Reflecting on 25 years of the Denker SCI Equity Fund

Introduction

0:00Welcome to the Denker Capital Podcast, where our highly experienced team of in-depth thinkers and other experts share their insights on a range of investment-related topics. In this podcast, we have conversations about developments in South African and global markets and what these may mean for investors. We analyze specific stocks and sectors and explore general themes relating to the fundamental principles that underpin sound investment decisions in an ever-changing world. I'm Kaelin Conradi, Head of Marketing at Denker Capital. Today is the 27th of

0:39October and it's quite fitting that our 25th episode, which we are recording today, is about the 25th anniversary of the Denker Sky Equity Fund. We are very proud to have reached this milestone as not many funds in South Africa boast such an extensive track record. So today I'm chatting with Claude Van Kijk. He is Portfolio Manager of the Fund to gain his insight into what he's learned over this time, how the fund has performed for investors and his take on the SA Equity market. Welcome, Claude.

1:09Thanks, Kaelin.

Fund Launch

1:11So let's maybe start at the beginning. Why was this fund launched? Kaelin, the fund was launched, as you said, 25 years ago. And the real objective here is to compound real wealth for clients over long periods of time and for us to be able to do that through an active management approach, but at the same time also providing a reasonable level of current income, and that obviously via steady flow of dividends from the fund. By providing access to really good quality management, well-managed

1:45businesses, good quality companies at favourable valuations, you know, this allows clients to really grow their real wealth and wealth well ahead of inflation.

SA Equity Market

1:57So you've been researching SA Equities for over 30 years. You've obviously seen quite a lot in this time, and I would be very keen to hear your take on how the SA listed environment has changed over the years. Kaelin, over, you know, the 31-year period that I've been involved in the markets, the SA listed space and the environment has changed significantly. If we go back, you know, through that, especially pre and post the IT boom or the IT sort of boom and bubble that we saw in the late 1990s and early 2000s.

2:33So to put that in context, in 2001, there were over 600 companies listed on the JSE. And since 2000 and that 2001 period where the bubble sort of burst, we lost almost 250 listed companies on the JSE. So today, we have just over 300 companies listed, very much closer to what was listed in 1994. And we generally see, you know, these listing booms when, you know, the economy is really booming,

3:03global markets are booming, and you have these sort of behavioral factors, and in particular greed, that really drive the listing booms as many private companies sort of come to the market with players, hopefully, or participants, hopefully, trying to get rich fairly quickly. So, you know, again, we saw this run up to the IT boom in the early 2000s and between 1997 and 2000. We had 240 new listings, and when the bubble burst post-2000, we saw 290 delistings between 2000 and 2003.

3:41That is quite a change in listed companies over time. Has that created opportunities for you? Yeah, Kaelin, more recently, we've seen, you know, quite a few delistings in the SA environment, and in particular, you know, the likes of Distel, some really good quality businesses that have delisted, not only Distel, Mediclinic, RB Platinum, Pioneer Foods, a little while ago. So, and, you know, very often when you go through these delisting periods,

4:15they tend to, these companies tend to be taken out at fairly significant premiums relative to the market. So, we've benefited substantially from that over the last few years. We were big investors in Mediclinic. We were large investors in RB Platts. We had Alviva, which is a small-cap IT company that was taken private at a significant premium. It was taken out at 28 Rand. We initially bought shares at 6 Rand.

4:45So, you know, that does create opportunities to unlock value for our investors.

Fund Performance

4:52And how has that unlocked value over 25 years? So, yeah, to maybe talk a little bit about the performance of the fund. Over the last 25 years, the fund has compounded. This is net of fees, the highest fee class. The R-class. The R-class at a rate of 15.7% per annum, outperforming its benchmark over that 25-year period per annum by a rate of 1.6%. So, you know, maybe just to contextualize the power of compounding over a long period of time.

5:30If an investor was invested in a fund on day one and had a R1 million Rand investment in the fund, in order to double your money over a five-year period, you need to generate a compound return of just under 15%, 14.9% per annum. So, that means over 25 years, you will have five opportunities to double your wealth over that period. Since the fund compounded at a rate higher than that 14.9%, so 15.7%,

6:02that means that a 1 million Rand investment invested 25 years ago would have grown to 38.3 million Rand today. And that compares to if you were just purely invested in the market, your 1 million Rand would have compounded to 27 million. So, the fund has generated wealth at a rate of 42% higher than that of the market. And maybe just to finalize that sort of power of compounding,

6:32if you had compounded just at the rate of inflation, which averaged about 5.6% over that 25-year period, your 1 million Rand would have compounded to 3.8 million or just under 4 million Rand. So, the fund has actually created 10 times more wealth in real terms, you know, for an investor over that 25-year period. And when you say market, what index are you looking at? So, that would be in the initial stages over a large component of the 25-year period.

7:08It was initially the all-share index. And then at a later stage, we changed that to the capped SWIX. And then over the last number of years, because we had increased our exposure, we were able to invest offshore. We included an MECI global portion to that benchmark. So, as it sits today, that benchmark is 87.5% the SA, JSC, FTSE, capped SWIX, and 12.5% the MECI durable index.

7:39So, it's a massive outperformance of the benchmark over time. As long-term investors, obviously, we hope for investors to be invested for 25 years, but not everyone is. So, if we look at shorter-term performance. So, over the shorter term, so if we're looking over the last one, two, three, and five years, the fund has outperformed its benchmark fairly consistently over that period. Over three years, the fund has compounded at a rate of 16.4%, so slightly higher than the 15.7% compound rate over the 25-year period.

8:14But, obviously, everything moves in various cycles. We'd love to be able to compound continuously at a rate of 16%. But the fund is in the top quintile, top 20% of funds versus its peers over one and three years, and in the top third over five years. Great. Well done on that performance. Thank you. Again, Claude, we spoke about this fund has been going for a long time and you've been in the industry for a long time. What are some of the successes and challenges that you've experienced

8:46over your time managing the fund? Yeah, I think let's start with the challenges. So, you know, it's fantastic that, you know, the fund's had great performance, but as I said earlier, it doesn't all come in a straight line. You know, there are periods where you do have challenges, and that's why investors, I feel, should be invested for the longer term. So, on the challenger side, I'll talk specifically to 2015 and 2017. We had a fairly tough period of performance in late 2015,

9:21and that was at a time where we had a fairly large holding in SA banks where we saw a significant amount of value. But if, you know, you can recall in 2015, we had the Nannygate scandal, and that's when Jacob Zuma decided in his wisdom to fire the finance minister in Schlundfler Nanny in December 2015, which was a terrible Christmas present for us. So, we've certainly learned over time by avoiding mistakes

9:52and particularly avoiding bigger mistakes. You know, you already won half the battle. And we experienced, you know, some challenges in 2017 as well. We had a fairly tough period of relative performance, and that came down to a holding that we had in Steinoff. We did react very swiftly to the news when the news broke out. So, that broke out in December 2017, and we immediately sold our investment because the whole investment case had changed.

10:25And we managed to exit at around about 19 rand a share. So, again, that was December 2017 and not a very pleasant Christmas present. But, yeah, you've got to take the good with the bad and learn from those mistakes. Okay. So, after two bad Christmas periods, what did you learn? Is there anything you did differently after those periods? Yeah, we absolutely did. You know, again, although your investment philosophy never changes or shouldn't change,

10:58I mean, that should be embedded in your DNA. But your process needs to adjust and needs to evolve to, you know, conditions that might change over time. So, you know, through that period, we realized that, you know, consistency of performance is crucial to our investors. And as I said earlier, avoiding mistakes is a big part of winning the game, I guess, in this environment. So, we brought in very tight risk controls in late 2017, early 2018 into our risk management process.

11:36So, we incorporated a proprietary risk management dashboard or tool that monitors various company-specific or idiosyncratic risks as well as market-related risks. And we also incorporated ESG directly into the process in 2020. And that was really to tighten up our responsible investment framework. On the risk management dashboard, Claude, what are some of the factors that you look at from a company point of view? So, Caelan, a lot of thought obviously went into that process.

12:12And when we look at company-specific risks, and this is an important part of our investment philosophy as well, is identifying, you know, companies that have really good business economics, that have competitive advantages, that are able to generate return on invested capital well above the weighted average cost of capital. Because if you can identify those companies, you are able to grow the intrinsic value of your underlying investments over time.

12:42So, a lot of time is spent on understanding the business economics, firstly, and the moat of a company. And then secondly, looking at management, the quality of management, we feel that very often the market underestimates the significance of a really good management team. And we rate our universe of 100 companies that we follow very actively across the JSE between an A-rated management company,

13:13which is a good quality management team, and an E-rated company, which is a very poor quality management team. So, we've got the quality of the business economics of a business, the quality of a management team. And then a third very important factor is understanding the intrinsic value of a business. So, i.e., do you have a margin of safety when you're allocating capital? And how has looking at these specific factors in a business contributed to success in the past?

13:43Yeah. You know, I think we've had a… So, apart from the risk management dashboard? Sure. So, look, we've had clearly a number of successes over the years. But again, you know, just to remind investors that we should never rest on our laurels with past successes. We clearly need to focus on, you know, future opportunities. We're only as good as our last successful investment. And, you know, success is not only measured by what you own in the portfolio.

14:14It's also about what you've been able to avoid, avoiding some of the disasters. And to tie that back into the risk management process, you know, if you are able to identify overvalued sectors or companies or identify poor quality businesses, you are able to eliminate that, you know, risk factor when you're making your investment decisions. So, if I go back to 2008, you know, the run-up to the resources bubble where commodity prices were at extreme levels, you know, driven by a huge demand from China, we felt that the resources sector in 2008 was hugely overvalued.

14:54And at that time, resources were almost 50% of the all-share index. We had less than 10% of our client's capital allocated to resources over that period. So, just by avoiding a significantly overvalued sector, you were able to really protect a fairly large amount of capital for your clients. So, maybe that – I just wanted to contextualize that. It's also about avoiding disasters. And then we've had, you know, other successful investments. You know, I'll talk about two in particular on the small-cap side, you know, combined motor holdings.

15:30We've owned the company and the portfolio for many, many years. And, you know, the past 15 years, it's increased value almost 17-fold over that 15-year period. You've had two of the oldest serving directors on the JSE. The CEO, Jeb McIntosh, was appointed in 1976, just to put it in context. And, you know, this is a – it's a simple business. It's an auto retailer. It's got a car hire business to it. It's a fantastic business. It generates extremely high return on invested capital, certainly relative to its cost of capital.

16:05And it's been able to compound a huge amount of value for us over the years. And then I'll also maybe highlight another company, which is Ultron, which, you know, unlocked significant value, where we took a very active approach to unlock value. We engaged with value capital partners in early 2017. And together with some other shareholders, we were able to drive significant shareholder value creation. So to put that in context, in March 2017, Ultron share price was 7 rand a share.

16:39It had a market cap of less than 3 billion rand. Three years later, by Feb 2020, the share price had gone from 7 rand to 23 rand, from a market cap of just under 3 billion to 8.5 billion. And then subsequent to that Feb 2020 period, they unbundled Bytes Technology Group and listed that in the UK. And the current market capitalization of Bytes Technology Group is 26 billion rand. So you took a 3 billion rand investment in 2017 to well over 30 billion investment opportunity, which was more than a tenfold increase in value over that period.

17:22You know, so that also added significant value. And these are the types of opportunities, Kelly, that you're looking for. And when did you invest in Ultron? So we had invested in Ultron prior to that. I can't call our exact entry level, but it probably was in the order of 8 or 9 rand a share on average when we invested. But as I said, by the time we had exited that investment, it was, you know, almost a tenfold increase in value.

17:52You spoke earlier about avoiding resources. It must take quite a lot of discipline to do the opposite of what everyone else is doing in times like that. Yeah, absolutely. I think, you know, it talks to some of the behavioral factors of investing. The biggest mistakes you make will be if you get sucked up into this sort of greed scenario where markets are performing incredibly well. There's a huge amount of momentum and you get sucked into that and vice versa. You know, you need to have that discipline as a portfolio manager to say, when times are tough, that is when you have your best long-term investment opportunities.

18:32And when there's a bubble emerging, you need to have the fortitude to say, look, I don't want to get involved in that bubble. And it can last for, you know, a fairly long period of time. So, you need that discipline. Obviously, discipline comes from experience, which is something that you and your team have.

Competitive Advantages

18:50Could you tell us what else differentiates this fund from the rest? Yeah. So, you know, that talks clearly to what you believe your competitive advantages will be relative to your peers. So, you know, there are three or four that, you know, we can clearly highlight. And the first being as a smaller sort of boutique asset manager, we have a much broader universe of stocks available for us to choose from. So, we actively cover 100 stocks.

19:22Many of your larger peers, purely from a liquidity point of view, will only be able to really invest in the top 40 stocks. So, that small and mid-cap space is a significant differentiator for us where we can tap into opportunities. So, our top 10 relative positions often differ quite substantially from our peers. And, you know, over time, we've probably averaged about 30% of the capital allocated to that mid- and small-cap area of the market that is under-researched.

19:54So, that's maybe the first point. The second point, I think, is the experience of the investment team. You know, we focus, we're passionate about generating great returns for our clients. I've been focused on local equities for a 31-year period. My colleague, Jan Mankis, whom I've worked together with for many, many years, has been in the market for 28 years. And, you know, we've got a great team of analysts that support us. So, with that, I think, you know, our clients can benefit from the stock-picking skills of the team across mid-large and small-caps.

20:30So, that would be the second point on the experience side. And I think, thirdly, there are very few boutique asset managers that have an extensive and integrated global equity team available to them. You know, we've run global equity funds for decades. Corky Coyman has been around for over 30 years. Our global equity team has managed funds for a long period of time. And we are able to invest up to 45% now of our assets globally. So, we need to be able to tap in to really good quality global opportunities.

21:04So, I think, you know, that is a significant differentiator for us as well. So, with all these skills in the team, what opportunities are you seeing at the moment? Yeah, I think, Callan, we're seeing a lot more opportunity at this point in the SA equity markets relative to global, just given the fact that there's a lot of negative news, certainly in SA at the moment. And that's, you know, a function of the obvious consumer pressures that we're seeing on the back of, you know, high inflation, high interest rates,

21:37obvious ESCOM challenges, which have had a dramatic impact on domestic SA. So, you know, long-term opportunities are generated through, as I mentioned a little bit earlier, when the environment is fairly tough. You see the breadth of opportunities increase dramatically. You see a lot of good quality businesses derating significantly and offering, you know, a lot of investment opportunities. So, if we look at the investment universe of 100 stocks that we have, the median price to earnings multiple of that universe currently is about nine and a half times,

22:15with a median dividend yield of approximately 5%. So, in the context of seeing pretty decent value opportunities in SA, the likes of the Mr. Price, Italtal, Pepco, Hudayco, you know, all of these companies are trading anywhere between a seven and a half times price to earnings multiple to a 10 times multiple. So, we're seeing a lot of opportunity there. I'll give a few other examples. Sun International, you know, we've built up a reasonable position there over time.

22:48They're recovering, you know, post-COVID as consumers return to their gambling habits, as hotel occupancies are increasing, the likes of famous brands, you know, consumers are now eating out a lot more post, you know, the COVID recovery. You're seeing a lot more travel, the quick service restaurant environment is improving, people are dining out. So, those are some of the opportunities. The banks in South Africa remain relatively cheap, trading anywhere between seven and eight, nine times multiples.

23:24But we also have to look at our banks in the context of global opportunities, because, as I mentioned, we can invest up to 45% offshore. So, we do see some opportunity in local banks, but we also see a lot of opportunity in Corky's Global Financial Fund. So, we've got about 7% of the fund exposed to Corky's Global Financial Fund, which is very well diversified across developed and developing market banks and insurers and asset managers. Well, I think we're looking forward to see how these opportunities play out for investors.

23:57So, Claude, I think just to finish off, I've got one last question for you. If an investor had to sit in on one of your investment meetings, what is the one thing you'd like them to take away from it? Cairlyn, I think, you know, in line with our company vision, and it might sound a little bit corny, but our company vision is we want to be our client's greatest discovery. And, you know, if a client was sitting in one of our meetings, I would like to convince that client

24:28and show that we are able to create real wealth for our clients over time and to do that by identifying, you know, fantastic investment opportunities that can compound wealth over time. And we would do that with the robust debate that we have within the team. You know, in all of our team meetings, we are focused on, you know, one thing at the end of the day, and that is identifying and searching for these great long-term investment opportunities.

25:00So, hopefully, they'll walk out of that meeting and, you know, realize that we are our client's greatest discovery. Yeah, Claude, from, I mean, I'm not on the investment team, and it is very clear to me that the team is very passionate and skilled at what they do. So, thank you so much for your time today. It's been very interesting taking a trip down memory lane with you. Yeah, and we'll chat again soon. Thanks, Cairlyn, and yeah, thanks for the opportunity to talk about the fund.

25:32Thank you for listening to this episode. We hope you found it interesting. If you would like to join us again, please subscribe for more investment insights. To find out more about our team and the funds we offer, please visit our website at denkacapital.com.

25:49The opinions expressed in this podcast are those of the participants and do not necessarily represent those of Denker Capital. This podcast does not take the circumstances of a particular person or entity into account and is not advised in relation to an investment. Please do not rely on any information without appropriate advice from an independent financial advisor. The value of investments may go down as well as up, and past performance is not a guide to future performance. Denker Capital is an authorized financial services provider in South Africa. Please visit denkacapital.com forward slash disclaimers for the full disclaimer relating to the South African fund mentioned in this episode.