Quarterly Review – Q3 2020
As we head into the last quarter of what can only be described as a challenging 2020, the divergence between “Wall Street and Main Street” grows ever wider. Global equity returns posted another quarter of strong gains whilst global economies were plunged into deep recession. The idea behind investment markets pricing in future expectations supposedly indicates brighter economic prospects ahead, certainly when one reads of record highs on the tech-laden Nasdaq or US growth-driven S&P500 in the current harsh landscape. For the South African investor, as evidenced time and time again, diversification across all asset classes and in particular into global assets provides your best cushion in uncertain markets.
Global stocks have made up significant ground since their March lows, in fact the recovery for some of the above-mentioned indices has been almost as swift as their plunge. Although to a large degree the recovery has been narrow in extent, the predominant drivers of the Q3 investment returns have been:
18.104.22.168 Asynchronous recovery follows deep recession. China leads the pack.
- Global GDP growth numbers released during this quarter showed the extent of the damage of the Covid-19 pandemic that plunged almost every economy into deep recession. For some countries, the contractions are their worst on record. (See GDP macro table on page 5.)
- However monthly data released during the months of July through September showed a strong pullback in key sectors, predominantly manufacturing. Consumer, travel and tourism sectors far less so. Unemployment data also showed an improvement in the US and China but worsened across Continental Europe, the UK and Japan.
- This ramp up in manufacturing, led very prominently by China, has been to the ultimate benefit of emerging markets and commodity prices this quarter.
- It is clear that the globe is in an early recovery phase and although every region is faced with a different set of hurdles and parameters going forward, the shape of this macro recovery is driving investment returns. Given that this phase typically implies a period of low inflation, low interest rates and low real yields – it is an environment that favours equities over bonds. This is part of the explanation of why Wall Street is at odds with Main Street in this current environment.
22.214.171.124 A narrow recovery – has FANMAG killed value?
- Following on from the discussion of recovery, the next topic and driver of returns during the quarter has been the value vs growth debate and one of the most asked question of fund managers, “Is value dead?”
- Value stocks have experienced their worst decade in history relative to growth stocks, worse than the dotcom bubble period.
- Growth stocks, specifically in the US large-cap space (FANMAG), are plays on deflation and low interest rates. Lower growth expectations, lower inflation and a flatter yield curve help growing companies that rely on long-term debt, whilst those same macro conditions reduce the worth of short-term dividends, which are typically paid by value stocks.
- The global pandemic and lockdown restrictions have played a monumental role in this value versus growth debate (and by implication the US versus the rest-of-the-world). Thus, it is no surprise that the returns remain heavily skewed and very narrow in the growth / tech camp and which plays into the outperformance of the Nasdaq, S&P500 and Chinese equities over the more cyclical UK and European stocks.
SOUTH AFRICA drivers
126.96.36.199 SA cautiously reopens its economy and moves to Lockdown Level 1
- Cyril Ramaphosa cautiously dialled back the lockdown levels that saw the country in hard lockdown Level 5 from the 26th of March. Restrictions were lowered from Level 3 down to Level 2 mid-August and further lowered to Level 1 mid-September.
- In response to the opening of the economy we did see a pickup in macro data with both consumer and business confidence bouncing off multi-year lows. Manufacturing, mining and retail sales all turned the corner and showed signs of monthly improvement.
- Tied to the lift in sentiment, the rand and local bond market held ground over the quarter, the rand strengthening to end at 16.75 to the USD by quarter-end. Local buying of our bond market in the search for yield remained topical, although auctions remained relatively low in volume. SA Inc (domestic stocks) and small and mid-cap stocks also found support through Q3, although property remained the dog of the JSE.
188.8.131.52 Foreigners steadily dump SA investment assets
- Not a recent trend, but certainly growing in discussion, has been the selling of both the JSE and the SA bond market by foreign investors. Foreign bond holdings have steadily fallen from over 37% in January to below 30% by August, its lowest level in more than 8 years.
- The comment and concerns have revolved around the growing fiscal debt burden as well as the deep recession that plagued our economy even before Covid-19 hit. The fall of our sovereign credit rating in March has certainly not helped our plight and other emerging markets have benefitted from the exodus out of SA.
184.108.40.206 Confidence lifts – Ramaphosa stands firm on corruption and the first of the Zondo arrests buoys sentiment
- In early September, President Ramaphosa survived a crucial party challenge over corruption following a weekend long meeting of its top decision-making body, with the ANC endorsing the President’s claims and supported the order to those members facing graft charges to step down.
- This was followed by several high-profile corruption arrests emanating from the Zondo Commission that has left South African’s breathing a small sigh of relief and slowly restoring confidence in Ramaphosa’s support base and in our justice system.
220.127.116.11 2020 and Q3 SA returns follow similar narrow global trend – PGMs lead the recovery
- The recovery in SA equities has followed a similar narrow trend seen in global markets – gains have been dominated by resources and in particular gold and platinum companies.
- Their surge to prominence has been led in part by the early and impressive recovery seen in Chinese manufacturing as well as the mines being restored to capacity early in the lifting of lockdown.
- This lack of breadth in the market recovery has meant that the weight of resource counters in the indices has swelled with strong sector rotation in the Top40 rebalances towards these growing companies.
- At the other end of the spectrum – property stocks remain dogged by poor demand and even worse prospects with life under lingering Covid-19 threats not driving huge demand for office or retail space.
Although the global macro recovery has shown tremendous monthly improvements, investment markets have not followed a linear positive path with risk appetite continually waxing and waning weekly. September saw elevated volatility and risk sentiment that soured in response to the following drivers of what may lie ahead:
- Covid-19, alas, is still with us and remains the key risk variable as we move into the final quarter of 2020. The resurgence of Covid-19 cases across continental Europe and the US has seen these governments grapple with the trade-off between re-introducing economic restrictions to supress the spread but damaging growth versus keeping the economy open to support growth, jobs, and frankly, citizens’ mental well-being. Encouragingly mortality rates have remained relatively contained through these second wave spreads and indicates that the world is doing better at successfully treating the virus than previously.
- Covid-19 vaccine and therapeutics progress continue to oscillate between optimism and pessimism as some trials have been met with disappointment. But with 11 vaccines in phase 3 trials (i.e. large scale efficacy tests) and with a number due to deliver results in this Q4, it does feel as if the end game is in sight.
- Politics remains firmly front and centre (and as confusing as ever) – the US presidential debate left no-one the wiser whilst the UK Brexit deadline at year end remains no closer to finality. The US election is scheduled for November 3rd and at current polls, the Democratic Presidential candidate, Joe Biden, stands comfortably in the lead. Of course, given recent history, it is by no means a fait accompli. However, should Biden be the next POTUS, it more than likely means higher taxes for US corporates as well as a greater likelihood of anti-trust enforcement against some of the mega-cap tech giants. This could see some of the much talked about sector and cyclical rotation towards some of the value plays away from growth.
- As a result of the Fed holding rates lower for longer and running immense twin deficits, the US dollar continues to trend lower. Ultimately a soft dollar policy will continue to have direct beneficial implications for both emerging markets and commodity prices (and by implication South Africa too).
- Lastly the promise of additional federal fiscal stimulus once the election is finalised will continue to drive risk appetite. Importantly the size of the US election majority is likely to have an impact on the amount of further stimulus air-dropped on the US public – a narrow majority would likely result in less fiscal stimulus than a large Democrat “blue wave” Senate over-haul.
- Closer to home, the single biggest risk for South African investors is how our Finance Minister, SARB Governor and National Treasury deal with controlling the fiscal gap and spiralling debt burden plaguing our country’s investment prospects. The Medium Term Budget Policy Statement due for release 28th of October will likely shed light on how government intends to tackle these issues and debt burden that has already seen the budget deficit double from the previous fiscal year. Wage bill reform and the sustainability of State Owned Entities are also main priorities and will require tough trade-offs.
- On the upside, the recent Zondo arrests and affirmation of clear intent in fighting corruption by Cyril Ramaphosa is a net positive and will hopefully gain traction.
In summary, our prospects and ultimate investment returns will remain tethered to the drivers of global economies and markets and it thus remains imperative to maintain a diversified balance across asset classes as well as regions. The outlook for emerging markets as well as commodity prices appears moderately positive which bodes well for South Africa as a whole.
Asset Class Returns
QUARTERLY MACROECONOMIC DATA
MONETARY POLICY (RATES & EXTRAORDINARY MEASURES)
Building Block Commentary
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 7.2% over the past 12 months (-5.7% vs 1.5% for the fund) relative to its FTSE JSE Capped SWIX benchmark,
- Over the quarter the fund outperformed by 1.4%, as the index returned 0.9% and the fund generated 2.3%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE Capped SWIX):
- Ninety One SA Equity: outperformed by 1.61%
- 36ONE BCI SA Equity: outperformed by 3.02%
- Laurium Equity: underperformed by -3.44%
- Fairtree Equity: outperformed by 8.69%
- Coronation Top 20: outperformed by 0.45%
- Satrix Mid Cap Index: outperformed by 0.41%
- The PortfolioMetrix BCI Equity Fund successfully converted from a fund of funds to a standard fund during the quarter. This change was cost neutral to investors but provides meaningful operational flexibility and investment control, particularly with regards to mandate allocations
- Despite an overly pessimistic outlook on the South African economy and government debt situation, there was a pickup in local earnings momentum over the quarter; perhaps it’s too early to call a full rebound but certainly a situation to keep an eye on
- SA Equity valuations (ex-Naspers) are currently very cheap on a forward P/E basis of only 8x (MSCI South Africa). Combine this with a possibly over pessimistic outlook on earnings and there is room for a local rerating, should confidence take hold
- Amidst a weak currency the market has presented two diverging clusters; those with offshore earnings and those without. In particular, resource companies have benefitted both from a weak rand as well as strong spot commodity prices, largely driven by demand in China and as an inflation hedge amidst an uncertain macro environment
- The local consumer economy is one which faces an interesting dynamic of forces; widescale unemployment threatens the most basic needs and spending habits. Much of this is reflected in the market sentiment towards retailers and property companies, confidence however is key, and given generationally low interest rates, those with disposable income are likely to at the very least maintain spending habits. It is of course how these forces interact with one another that will determine if or when the local bourse shows clear signs of recovery
South African Bonds Commentary
The PortfolioMetrix BCI Bond fund outperformed by 0.6% over the past 12 months (3.5% vs 4.0% for the fund) relative to its FTSE JSE All Bond Index benchmark,
- Over the quarter the fund underperformed by -0.2%, as the index returned 1.5% and the fund generated 1.2%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE All Bond Index):
- Coronation Bond: underperformed by -0.58%
- Ninety One Gilt: outperformed by 0.16%
- STANLIB Bond: underperformed by -0.66%
- On 23 June 2020, the PortfolioMetrix BCI Bond FoF completely disinvested from the Stanlib Bond fund in favour of the Ninety One Gilt fund.
- The SA 10-year government bond yield moved from 9.26% to 9.45% over the course of the quarter. These attractive yields reflect fiscal risks and continued uncertainty relating to government actions and commitments. However, there is significant margins of safety built into our bond valuations, particularly in longer dated, 10 year plus, instruments
- With cash rates so low, SA investors who require income are needing to turn to the domestic bond market for real yields. Local bonds are attractive versus inflation, cash and our emerging market peers.
- The Ninety One Gilt fund outperformed the benchmark over the quarter. Key contributors were the fund’s mid-dated duration exposure and yield enhancing corporate bond allocations. Whilst inflation linked bonds marginally detracted.
- The Coronation Bond fund underperformed the benchmark over the quarter. The fund has been neutral to slightly overweight SA government bonds, has a small allocation to Inflation linked bonds and limited exposure to listed credit.
- The Ninety-One Gilt fund has a duration of 6.7 years and yield of 10.7%. Whilst the Coronation Bond fund has a duration of 6.6 years and a yield of 9.5%
South African Cash and Stable Income Commentary
The PortfolioMetrix BCI Income Fund fund underperformed by -3.2% over the past 12 months (7.3% vs 4.1% for the fund) relative to its STeFi + 1% benchmark,
- Over the quarter the fund outperformed by 0.2%, as the index returned 1.4% and the fund generated 1.6%
Underlying funds over the quarter produced the following relative returns (vs STeFi + 1%):
- Coronation Strategic Income: underperformed by -0.29%
- Ninety One Diversified Income: underperformed by -0.52%
- BCI Income Plus: outperformed by 0.50%
- Nedgroup Investments Flexible Income: outperformed by 0.62%
- Matrix NCIS Stable Income: outperformed by 1.34%
- The PortfolioMetrix BCI Income Fund successfully converted from a fund of funds to a standard fund during the quarter. This change was cost neutral to investors but provides meaningful operational flexibility and investment control with regards to mandate allocations
- The Ninety One Diversified Income fund and Matrix Stable Income fund were added to the portfolio last quarter. On relative terms the Ninety One fund was the worst performer for the quarter but the Matrix fund more than made up for this with the best relative performance
- Due to lack of demand and falling inflation, the SARB has cut interest rates to 3.5% from 6.5% in the beginning of the year. This is the lowest rates have been since inflation targeting was introduced in 1998. This means forward yields in short term income funds will come down
- Nominal bonds still show value in the longer end, and with short term rates so low managers have been tempted to push out duration to capture meaningful inflation beating returns
- Property continued to disappoint over the quarter (down 14%) but pockets of value are present in certain quality names. That said, managers are cautious to take advantage of this
- After years of underperformance, inflation linked bonds bounced back in the quarter (driving the Matrix outperformance) and continue to show value to managers on a forward-looking basis
South African Property Commentary
The PortfolioMetrix BCI SA Property fund outperformed by 6.9% over the past 12 months (-46.1% vs -39.2% for the fund) relative to its FTSE JSE SA Listed Property benchmark,
- Over the quarter the fund underperformed by -1.5%, as the index returned -14.1% and the fund generated -15.6%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE SA Listed Property):
- Sesfikile BCI Property: underperformed by -0.37%
- Absa Property Equity: underperformed by -5.84%
- SA property’s woes continued in Q3 having lost a further -14%. The Covid-19 pandemic has accentuated many pre-existing challenges facing the asset class before the start of the year
- Within the asset class there are pockets of opportunities, particularly in underlying subsectors. Logistics remained operational through lock down and benefited from the uptick in online activity. Office typically has fixed leases and many large inflexible tenants, so rentals are somewhat fixed. Work from home’s impact on office bound staff will largely be offset by the need to spread out desks to maintain social distancing. Retail has undeniably been hurt.
- Clear disconnects of opportunities like this should be beneficial to active managers who can proactively position to benefit from these dislocations. That said, both underlying managers lagged the benchmark in Q3, but they have both outperformed over the last year, by more than 5%
- Small positives relating to the asset class include the fact that stocks have remained liquid, cashflow positive and received continued support from their lenders throughout the pandemic. Recovery rates of rentals have also picked up quicker than initially expected, with retail’s recovery being particularly strong. Lower financing costs (interest rates) should also be beneficial to SA property
- SA Property’s calamitous fall has therefore already priced in a lot of bad news. But the asset class’ prospects do still largely depend on whether all this bad news has been correctly factored in and what unknowns still lie on the horizon
Global Equity Commentary
The PortfolioMetrix BCI Global Equity FoF fund underperformed by -6.3% over the past 12 months (21.5% vs 15.2% for the fund) relative to its MSCI ACWI benchmark,
- Over the quarter the fund underperformed by -0.8%, as the index returned 3.8% and the fund generated 3.0%
The performance of the underlying funds (versus their respective regional indices) is shown below. LF Miton continues to demonstrate exceptional alpha alongside Liontrust, whilst the more value orientated funds (Fidelity America and Man GLG) underperformed.
- The 3rd quarter was a continuation of many trends that have emerged during 2020:
- Momentum continued to steam ahead, Growth outperforming Value. This is indicative of the market dominance by US megacap technology stocks
- EM Asia and North America outperformed their emerging market and developed market peers, in particular UK equities suffered amidst disappointing performance from the oil and financial sectors as well as uncertainty around the shape and form of Brexit
- In general risk assets performed well, but selectively so. The steady and low global discount rate has ensured that lofty tech sector valuations remain intact (despite a small sell-off in September). This risk-asset performance is likely the beneficiary of comforting economic indicators such as improving US employment statistics
- EM Asia performance can also largely be attributable to its growing technology sector, and despite prominent US-China skirmishes, this sector continues to grow earnings amidst an evolving and receptive consumer base
- Within the US market, consumer discretionary stocks performed the best, this is important since the US consumer is the largest component of their economic growth, and therefore the growth of the global economy
- Elsewhere, the EU approved a €750 billion grant and loan programme, a timely intervention given the second wave of Covid-19 threatening their economic outlook. Japan also performed reasonably well given their change of leadership
- The PortfolioMetrix BCI Global Equity Fund made an implementation change within the North American equity block;
- Exposure to the Fidelity America Special Situations strategy was reduced in favour of a tempered and more efficient implementation of the Invesco FTSE RAFI US 1000 exchange traded fund
Global Bonds Commentary
The PortfolioMetrix BCI Global Bond fund underperformed by -0.5% over the past quarter (-1.4% vs -2.0% for the fund) relative to its Bloomberg Barclays Global Aggregate benchmark,
Underlying funds over the quarter produced the following relative returns (vs Bloomberg Barclays Global Aggregate):
- iShares Global Govt Bond: underperformed by -0.25%
- iShares Global Corp Bond: outperformed by 0.37%
- The fund was launched on 17 March 2020 and has successfully transitioned to a fully passive implementation with the two underlying instruments (shown above) implemented in a 55/45% proportion
- A revisit of the rationale behind the fund launch can be found here: C:\Dropbox (PMX)\PMXSA Adviser Documents\1. Monthly Performance Reports\1. Communication\Portfolio Updates\2020\20200302 PMX BCI Global Bond FoF Launch.pdf
- The iShares Global Government Bond ETF has a yield to maturity of 0.24% and a duration of 8.8 years. Whilst the iShares Global Corporate Bond ETF has a yield to maturity of 1.55% and a duration of 7.3 years. This implies that the fund has a yield of 0.83% and a duration of 8.1 years.
Global Property Commentary
The PortfolioMetrix BCI Global Property fund outperformed by 11.1% over the past 12 months (-9.3% vs 1.9% for the fund) relative to its FTSE EPRA Nareit Developed Rental benchmark,
- Over the quarter the fund outperformed by 3.9%, as the index returned -1.4% and the fund generated 2.5%
Underlying funds over the quarter produced the following relative returns (vs FTSE EPRA Nareit Developed Rental):
- Catalyst Global Real Estate: outperformed by 2.12%
- Sesfikile BCI Global Property: outperformed by 2.83%
- Meaningful divergence of returns across countries, sectors and stocks in the global REIT space has provided relative opportunities for astute active managers.
- Dislocations are expected to continue and companies in this space need to adapt quickly to stay a going concern. Certain companies have been better positioned than others in a post-Covid world and have been rewarded for this.
- Sectors such as hotels, malls and companies otherwise retail focused have struggled immensely over the year, whereas data centres, lab space and industrial properties have held up well.
- Both underlying managers have added considerable value year-to-date and continued to do so during the quarter. This did not necessarily come from country selection but more adapting quickly and being correctly positioned from a sector perspective.
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