It is said that the best way to make money is to invest with the worst rather than the best unit trusts, as the tables can quickly turn.
This is not true for sectors: it is highly unlikely that Allan Gray Equity or African Harvest (soon to be renamed Nedbank) Rainmaker are destined to fall to the bottom of the general equity tables. But investors who bought the poor performers among specialist funds of 2001 should be smiling now.
Absa Specialist Growth, which for several quarters had the distinction of being the worst performer in the entire unit trust industry, has moved to fifth over 12 months with a 28,3% return and third for the quarter, giving investors almost 16%.
Another past laggard, Sanlam Select, has risen to second over 12 months and first over the quarter.
Fund manager Rico Friedrich says special situations helped, such as Ellerine's buy out of Wetherlys, which was the fund's largest holding at about 5%, and the bidding war for Nail.
But the tide has turned in favour of small caps, propelling shares as diverse as Edcon, Group Five, Pepkor and Astrapak to strong performances. The small-cap and midcap indices are already skewed towards industrials and away from resources but Sanlam Select was even more underweight in resources.
Nedbank Entrepreneur has proved to be a consistently strong relative performer in the small-cap sector. It topped the entire industry over the 12 months to September with a 34,9% return. The philosophy of its fund managers, Neil Brown and Alistair Lea, is that "the grass is always richest where the rest of the herd has not grazed".
In spite of strong returns from small caps, there is still no public appetite; the sector has suffered R230m in net withdrawals (see next story).
Lea says small caps are easier to forecast as fund managers can get a good handle on the operations by visiting management. And the share prices are driven by SA investors, unlike the large caps, particularly resources, in which prices are often determined abroad, leading to prices well below or well above what SA managers would consider fair value.
Lea says that despite the recent run, the average p:e ratio of shares in Nedbank Entrepreneur trades at a 24% discount to the Alsi 40.
The only broad-based fund in the top 25 for the year is Investec Value, with a strong 28,6% return. It is no surprise that its portfolio has a lot in common with the small-cap funds.
A year ago, it was invested entirely in middle and small caps except for a small position in Absa, but the fund is now 25% invested in large caps such as FirstRand, Abil and SABMiller.
Fund manager John Biccard has avoided resources, except for a 4% "insurance" holding in Gold Fields in case gold shares have another rally.
In spite of the strong rand, which will lead to some earnings shocks in resources shares, there was an 11% rise in the resources index over the quarter.
Biccard says the rand's strength has been offset by higher dollar commodity prices and expectations of still higher prices. "But this is more than discounted in the resources sector p:e of 17 times to December when compared with the big three domestic banks' p:e of just 7 and most industrials on 8," says Biccard.
RMB Equity co-manager Shaun Bruyns agrees there is a risk of being sucked in by the noise surrounding commodity prices. Just 9% of his fund is in mining shares. "We will underperform if resources rise another 40% , and not holding BHP Billiton has hurt in the short term. But we can't justify buying resource shares at these multiples."
Bruyns says the issue is not whether to buy rand hedges but whether shares have the right dividend yield, sustainable growth rate and potential for change in p:e multiple.
"For example, we have bought Steinhoff as it has a forward p:e of 6,5 and a sustainable return on equity of 20%. Iscor also looked compelling at a 50% discount to NAV."
Liberty Value fund manager Errol Shear says there is a wide selection of undervalued shares in the SA market. "The only clearly overpriced sector is gold as the share prices are often double the net value of the reserves. You must be prepared to speculate on a much higher gold price if you buy these shares," Shear says. "Compare that with the risks of buying RMB Holdings, which has a proven management team, far more predictable earnings and a forward dividend yield of 5%. It's not a difficult choice."
In spite of the recent run in resources, large caps have continued to underperform. In the year to date, the Alsi 40 is down 3,1% compared with 25,6% from midcaps and 25,3% from small caps. This has hit funds with a large-cap mandate, such as Liberty Wealthbuilder and Old Mutual Investors.
Old Mutual Asset Managers executive director Peter Linley says that as Investors is focused on the top 100 shares, it will sometimes underperform. Nevertheless, it has remained in the top third of funds on a rolling three-year basis.
But there has been a strong turnaround in the Top Companies fund, which is 10th in the general equity sector over 12 months and sixth for the quarter. This fund aims to take the top 25 ideas from the house view and this has included recent winners such as Pepkor, Massmart, Astral and Group Five.
