Regarding… Vol 2 no 44 – But is it art?

Dear Fellow Investors and Friends,

Welcome to this week’s edition of my investment musings, where I try to make sense of the world around me.  I do appreciate you taking the time to read this.

Today is Thursday, November 28th, the 333rd day of the year. There are 33 days left until the end of the year. That’s a lot of threes!

The number 3 is often associated with the third zodiac sign, Gemini, which apparently represents adaptability, curiosity, and versatility. In numerology, the number 3 is regarded as a symbol of creativity, communication, and joy.

So, the number three is all about art, isn’t it? Its appearance this week is a nice coincidence, as this letter starts a two-part rumination on the value of art. Last week, the purchase of a banana taped to the wall for $6.2 million by an “art collector” nudged me to think through this contentious subject.

They say an art collector is defined by the irrational buying of ever more art, even when no space is left on their walls.

If that’s true, I have been an art collector for a long time.

I have also tried to be a rational investor, evaluating investment opportunities based on the present value of their conservatively estimated cashflows.

These two activities seem irreconcilable.

But isn’t art an “investment”?

Ben Graham said:

“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

To establish if art is, in fact, an investment, let’s dive into the world of art:

(Avant Car Guard: “Diving into the SA Contemporary Art market”)

An investment analysis starts by estimating the size and timing of the asset’s cash flows. The analyst then considers any factors affecting the contract that confers ownership of those cash flows. Finally, the analysis is expressed through a purchase or sale of the asset, often on a regulated, liquid market.

Fortunately, the cash flow analysis is simple for art – no cash flows exist. Unless you count the negative ones. Storage, insurance, and maintenance all add up. These negative cashflows start the day you buy the artwork. A positive cash flow might eventuate when you sell it. If you can sell it.

The JSE – a small market – is worth around $1.3 trillion. In 2009, Skates Art Investment Handbook estimated that the worldwide art market was worth between $4 trillion and $6 trillion. Of this, only around $400 billion worth of art is available to transact, the rest being owned by museums. The art market is tiny.

Data on art transactions is minimal and unreliable. Shares are fungible – each share of a company is exactly like all the other shares. Art is not. As a result, it’s tough to obtain reliable pricing on any specific work of art. The art market is highly illiquid.

The art market also has no regulatory, compliance, or governance underpinning – not little, none. ESG analysts, avert your eyes! Unsurprisingly, given the incentives at play, this small, illiquid, unregulated market is prone to manipulation.

Based on these factors, Ben Graham would conclude that art is not an investment but a speculative asset.

The Oxford Dictionary defines art as:

“The expression or application of human creative skill and imagination, typically in a visual form such as painting or sculpture, producing works to be appreciated primarily for their beauty or emotional power.”

This is a sculpture of a bird by French artist Xavier Velhan:

SA Inc stands for “South Africa Incorporated”, a collective noun for companies who operate predominantly in South Africa. “SA Inc” is market shorthand for these stocks that South African investors don’t own much of.

The reason they don’t own them lies at the confluence of a few factors:

• Most jaundiced market commentators’ inherent pessimism about the local economy creates a negative consensus.
• The once-in-a-lifetime outperformance of a specific geography – in this case, the USA – creates massive FOMO.
• SA’s market structure where a couple of huge fund managers dominate. Due to their size, most of SA Inc. is too small for them to invest in, so they employ a combination of strategies:
  • Emphasise the offshore good/local bad narrative so they can continue to grow their AuM by investing offshore.
  • Mimic the index, which is dominated by a random collection of large foreign businesses like Richemont, BHP and Naspers. This allows them to deploy their large AuM in a manner which avoids taking a view on South African business.

As a result, SA Inc. has historically struggled to attract investment. Even high-quality businesses are trading at depressed levels. But the narrative is slowly changing.

Consider the following:

• The political environment has stabilised since the election.
• South Africa becomes president of the G20 this year, raising our profile.
• The ratings agencies are increasingly positive in their outlook statements.
• Retailers are starting to report better business conditions due to, amongst other things, the effect of the two-pot system.
• Also – interest rates are declining.
• And just this week, local company Holdsport, which owns Sportsmans Warehouse and Outdoor Warehouse, was the subject of an offer by UK-based Frasers.

This is the P/E ratio of SA Inc. as calculated by Investec Securities:

Since the election, SA Inc. has increased by 35%, primarily due to a higher P/E ratio. We will see higher earnings over the next few years, leading to excellent returns.

My take: SA Inc. is healing. But the process has only started. Wait until someone like Coro or Gray tries to move money into the space!

This is one of those high-quality local businesses. It listed earlier this year when it was separated from its troubled mothership, Transaction Capital. The price at which it debuted on the JSE was around R20. Since listing, it has more than doubled to R44 per share. Here is a graph of the share price:

Not bad for an IPO!

It should earn between R2 and R3 per share next year, which puts its forward P/E ratio at less than 20. This is comparable to or cheaper than other quality growth stocks like Boxer, Shoprite, and Capitec.

Sadly, I don’t own it. I misread the environment around its listing and have been looking for an entry point ever since, which has not been forthcoming. I kick myself awake every morning.

My take: When the chance comes around to buy a wonderful business with wonderful management, you don’t need to wait for a wonderful price. This shows that you just keep on learning. About markets and, more importantly, about yourself.

Fortunately, sometimes the market allows you to score the trifecta of a wonderful business, management and price. In Lewis, the MWI Value fund found such a stock. It is one of the top holdings of the fund, and here is its share price development over the past few years:

Over the past few months, Lewis has also just about doubled. And it’s still only on a 7 P/E and a 30% discount to NAV.

I first wrote about Lewis in June this year in Regarding…Vol 2 No 24.

My take: Lewis is possibly one of the primary beneficiaries of the two-pot system. People might use their windfall to reduce debt or buy more furniture, which will be a tailwind for the business.

Reinet also reported its results over the past week. Johan Rupert ostensibly started this investment holding company to show fund managers that he could do better than they could – or so the story goes.

Which he has done.

Reinet has generated returns in line with the All Share (Total Return) Index since 2010. Most of the large fund managers have done worse than that.

Reinet mainly consists of two investments: BAT (the tobacco company) and Pension Insurance Corporation. It also includes a handful of smaller investments: some poorly performing Chinese assets and some private equity funds with varying levels of success.

But there is one interesting holding I had not spotted previously – a company called Grab Holdings. Grab is a leading super-app platform in Southeast Asia that offers various services, including food delivery, ride-hailing, and financial services. For multiple reasons – population growth, productivity gains, energy intensity gains – I believe Asia will be the next big generational investment opportunity. And it strikes me that a (successful) super app might be a good thing to own.

My take: Grab is tiny in Reinet’s life but bears watching. It’s by far the most exciting thing they own. The MWI Value fund owns Reinet because of its steady performance and a significant discount to NAV. Maybe Grab can become a kicker?

ESG has become quite the investment fad over the past few years. However, like any investment proposition reduced to an acronym, it almost immediately stops working. Remember the BRICS, TMT, etc.?

Recent trends indicate a significant decline in the popularity and launch of Environmental, Social, and Governance funds. This can be attributed to various factors, including poor performance and growing scepticism regarding the effectiveness of ESG investing.

According to Reuters Breakingviews, COP29 stole defeat from the jaws of victory. But that’s no surprise, given that the Taliban’s appearance at the talk shop was now saying the quiet part out loud. “All the countries must join hands and tackle the problem of climate change,” Matiul Haq Khalis, former Taliban negotiator and co-head of the Tora Bora Military Front turned director general of Afghanistan’s environmental protection agency, told the Associated Press.

Really?

The Taliban is simply hiding under the umbrella created by all the do-good banks that have been using the movement as a marketing tool.  Those with less-than-green ideals have hijacked the movement. Destroying its credibility in the process.

Prof Aswath Damodaran has written a hard-hitting piece on the problems with ESG investing. He’s straightforward about his views on ESG: “…which I have described as an empty acronym, born in sanctimony, nurtured in hypocrisy and sold with sophistry.” Touché, prof!

You can read the full piece here. It’s worth taking the time to read. Prof. Damodaran is no screeching heretic. His views are well-reasoned and logical. Also, pretty damning.

The recent election of Javier Milei in Argentina has catapulted another straight talker into the limelight. Here is a wide-ranging interview with Lex Fridman, which is worth spending its two-hour running time on. Some takeaways here:

• He studied the Austrian economists Von Mises, Hayek and Rothbard.
• He describes himself as an anarcho-capitalist who advocates the complete abolition of the state. Practically, however, he calls himself a “minarchist,” supporting a minimum of government.
• He has already removed half the Argentinian government departments and dismissed 50,000 civil employees.
• Some quotes from the podcast:
  • “When you tell a socialist the truth, they cry because it hurts.”
  • “The Berlin wall was built because people were leaving communist Germany for capitalist Germany. Communism was such a wonderful idea they had to apply it at gunpoint, and they had to build a wall to keep the people inside.”
  • “Socialism’s strategy is to take over the media and culture and define what is politically correct and what is allowed to be said. Anyone who says anything else is considered reactionary and banned. Free speech is gone, and the socialists can control society and extract from it the taxes that sustain them.”

Finally, Donald Trump’s election in the USA has driven another nail in the socialist ESG/DEI agenda. Trump has nominated Chris Wright to the position of secretary of energy. Wright is a pioneer of the US shale gas revolution, Liberty Energy’s CEO, and the founder of Okio, Inc., a next-generation small modular nuclear reactor company. Liberty Energy published a 180-page policy document earlier this year titled “Bettering Human Lives.”

You can read the full report here, but the key takeaways were:

1. Energy is essential to life, and the world needs more of it.
2. The modern world today is powered by and made of hydrocarbons.
3. Hydrocarbons are essential to improving the wealth, health, and life opportunities for the less energized seven billion people who aspire to be among the world’s lucky one billion.
4. Hydrocarbons supply over 80% of global energy and thousands of critical materials and products.
5. The American Shale Revolution transformed energy markets, energy security, and geopolitics.
6. Global demand for oil, natural gas, and coal is at record levels and rising – no energy transition has begun.
7. Modern alternatives, like solar and wind, provide only a part of electricity demand and do not replace the most critical uses of hydrocarbons. Energy-dense, reliable nuclear could be more impactful.
8. Making energy more expensive or unreliable compromises people, national security, and the environment.
9. Climate change is a global challenge but is far from the world’s greatest threat to human life.
10. Zero Energy Poverty by 2050 is a superior goal compared to Net Zero emissions by 2050.

My take: The Overton window for discussing the trade-offs implied by net zero and ESG generally, is widening by the minute. Speech is becoming free again. This has important investment implications, which I am still processing. It would be a game changer if we could start talking freely about point 10 above.

My friend Deon Gouws forwarded this thread on X by Jason Zweig to me. Since Deon and Jason are both much better writers than I am, I will simply leave a link to the thread here.

My take: A remarkable story, wonderfully told. Art is always in the eye of the beholder.

In 1987, the military police finally caught up with me. I had to do my “national service”. That, or face jail time. Now, I was not a fan of the prevailing political environment at the time, but I was also not partial to being incarcerated for three years. So, I chose the lesser of two evils. I worked the system to change my call-up to the Finance Corps – as non-combatant a unit as possible. Proof that my varsity years were not entirely wasted.

So, when I think back to 1987, I think about early morning inspections, ducking and diving to avoid extra duties, and spending 120% of my free time coming up with new ideas to get sports passes out of the camp – mostly successfully.

Basic training, on to JL’s and then an Officers course meant I was super fit. And super bored.

The music of 1987 reminds me of those things. Above all, it reminds me of that sense of freedom I felt when I walked out of the camp’s gates on a sports pass, even if it was just for a few hours.

Pure joy.

So here are my best albums of 1987, on Apple Music. Some comments:

• Sinead O’Connor, who died last year, absolutely stole the show. Her voice still rips me apart.
• REM started to emerge as something really interesting.
• I didn’t like Bryan Ferry then. I love him now.
• Echo and the Bunnymen went commercial, albeit with a member of Jim Morrison’s band The Doors backing them. It was good.
• The Flaming Lips came to my attention. Their music made me very, very happy.
• Tom Waits. What can I say? Down and out never sounded so good.
• I hated this album of Fleetwood Mac, then. I am old and soft now, and I like it now.

Here is a long list of the best songs from 1987 on Apple Music.

And the top 20 on Apple Music. And Spotify.

I hope you find something new – or rediscover something old – that increases your joy quotient!

By the way, you can find some of my other annual lists in various previous mailers as follows:

1986

1985

1984

1983

I’m writing this to you somewhere over Africa on a plane – on my way to watch Arsenal play West Ham on Saturday. I’m an Arsenal fan, and my friend Simmy is a West Ham fan. He’s never seen them win, live. I secretly hope he doesn’t break the streak this weekend.

There’s a real bull market on the go out there. But you still need to be careful. Very, very careful.

Piet Viljoen
RECM