The majority of professional investors in South Africa have expressed displeasure at the deal, but concerns have focused on the complexity of the transaction and the resultant corporate structure, and underlying management incentives.
Of greater concern to South African investors in general is the fact that the Capped Swix exposure to Tencent will be similar to that of the Swix, introducing additional broader risks to the South African investing landscape.
This is ironic because the deal explicitly targets Naspers’ heavy weighting on the JSE as the apparent cause of its deep discount to net asset value. An added irony is that the Capped Swix was designed specifically with Naspers in mind.
Irrespective of whether asset managers track a broad share index (passive funds) or use it as a performance benchmark (active funds), they expect it not to present concentration risk. A market-cap weighted index may be the ideal, but it is not always the most sensible option.
The Helsinki Stock Exchange is a good example of what can go wrong. In 2000, Nokia accounted for 70% of its total market capitalisation. The company was the global leader in the mobile phone market and had boosted its share price 30-fold in six years.
The Nokia share price fell sharply when the tech bubble burst, and it kept falling after the company missed the move to smartphones and was dislodged by Apple and Android. The share price lost 95% peak to trough (2000 to 2012).
Fortunately, there were no market-cap weighted index funds tracking the Helsinki Stock Exchange in 2000 (or even today). The first such fund was launched in 2006, and it shadows the benchmark OMX Helsinki 25 index, which caps exposure per share at 10%.
The FTSE/JSE Capped Swix was introduced in November 2016 to address the dominance of large international companies, principally Naspers, in the FTSE/JSE Swix. The weighting of this once sleepy publishing house had ballooned to more than 20%, thanks to its fortuitous investment in Tencent.
As no prudent portfolio manager or index fund would take on so much stock-specific risk, the Swix lost its standing as SA’s primary institutional benchmark. According to Alexander Forbes, more than 47% of SA Equity managers surveyed now use the Capped Swix, which restricts the maximum weighting per share to 10%. But even this may now be rendered unfit for purpose.
In 2019, Naspers spun off its international assets (mainly Tencent) into a subsidiary called Prosus (listed in Amsterdam, with a secondary listing on JSE). This structure gives local investors access to Tencent though both Naspers and Prosus.
The proposed corporate action could leave the combined weighting of Naspers and Prosus in the Swix almost unchanged at around 22% (previously 23,4%). In the Capped Index, however, both Naspers and Prosus will hit the 10% limit, increasing its effective exposure to Tencent from 11% to 20%.
This defeats the purpose of this index. Local fund managers must look for another performance benchmark, or the Capped Swix rules must address pyramid structures. The JSE recently asked market participants to express their views around current index rules and whether these should be amended given the potential result of the corporate action.
This exercise begs the question whether even a 10% cap is enough to offset concentration risk. Whilst Naspers has been the darling of the local equity market for the last 10 years, all individual stocks face company-specific risks.
In fact, Chinese regulators have been cracking down on Chinese internet companies with foreign shareholders, like Tencent. A recent example is the IPO of Didi, the largest e-hailing company in China (in which Tencent is a shareholder).
Didi listed on the NYSE on Wednesday 30 June. Two days later, Chinese regulators ordered the app to be pulled from app stores and halted new registrations, in the name of data security and safeguarding national interests. One week after listing, Didi was down 25%.
Investors should assume only those risks that promise a potential higher return. Investing in the stock market is such a rewarded risk because, despite short-term volatility, this asset class habitually delivers the best long-term return.
Unrewarded risks include stock picking, market timing and high fees: all of which lower the return for the average investor. Concentration risk also falls into this category. Coupled with disciplined rebalancing, a well-diversified portfolio will, on average, yield a higher return, with less volatility than a concentrated portfolio.
The most popular index in the US, the S&P500, does not have a single stock concentration problem. Its largest share, Apple, has a 5.5% weighting. Locally, the 10X Top 60 SA Equity index falls into this category. It comprises the top 60 shares on South African equity markets, individually limited at 6% at the time of reweighting.
The offshore investment limits imposed by Regulation 28 force South African equity to be the largest asset class in most retirement funds. In this context, investors need to evaluate the suitability of their SA equity exposure given the dominance of a few international mega-caps and ask whether it is prudent and risk-appropriate given the long-term savings horizon.
The content herein is provided as general information. It is not intended as nor does it constitute financial, tax, legal, investment, or other advice.
