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Citation – Third Quarter 2021









Nishlen Govender
Portfolio Manage
Estimated reading time: 11 min

Naspers is perhaps South Africa’s most notable listed stock. It is a giant on the Johannesburg Stock Exchange, and what happens to the company has a dramatic impact on the bourse’s performance. However, while local investors are all too familiar with the behemoth that has dominated South African equity indices for years, most global investors have never heard of this South African technology holding company. The company they are familiar with is Naspers’s largest holding, Tencent. Now, a new associated entity, Prosus, is becoming particularly familiar to European investors.

When it comes to Naspers, the last few years have seen corporate action dominate the headlines, with this very publication focusing on issues like the discount-to-net-asset-value available in Naspers, and whether that could unwind, to unravelling the effect of Naspers splitting into two entities and listing offshore. In this article, I want to reflect on how we measure our Naspers investment against the JSE benchmarks, together with the impact corporate action has had on these measures.

Capped Benchmarks

As investment managers, our core focus should be our portfolios and how we are positioned. We do this through measuring our performance against industry benchmarks. However, not all benchmarks are made equal, and it is naïve to assume that the benchmarks we choose, and their construction, don’t matter. Chosen benchmarks represent a performance objective, and thus an agreed upon standard, between a manager and its clients. For this reason, the benchmark’s performance should reflect the correct universe for both the client and manager.

Benchmarks and indices allow us to understand a company’s performance within an industry. We do this by assessing the performance of a company against the different benchmarks and indices available. As local companies grow, they increase their overall weight on the Johannesburg Stock Exchange. To accommodate this growth, new indices are created compensate for their larger weighting because companies with larger weights can distort the benchmark’s performance. These indices are typically capped and actively constrain stocks that have reached a certain level. For instance, the FTSE/JSE Capped All Share Index limits any stock to a maximum weight of 10% of the benchmark’s total.

With a stock like Naspers, the result of a capped index has been that the overall Naspers weight was effectively halved from the original FTSE/JSE All Share Index, dramatically reducing the index’s overall exposure to Naspers, while giving other stocks an increased weighting.

Fund managers often consider their investment positioning relative to the benchmark that they are assessed against. Thus, if a manager feels a stock is going to deliver, they will typically need to invest a larger weight than represented in their benchmark. In contrast, if a manager believes that a stock faces poor prospects they will invest at a lower weight in the benchmark or not invest anything at all. Thus, the weight of stocks in your benchmark is crucial as it can dictate your relative performance of your investment strategy against the chosen benchmark.

With uncapped benchmarks and indexes, when a stock like Naspers is naturally weighted  between 20% and 25%, it means that fund managers had to consider similar weights in their portfolios. If they don’t, they face the risk of Naspers outperforming their holdings and thus stand the risk of lagging their benchmarks from a performance perspective. In addition, an overall weight of 20% to 25% in one stock is not necessarily ideal, from a diversification perspective, as the risk of the overall portfolio is heightened by the unique risk in a single company.

This is the case for an investment in any stock, but Naspers has specific risk, not only from being a collection of technology companies, but also  having its largest exposure come from a single Chinese internet company. Single-stock risk has made capped benchmarks attractive to fund managers, and as such, many have swapped their benchmarks to capped, as they feel this better reflects their intended investment goals.

Naspers’s performance against the FTSE/JSE All Share Index

Citadel has chosen to measure our performance against capped benchmarks in our investment strategies. As such, we have made the move from the uncapped indices to the FTSE/JSE Capped All Share Index and the FTSE/JSE Capped Top 40 index for a number of our investments. We believe the change in our benchmark better reflects the performance and risk management outcomes we have achieved for our clients.

We started making changes to our benchmarks in 2018. The graph below outlines the performance of capped and uncapped versions of the FTSE/JSE All Share Index to better illustrate the impact the change of our benchmarks has had.

Figure 1 – Source: Bloomberg

The black and orange lines represent the performance of the two benchmarks – uncapped and capped respectively. At first glance they seem very similar, and in fact end at almost the same point, which highlights that the change in benchmark seems to have had little overall effect on performance.

However, the grey line at the bottom, which corresponds with the performance of one benchmark versus the other, reflects periods of dramatic outperformance of the uncapped benchmark, especially during 2020. The outperformance comes from the index that has the higher weight in Naspers, reflected in black. This could lead to the conclusion that the uncapped benchmark might be more appealing and that you should choose to measure performance using the uncapped  benchmark rather than the capped one. While that may seem like the likely conclusion, I would urge you to consider the latter part of the graph in grey, which represents a dramatic reduction in outperformance back down to zero. Ultimately, eliminating 2020s outperformance of the uncapped benchmark.

The uncapped benchmark’s recent underperformance came from the underperformance in Naspers during that period. And as a heavily weighted stock, when Naspers underperforms, it brings down the entire benchmark’s performance with it.

So, why did Naspers underperform? In most cases the question of out or underperformance of a stock is multi-faceted and could be linked to the economy, investor sentiment or idiosyncratic issues related to the company, its industry or even the product that it creates. With Naspers the underperformance over the last few months, has been related to one key factor: regulatory tightening, by the Chinese Communist Party (CCP), on Chinese technology companies.

Chinese Regulatory Action on Chinese Tech Conglomerates

The saga of Chinese interference in technology is a long one, with a number of interventions by the CCP over the years. In the past, this has resulted in a delay in the regulatory approval of new games,- which is crucial for Naspers-owned Tencent, as gaming is one of their largest revenue streams -to new rules relating to minors and gaming. Regulatory action has not been exclusive to the gaming industry. In fact, it reached a fever pitch in 2020 with the suspension of the listing of China’s largest online payment platform, the Ant Group, for various reasons, as well the suspension of activity for the ride hailing app, Didi, just two days after their United States listing, with privacy concerns the cited reason.

Antitrust laws in China are also not a new conversation. Antitrust has been talked and written about as far back as 2008. However, the State Administration of Market Regulation (SAMR) was only founded in 2018, while the watchdog for data security, the Cyberspace Administration of China (CAC), was formed in 2014. Didi was suspended for violating data protocols based on rules from the CAC while 35 other technology companies were called in, post the Ant suspension, on the basis of various regulatory infractions including: failure to disclose mergers, signing exclusive contracts, misleading market tactics and merger irregularities. It is important to note that some, if not most, of these violations correspond to corporate actions that happened prior to the creation of the SAMR, CAC or any specific Chinese regulatory code relating to technology companies. Since the Ant suspension most of the 35 companies have faced some sort of fine or regulatory constraint which includes limits to certain core business practices. In the case of companies in the educational sector, such as Tal Education and New Oriental Education, new rules were created relating to online tutoring and education that these businesses now must consider as part of their operations, or face sanction.

While I am not trying to question the CCP in their attempt to regulate Chinese technology companies, this summary of the Chinese regulatory environment serves to highlight the country specific sector risk that has affected Chinese internet companies, and has resulted in a significant sell-off in some of the largest technology companies in the country. The underperformance of Naspers, via Tencent, is an example of this, alongside other heavyweights such as Alibaba, NetEase and Didi.

Crucially, South African investors need to question whether they should be significantly exposed to issues on the ground in China. An investment in local equities should, in theory, provide exposure to the South African equity market and economy, as opposed to being linked to very specific issues in China. This serves to strengthen our view that capping our benchmark was the right thing to do for our clients.

From a different perspective, resource companies currently make up 35.5% of the capped all share index of which China is a significant source of demand. Thus, a large portion of SA equities already have exposure to economic prospects on the ground in China. We would argue that this is secondary exposure, as our resource companies operate in South Africa, other African countries, or offshore and are thus not directly linked to China, but it is important to note the significant demand that China has for commodities such as iron ore, which is used in the production of steel. This layer of Chinese risk is unavoidable, which makes it even more important to reduce overall reliance of South African equity investors on direct exposure to China.

Corporate action has muddied the water

In previous articles, we have covered the extent of the corporate action that Naspers has taken to limit its overall exposure to Tencent and close the significant discount that it trades at, in relation to the sum of its parts. However, two corporate actions have started to unwind the effect of changing to capped benchmarks. The first was the listing of Prosus in Europe. This entity was meant to diversify the investor base of Naspers to a wider audience while maintaining SA exposure in the listed Naspers vehicle. The second corporate action sought to distribute more of the shareholding of Naspers into the offshore entity thereby making Prosus a larger entity in the context of the entire group.

The result of this corporate action created two listed Naspers entities in SA: the original Naspers listing as well as the newly listed Prosus, which has a listing in Europe as well as in South Africa. Based on how capped indices work, these two entities, whose combined market capitalization was roughly equal to the original Naspers entity, could exist as two listings thus flouting the 10% cap that these benchmarks use as a rule (by distributing the weight between two entities). To illustrate the effect, consider the figure below.

Figure 2 – Source: Bloomberg

The figure reflects the weight of Naspers in capped benchmarks before and after the listing of Prosus. As you can see, before the Prosus listing, Naspers rarely breached the 10% cap limit. When it did it was brought back down to 10% when the index was rebalanced, thereby limiting the growth of Naspers in the benchmark. Since the listing of Prosus the combined entity (in orange) has been able to remain above the 10% limit, as the group’s combined listing is not considered in capping. The effect has been exacerbated as the weighting of Prosus increased. As both entities are significantly below 10%, thus not breaching the rule, the combined entity remains well above 10%. You will note that this effect has become less pronounced in recent months, due to regulatory crackdowns in China. Crucially, should the combined group start to outperform, there is headroom for the combined entity to grow to a weight above the 10% cap thus increasing the single entity risk. In this new allocation the capped indices will have no ability to limit the risk based on their current capping rule.

Going forward

Originally, the weight of Naspers in benchmarks, and its overall reliance on China, did not sync with the objective for South African equity investors that sought exposure to South African companies. This fact, and the recent underperformance relating to the Chinese tech crackdown, leading to the underperformance of Naspers and Prosus, vindicates the initial assertion that we needed to address the growing weight of Naspers in our benchmarks.

However, we yet again face the dilemma of a Naspers entity that could again grow to ungainly weights in our benchmarks. We are actively monitoring the situation and the associated risk. This article serves as a way for us to share some of our thoughts and insights with you so that you understand the conversations and deliberations that we are having in real time. If you have any questions, thoughts, or comments about any of the issues discussed please feel free to reach out to your Citadel advisor.