Delphine Govender: A cool head will always beat Mr Market’s insanity. Especially now.

It's half a dozen years since star asset manager Delphine Govender left her cushy home at Allan Gray to co-found Perpetua Investment Managers. In this insightful discussion drawn from the latest episode of Rational Radio, she offers some perspective on the current stock market turbulence. Delphine shares some of the value investing disciplines of Benjamin Graham and his disciple Warren Buffett, an extremely valuable tool for those looking for future profits. – Alec Hogg.Well, it has been a while since I've had the privilege of talking to Delphine Govender at Perpetua, the company she founded. In fact, Delphine, how old is Perpetua now?.___STEADY_PAYWALL___.Hi, Alec. Good to talk to you again. So, we are 7½ years old now. We started managing money in October 2012..Wow, time flies..Yes, it has flown..And prior to that, you were one of the superstars at Allan Gray, went off and did your own thing. In this kind of a market – and we're going to talk about it in a moment – is it more difficult, having your own business rather than having a big brand behind you?.I think it's a good question. Obviously, for companies that are more marginal, you tend to find that this would be a tricky time. Important though, for I think… and again, every entrepreneur is going to have different economics. I think the important thing for investment firms is that if you have the right owners (the right people that own you) and typically, they should be investors as opposed to necessarily short-term business owners; they tend to understand that investment businesses are, by their very nature, exposed to good and bad times and that one can never predict the extent of both a bull run and a bear market, so volatility is what you sign up for. Profits don't come in a straight line because your top-line totally depends on the market. Having that understanding, for any person starting an investment business is almost essential. I often think it's one of the most under-estimated focus elements of investment firms is who owns you, and that they have this key understanding of what you're signing up for..Sasfin's David Shapiro is with us as well. David, have you ever, in your many years – many decades and certainly more decades than Delphine and I – seen a market environment like this; I don't know if you were close enough to 1969 to have….Do you want me to list them, Alec? You know, I'm just writing something for tomorrow and I remember the dark days of 1976. Okay, different story with the Soweto uprising; there were days in which we did not do a deal. We never put a transaction through to the Stock Exchange. I've lived through many difficult times. I came in the aftermath of 1969. I was doing Chartered Accountancy but I remember 1998,1987, 2000, 2001, and 2002. All the wars, the 9/11, 08/09 (that was a disaster) and as Delphine says, you learn that this is just part of the journey. We seem to get one every six or seven years and you just have to understand it, position yourself properly, and just move on..Delphine, I'm interested to get your take on this because Hendrik du Toit last week, who you know well, started what is now Ninety One – Investec Asset Management; he says that as investors, we should be looking at this as though it's a war where governments just spend money not worrying about who's going to repay it. That will come on another day. David was saying that yes, he agrees that it is like a war that's going to last 90 days. How are you seeing it?.Well, I think the observations by both obviously highly-experienced people that are seeing it and have experienced more than just two or three decades is showing you that actually, no-one knows what the scenarios are going to be. So, what we're saying is that we're sitting with incredible uncertainty and I think what's hard is when you ask David, "Have you seen anything like this before, David?", the tricky thing is that why this feels so different – and I mean, I started my investing career as an analyst in March of 1998, so about 22 years ago – and we were just coming into this peak of this incredible bull market in South Africa. The likes of Steinhoff were listing back then and the crisis, but where this one is different is that we've got these two threats. We've got this public health threat, which is very real and then we've got this economic threat, which is multi-faceted because it's the supply side, the demand side, and the whole financial system. So, why we're not sure and why we're sitting with this uncertainty is that in the response from governments, from policy-makers, from the war room in every single country and government right now, is trying to address all of these things when historically, when we've had bubbles burst or events-driven issues, it's typically due to constraints to a manageable kind of test. And now, we're sitting with the situation where no-one can prove or disprove what our worst-case scenario is going to be. We've got no experience of a similar situation and so, we've got no way of predicting an impact. It could be that absolutely indiscriminate spending is required – both on the public health side and on the economic side – but what we do know is that we're facing potential scenarios where global growth could be significantly negative double-digit quotes in the next two quarters. So yes, I think these things are plausible and I think that's what we're seeing now, that this uncertainty has created this massive fog and blur and so we're all – and the market is really struggling to make invest efficient because of it..And Mr. Market is completely depressed..Yes. I think what's happening is that you're seeing that because it's trying to work out who will come through, how this will happen… Mr. Market is, even in the best of times, always swinging between the extremes of euphoria, which is typically unsustainable and then pessimism, which is often both unjustifiable and unsustainable. And so, you have this impatience and this irrationality. They say when Benjamin Graham coined it, he almost said there was like a manic-depressive nature of Mr. Market. The problem is that we're supposed to behave as though the market is there for us to take advantage of, not in reverse but as we know in the short-time, the opposite occurs..What about value investing, Delphine? I know this is your background – looking for stocks that you can buy at a discount. Value investing has been so out of fashion for so long. Do you think that this could be the transition that makes people look differently at stocks?.Well, I think it's an absolute germane and relevant question, Alec and it's funny because you asked when I started my own business. It was 2012 and I probably, as a value investor with the benefit of hindsight, I couldn't have picked a worse time because we literally started at a point where value had gone through a terrible year, and I think what's been so difficult for value in this cycle compared to all previous cycles has been not the extent of the underperformance but then, how contracted it's been. There's been the odd flash where certain sectors have done OK, but point-to-point, the better part of the last decade has been terrible. Really, where value had its run, was just coming out of the GFC. I think that the most important point is to understand 'well, when is it that this style of almost fundamental-driven investing tends to do well' and unfortunately, we have quite a few crises that we can look to. When we look at what happens in bull markets – and bull markets is when the value style, which tends to be more fundamental-driven, tends to lag… The bull markets have all been driven by slightly different things. We had the tech boom in the 90's. We had the commodities super cycle in and after 2000 and then more recently, this same so-called bull market has been really about platform companies and we've seen how that has transmitted into our markets through the likes of NASDAQ but bear markets on the other hand, have this unique correlation. You look at your screens today and it's as though everything is correlated..South African shares are down over 30% year-to-date. Resources are down over 40%. Properties are down over 50%. The US market is down over 30%. So you're finding that bear markets are similar. The question is, "Does this bode well for fundamental base investing and interestingly, we've got the evidence to show that through all these cycles; while value will perform equally poorly as we go into the bear market, as we've seen, coming out of it is where value typically performs significantly better and so this is why, if you look closely at the tech bubble bursting post the GFC, that value style can perform significantly better and that's really because of where value managers tend to position their portfolios. What happens is that you tend to find that recovery is what really makes those times so obvious but we're actually basing it on empirical evidence and so, when we're seeing the absolute valuation that is available and then the ratio of very expensive shares going cheap, we've had this massive widening. So, if things bode well – and I guess the point is that we're dealing with shock and uncertainty and when you're in that space, the best anchor to use, is valuation. So, you avoid over-valued shares that are priced to perfection and then you buy assets that are priced for extinction and you try and do your work to ensure that you don't invest in potentially extinct shares, which are being sold down and are going to go extinct..Which is a segue into Sasol, surely. Today, it's just over R20 per share..Yes. Sasol's obviously a very tough one because any value investor, including ourselves, would have probably not owned it at multiples of the current price because it would have been extremely expensive and then, as it started coming off in the last several months, it started to look interesting notwithstanding some of their self-inflicted issues. The issue with Sasol right now is that management did come out last week – and remember, the real trigger event is that Sasol is the combination of what has happened to the oil price post the whole breakdown between OPEC and Russia and then what that translates to Sasol's own balance sheet, given its new level of nett set and how tight it's kind of precarious situation is. The scenario I do not envisage is that we would be dealing with a $30 or sub-$30 oil price. So, Sasol has come out and given a plan, which is a pretty meaty plan – a $6bn program to reduce nett set – and while the plan seems quite plausible, it is quite within their control e.g. delaying expansion capex, environmental capex etc. They're conserving about $2bn of cash. They seem to be quite well down the price of asset disposal and then raising about $2bn and then, potentially raising a further $2bn doing a partnership on their US chemical business. The issue we have right now is not necessarily what is within Sasol's control, but this call on the oil price. And so, the market is now incredibly jittery and it will be true for I guess any oil major who has similar balance sheets. The question is, how do you know this current oil price environment continues? And it is protracted. We'll see a continued well supplied market and terrible demand. Which then just means the oil price remains lower. And at some point – and this is when the profitability of the business starts to come under pressure – I think that is the bigger factor right now that is in an investor's mind. It's really how long will this oil price stay low..But isn't the point with Sasol that it's a rand oil price? And if you offset what the rand has been doing, the way the rand has fallen out of bed. It must surely give them some kind of a shield..Absolutely and in fact if you've go back long periods of time and you place the correlation, absolutely. The types of correlation over a long period of time has been Sasol's share price relative to the rand oil price. So, it has been and that's why it's always perceived as one of those kind of almost perfect rand hedge for South African investors. But what has been very unique and curious and I think this is where things have become tough is that in the last period particularly in the last 6 to 12 months that actual relationship broke to some extent. In that Sasol because of some of its own self-inflicted issues and we'd still be following the journey of Sasol late last year. It became less a call on the level of the rand and more a call on the oil price and then the businesses own kind of action. And so, we have had a break and then we feel the same thing. So, if you are running almost a barbell portfolio as many fund managers are doing coming into this year which is buying some of the cheaper SA inc that you know we thought could withstand and then trying to add a hedge with a rand hedge. Sasol wasn't proving to be that kind of perfect Rand hedge that it has historically been. So that relationship has broken of late..So, what is your suggestion now to your clients? I'm sure, not just clients. Family and friends are saying, well we know that Delphine – this is her game. Let us ask her what to do. Should we be jumping in and buying cheap now? Should we be selling everything? Or should we be sitting on the side lines waiting for better days?.I think the reality is that what we do know is because we do our investment in the market. We do our investments funds alongside our clients. Exactly as you say. We are managing indirectly our family members, our pension funds depending where they have been employed in the past. So, people are scared. People are panicked and it comes all the way back to the point that I made in the beginning because we actually we do not know how bad it is going to get. But I think the point is that we need to have something that we can hang our hats on. And something that we can say, can we look to see while this might be a completely different price and it might; How can we know historically there was a great depression. What worked then? I think the point is that we must remember how the market works. You know you spoke of this market. The market always reacts in advance. And so what the market is telling you right now is that economic and business conditions are going to get worse. And I think that's now almost certain we just do not know how bad. The market is telling you Covid-19 is going to spread. We do not know where deaths will peak but it is going to definitely spread. And the reality is that's been frightening. So, you look at the prices of banks, retailers, property companies, anything saying that has you know basically anything really, industrial companies, manufacturers. So, the question is equally on their end as we started seeing some sort of light at the end of the tunnel, the market and the share prices are going to react on the upside before things actually demonstrate improvement. And so, the way we look at it is we say which are the businesses that we think will make it through that can actually generate cash even under dire top line scenarios. Or can potentially generate positive profits even if they are small and significantly down from the prior year, but not necessarily losses, and can actually still fund..So, can they make it through this period to have reasonably sure balance sheets with an ability to just get through. Because if you can find those businesses, I think you have a massive buying opportunity. As long as you avoid the pockets of over evaluation, avoid the bankruptcy risk. It sounds obvious but at the same time we are almost putting too many decent companies in the bankruptcy risk basket. And so, if we can work out the ones that will survive because now the market has contracted. I think if you can find positive net income, positive operating cash flow, it becomes what you can use as an anchor in a bear market. So, we to the extent of our balance fund for example have been well below fully invested. So, this is where we're actually putting, this is when you put your driver hard at work. But with an opportunity of higher-grading your portfolio you have no reason to buy a cyclical business now because actually really solid businesses, which are typically un-geared are trading on way more depressed multiples. So, this is the time to take advantage. We know things can get worse, but what we are not trying to do is time-led. We know that there can be temporary further decline in share prices. Then you can perhaps average down even lower as you purchase. What we are trying to do is look through it, to say where are the sustainable earnings looking through this because we know the market will respond sooner than when the actual improvement is revealed.

Delphine Govender: A cool head will always beat Mr Market’s insanity. Especially now.

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