There is no denying that local equities have endured a challenging decade. Despite an improvement in returns since the onset of Covid-19, the South African equity market has undergone significant structural changes. We would argue that what has worked well for investment managers over the past ten years may not be as effective in the years ahead.
Structural shifts in the market
Over the past 25 years, the number of listed stocks on the JSE has declined dramatically — from over 1,300 in 1997 to about 270 in 2025. This contraction has had far-reaching implications, not only shrinking the investable universe but also limiting the ability of managers to implement pure-style strategies effectively.
Moreover, South Africa’s relevance in the emerging market (EM) equity landscape has diminished. As the global EM space becomes increasingly competitive, SA equities now comprise a smaller portion of the investable universe, reducing their influence and visibility among global investors.
Adding to the complexity, mid- and small-cap stocks — traditionally fertile ground for alpha — now represent a smaller slice of the overall All Share Index (ALSI). This limits diversification and narrows the scope for strategy differentiation.
The result? A market that has become significantly more concentrated and cyclical. Performance has grown increasingly polarised, with stark differences in returns across sectors and stocks over the past decade. See Chart 1 that follows.
Chart 1: South African sector performance – 10 year CAGR (%)
Source: SBG Securities (March 2025), Northstar Asset Management
Given these changes, the implications for portfolio construction are critical, and the importance of a well-thought-out investment strategy has never been greater. We believe that tactical flexibility — underpinned by a deep understanding of risk, return, and probability — is essential for success in this evolving environment. Let’s explore this concept in practice.
Compounders vs. cyclicals: A tale of two stocks
Consider two local stocks: Clicks (CLS) and Mr Price (MRP). Both are household-name retailers, but their return profiles tell vastly different stories (Chart 2). CLS is one of the JSE’s most successful compounders of returns — a company with consistent earnings growth and relatively low forecasting risk (i.e., the uncertainty in estimating returns). The stock has grown at a rate of 17% per annum over the past decade.
MRP’s return profile, on the other hand, has been highly cyclical, heavily influenced by economic conditions and consumer sentiment, and has delivered only a 1% annual return since 2015.
Chart 2: CLS and 10-year share price performance (log-scale)
Source: S&P CapitalIQ, Northstar Asset Management
While investors may profit from well-timed entries into MRP — think August 2020 or September 2023 — the complexity of such a strategy is far greater than that of a simple buy-and-hold approach.
Based on our calculations, more than 80% of local equities now tend to exhibit MRP-like cyclical characteristics. It is therefore increasingly important for investors not only to conduct robust qualitative assessments that uncover a business’s earning power and quality but also to develop a strong understanding of cyclicality and the ability to quantify valuation and forecasting risk.
Risk, return, and the role of probability
When comparing CLS and MRP within the broader context of local investment opportunities, it becomes clear that while profits can be made from buying cyclical stocks like MRP, the associated forecasting risk tends to be higher than for typical compounders like CLS. As a result, our conviction in such positions is generally lower.
In Chart 3 that follows, we highlight this concept: while we expect higher medium-term returns from MRP versus CLS, the accuracy of such estimates is lower compared to CLS’s more stable return profile. For this reason, we believe a portfolio construction process that accounts for forecasting risk — and not just prospective returns — is more likely to deliver reliable results over time.
Chart 3: 3-Year prospective returns vs forecasting risk
Source: S&P CapitalIQ, Iress and Northstar Asset Management
This probabilistic framework also challenges the notion of highly concentrated portfolios in the local market. Given the elevated uncertainty — particularly in cyclical sectors — we believe it is difficult to justify a 10- to 20-stock portfolio with confidence in the consistency of returns.
Conclusion: portfolio construction focus
South Africa’s equity market has changed fundamentally, with fewer stocks, greater cyclicality, and increased concentration. Traditional strategies are becoming less effective, making it crucial for investors to adopt a more flexible, risk and market aware, and probabilistic approach to portfolio construction.
At Northstar, we not only invest significant effort in understanding the qualitative aspects of a business and modelling its medium-term earnings outlook, but we also strive to better understand the forecasting risk associated with our estimates — incorporating this knowledge into a robust and disciplined portfolio construction process.