Regarding… Vol 2 no 21 – Structure Drives Strategy

Dear Fellow Investors and Friends

Welcome! I do appreciate you taking the time to read this.

I’m Piet Viljoen, and today is Thursday, the 6th of June, the 158th day of the year. There are 208 days left until the end of the year.

Today, 45 years ago, in a by-election at Randfontein (formerly Dr Connie Mulder’s seat), the National Party (NP) candidate wins, but with a much-reduced majority. The by-election resulted from Mulder’s fall-out with his constituency after the Information Scandal of 1978, which brought his political career within the NP to an abrupt end and, to a lesser degree, that of State President John Vorster.

Effectively, that by-election was the beginning of the end for the NP. History has not treated them well. We’ve just experienced an election that probably marks the beginning of the end for their successor, the ANC. History is unlikely to treat them well, either.

Forty-five years ago, one wouldn’t even have been able to imagine an ANC-led government; today, they are almost in the rearview mirror. I think it was Bill Gates who said something like, “We overestimate what happens on a short timescale but underestimate what happens on a long enough timescale.”

This week, my stepson, Ben, got his first job after a few frustrating months of rejection. My son Nic also started a new job, which he is excited about. It’s great to see young men excited to be making their way in the world right here in South Africa. I continue to believe that – with the right mindset – this country offers enormous opportunity.

Last week, I shared the first piece of what will eventually become a trilogy. In it, I wrote about investment lessons I had learned. This week, I explain the how-and-why of the structures within which I manage money today. Next week, the trilogy will end by discussing the cockroach – the fund where the rubber hits the road.

Everything I have worked at has culminated in how I manage money today. To understand how I got to where I am today, it’s helpful to look in the rearview mirror.

For a very long time, I was a cog in the wheel of the institutional money management business. In this machine, everything you did was to increase your AuM (Assets under Management). AuM is the lifeblood of an investment management firm, and the incentives institutions put in place to generate AuM are inescapable. Even if you think – as I did for a long time – you are above the fray, when you dive deep down into why you are doing things, it all boils down to the rules of the game:

• Never stray too far from the herd; the herd knows where the AuM is.
• Never criticise the behaviour of the lead steer in the herd; he knows where the AuM is.
• Never tell a fellow herd member they’re lost; if we’re all in the herd, we’ll find the AuM.
• And never, ever say to the herd that the AuM is less important than the path taken. It will turn on you.

In short, the herd sticks together finds the AuM and gets big bonuses. Even if the client is getting poor outcomes, it’s not about the client but about the AuM. Or, at least, it is about the client insofar as the client is a means to an end.

It’s called the institutional imperative. Do whatever it takes to get to the AuM.

The trick successful money management firms pull off is to convince the investment team to think it’s all about their efforts to generate performance. Simultaneously, the marketing team must be confident they are just representing the facts around performance. And while all that is happening, the client must be convinced that they have picked the best investment firm. It’s almost like a three-card monte – each player thinks they are the “money card” when there is none.

Institutional money management firms are nothing more than a huge marketing machine wrapped around a sweatshop of “investment analysts” and “portfolio managers”. On average, over time, large institutional funds deliver similar returns. But each one has been able to convince its set of clients that it is the best.

I’ve become somewhat cynical about the whole money management game. I guess cynicism is part of growing older, but growing older also means seeing things from a different perspective.

Growing older also means you might have been lucky enough to build up your nest egg, which must be managed. It is most satisfying to manage your own money in a sensible way that allows you to escape the institutional imperative.

As Nick Sleep said, on winding up his investment partnership, “We wanted to feel that we did not have to justify actions, and inactions, on an ongoing basis to a revolving door of interested parties.”

Over the last few years, I have worked hard to leave the comfort of the herd behind me. Today – together with my partner Jan van Niekerk – our firm, RECM, manages a few pools of capital. Each one as if we were the only investors. From time to time, some outside capital is interested in what we are doing, so everything we do is open to outside investors on our terms.

But that’s not why I’m doing it.

It’s not about the AuM.

It’s about achieving genuinely satisfactory long-term outcomes using sensible processes, not impeded by the institutional imperative.

And sleeping well at night.  

Right now, Amplats must feel like the red-headed stepchild of the resources sector. Unloved and unwanted.

BHP bid for Anglo-American, with the condition that Anglos first unbundle the assets BHP didn’t want to buy, specifically Kumba and Amplats. Anglos then countered by saying that’s too hard, and your price is too low. Their proposal to create more value than the BHP bid was to spin off other assets. But also Amplats.

It’s no wonder the share price of Amplats is where it is:

My take: As discussed last week with TCP,  spin-offs are an excellent place to look for sensible investments. But they have to be spun off first. I would sit on my hands here.

This is a long-term chart of the share price of Brait:

It’s gone from a hubris-inducing R114 per share to a humiliating 99cps. That is a 99,1% loss in value suffered by shareholders. I can’t say it’s too surprising, as the company has been managed by a succession of capital market raccoons with no skin in the game. Their only interest has been to stretch out the period over which they could earn fees for as long as possible.

Over the past three and a half years, shareholders have paid management almost R600mn to preside over what can only be charitably described as a train wreck, including a rights issue of R3bn and now another one of R1,5bn. The current market value is R1,3bn.

There is only one winner here. Here’s a clue: it’s not the shareholders.

My take: One of your most important jobs is to find out whether the people managing your business or your investments are raccoons. You can learn more about racoons and what they do here, and I’ll write more about raccoons in a future letter. But for now, I would continue to steer clear of this. There are more fun ways to throw away your money, like buying a Versace Padel racket or something

Here’s another SA small cap that’s reaching for the stars. Argent used to be a metal-bashing domestic-only SA company with a minimal concept of shareholder value. Subsequently, an excellent investor acquired an influential stake in the business and went about changing the strategy. Today, Argent is somewhat of a Rand hedge, having made a few acquisitions in the UK. Importantly, this is not the typical desperado bet-the-ranch; get-me-out-of-SA-at-any-cost path that many South African businesses have followed.

These acquisitions have not been expensive in price or transformational in scope. But, they have added some degree of diversification to Argents’ earnings stream. Plus, there is some growth momentum.

I also touched on Argent in my “Riding the Dragon” letter earlier this year. This unsexy company’s share price is up 33% so far this year:

My take: Despite this good performance, the share is on a 4.5 P/E and dividend yield of 5.2%. Results are due in a month and should show more growth. The MWI Value fund is the unit trust in South Africa with the biggest holding of Argent as a % of assets. Our associate fund, Desert Lion, also holds Argent.

Birkenstock IPO’d at $40 per share in October last year. When discussing the IPO in “The Infinite Game”, I repeatedly warned against buying into any IPOs (here and here).

Fact check: I was wrong on this one. Birkenstock recently reached a new high:

My take: A 36 P/E for a sandal maker? Also, the Wall Street Journal fashion page recently commented: “Are open-toe Birkenstock sandals a turn-on? No, not really.”

I still wouldn’t buy the stock, and I definitely wouldn’t buy the sandals. Grown men should not wear open-toed sandals away from the pool or the beach. But the market disagrees with me here.

Last week, South Africa had a national election that produced some surprising results. Only one person was on top of the voting changes from a very early stage. This was Dr. Frans Cronje of the Social Research Foundation. Dr Cronje presented to the clients of Merchant West Investments two weeks before the election, and his views turned out to be quite prescient. You can watch his talk here.

Dr. Cronje was so well informed because he based his views on uncannily accurate polling by market research company Victory Research. The CEO of Victory Research is Gareth van Onselen. Gareth is quite active on X (you should follow him).

Polling has gotten a bad rap over the past few years for being wholly inaccurate. Victory Research’s polling was the opposite. And that in an environment that was rapidly changing. Kudos to them. I spoke to Gareth this week to learn more, and their accuracy boiled down to applying a well-structured methodology regularly and consistently.

There is a lot for us to learn from in the investment world.

This is what Gareth posted on X:

“I’d like to say something about Frans Cronje and the SRF. It takes a lot to run a track like this. The SRF made it all public in the interests of informed debate and data-based analysis. SA is rife with distrust and conspiracy; it was brave and helpful. They deserve credit.”

Already most of Victory’s work is from offshore. I hope they get a lot more. As a bonus, Gareth published – on X – a number of “predictions” by politicians based on their “views”, “feelings”, and “opinions” and, I guess, “vibes”.

And what the actual outcome was.

Here is #1:

And here is #28:

If you look at his timeline on X, you will find the other 26. They are just as illuminating.

My take: “Follow the science” is a discredited slogan, but in this case, it worked. I hope Victory Research gets a lot more business as a result. They do good work.

The FT reports that Shell’s shareholders have taken a shine on recent discoveries in Namibia’s offshore basin. This is exciting news for Namibia, as oil revenues will drive growth, create jobs and strengthen government finances. And don’t @ me with your renewables. The world will need increasing volumes of oil and natural gas for a long time, notwithstanding the current push towards renewables (in the affluent West). Drilling for oil is not only useful but necessary.

At almost the same time, the Business Day reported that the high court had rejected Shell’s application to explore for oil off the South African East Coast. However, @smalltalkdaily reported on X that the judgment was much more nuanced – and that overseas media sources reported that Shell won the appeal. In short, Shell can still explore but first needs to consult more.

This is good news for the country and HCI, which has a shareholding in the exploration block in question. HCI also happens to be a large holding in the MWI Value fund.

My take: This again shows why it’s not worth taking the mainstream news outlets seriously. They have their own agenda, which is not always “The News”.

If you can get hold of it, it’s always worth reading Russell’s stuff. Here’s an article by him in the FT (for which you also need a subscription). In it, he details the changing global monetary landscape and describes the driving forces behind increasing financial repression in highly indebted countries.

Another favourite read of mine is the fairly regular “memo to Oaktree Clients,” which Howard writes. In this one, he talks about how high debt levels can affect investments. What applies to investments also applies to the finances of countries.

In Howard’s note, he references this note from Morgan Housel. Morgan is – in my opinion – one of the best writers out there today. He can take complex financial and historical constructs and distil them to their bare essence, making them accessible to all of us – a rare skill.

In this note, he presents an interesting and unique way to think about how debt affects your ability to endure inevitable volatility over time.

My take: Understanding the debt dynamics in the global macroeconomic environment will be vital in navigating your way through what promises to be a market minefield over the next twenty years. As if the past twenty years weren’t!

Jerry Seinfeld on the rules of comedy and life. We all know Jerry as a comedian who can see the funny side of any situation. But to do that takes a lot of hard work.

The money quote?

“Embrace the difficulty of writing. Yes, it’s hard. What’s your point? Either you want it, or you don’t, but if you expect it to be easy to write something great, drop the pen, walk away from the keyboard and do something else. You don’t want it bad enough.”

That resonated with me. And it applies to most worthwhile things in life. Also, in a recent interview with Tim Ferris, when asked what message he’d put on a billboard for other creatives to see, Seinfeld said, “Just work.”

My take: Nothing good in life comes without putting in the hours. So if you want something, just work.

Jason Zweig was the keynote speaker at the 2024 Value Investors Conference. The topic was whether Ben Graham (the father of value investing) was still relevant today. Zweig’s surprising conclusion? A resounding yes.

But the money quote in this speech was something said by Alfred Chandler:

“Unless structure follows strategy, inefficiency results.”

Zweig said that for most asset managers, strategy follows structure instead. As a result, funds own too many stocks, trade too frequently and charge too much. No wonder most active managers underperform market-tracking funds that charge a fraction of their fees. Notably, the crux of his argument is this: we tend to focus on fees per se when it’s the overall structure we should concentrate on. The structure drives the actions and the costs. And fees are by far not the only cost.

You can watch the speech here. It is worthwhile.

My take: Zweig makes a good point. It is no coincidence I have chosen to structure my investment life the way I have.

That’s it for this week. There is no music, unfortunately. But I’m sure my good friend Mark Rosin will have another great Friday Song tomorrow. If you don’t know about this weekly WhatsApp and like to explore music that is off the beaten track, ask me about it.

I look forward to the new song each Friday when I wake up.

And remember – let’s be careful out there!

Piet Viljoen
RECM