IT MAY be the end of an era for retail shares and the dawning of a bright new age for mining stocks and bank shares.
A Merrill Lynch survey of South African fund managers suggests that the ardour has cooled on the JSE's previous darlings such as Shoprite, Woolworths and Mr Price. Instead, fund managers are now looking with new interest at companies such as Old Mutual, Exxaro and Anglo American.
The survey, done earlier this month on behalf of the Bank of America, revealed that 62% of fund managers expected equities to gather steam over the next year.
But the same percentage of fund managers sounded a cautionary note by saying they believed the JSE was overvalued right now.
Overall, 23% of the fund managers said they were overweight in cash, 8% were overweight in equities and 37% were underweight on bonds. But what was particularly interesting was that, despite South Africa's long-standing love affair with retail, no fund manager was overweight on retail and the number of those shying away from retailers set a record.
So, if this is indeed a new era, what should we do differently?
Shares in general mining companies, banks and transport were preferred by these fund managers.
The least-preferred sectors were general retail, gold, media and telecoms companies. Unsurprisingly, Merrill Lynch's report said the contrarian fund managers were still picking retailers. Adrian Saville, chief investment officer at Cannon Asset Managers, said his company had worked deliberately to make sure the companies they invested in fit a certain set of attributes.
"We want a firm emphasis on value, but also on quality. There are environments in which investors can be forgiving of quality to look past vulnerability, weakness or management distraction, but this is not one of those. Emphasis must be placed on a high degree of agility and new opportunities, particularly where old opportunities are flagging."
Mr Saville said companies looking to build new business relationships in the global economy were best placed.
"The emerging markets of the world average economic growth of around 6%, while the developed world sits on 1%. Old customer-business relationships are at risk, under strain and experiencing pricing pressures. For example, platinum's demand among vehicle manufacturers is down 30%. Old clients are flagging, which demands higher agility and [a focus on] quality will deliver that," he said.
Businesses that are reshaping to fit this new global environment will inevitably get some things wrong and must be able to absorb missteps.
The result of Mr Saville's intensive quantitative and qualitative analysis does not align with common investor sentiment about what constitutes a strong balance sheet.
"Investors often want balance sheets to be lean and optimised, but I'm a fan of surplus cash. You just have to look at the calls for Apple to do something with its cash. Lazier balance sheets actually have been shown to correlate with better performance."
Mr Saville said that apart from looking for stable operating margins, return on equity, return on assets and a good geographic distribution of customers, he wanted earnings underpinned by cash flow. "Dividends are a good sign of that — there is no better sign than persistent, improving dividends.
Also, management must be focused on the business, not fussing over tax issues, a large deal structure or litigation. Such things unfortunately cannot be forgiven in this environment, hence our sale of our position in Hudaco."
Hudaco is facing R1bn in penalties from SARS - a huge setback considering its R3.2bn market cap.
"I was disappointed to let Hudaco go. We had been invested in it for a long time, successfully. It is a superbly run company with operating strength, great products, a good and diverse customer base — it ticked all the boxes for us. But the disrupter is the tax issue."
Mr Saville added that no company was immune from missteps. "The chances of management missteps are always high, but then you need sustainability of company earnings. We looked at the figures and, over 15 years, only four companies out of 150 had enjoyed uninterrupted cash generation ahead of inflation. On average, companies can't do it over five years."
So, to be a good investment, a company must be well equipped to recover from these occasional hurdles.
"Broadly, we are adding weight in resources, with African Rainbow Minerals and Exxaro being our biggest positions. The reason is a very deep discount in their pricing, although they're trading in a difficult environment. We expect them to produce earnings through the cycle and their multiples are depressed, so they're relatively cheap."
The valuations for mining companies were reworked during the financial crisis, which started in 2008 and led some fund managers to avoid resources stocks. But it is a different world now. "At the end of 2012, emerging markets had six-billion people in them, with one-billion residing in the developed world. That means the demand for cars, consumer goods - in short, commodities — will come from the majority, and that's not how these companies are being priced," Mr Saville said.
Duncan Artus, portfolio manager at Allan Gray, expects most managers to be underweight on domestic consumer-facing shares.
"We hold no retailers. The consumption, while mining struggles, cannot last. The weakening rand will also hit retailers. Our biggest holding is still Sasol, based on its price-to-earnings ratio of nine.
"It has a large capital expenditure programme in the offing and that always introduces risk, but it's done well with similar programmes in the past and the rand weakness suits it," Mr Artus said.
Next on Allan Gray's favoured list are British American Tobacco and SAB.
"These shares are quite pricey, but we hold them because ... these companies make good rand hedges in a domestic scenario. They are high-quality businesses with global diversification. Remgro has been a good performer for us and we like its diversification. Unilever, Mediclinic and industrials also feature. Our direction is moving towards resources - we have the highest weighting in ten years: Anglo American, BHP, platinum and gold."
Mr Artus said Allan Gray also held insurers such as Sanlam, Old Mutual, MMI and Liberty.
*This article was first published in Sunday Times: Money & Careers