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The Asset Class: Sumesh Chetty · Strictly Business

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You're listening to Strictly Business Podcast with Lindsay Williams.
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With me is Sumesh Chetty.
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Sumesh is one of the portfolio managers responsible for the 91 cautious managed
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fund.
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He's based in Cape Town.
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Now, I want you to indulge me, please, Sumesh, because there's a war going on in
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the Middle East that might drag on for weeks, months.
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We don't know, given the intransigence of the three parties, the US and Israel and
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Iran.
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And what's happened is that as we speak,
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The oil price is almost exactly double the low point of 2025.
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So what have we got?
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We've got rising fuel and energy prices, higher mortgage rates, fertilizer prices
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going through the roof, bond yields creeping north,
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inflation almost set to soar, some people say, and therefore interest rates too.
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So just to summarize, the basics of every human being, food, fuel, energy, shelter,
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all higher,
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may be going much higher.
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My final indulgence that I ask of you is the following.
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I spoke to an economist and he said to me, Lindsay, I don't think we understand what
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a prolonged period of high oil prices and
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the destruction of the world order means.
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And yet it's on a plate before us.
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How do you and Cautious Managed look at it and how do you handle it?
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Thanks, Lindsay.
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I guess the one thing I'd add to your list is at the same time,
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the S&P 500 and the Nasdaq are making new highs, or at least they were making new
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highs last week.
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So it's extraordinary, isn't it?
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We're going to come to that.
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But Jesse, it really doesn't quite fit with what I've said in my introductions.
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But sorry, I interrupted you.
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No, no, not at all.
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No, so it doesn't fit.
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But coming back to what you're saying, you know, we've also, this crisis is a little
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bit different to what we've seen in the past.
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So you've obviously seen.
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peaks and troughs in the price of oil.
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But this is very much, I guess, somewhat akin to what we saw in the
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70s when we had the Arab oil embargo.
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There are similarities.
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There are a fair amount of differences.
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And remember, the Arab oil embargo happened because OPEC decided to punish
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everyone who supported
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Israel in the Yom Kippur War.
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Back then, you had about 8% of oil taken out of the market.
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oil went up four times, almost immediately.
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I think it was like trading at $3 a barrel, and it went up to about $12 a
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barrel.
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And when you think about those numbers, please remember, you have to inflation
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adjust them.
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So now we've had a doubling of the price of oil.
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And about, let's call it 13% of oil supply has been taken out of the market because
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of the closure of Hormuz.
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And you would have expected, of course, for there to be far greater implications.
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I mean, inflation in the US, I think, skyrocketed to about $1.
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12%, you're not seeing that movement yet.
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And I think effectively what the market is relying on is the fact that this is going
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to end very quickly.
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You go back to Arab oil embargo in 73, that lasted five months.
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We're in month three now.
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But the difference is, I can't see what the end is going to be.
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And I don't mean this is going to last for three years or five years or 10 years.
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What I mean by that is it basically depends on two parties.
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how the Iranian regime reacts and how Donald Trump reacts.
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And neither of those parties is forecastable, or their actions aren't
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forecastable.
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And of course, where you are 100% right, I think the market is massively
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understating,
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underestimating the impact of what we're seeing here.
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Because it's not just this concept of inflation.
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You know, disaster of disasters.
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Obviously, we saw petrol prices in South Africa go up.
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So 95, I think, unleaded.
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got to 22 rand and 49 cents at the coast and now we're going to get another 3 rand
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30 increase on Wednesday.
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But why this matters you know energy makes the world go around.
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When you think about growth, growth is is driven by energy and these high energy
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prices are going to take cash
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out of consumer pockets and given that the US is a consumption-led economy, South
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Africa is a consumption-led economy,
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the consumer is going to have less to spend on the things that they want to and
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see you.
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And so when we think about this, it's not just inflation, it's also growth, the
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impact on growth going forward.
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Yes, that's where my comment in my introduction again says we haven't yet
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really
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understood the implications.
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What's happening is, I think, is that if you're a retailer, for example,
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you've got stock that you bought over the last few months at old prices.
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New prices are coming in with new stock.
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New stock will be on the shelves soon.
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And you can't...
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You can't pass everything on to the consumer, but you pass something on to the
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consumer.
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Inflation creeps up.
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Eventually, you have to pass it all on to the consumer, and then inflation soars.
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So it'll be a gradual sort of slow burn to start with and then take off.
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That's my view, not the view of 91.
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The other thing that troubles me, as a troubled person, Sumesh, is the nature of
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the market,
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because I thought 2026 would be a broad-based bull market, but it's still as
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narrow as ever,
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and that leaves it vulnerable, don't you think?
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Well, yes, it leaves it vulnerable,
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but I think it's also helped investors navigate the current malaise.
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Because, I mean, effectively what you're seeing is that the market is more
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concerned about deficits
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that exist
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in AI capacity than the market is concerned about the deficits that exist in
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the oil
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market.
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Because everyone's still so focused on this very narrow AI trade.
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be it um a chip trade or be it cloud-based infrastructure trade.
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You're seeing how well these companies do.
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And this might be the saving grace of this initial oil crisis that we're
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experiencing.
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But what ultimately worries us about this is that we think that there's still too
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much hope being focused on AI.
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Because if you think about the large hyperscalers, you think about the Amazons
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of the world, the Microsoft, the Googles, whoever,
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you've got this very large...
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infrastructure spin that's occurring.
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And what's uncertain is the potential return on infrastructure.
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I mean, we're effectively in an arms race.
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AI is going to change the world in ways we can't even imagine right now.
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The best example I can think of is if you think back to the dot-com era, late
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90s, early
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2000s. And the market was so exuberant about how the internet was going to change
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the world in the very
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near term.
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Like, what was the world going to look like?
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in 2002, 2005, 2010.
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But what was imagined for that first decade massively overstated what happened,
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but massively understated to the impact the internet had on all our lives, how we
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live today,
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how we do business today.
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And I think the same thing is going to happen with AI, whereas there's this
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massive overstatement,
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this exuberance about AI in the short term, but we can't imagine how our lives,
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how commerce is going to change.
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in the long term.
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And so what worries us ultimately is once you have normality, for lack of a better
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word,
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and you can focus on, let's say, all the risks in the world, perhaps the market
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gets back to worrying that, let's say,
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valuations are too high around AI.
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In a weird way,
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I think concerns around oil potentially lead people to double down on AI in their
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portfolios.
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Let's say.
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Just before we get off AI, if we can, because it's such an important topic, I
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said to somebody who knows about these things,
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I said, where are we on the AI momentum curve?
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I said, you know, just give us an idea.
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Are we 25% of the way through as we know AI at the moment?
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Where are we?
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10%, 50%?
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And I threw around some numbers.
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And he said, Lindsay, the only way I can describe it is go back to the Industrial
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Revolution.
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And imagine you're in Manchester.
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Somebody just got a steam engine.
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And that is right at the beginning.
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In other words, comparing it to the Industrial Revolution, which it is.
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It's a new Industrial Revolution. It's the fifth Industrial Revolution, something
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like that.
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The other thing I need to ask you before we get on to Cautious Managed and how
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you're managing to weather these storms that keep on
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battering us every day, where does the 750 billion capex come from from these
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companies?
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And can the 750 billion deliver returns, as you just said?
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And also, does the infrastructure around the 750 billion capex spend on AI, can it
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cope?
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In other words, energy, etc.
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A couple of questions in there.
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Where does it come from, first of all, the money?
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Okay, so there's a lot to unpack there.
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So I referenced the dot-com era.
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And, you know, what everyone was acutely aware of back then, there were these mass
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evaluations,
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but there wasn't any profit being generated by a lot of these businesses.
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And no profit also meant that cash flows were negative.
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But today, these hyperscalers, they have a ton of cash.
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They've been generating a ton of cash.
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They've been holding on to a lot of cash in their balance sheets.
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In fact, a few years ago, if you remember, there was a lot of debate in the U.S.
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about the tax that wasn't being paid by these companies because the cash wasn't
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coming back to the States.
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They were being held in tax-friendly jurisdictions like Ireland
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And so this cash is available for them to invest, number one.
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They have the cash that they're generating.
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Number two, they can actually...
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raise debt in order to finance expansion.
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And number three, there's private credit that's actually coming to them and saying,
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hold on, we can come up with off balance sheet financing for you,
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where we'll actually create data centers, for example,
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for you to make use of because there's so much money sloshing around in private
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credit right now.
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So the demand, the demand is very much there.
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You asked me a second question around that, oh, it relates to the
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infrastructure.
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So if you think about the infrastructure and the power requirements, then Um,
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This is part of what's creating this desire for hard assets.
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You know, I don't know if you've heard the term halo, hard asset, low obsolescence,
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because there's this, you know...
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Ignoring what's happening in the Middle East right now, there's an increased
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demand for copper, there's an increased demand for power.
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People are thinking about whether it should be nuclear, whether it should be
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clean energy.
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There's an increased demand for land because there's so many people saying,
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hold on, we don't want these data centers,
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we don't want these new power outputs in our backyards.
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There are companies that are saying, hold on, we can't actually rely on the grid.
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You've got this aging infrastructure throughout the world.
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So we actually have to put up this energy infrastructure ourselves, either next to
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our data center or somewhere else.
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So this is creating a lot of demand.
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So when you think about the market as a whole, perhaps it's been a little bit
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unfair saying, hold on,
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it's the AI trade and oil isn't impacting the rest of the markets to the extent it
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should.
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But there's this underlying driver for commodities, not just the AI.
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But you've also got to be careful because one of the things that we haven't raised
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is when you think about the Middle East.
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And you reference, or I reference, that Arab oil embargo back in the 70s. What's
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different this time?
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So OPEC just said, hold on, we're not selling oil to the following nations.
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But today, if you think about the Straits of Hormuz, it's not just 20% of the
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world's oil that goes through it, it's 20 to 30%
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of the chemicals required for fertilizer.
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It's helium, which is integral in the production of chips.
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You know, you need this helium-filled environment for chip cooling and for
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machine cooling.
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So there are a lot of knock-on impacts that create that inflation in the system.
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But I think broadly, the market is very excited by a number of industries around
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the AI theme that are
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actually going to benefit from this infrastructure build-out.
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Okay, with that great answer, I'm getting the feeling that you don't think there's a
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bubble and you don't think
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there's going to repeat the tech crash of 2000.
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Oh, I didn't say either of those things.
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I know, I was implying it.
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I'm trying to weedle it out of you.
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Valuations really matter.
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No, no, valuations matter.
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And the thing is, in order for there to be a crash,
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you need people to feel that the prices are irrational.
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And I think in an environment where no one knows who the winner is going to be.
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So you come back to the hyperscalers, and the hyperscalers are just saying it's an
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arms race.
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We've got to just keep investing.
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And I think a lot of investors are thinking the same way.
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And you see it when you see the bifurcation and performance between, let's
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say, the hyperscalers and you think software as a service.
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Because the market is looking at software as a service and saying this sector is
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going to be absolutely decimated.
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Software is not going to exist because people are going to vibe code everything
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in AI.
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I mean, that's absolutely ridiculous when you think about the demands for software
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for enterprises, you know,
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the security that needs to exist around it, the interoperability.
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that needs to exist within enterprise-based software.
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So there has to be a catalyst.
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And in the current environment, you know, where the market is just, it doesn't seem
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to be that concerned about inflation.
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And remember, you go back to the 70s. And I'm sorry, I keep coming back to the 70s.
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But back in COVID,
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we were talking about the Arthur Burns moment and Jerome Powell wanting to avoid
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that.
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And Arthur Burns is the chairman of the Fed who ignored the inflation that came
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from oil.
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and he allowed it to get out of control.
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No central banker wants to repeat that.
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So now you think about an environment where valuations are elevated offshore.
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In South Africa, they're still looking relatively attractive.
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You think about the risk of central banks around the world not wanting to be seen as
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behind the eight ball.
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They don't want to be seen sleeping at the wheel.
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They're probably going to proactively increase interest rates.
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In South Africa, the market's already pricing in two to three increases of 25
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basis points each.
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They'll want to.
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to fight inflation.
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And you're doing this in the context of this geopolitical risk, you're doing it in
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the context of elevated valuations,
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you're doing it in the context of a private credit market that no one fully
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appreciates the size of.
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And I think there's a lot of risk out there that could impact AI valuations,
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while not necessarily being directly related to AI valuations.
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So you've got to be careful.
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What about South Africa?
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South Africa, in a way, doesn't get, and Africa as a whole, actually.
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doesn't get the full benefit of AI,
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but it might get the full force of an AI bubble that bursts and all of the other
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things we've said,
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rising interest rates, etc.
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So what does all this mean for South African assets in the context of what
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we've been saying?
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And then you've got to bring it back to cautious manage, please.
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Okay, so
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I guess we're more directly held hostage to what's happening with oil than the US
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is.
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Remember, the US is a net oil exporter.
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We're a net oil importer and we're importing a fair amount of refined product
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as well.
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And when I talk about refined product, I mean diesel and petrol because
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The refineries up north are up and running.
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The refineries down south, so in the Western Cape,
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they are currently on maintenance.
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So they're offline right now.
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So when you look at how South African assets have performed, while U.S.
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assets are hitting all-time highs, South African assets have not recovered to where
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they were in February.
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Our bond yields are slightly higher.
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The RAND is slightly weaker.
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Don't get me wrong.
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They've been on an absolute tear over the last...
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year or the last two years.
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But I think the market's more acutely aware of the impact of inflation in our
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country.
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And remember, there was a lot of hope being built in as well around the GNU and
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improvements in
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South African growth and ultimately the impact on the consumer.
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But our consumer's weak.
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And so you're in an environment where petrol is going to be, let's call it 26
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rand in May.
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And you can imagine how that's going to negatively impact the consumer that was
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already on their knees.
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So how do we think about this in Cautious Managed?
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So Cautious Managed, it's a safe harbor portfolio.
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It's a portfolio where you have to be able to sleep easy at night.
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The portfolio manager is stressed for you so investors can sleep peacefully at
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night.
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And when we think about constructing the portfolio, we're always thinking about
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balance.
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And in spite of those inflationary risks in South Africa,
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and maybe partly because of those inflationary risks in South Africa and the
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lack of recovery that we have seen since.
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February,
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those local equities are pricing more than they should for a downturn in
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South Africa.
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So the valuations are starting to look more attractive.
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They've looked attractive.
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They're even more attractive today.
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But you've got to, of course, balance that out to the fact that there's no growth.
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So South African assets in the portfolio, equities, I think we're currently sitting
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with about 15%
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in ST equities.
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Remember, we can only have 40% in total.
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And on the global side, we've got about the same, but we're very, very selective.
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Now, we've said some positive things and we've said some negative things about the
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AI trade, but one thing's for certain,
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AI is here to stay.
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But you've got to be very careful about those highly disruptive businesses that
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can themselves be disrupted.
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So we prefer investing in the picks and shovels, those businesses that will be
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required almost irrespective of who's going to win.
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Businesses like ASML, businesses like TSNC, there's no one in the world that can
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do what they do.
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We've spoken about ASML before, the only manufacturer of extreme ultraviolet
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lithography projectors
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required to carve chip architectures onto five nanometers and smaller in terms of
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those chips.
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So that's the balance we have, but none of it looks like the index.
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We aren't indexed relatively in any way.
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We've been decreasing our bond exposure.
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You know, Bondi over the course of a decade.
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We're coming from $12.20 down to about, let's call them $8.50 right now.
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So we've been taking profit on that.
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And cash has slowly been building in the portfolio.
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We have been buying up more inflation linkers.
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We've been worried about inflation offshore for a number of years now.
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This concept of the Fed getting back to 2%, given that the changes you've seen in
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the world, that just-in-time manufacturing is dead,
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there's an inventory build, there's an energy transition.
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that's occurring.
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More so now with what we're seeing in the straight of Homo's, we were very keen to
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have
18:36
US inflation-linked bonds in the portfolio as well as South African inflation-linked
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bonds.
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And we've actually been buying more of those South African inflation-linked bonds
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recently.
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And that's how we think that balance gives investors more confidence around
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navigating the
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uncertainties that you currently find in the world.
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You mentioned sleeping.
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Are you sleeping well at night?
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No, I'm stressing.
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It's what I said.
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I stress so that investors don't have to.
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All the stress rests with us, Lindsay.
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Very good answer to end a great conversation.
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Thank you very much, Sumesh.
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Sumesh Chetty is one of the portfolio managers responsible for the Cautious
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Managed Fund at 91 in Cape Town.
19:16
The views and opinions expressed in these podcasts are those of Lindsay Williams and
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