Newsmaker: Ian Liddle:Chief investment officer, Allan Gray

The man who leads SA's top team of professional investors has unpopular views on the value of local stocks, writes Chris Barron

The captain of South Africa's most successful investment team says local companies listed on the stock exchange are overvalued.

Their share prices have benefited handsomely from the current popularity of emerging markets and there is a growing belief that, after the horrors of the recent past, the good times are back again.

But, says Ian Liddle, chief investment officer of fund management business Allan Gray, watch out.

"My feeling is that general expectations for real returns over the next decade are too high. People are going to be disappointed."

Among those he's referring to are his clients, many of them financially savvy people who head pension funds, university endowments and unit trusts.

Their optimism seems misplaced given the risk-averse mood that has gripped markets in the developed world in the wake of the 2008 market crash, so how does he explain it?

"It's a natural human thing. What all of us do is look in the rear-view mirror. And returns, specifically in South Africa, have been so strong over the last decade."

The shift to emerging markets following the blood-letting in Europe and the US is "a pretty powerful trend", Liddle concedes. "But that's not to say emerging market stocks will be the best place to be over the next 10 years. Not at all."

Indeed, it is precisely the current popularity of emerging markets that he finds "worrying".

"Emerging markets are not an undiscovered secret. Your best investments are made when nobody is talking about it, nobody is thinking about it, when it's an undiscovered gem. That's not the case with emerging markets right now."

Everybody's talking about emerging markets, and there are record inflows going into emerging market funds. But divorcing the euphoria from actual valuations of the companies being invested in must give one pause.

"When one looks at the valuations, I'd be fairly cautious on emerging markets as a whole," says Liddle.

When it comes to overvaluing local stock, foreign rather than local investors are the culprits.

"They generally put higher values on, for example, South African retail stocks than local fund managers do."

This is why a company such as Massmart is trading so high - over 20 times earnings. Foreign investors are piling in while many local fund managers have sold out.

Are South Africans too negative, perhaps, and are foreigners seeing the big picture?

"It'll be interesting to find out," says Liddle, sceptically.

Allan Gray does not see value in local retail stocks and in the short term, certainly, this has cost it.

It used to own close to a quarter of Shoprite but started selling after it reached the R30 mark. With Shoprite now trading at about R90, Allan Gray is "pretty much" out.

On the subject of foreign ownership of local shares, Liddle recently drew attention to the sobering fact that 11 of the top 100 companies listed on the JSE have a primary or dual listing in Europe, and are majority-owned by foreigners. Another 10 are subsidiaries of multinational companies with a minority shareholding trading on the JSE.

In other words, foreign shareholders own most of the shares in 21 of our top 100 listed companies and a significant minority of the shares in three others.

What are the implications?

First of all, he says, a lot of money will leave South Africa in the form of dividends, and this will affect our balance of payments.

Secondly, heavy foreign ownership of JSE companies "ties us in more closely to what's happening in the rest of the world, and makes us more exposed to sentiment changes among foreign investors".

As we saw in 2002-03 and again in the second half of 2008, this leaves the JSE perilously exposed to sudden foreign outflows based more on what is happening abroad.

The upside is that even if South Africa seemed intent on going to hell in a hand basket, the local share market would still hold up.

"People investing in South Africa tend to be emerging-market specialists who are quite used to the vagaries of investing in such markets," says Liddle.

The kind of stuff we're seeing now - civil unrest, strikes, fierce infighting within the governing alliance - is no cause for alarm. "For them, it comes with the territory."

While not overly nervous about local events, Liddle admits that recent controversies around the issuing of mining licences are a "concern".

This is because quite a lot of the R150-billion Allan Gray has invested in the JSE is in stocks directly (Anglogold, Harmony) or indirectly (Sasol) dependent on the health of the local mining industry.

The ongoing debate about nationalising the mines is less of a concern because Allan Gray regards it as more of an "extreme event", meaning there is, in his opinion, a "fairly low probability" of the talk leading to anything but more talk.

Calculating the likely effect of local events on investments is a lot more "tricky" than one might suppose, he says.

For example, "if there were to be radical policy changes in South Africa, it might have the effect of weakening the rand substantially and making mining companies very profitable, while the domestic consumer economy would really struggle".

Anything that leads to social instability is bad news for investments, which is why he is "bearish" about the future.

The current high share prices of companies that provide goods and services to South Africans tells him they are pricing in social stability.

But looking at current events, "there must be some risk of more social instability in the next decade than we had in the last decade".

Over the past 10 years, Allan Gray has outperformed the All Share index by 5.9%, a significantly higher margin than any of its peers.

Liddle, a business science graduate and chartered financial analyst in his mid-30s, believes that what gives Allan Gray the edge is being privately owned.

The shareholders are founders or former executives.

"It makes it a lot easier to do my job knowing it's not under pressure because of quarterly performance numbers," he says.