What really drives returns on the JSE?

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SIMON BROWN: I’m chatting with Chetan Ramlall. He is portfolio manager in the Systematic Solutions team at STANLIB Asset Management. Chetan, I appreciate the time, as always.

The JSE is often described as a resources market, and at times I suppose maybe it is, but is that still a fair conception or is it perhaps a bit outdated? And if it is, what does our market more accurately look like these days?

CHETAN RAMLALL: Yes, Simon. I think increasingly that perception is becoming outdated. And as you rightly say, I think if you look historically our market has at times been very much dominated by the Resi. If you go back all the way to the late ’70s – so even around that 1978 and early ’80s period – for context resources made up around 68% of our market.

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SIMON BROWN: Oh, wow.

CHETAN RAMLALL: But I think since then, over the last 30 years there’s definitely been a broadening out. So if you look at how our banks have done, our financials, consumer staples, industrials, et cetera, there has been this great broadening out.

But once again, as you say, it is cyclical and it moves through time. Currently in fact, with the massive run-up in gold that we’ve seen, miners have dominated the market. So at the moment I think the Resi is sitting at about 30% of the All Share. But once again, that does vary through time, just as the market evolves.

SIMON BROWN: Yes, I get that. Markets are, in their different parts, cyclical. Also, in a recent article you wrote, you were talking around how the JSE actually might be more diversified at sector level, yet we still see concentration perhaps at company level. That distinction is that we’ve just got some big stocks in our market – and that’s not even unique to us for that matter.

CHETAN RAMLALL: Exactly. It’s quite an interesting sort of interplay, where the JSE has definitely become more diversified across the range of sectors that it represents. But what we’ve seen is that it remains quite concentrated in a relatively small number of companies.

So for context, the 10 largest shares in our market account for roughly half of the market value. That just shows you how sort of concentrated we are at a stock level. And once again, this changes over time and leadership changes over time.

If you go back to 2002, that was when the modern All Share Index was set up.

Very interestingly, there’ve only been 24 unique companies that have appeared in the Top 10 since 2002, so that actually gives you a flavour of the relatively small number of names that do tend to lead.

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SIMON BROWN: I would never have guessed the number was that small. I would have thought maybe a hundred or so.

You made the point that the concentration risk should be assessed through sort of underlying return drivers. Worry less about the sectors, worry what that return driver is, and then plug that into portfolio construction.

CHETAN RAMLALL: Yes, this is so crucial, Simon, because I think it’s very easy to get fixated and simply look at the sector labels – Resi, Financials, Staples, et cetera. And then by looking at those labels, you think that you are diversifying away your risk as an investor and you’re sort of broadening out your risk exposure. But actually, you need to go deeper.

When you go deeper it’s to actually understand what is driving these companies. For example, companies that are in one sector – or among, it might seem on the surface, different sectors – you might find that they all have underlying exposure to the rand, or to Chinese demand, or to the commodity cycle.

So in essence you are actually doubling up on risk instead of diversifying risk, as an example. So investors need to start assessing diversification across several dimensions.

That’s not simply sector exposure, but rather think in terms of currency sensitivity, think in terms of geographical earnings, macro risk – and then also the relationships between these risks.

So I think genuine diversification really comes from holding different sources of return, not simply focusing on sector labels. I think that’s really the key.

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SIMON BROWN: I get that, absolutely. I like that. You mentioned China and obviously there’s Prosus on the one side, there’s Richemont on the other, and you could put an iron ore company in the middle – they’re different sectors, the same driver.

If we look ahead, if the JSE is going to continue to evolve with different leadership – not as much as I had thought, but still there. What does remain consistent in that process? I imagine your systematic approach is having that process perhaps as important as anything.

CHETAN RAMLALL: Yes. So I think most important, because as we’ve seen – and as you’ve seen – different cycles of the market play out, the market itself changes. And I think especially now, more than ever, the importance of having an investment framework and a solid process to make decisions is actually what’s needed.

So it’s almost finding that anchor in the sea of change that keeps unfolding because that idea of having a framework, Simon, is so crucial, especially when there’s so much noise in the system.

And that attempt at separating signal from noise becomes ever more important because, as we’ve seen with social media and all of the noise that’s going on in the news, it’s becoming increasingly difficult to know what’s real, valuable information and data, and what’s simply fluff, noise, and froth in the system.

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So I think understanding leadership in terms of what drives returns – and companies will change – but having that disciplined and adaptable investment process is really the key at the heart of it.

SIMON BROWN: I get that, absolutely. You’re a portfolio manager in the Systematic Solutions team, and that is your process, that is your framework. But I’m imagining there’s still some human judgment; you’re just trying to sort of make that an easier process for the individual.

CHETAN RAMLALL: Yes, I think at this point – especially if you look at how the whole technology theme is playing out at the moment with AI and all of these amazing technologies, Simon – now more than ever the skill of the human manager is paramount.

By no means is human judgment being pushed aside, but rather by having a solid framework and having a systematic approach of making decisions, when you combine that with the excellent tools and technology we have, in a sense it enhances and strengthens what we can do as skilled human managers.

That’s really the heart of why a systematic approach creates a structured and consistent way of assessing companies; that’s really it. Why that’s so important is that it ties in very neatly to the risk-management dimension.

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You’ll find that with managing these types of portfolios, building strategies that do outperform over the long term, these really become multidimensional problems. If you look at all of the noise, like I mentioned, you’re trying to find companies that perform well while simultaneously accounting for various risk dimensions and risk factors. It’s actually a near-impossible task to just do in your head or to do in a sort of heuristic way.

That’s where the need for sophistication comes in. Human judgment is paramount in terms of designing these processes, and it’s part and parcel of the process. But it doesn’t mean we can’t use these sophisticated tools that are now at our disposal.

SIMON BROWN: And just using the best parts of both – whether that be the tools or whether that be the humans.

We’ll leave it there. Chetan Ramlall, portfolio manager in the Systematic Solutions team at STANLIB Asset Management, appreciate the time.

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