or international markets and seeing companies at 16 and 17 times earnings. Whereas now, of course, you have some very highly priced equities in South Africa.

You’re now targeting South African investors as well, from what I can see from your website. Can you tell us how that works?

The Ranmore Equity Fund is what is known as an Irish UCITS and that is a highly regulated fund structure. So, in 2015 there were some nine trillion Euros invested in UCITS assets. Because it is so highly regulated, regulators in more than 70 countries accept UCITS as suitable for distribution into their domestic markets and there are a whole lot of rules and those would be how diversified the fund has to be, how much cash you’re allowed to have at any one institution if you’re holding cash etc. — very conservative rules.

A number of years ago the fund received approval from the FSB as a foreign collective investment scheme permitted to market and distribute in South Africa in terms of s65 of CISCA., and the fund is also on a number of the South African investment platforms, such as Momentum and Investec. But, of course, South African investors who want to invest in the fund should consult their IFAs and those investments take place using their offshore foreign advance.

How has the fund performed since inception?

The latest data from Morningstar suggests that we’re in the top quartile of peers over one year & five years. Since inception and we’ve been going nine and a half years, it’s in the top 6% of peers but we haven’t outperformed every year. We’re coming up for our tenth anniversary and we’re certainly happy with how we’ve been performing since we started.

Tell us more about your team and their background? Obviously, you’re South African, so are your team South African as well, or are they British?

I have a small team. In fact, there are six of us. We’ve just hired a person recently and three of us are South African, two are British and one is from India, but I met him when he was studying in the UK. Some people question how on earth one can manage a global equity fund with such a small team. The answer really is technology. If I had started this 40 years ago, I would’ve needed an army of analysts to run around the world meeting management, visiting factories and talking to investor relations teams. But these days with technology I have built and refined systems that link into the Bloomberg platform that we use and that extracts all the financial data that I need to make my analysis.

And so, I have no need whatsoever of ever having a large team because I want to spend my time managing the portfolio and not managing analysts and also I want to be very hands on and analyse companies myself and not be reliant on analysts telling me what they think. I think in large teams, it’s very easy for behavioural biases to creep in and I don’t want any of those to creep in and distract or affect the performance in any way. So, we have a small team, we only run one fund, we don’t run managed accounts. We’re all focused on one fund and I have no plans for increasing the size of the team.

On your website you wrote an interesting piece about what Steinhoff shows us about the dangers of exchange controls and obviously, in South Africa, Steinhoff has been probably the biggest business story of the decade. Can you explain a little bit more about what you wrote there?

In my early days, I worked as a short seller on the hedge fund that I helped manage in South Africa and our fund was short Profurn, it was short African bank. I’m also a CA and I spend all day looking at income statements and balance sheets. Sitting here in the UK, we have a position in Sainsbury’s and Steinhoff bid for a company called Home Retail and Sainsbury’s then outbid them and eventually took ownership of it. But no sooner had they done that, Steinhoff was out acquiring other companies, such as Poundland. And they went on this frenzy of overseas acquisitions buying Mattress Firm, Poundland, they had just bought Tekkie Town, and so I became intrigued, because of my interest in furniture retail and also because of my South African connection.

So, when the news broke, what frightened me were reports on how exposed South African investors were to Steinhoff. I mean, Steinhoff had been part of our investment universe to be screened, but it had never come up as an interesting opportunity and so I just took a look at the largest ten equity funds and I did a bit of an analysis. I found that the holdings were so concentrated (and it went beyond Steinhoff) that every single one of the funds had a position in Naspers and I mean average position size was 15%, which is not permitted in the UCITS fund structure. I cannot have more than 10% or rather the fund cannot have more than 10%  invested in any position.

I know you can under the South African rules, but if I buy Ten percent  under the South African rules and the share price goes up, I can leave it and so it can become as big as it wants, it can go up to 20%, it doesn’t matter because at the time of purchase it was 10%. Overseas or certainly in the UCITS structure, if it went up to 11%, I would have to sell one percent so that it at all times remained below ten percent. I saw that every single fund had British American Tobacco at an average 7%, which is a massive holding internationally and every single fund had Sasol. Other than the Allan Gray Equity Fund and Satrix, where Steinhoff was number 11, every fund had Steinhoff but the overall holdings were so concentrated that some 29% of these 10 fund assets were invested in only four companies, 40% of fund assets were invested in eight. What I was amazed by was that even if you took these ten largest equity funds and put them all together theoretically, the funds would be so concentrated that even then they would fail these UCITS diversification rules that I have to adhere to on a consolidated basis. So, my point is that there must be many investors out there who are invested in a number of these funds and they think they’re diversified, but actually maybe they’re not because they own exactly the same shares just in slightly different weightings. I think what I’ve learnt in my 17 years overseas, is that things happen and they come out of nowhere.

There was the CEO of Compass Foods recently who was killed in a seaplane accident off the coast of Australia. Netflix, for example, has come out of nowhere and made life very difficult for some of these other media companies. Therefore, conditions are always changing. Amazon has disrupted retail, Uber has disrupted taxis, Priceline, and disrupted travel agencies. So to have such high concentration, I think is quite risky. Then when I looked at the rules in terms of what investors in South Africa can take offshore, it amazes me that a retirement fund can have ten percent of their money invested in gold coins, but no more than 25% invested in some of the best businesses out there in the world.

If you look at it, internationally, more than 60% of the UK pension fund assets are invested outside the UK and I think the number is even higher in Holland. And thes UK is the  the sixth largest economy in the world. I really think that investors should apply pressure on regulators, certainly in South Africa, to allow them to be able to take their retirement assets offshore and to diversify. And it’s in the interest of government, because if people are unable to pay for their own retirement, then they become a burden on the state. So, the state should want their retirees and future retirees to be invested in the best investment opportunities out there and to be exposed to as little risk as possible and I think having very concentrated holdings in a single market exposed largely to one currency is not a prudent way to invest.

How does your fund differ from what else exists in the market?

Our fund has a dual objective, which is different to many other funds. The first objective is to outperform the MSCI World Index and the second is to generate capital growth over the medium-term. So, for example, if the market falls 30% and we’re down 28% or the fund is down 28%, that’s not a good outcome for us. We may have outperformed the market because we went down less, but there’s been capital destruction. Given that, the market has been going up since the bottom of early 2009. It may not feel like it, but markets don’t only go up and so what we do is, we spend a little bit of money each month buying exchange traded index put options.

Now that costs us around one and a half percent to two percent a year and when the market is on a tear like last year, we have to run hard to keep up with the performance drag, but it’s in the performance numbers and we see it a little like buying car insurance. We want some insurance in case of an accident, okay. It might not be our fault, so you know it’s not free, you pay your premium, and then if you have an accident, well then there’s the excess, but it should protect you against a sharp, sudden negative move in the markets.

So, that’s really what we seek from these put options. It’s not going to protect us from every down move, we’re not a hedge fund, we’re not totally insulated from any market move. But if we get a sharp, sudden, large connection it will protect us and a portion of the capital and. if you want to invest in the markets you have to be able to cope with some volatility, but all my family’s money is in the fund and I don’t like losing money, so if a black swan comes paddling into the scene, I want to have some downside protection.

Then the other point about the fund is that we are a relatively small fund and so we’re nimble. We’re only just over $100m and so we can react fairly quickly. If you look at the recent experience in South Africa with Steinhoff, the smaller funds, even if they had a position, were able to exit their position in a day.

The larger holders were stuck with their position and so being small and nimble, it allows us to be reactive. And if something comes out of nowhere and it’s a disaster, well, we’re able to limit our losses. But it also gives us exposure to some exciting opportunities that perhaps some of the larger funds wouldn’t be able to acquire. So, we can move and acquire a meaningful position, but still retain the flexibility that when we want to take profits and when the share prices hit our target price, we’re able to exit without disrupting the price.

Sean, I think you’ve given us some very thought-provoking insights regarding the investment landscape both in South Africa and globally. Thank you very much for taking the time to chat to me today.

My pleasure, Gareth.

This special podcast is brought to you by Ranmore Fund Management.

Please note Sean Peche’s opinions on such topics as global investing and portfolio concentration are his own and don’t constitute investment advice: readers should consult their investment advisers to discuss the most suitable asset allocation for their circumstances.