Quarterly Review – Q1 2021
With appreciation to PortfolioMetrix
SOUTH AFRICAN PORTFOLIOS EDITION
Asset Class Returns
After last year’s false start and paralysing pandemic, the prospects for a sustained reopening of economies and evidence of a tangible global recovery have begun to unfold in the first quarter of 2021. The resultant improving macroeconomic landscape, ballooning stimulus packages and vaccine rollouts has provided the underpin to another very strong quarter for global and SA equity markets, many indices trading very close to record highs.
Asset class leaders for this quarter has been the 13.1% rally of SA equity (JSE All Share Index) but more striking the 21% jump among small cap shares that lagged the Top40 all of 2020. This theme of rotating out of the 2020 large cap growth stock winners (such as Naspers/Prosus) towards the relatively cheaper, cyclical and smaller cap names was evident even in our smaller equity market.
Within the Super Sectors, it was once again the 2020 favourites, resources that benefitted from the rising commodity price complex, with the exception of gold (defensive exit). Oil and industrial metals enjoyed another great quarter in response to mines at full capacity, rising global demand and in many cases supply squeezes in some of the commodity markets.
The rand ended the quarter almost where it started the year, however, its relative strength versus its Emerging Market peers in March was particularly noteworthy. An improving trade balance (good mineral exports), somewhat hopeful revenue collections and tame inflation helped stabilize the local currency when many of our peers felt the brunt of the US treasury sell-off and other political stumbles. (Turkey’s PM fired yet another central bank chief, Brazil and India’s covid cases balloon out of control and Russia faces fresh US sanctions).
On the downside, bond markets across the globe, including the higher yielding SA bond indices, all gave up ground to the riskier asset classes with a strong sell-off in US treasuries becoming a key feature for the quarter.
Biden’s flood of fiscal stimulus – too much of a good thing unsettles bond markets but bolsters risk assets
A primary market theme of Q1 was the flood of fiscal stimulus that the newly sworn-in Democratic Biden government has laid on the table. The stimulus at the end of 2020 ($900 billion) and the relief package signed in early March ($1.9 trillion) equate to nearly 14% of US GDP. The American Jobs Plan announced on the last day in March proposes an additional $2.25 trillion in spending geared largely toward improving transportation, communication, and power infrastructure. The US infrastructure plan will be paired with an additional $1 trillion in spending focused on social programs and is expected to be unveiled in April. Time will tell how much stimulus will be passed by Congress; however, overall fiscal spending is unprecedented and clearly larger than what markets were pricing at the start of 2021.
The promise of all this fiscal aid and better than expected US macro data releases saw a noticeable shift from investors worrying that growth would be too sluggish and bogged down by second and third Covid waves, to now fearing that growth will be too fast. Bond investors quickly began to fear that the party would end before it really got going, and that the path of interest rate normalisation would be sooner than equity markets were betting on. Yields on US treasuries rose sharply with the yield curve markedly steeper and driven mainly by the higher inflation expectations. However the US Federal Reserve Chairman did his best to pour cold water on these heated expectations and continued to reassure investors that the end is not yet in sight.
Thus far, these yield curve adjustments in the US have left growth-sensitive assets (e.g. equities) well supported and financing conditions favourable. Outside the US, the global rise in longer-term bond yields has created some concern, especially in the euro area, where the recovery looks more vulnerable. The ECB responded with increases in its bond purchases to limit further yield increases, while in Japan, the BoJ acknowledged the move in yields by widening the yield curve control band. The pressure on Emerging Market economies has been more pronounced. Higher US real yields, accompanied by some re-strengthening of the USD, weighed on capital flows, thus weakening currencies and deteriorating the inflation outlook on these markets. This already led to some unexpected (Russia) or higher-than-expected (Turkey, Brazil) hikes and more generally means, with few exceptions (Mexico), an end to the EM rate-cutting cycle. That said, South Africa has fared relatively favourably in the EM mix with inflation figures coming in lower than expected and the rand holding up well against a slightly stronger US dollar.
Controlling Covid – China leads but the US stages an inspiring vaccine catch-up
Although very little information has been provided on the efficacy and rollout of the Chinese vaccines, the almost complete eradication of Covid cases would suggest that China certainly has led the world in terms of controlling the pandemic and returning to normality. This has fed into a recovery far faster and stronger than many had expected out of China with incoming data in recent months continuing to surprise on the upside. Robust credit expansion and very strong export performance suggest that Chinese growth will continue to support the global economy (particularly commodity-based Emerging Market economies such as South Africa).
And although slow out of the starting blocks, the success of the US vaccination rollout has far surpassed all expectations with estimates suggesting herd immunity could be achieved during Q2 2021. The US now has the highest daily vaccination rate in the world and accounts for around one in every four vaccines given globally per day. The results of this success are becoming clear, as cases have fallen from more than 250,000 per day in January 2021 to below 70,000 in March. Demand, not supply, will soon become the biggest challenge.
Europe’s relatively slow vaccine rollout and smaller fiscal stimulus means it continues to lag the US in terms of economic performance. However, its pace of vaccinations is increasing, putting the region on track for an economic reopening by the third quarter.
The Great Rotation
The rotation out of “pandemic winners” and into more cyclical or potential “recovery winners” was a theme that played out all through the quarter. Momentum also carried the “reflation trade” over from the previous quarter as the prospect of economic reopening in large parts of the world seemed nearer. These purchases were funded by the selloff in defensive assets such as US Treasuries, gold and the Swiss Franc.
QUARTERLY MACROECONOMIC DATA
MONETARY POLICY (RATES & EXTRAORDINARY MEASURES)
There is no doubt that the cloud that shrouded the globe a year ago appears to be lifting. Vaccinations, coupled with economic resilience from China and accelerating activity in the US, are powerful catalysts that are expected to lift all economic boats in the months ahead. The following summarises some consensus thinking on the path ahead and should guide a more optimistic outlook for 2021:
- The global economy is expected to expand robustly at around 6.4% in 2021. This comes after its 3.3% contraction in 2020. The US in particular is primed for supercharged growth, possibly as high as 7% for 2021.
- The recovery is being driven by the US and China, fuelled by an unprecedented US fiscal stimulus. The related spillover should also support Europe and Emerging Market economies that are lagging.
- Inflation should rise in the coming months, on a combination of base effects, higher oil prices, supply bottlenecks and strong demand. However this is forecast to be transitory, but some uncertainty remains.
- Core central banks remain committed to look through higher inflation data prints, although likely to create volatility, but not expected to derail the recovery.
- The Fed is expected to keep its benchmark rate at zero until late 2023, which should slow the rise in US 10-year treasury yields from here.
- China’s early exit from the lockdown and early stimulus measures should benefit Emerging Markets more broadly, as will the recovery in global demand and a weaker US dollar.
- The US dollar has been supported in Q1 by the US stimulus, better US macroeconomic data and expectations for early Fed tightening. Going forward the dollar is expected to resume its weaker trend as the global economic recovery gets underway. This is likely to benefit EM currencies and commodity prices.
Diversifying your portfolio is crucial for long-term investment success.
Building Block Performance Table
Building Block Performance Table
Note: All returns provided are in SA rands (ZAR)
South African Equity Commentary
The PortfolioMetrix BCI SA Equity fund outperformed by 13.5% over the past 12 months (53.2% vs 66.8% for the fund) relative to its FTSE JSE Capped SWIX benchmark,
- Over the quarter the fund outperformed by 3.0%, as the index returned 12.4% and the fund generated 15.4%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE Capped SWIX):
- Ninety One SA Equity: outperformed by 2.12%
- 36ONE BCI SA Equity: outperformed by 4.15%
- Laurium Equity: outperformed by 2.53%
- Fairtree Equity: outperformed by 2.99%
- Coronation Top 20: outperformed by 1.97%
- Satrix Mid Cap Index: underperformed by 3.15%
- South African Equities had an exceptional quarter comfortably outperforming all other asset classes with a rand return of 12.4% for the Capped SWIX (Global equity +5.12%).
- Resources led the charge up 19% followed by Industrials and Financials up 13% and 4% respectively.
- Much like global equities, the market segment that performed the best from a market cap perspective was small caps with a return of 21.2% for the quarter. The Top 40 index returned 13.2% and mid-caps languished with a return of 9.4%.
- Active performance in the portfolio was strong for the quarter with all managers outperforming and further contributing to significant alpha within the fund over longer time periods.
- This performance has coincided with a very stark difference in performance across sectors with resources dominating from a returns perspective. This has benefitted the fund as the fund has been running an overweight to basic materials for quite some time and continues to do so.
- The overweight to basic materials is by far the dominant active risk factor in the portfolio and is contributing to the portfolios bias towards the momentum and volatility factors.
- From a company perspective, the largest contributors to active risk are Impala Platinum, Exxaro Resources and Northam Platinum followed by an underweight to Prosus.
- The Top 10 holdings of the fund vs benchmark is shown below:
- Over the quarter the PortfolioMetrix team decided to make a fund change by switching from Laurium Capital to Matrix Fund Managers. The change officially took place on 1 April 2021.
- Our engagements with Matrix date back to 2017 and have been extensive. We have sat at their analyst’s desks and have done numerous deep dives on individual elements of their investment philosophy & process. The overwhelming take-away from these engagements is the consistent messaging and how it is applied, regardless of who was delivering the message.
South African Bonds Commentary
The PortfolioMetrix BCI Bond FoF fund underperformed by 1.2% over the past 12 months (17.0% vs 15.8% for the fund) relative to its FTSE JSE All Bond Index benchmark,
- Over the quarter the fund underperformed by 0.3%, as the index returned -1.7% and the fund generated -2.1%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE All Bond Index):
- Coronation Bond: outperformed by 0.42%
- Ninety One Gilt: underperformed by 0.13%
- Stanlib Bond: outperformed by 0.07%
The Stanlib Bond Fund was reintroduced to portfolios. During this transition period the market moved quite aggressively resulting in the unusual performance of the PortfolioMetrix BCI Bond FoF that was below that of its underlying funds. In the long run this move will however benefit investors through a lower portfolio cost.
- South African government bonds had a weak quarter in which they sold off across the curve. The path the asset class took however was that of a strong risk-on rally from the middle of January into February as foreigners allocated to the local bonds.
- The yield of the benchmark government 10-year bond moved out from 8.75% to end the quarter at 9.5%, the popular R186 bond (currently a 5-year bond) moved out from 6.7% to 7.5% over the quarter.
- Continued easy monetary policy, supported by low and stable inflation, has removed any immediate pressure on the short end of the curve however at the end of the quarter both the yield curve and the market’s expectations of rates indicate that the SARB should start hiking. This may be the influence of global conditions rather than the local economy.
- The insurance on a South African 5-year bond (CDS) cost 30 basis point more at the end of the quarter moving from 204bps to 237 bps, faring better than the Brazilian CDS, yet still representative of a cautious global risk environment.
- The budget speech in February provided a moment of relief as the national purse requires less debt funding than originally expected. This is significant since the current debt levels are perhaps one of the greatest concerns facing the National Treasury and investors alike.
- Reduced funding needs eases the pressure to issue expensive debt and further increase debt servicing costs.
- The greater than expected tax collections (R38bn better than estimates) as well as the unexpected current account surplus gave a glimpse into what could be possible given the correct macro environment.
South African Cash and Stable Income Commentary
The PortfolioMetrix BCI Income fund outperformed by 3.1% over the past 12 months (5.6% vs 8.7% for the fund) relative to its STeFi + 1% benchmark,
- Over the quarter the fund outperformed by 0.2%, as the index returned 1.1% and the fund generated 1.4%
Underlying funds over the quarter produced the following relative returns (vs STeFi + 1%):
- Coronation Strategic Income: underperformed by -0.28%
- Ninety One Diversified Income: outperformed by 0.02%
- BCI Income Plus: outperformed by 0.60%
- Nedgroup Investments Flexible Income: outperformed by 1.03%
- Matrix NCIS Stable Income: underperformed by 0.67%
- The PortfolioMetrix BCI Income Fund successfully converted to a standard fund in Q3 2020. The fund took part in its first private placement since the change, buying Nedbank additional tier 1 notes at a spread of 467bps over Jibar.
- The South African Reserve Bank unanimously voted to keep its benchmark repo rate unchanged at a record low of 3.5% during its March 2021 meeting to support the country’s recovery. Looking forward, the SARB sees two interest rate hikes of 25bps each in Q2 and Q4 2021, but this will be highly dependent on the state of the nation’s economy.
- Inflation linked bonds continued their bullish run from the end of last year, increasing 4.1% for the quarter. Most of our managers continue to hold ILB’s and view the asset class as a positive contributor on a forward-looking basis.
South African Property Commentary
The PortfolioMetrix BCI SA Property fund outperformed by 1.2% over the past 12 months (34.4% vs 35.6% for the fund) relative to its FTSE JSE SA Listed Property benchmark,
- Over the quarter the fund outperformed by 3.1%, as the index returned 6.4% and the fund generated 9.5%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE SA Listed Property):
- Sesfikile BCI Property: outperformed by 1.27%
- Absa Property Equity: outperformed by 7.84%
- The resurgence of South African List Property continued in Q1 2021, following what can only be described as a fantastic Q4 2020. In recent times, the asset class has faced the full brunt of the pandemic and our paltry domestic economy, causing the asset class to be extremely downtrodden.
- Glimmers of positivity have started to emerge, and this has been supportive for the asset class.
- Rental collections have been better than expected, although retail, cinemas & dining continue to suffer. Level 1 restrictions are expected to be beneficial.
- Office vacancies have stabilised, even in the face of a permanent shift to a Work from Home culture. New development has ground to a halt, and this will stifle supply.
- Industrial demand has been resilient and benefitted from the shift and growth of ecommerce
- Sesfikile are positioned underweight retail, with neutral allocations to office & industrial. They have a defensive cash position which is being allocated opportunistically. Their biggest underweight position is Hyprop (Shopping Malls) and overweight Irongate Group, previously Investec Australian Property Trust (JSE listed Australian Property)
Global Equity Commentary
The PortfolioMetrix BCI Global Equity FoF fund underperformed by 0.2% over the past 12 months (27.8% vs 27.7% for the fund) relative to its MSCI ACWI benchmark,
- Over the quarter the fund outperformed by 0.9%, as the index returned 5.1% and the fund generated 6.0%
The performance of the underlying funds (versus their respective regional indices) for the quarter is shown below (in ZAR). Funds biased towards value and smaller cap stocks performed best in the quarter.
- Global equity markets continued their rally in the first quarter of 2021 as vaccine roll-outs led to improved expectations and bullish earnings forecasts.
- Global value stocks and small caps continued their strong run during the quarter outperforming the MSCI ACWI (representative index for global equity) by 4.3% and 4.7% respectively.
- After a long period of outperformance, growth and momentum stocks underperformed with momentum in particular experiencing a sharp drawdown from the middle of February.
- Global bond yields experienced a sharp increase as the US 10 year Treasury yield rose from 1.12% midway through February to 1.74% at the end of the quarter.
- The narrative has been that rising yields are driving the rotation in markets as they tend to harm long-duration growth stocks. However, upon further research from Schroders this explanation falls short of neatly explaining the movements. In general, factor indices do not hold a constant set of securities over time and this turnover means that their overall relationship with interest rates varies.
- That said, market participants are closely monitoring overlapping stocks of the value and momentum factors as the momentum factor starts acknowledging the recent run up in value. This potential rare overlap may reinforce the value rally and its continuation.
- Sector performance on the S&P500 bears testament to the run up in the unloved parts of the market with Energy and Financials outperforming the broader market by 24% and 10% respectively. In contrast the Consumer Staples, IT sector and Consumer Discretionary sectors underperformed by -5%, -4% and -3% respectively.
- Developed markets comfortably outperformed emerging markets over the quarter with UK equities the best performing region (energy and financials bias) in the developed world.
- In emerging markets, Latin America was the worst performing region underperforming the broader EM region by -7.6%. However, more meaningful to EM’s underperformance was that of Chinese equities (38% of EM index) blowing off steam as lofty valuations and rising global bond yields weighed on market sentiment.
Global Bonds Commentary
The PortfolioMetrix BCI Global Bond fund outperformed by 1.8% over the past 12 months (-13.5% vs -11.7% for the fund) relative to its Bloomberg Barclays Global Aggregate benchmark,
- Over the quarter the fund underperformed by 0.1%, as the index returned -4.0% and the fund generated -4.1%
Underlying funds over the quarter produced the following relative returns (vs Bloomberg Barclays Global Aggregate):
- iShares Global Govt Bond: underperformed by 0.61%
- iShares Global Corp Bond: outperformed by 0.20%
- Rising yields placed pressure on fixed income markets around the world, the US 10-year benchmark bond moved from 0.91% to 1.74% at the end of the quarter. The US was not alone as all longer developed market bond rates climbed on expectations of higher inflation, the fiscal and monetary policy responses are seen to be critical as the world tries to emerge from the Covid-19 pandemic.
- IG spreads of the US, EU and UK compressed further since the Covid-19 spike. US spreads at 0.9% are not far off the narrow spreads last seen in 2005-07.
- Despite a rise in defaults both US energy and ex-Energy spreads are very compressed printing 4.6% and 3.2% respectively
- In the US, inflation expectations (5y5y swap) climbed to a healthy 2.2% (higher over the quarter). This is significant since the Fed effectively influences the world with its monetary policy, which in turn is expected to be driven by the US growth and inflationary environment.
- Fed officials did raise their 2021 median inflation forecast from 1.8% in December to 2.4% in March, but at the same time said that they are prepared to allow inflation to run hotter as they expect it to normalize soon thereafter.
- Despite the 2021 increase, the Fed’s inflation forecasts over the next couple years has barely nudged higher. This underscores the Fed’s expectation that any pickup in inflation will be temporary.
- Easy Monetary and Fiscal policies, paired with rising oil, copper, lumber, etc. certainly points to upside risks in inflation and the question is whether the initial spike in inflation then gently eases as expected by the Fed, or alternatively holds at elevated levels.
- The iShares Global Government Bond ETF has a yield to maturity of 0.52% and a duration of 8.6 years whilst the iShares Global Corporate Bond ETF has a yield to maturity of 1.79% and a duration of 7.1 years.
Global Property Commentary
The PortfolioMetrix BCI Global Property fund underperformed by 4.8% over the past 12 months (12.5% vs 7.7% for the fund) relative to its FTSE EPRA Nareit Developed Rental benchmark,
- Over the quarter the fund underperformed by 1%, as the index returned 6.3% and the fund generated 5.3%
Underlying funds over the quarter produced the following relative returns (vs FTSE EPRA Nareit Developed Rental):
- Catalyst Global Real Estate: underperformed by 0.57%
- Sesfikile BCI Global Property: underperformed by 1.75%
- Global Property has been the laggard risk asset over the past year and has posted return’s comparable to Global Equity over the quarter. There is significant diversity across the asset class’ sectors & jurisdictions, positioning to benefit from lockdown easing and vaccine rollout is critical.
- Sesfikile have focussed on holding stocks deemed to be Covid beneficiaries, such as single family residential, industrial and manufactured homes. Whilst avoiding hotels, malls, retail & student accommodation. They have also reduced the funds overall risk, by reducing active share, increasing cash and disinvesting from small cap REITS with single rental streams
- Catalyst are currently seeing global real estate as being attractively priced based on expected total return spreads. Their fund is positioned underweight diversified, hotels & office property. Whilst they are significantly overweight residential.
- Millennials are now the biggest economically active population group in the US and they have a predilection for renting their home. Due to their stage of life (married with kids), there is a natural shift from apartment living to single family residential properties.
- Ecommerce is underpinning the industrial sector with a surge in online sales being clearly evident when the pandemic hit. This is believed to be another structural shift in human behaviour.
- Work from Home is the shadow overhanging the office sector, there have been many high-profile lease terminations directly attributable to this change in work/life balance. Pinterest for example have cancelled a $90 million lease in San Francisco. Catalyst are cautiously positioning around this new regime.
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