The art of market exploitation

The art of market exploitation

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One of the principles of Truffle Asset Management’s philosophy is that the “market is efficient over the long-term”, however there are many periods where short-term inefficiencies will present themselves. It is these inefficiencies that gives active managers opportunities to add alpha – and being in a position to take advantage of these opportunities is what will set good managers apart. 

In our recent Balanced Perspective event, Iain Power, Fund Manager of the Nedgroup Investments Balanced Fund explained that opportunities arise when, for various reasons, investors can become very optimistic about prospects. 

“This often translates into an expectation that the growth of certain stocks will continue into perpetuity, which we know is not often the case. Ultimately, growth rates will slow down, and growth multiples will compress, which is the efficiency that we talk about,” he says. The team at Truffle Asset Management prides itself on understanding the value of businesses and comparing those prices to value, to get a sense of those inefficiencies in the short-term. 

“Of course, these inefficiencies could also be because people are too pessimistic about prospects in the short-term, such as many of the SA Inc. stocks. He cited the example of ABSA which Truffle was able to buy at a discount despite the fact that the business was continuing to grow, compound its cashflow and improve its efficiency ratios. “It was just not reasonable that the stock would continue to derate as the cash flow continued to grow,” says Power. 

According to Power, the inefficiencies are what gives managers the space or a reason to exist. “If you can’t beat a benchmark, you shouldn’t be managing money because investors have the choice to buy a passive product at a very little fee which will track the index”. 

Another example of where market sentiment created inefficiencies that Truffle was able to take advantage of was the Covid pandemic. For fund managers, it is an exciting time when you have the opportunity to buy good companies that have been sold down equally with average or poor-quality companies, due to an exogenous shock such as COVID. Ultimately, we know that the differences between those business models is vastly different, which is an opportunity to buy into a more decent or quality business at a bargain price. 

“When the Covid crisis unfolded, everything went down with massive price compression in the equity markets and risk assets. Many of these equities were pricing in negative earnings growth into perpetuity and we saw this as an opportunity to buy high-quality businesses with the ability to compound over time - at a cheaper price. 

The period of “Ramaphoria was another data point which created a lot of optimism which wasn’t justified in the fundamentals and was therefore another opportunity”. 

Ian adds on that an active fund manager should always look out for entry and exit points because generally opportunities tend to be found when there is bad news. 

When asked about any other current macro themes that are showing short-term market irrationalities, Ian mentioned that from a South African perspective he still thinks there are a lot of local assets that have bad news priced into them. 

“Real bond yields are still attractive; the health of the country’s balance sheet is still quite good, and trade is still reasonable. That suggests that there’s a lot of value in our fixed-income assets as well as some local equity assets. The reality is a lot of local companies have done well to navigate a tough structural and macro environment. Which has resulted in SA equities trading at deep discounts to their long-term medians, which means that prospective returns going forward, look compelling. 

“One can’t say what the catalyst will be to unlock the value, but we think that South African assets are mispriced, and we are overweight some of the South African centric assets,” he says. 

The situation is more complex and muddier from a global perspective. The world is still trying to unravel from a period of super low interest rates and monetary policy, which has resulted in excessive risk taking, and ultimately a big misallocation of capital. 

“When the cost of funding is low, funds seem to find their way into projects that don’t necessarily deserve it and some of that is still likely to come out as rates and quantitative easing readjust. There are also areas where bad news is being priced into the system so there are some longer-term opportunities for us there,” says Power. 

One example of this is Google where the valuation is starting to look more attractive, and Truffle have therefore increased their holding of this stock.

 For more information on the Nedgroup Investments Balanced Fund click here.