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Four contrarian investment questions to ask in 2023

Jacques Plaut, portfolio manager, shares the four questions investors should consider this year and discusses how the Allan Gray Balanced Fund is positioned to protect against the risks and benefit from emerging opportunities.  

There are several investment themes that are currently emerging: Geopolitical risks emanating from China, loadshedding, as well as inflation and the possibility of a global recession. Amidst these, there are questions that may be troubling investors at the start of 2023.

These are important themes but reading the headlines won’t get you far in investing – you also have to ask the right questions.

Below are four questions that should be top of investors’ minds.

1. What is going to happen to the Chinese property market? (Not: Should I worry about the geopolitical tensions emanating from China?)

China is the world’s biggest buyer of iron ore, with South Africa being one of the largest exporters of this commodity. China has been using iron ore to manufacture steel to support its infrastructure boom. 

China has built a lot of infrastructure and houses over the past two decades. However, we are concerned by the vacancy rates and empty buildings, which could indicate a slowdown in iron ore demand from the country.

Investors are focused on geopolitical tensions, Chinese population growth and GDP growth, but in 2022 the square meterage of new houses under development fell by 39%. When this translates into lower iron ore sales, it will have a negative impact on major miners, like Anglo American and BHP, who are heavily reliant on export demand from China.

For investors who are exposed to iron ore miners in their portfolio, it is crucial to understand the dynamics of China on these companies’ earnings.

2. How will loadshedding impact the companies in my portfolio? (Not: How much more loadshedding will there be in 2023?)

The line “Hello darkness, my old friend” from Simon & Garfunkel’s famous song, The Sound of Silence, aptly sums up the current environment as Eskom produces less than 60% of the electricity it should be generating.

We know that loadshedding is persisting, with latest reports suggesting it will be with us for the next two years at least. We need to think about what the impact of continued power cuts will be on listed companies like food producers. Astral is a good example. The company needs electricity to keep its broilers warm so that it can continue to supply South Africa with chicken, but it is spending a lot of money on diesel for generators.

We are asking questions like will Astral be able to pass on the extra costs of generating its own power to consumers? What will happen to Astral’s competitors – are they in a better or worse position than Astral when it comes to loadshedding? How will Astral’s global position on the cost curve change? These are the long-term things that we think about when evaluating the business.

Evaluations are done over the long term, between 10 and 15 years, and what happens over the course of one year is not that important when looking at the long-term return potential of a company.

3. How diversified is my fund? (Not: Do I need most of my portfolio to be allocated offshore?)

Diversification is key amidst the current economic climate. As an investor, you need to make sure your portfolio is well diversified and positioned to benefit from a range of potential outcomes.

The Allan Gray Balanced Fund, as an example, has been constructed with diversification in mind. It has 51% exposure to JSE-listed stocks, with the remainder made up of offshore equities and fixed interest (through our offshore partner, Orbis), local fixed interest, frontier stocks, African stocks and fixed interest, precious metals, and some exposure to dollar bonds.

In total, 43% of the JSE-listed stocks are what I would call “SA Inc”, while the other 57% are global stocks or rand hedges. There has been good performance from SA Inc shares like Woolworths (even though 28% of its value is in Australia), as well as the banks, who are paying good dividend yields between 5% and 7%.

4. How much am I paying? (Not: What is going to happen with global inflation, and may we see a global recession?)

There are concerns with the global economy, especially when it comes to some markets’ large debt. Persistent inflation would lead to higher interest rates, and many developed-world governments can’t afford to pay higher interest rates on their debt.

In addition, many global stocks are expensive and finding value is proving challenging. High valuations need growth to justify them. There aren’t a lot of dripping roasts out there at the moment and this is one of the reasons why the Allan Gray Balanced Fund is not currently maximising offshore exposure.

For example, the US accounts for 25% of world GDP and 60% of world stock market capitalisation. So, the US is an especially tricky place to find cheap companies at present.

When it comes to investing, the most important thing is to remain focused on price.

Even if you know an outcome, you may not draw the right investment conclusions. If you had known about the pandemic in January 2020, would you have guessed that hospitals would be a bad investment and the luxury sector a good investment? If you know the answer to some of the macro questions, you don’t always know what the impact will be on an investment, which is why we rather focus on valuations.

It is not a good idea to invest based on headlines. If it is in the headline, it is in the price.

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