A significant valuation gap has emerged in equities between consumer and retail sectors and resources which, according to Alexander Forbes’s Global Large Manager Watch, has resulted in divergences in returns between fund managers of over 10% in the last year – a spread that has been steadily growing over the last couple of months.

The Alexander Forbes report shows that once one has stripped out the effect of asset allocation between the funds, the impact of sector selection accounts for as much as 20% differential in returns between asset managers. In other words those fund managers that continued to ride the consumer share momentum have on a pure equity basis outperformed those managers that invested more heavily in resources by a massive 20%.

Foreign investors which have traditionally viewed the JSE as a resource play have bought heavily into South Africa’s retail and consumer stocks continuing the momentum for stocks like Massmart, Foschini, Truworths and Shoprite which have outperformed the FTSE World Index by between 20 and 30 times over the past 10 years. The profits of some of the listed retailers have grown by over 15 times since 2000 and continued to grow throughout the 2007 the 2009 global financial crisis drawing the attention of global investors which now make up 40% of shareholders on the JSE.

Historically South African managers maintained relatively low weightings to resource shares relative to the index while foreign investors were overweight resources.

This relatively low weighting and bias towards domestically focused shares helped local asset managers to outperform the index when resource share prices were suppressed. However this relative positioning has changed as many local fund managers have gravitated to a value-orientated investment strategy since the financial crises.

According to Alexander Forbes’s report “a large segment of managers have piled into the undervalued mining shares to an extent that has not been seen in a decade or two. Unfortunately this is also the segment of the market that has performed the most poorly”. Year on year resources have declined by 9.9% while the financial and industrial index is up 21.0%.

While foreigners have maintained the price momentum in retail shares, the Alexander Forbes report questions whether the sheer weight of their presence will keep upward pressure on these shares for some time to come, or whether events from Europe or a prolonged global financial crisis will trigger a quick but devastating sell-off.

This is a question that will be top of investors’ minds depending on the view of their asset manager. Managers such as Allan Gray and RE:CM have preferred undervalued resource shares to retail stocks in the belief that the relative value play will deliver superior returns over the next few years whilst Foord Asset Management has been riding the crest of the retailers (and industrials) wave to deliver more than 10% outperformance over their nearest rival over the one year period according to the Global Large Manager Watch.

According to the report Stanlib have also benefitted from their underweight position in resources and Sasol while Prudential have also made good sector and asset allocation bets to place them in the top performing large managers over various periods.

Nick Balkin of Foord Asset Management says the asset manager is not about to sell out of its position in retail stocks any time soon. “The allocation to retail shares remains a good diversifier in our clients’ portfolios, and offset the risk associated with rand hedge shares, including commodity companies.  When we bought them 5 years ago, they were cheap.  The share prices played catch-up with the earnings over the last five years” says Balkin who adds that there is no reason to sell them because they have run and outperformed the market.

He argues that  the management teams in the domestic retail sector (clothing in particular) are amongst the best in South Africa and it would be very difficult to replace these management teams with equivalents should the asset manager decide to exit these holdings. “We continually assess the merits of our investments and still believe that retail shares have a role to play in clients’ portfolios,” says Balkin.

Allan Gray, however is also firm on its decision to sell out of retail shares. Simon Raubenheimer of Allan Gray says although retail companies have shown significant profits, the good news is already captured in the valuations of the consumer stocks. “It is very dangerous at this point to extrapolate the past decade, which really has been exceptional,” says Raubenheimer who point out that consumer focused companies have had had the tailwinds of falling interest rates and relatively stable currency which has kept imports affordable.

Over the last ten years households also tapped into credit, driving household debt to disposable income from a low of 50% to nearly 80%, and increased income has been driven by social grants and high real wage increases in the public sector rather than increased employment levels. “All of the above is unfortunately unsustainable. A decade ago, investors were extrapolating the poor conditions that prevailed at the time. They are doing so again; this time, to the boom conditions,” argues Raubenheimer who says consumer balance sheets are stretched and debt servicing costs are high, despite record low interest rates.

Not only are retailers expensive locally with price:earnings ratios in the 20’s but also on a global basis. Raubenheimer uses the example of Abercrombie & Fitch, a well-known global fashion brand, which has four times the revenue of Truworths and double the number of stores. Yet the market value of Truworths is double that of Abercrombie, in other words you could buy the entire Abercrombie & Fitch company twice for the price of Truworths. “Unsurprisingly we see no value in domestic consumer-focused stocks. They are expensive relative to their offshore peers and also relative to their own histories,” says Raubenheimer.

Most fund managers have once again missed out on the listed property run as listed property delivered 26.3% over the one year period compared to 9.3% from on the All-Share Index. This was on the back of declining interest rates and a growing pool of investors seeking yield in less volatile markets. Despite this return, according to the Global Large Manager Watch, the average manager was holding only 2% listed property in their portfolio.

 This article first appeared in the Mail & Guardian