Quarterly Review – Q3 2021
With appreciation to PortfolioMetrix
SOUTH AFRICAN PORTFOLIOS EDITION
Asset Class Returns
Towards the end of the third quarter of 2021, global equities saw their first sell-off in about a year as fears emerged that China’s heavily indebted property developer Evergrande Group might lead to the collapse of China’s systemically important real-estate market, as well as major central banks starting to indicate tighter monetary policy than markets expected. More generally, the quarter saw markets begin to worry more seriously about ‘Stagflation’, the worst of all worlds in the form of lower growth (stagnation) and rising prices (inflation). The previous narrative of reflation faltered as growth numbers softened, whilst reported inflation kept on rising.
In South Africa, the effects of Chinese policy risk were felt directly on the local market. Continued pressure on the Naspers / Prosus stable resulted in the two stocks falling 17% and 15% respectively. The resources sector also suffered a sharp correction in September falling over 9% for the month and 4% for the quarter. However, despite this the FTSE/JSE Capped SWIX still produced a positive return of 3% for the quarter driven by the financial sector as well as strong performance from the mid and small cap segments of the market.
Evergrande and Chinese Property Developers
Regulatory changes coming out of China has been a source of angst for global markets for a large part of the year now. Most recently the fears of an Evergrande default and potential knock-on effects were a contributing factor to the selloff in markets in September. But what started this and why now?
After a meeting in August 2020, China imposed the three red lines guidance on selected developers. This was done at a time when Chinese property was experiencing significant increases in land prices, booming sales and growing debt levels. To control excessive leverage in the industry, regulators imposed certain criteria that, depending on their adherence to these criteria, would dictate the levels of borrowing they could take on (access to finance). The criteria were as follows:
- Liability to asset ratio (excl. advance receipts) of less than 70%
- Net gearing ratio of less than 100%
- Cash to short-term debt ratio of more than 1x
If a developer met all criteria, they had greater access to debt than otherwise, as detailed below:
Source: UBS Asset Management
Evergrande’s level of debt has been a concern for many years now and the implementation of the three red lines accelerated the decline for the company due to their poor debt metrics. The reason why it all came to a head in September was that debt repayments came due, and the company simply did not have the liquidity to honour these. It is an ongoing saga with restructuring required.
But should we be worried? As it relates directly to Evergrande we think that the Chinese government have sufficient resources to manage the crisis successfully. However, Chinese property is a big contributor to GDP growth and so the broader issues surrounding the sector certainly pose a growth risk to the country and hence global growth.
Inflation numbers across the globe are high and the most recent U.S. inflation figure is the highest read since 2008.
Source: Bloomberg and PortfolioMetrix
Contributing factors to global inflation have worsened and markets are concerned that higher inflation will be around for longer. Logjams at ports in the U.S. pose serious logistical issues that need to be addressed in the lead up to Christmas as demand for goods are likely to pick up.
Although stagflation risks have accelerated, these periods are typically precipitated by a yield curve flattening, and then inverting. However, over the last month the yield curve has steepened:
Growth forecasts globally remain robust. Deceleration is expected but growth figures remain healthy:
Source: Goldman Sachs Asset Management
That said, risks to inflation are high as supply bottlenecks worsen and a recent energy price surge reminds us that growth needs energy. The fact that globally we are undertaking the greatest energy shift in history in a (justified) aggressive manner certainly means that it will not be plain sailing.
Although we still think that many of the factors driving up inflation right now are transitory this cannot be a static view held indefinitely. The global energy transition to greener sources have resulted in higher energy costs in Europe, power outages in China and the UK needing to fire up old coal-fired power stations to meet demand (and try to cushion price spikes). Currently, fossil fuels satisfy 83% of primary-energy demand and this needs to fall towards zero. With low inventories in fuel sources, the system is more vulnerable to shocks and the transition away from fossil fuels will be bumpy, if not carefully managed.
For now, the growth backdrop remains robust, inflationary pressures are expected to ease going into 2022 and central banks are still accommodative. This is generally supportive of risky assets.
QUARTERLY MACROECONOMIC DATA
GDP figures released in the third quarter were for Q2 2021, where many developed markets were bouncing back from winter spikes in COVID and so showed solid growth. Inflation increased during the third quarter overall whilst unemployment generally fell as restrictions were lifted and economies continued recovering.
MONETARY POLICY (RATES & EXTRAORDINARY MEASURES)
There was little change in developed market central bank action over the quarter as rates were kept low and central bankers maintained quantitative easing, although there was certainly more hawkish messaging around future rate rises and tapering of bond purchases. A number of emerging markets raised rates to control surging inflation in their local markets.
Despite the inflation risks, we are still cautiously optimistic around our portfolios. From a global investor’s perspective, it’s difficult to make a very attractive case for cash and bonds under a high inflation scenario. Ignoring for now more alternative assets, this boils down to acknowledging that mainstream portfolios have three main asset classes to choose from: cash, bonds and equities. With cash and bonds looking unattractive, equities are seen as the only remaining asset class for protecting and growing wealth going forward. This should continue to support investor demand for the asset class, provided global growth does not decline too severely. Equity valuations have also reined in from the end of 2020 leaving a constructive backdrop despite the risks.
Source: Goldman Sachs Asset Management
This is not to say that cash and bonds should not form a part of portfolios. In fact, there are very good reasons why these asset classes should remain in most well-diversified, appropriately risked portfolios.
As is always the case, there are risks that may or may not materialise and portfolios need to be able to weather either scenario. Our portfolios continue to hold many diversified return sources and we believe that this is the best way to navigate what is likely to be a risky and unpredictable environment.
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 3.6% over the past 12 months (29.4% vs 33% for the fund) relative to its FTSE JSE Capped SWIX benchmark,
- Over the quarter the fund underperformed by 0.4%, as the index returned 2.8% and the fund generated 2.4%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE Capped SWIX):
- Ninety One SA Equity: outperformed by 0.34%
- 36ONE BCI SA Equity: outperformed by 1.62%
- Matrix SCI Equity: outperformed by 3.63%
- Fairtree Equity: underperformed by 7.14%
- Coronation Top 20: outperformed by 0.20%
- Satrix Mid Cap Index: outperformed by 4.23%
- Once again, the performance of various South African equity indices was materially different over the quarter highlighting the stark differences in these indices:
- ALSI -0.84%
- SWIX +0.51%
- Capped ALSI +0.50%
- Capped SWIX +2.84%
- At a super sector level there was a very strong rotation that took place during the quarter with the financials sector significantly outperforming the industrials and resources sectors. Performances for the quarter of these indices are as follows:
- FTSE/JSE Financials +13.23%
- FTSE/JSE Industrials -4.30%
- FTSE/JSE Resources -3.57%
- Small caps significantly outperformed over the quarter up 11.72% followed by mid-caps +7.16% and large caps -1.6%
- Active performance in the fund was affected by a relative overweight to the resources sector on a look-through basis.
- The resources overweight was funded by underweights in consumer discretionary, consumer staples, property and telecommunications.
- Sizeable exposures to the platinum counters as well as the Naspers / Prosus stable were detractors however considering the broader market impact the fund still produced positive absolute performance up 2.41%.
- The Top 10 holdings of the fund vs benchmark is shown below:
Please note that due to data availability we can only provide a snapshot as at 31 August 2021
- With the exchange offer in the Naspers/Prosus stable taking effect over the quarter, Prosus became a much bigger weighting in the benchmark and the portfolio.
- The fund still holds an overweight to resources with basic materials stocks forming a meaningful part of the active risk taken within the fund.
- Importantly, the resources view amongst underlying managers is divergent with some changing their positioning from more cyclical shares into defensives given the risk environment and high base built into these stocks.
South African Bonds Commentary
The PortfolioMetrix BCI Bond FoF fund outperformed by 0.4% over the past 12 months (12.5% vs 12.9% for the fund) relative to its FTSE JSE All Bond Index benchmark,
- Over the quarter the fund outperformed by 0.4%, as the index returned 0.4% and the fund generated 0.8%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE All Bond Index):
- Coronation Bond: underperformed by 0.07%
- Ninety One Gilt: underperformed by 0.09%
- Ninety One Corporate Bond outperformed by 0.27%
- Stanlib Bond: underperformed by 0.07%
During the course if 2021 Q1 the Stanlib Bond Fund was reintroduced to portfolios. Further changes were implemented during the course of 2021 Q2, these changes have brought about efficiency in the implementation of the PortfolioMetrix SA Bond Fund. The target weightings are as follows:
- Coronation Bond Fund 19% (prev. 33%)
- Stanlib Bond Fund 19% (prev. 33%)
- Ninety One Gilt Fund 19% (prev. 33%)
- Ninety One Corp. Bond Fund 19% (new)
- PMX Core Bond Seg. Mandate 24% (new)
These changes were addressed in a dedicated session, should you have missed the event then please follow this link for more information.
- Risk appetite waned as the quarter wore on, some indications of this can be seen through a few examples:
- EM Equity underperforming and a rise in volatility
- A weakening in EM currencies and rise of the Dollar index
- Rise in the US 2-year yield and a flattening of the US Yield curve (10y-2y)
- Further indications of a higher price to bare risk was observed through a few increases in spreads and duration, more specifically the SA 5-year credit default swap rose from 186 bps at the end of June 2021 to 214 bps (+28 basis points over the quarter). Similarly, Brazil saw a rise of 41 basis points over the quarter.
- Global concerns centred around higher inflation and tighter monetary policy from central banks around the world, particularly the US FED which is looking to taper it’s $120bn per month purchase programme in the near term.
- In a local context the salient features of the bond market included:
- A steepening in the SA yield curve of 50 basis points
- The All Bond Index yield rising to 10.0% from a quarter start of 9.7%, the SA 10-year yield offered 9.6% (starting the quarter at 9.3%)
- The ZAR settling above R15 to the Dollar
- Much of the global macro-economic outlook has filtered into the South African outlook, specifically rising inflation and higher policy rates. Compounding this macro view is a concern around South Africa’s ability to grow and support the government’s spending habits; higher rates are likely to hurt an economy that is not seeing high levels of activity despite extremely low interest rates.
South African Cash and Stable Income Commentary
The PortfolioMetrix BCI Income fund outperformed by 2.6% over the past 12 months (4.8% vs 7.4% for the fund) relative to its STeFi + 1% benchmark,
- Over the quarter the fund outperformed by 0.2%, as the index returned 1.2% and the fund generated 1.4%
Underlying funds over the quarter produced the following relative returns (vs STeFi + 1%):
- Coronation Strategic Income: outperformed by 0.18%
- Ninety One Diversified Income: outperformed by 0.08%
- BCI Income Plus: outperformed by 0.39%
- Nedgroup Investments Flexible Income: outperformed by 0.71%
- Matrix NCIS Stable Income: underperformed by 0.1%
- The Monetary Policy Committee met twice over the quarter, unanimously deciding both times to keep the repo rate unchanged at 3.5%, in line with market expectations.
- The MPC revised its near-term inflation forecasts higher, resulting in a headline CPI inflation forecast of 4.4% (from 4.3% in July) for 2021, but the 2022 and 2023 forecasts were unchanged at 4.2% and 4.5% respectively. However, the MPC made a stronger emphasis on upside risks to the inflation outlook, in the short term and the outer years. The GDP growth projection for 2021 was lifted higher to 5.3%, resulting in a narrower output gap over the forecast horizon
- The embedded repo rate path generated by the SARB’s Quarterly Projection Model was largely unchanged in the near term, with one 25bps rate hike expected in Q4 2021 and further hikes of 25bps in each quarter through 2022 and 2023.
- SA corporate credit spreads continue to tighten as money managers seek to deploy the persistent flow of capital into this investment category.
- SA government bonds had a volatile quarter but managed to end the period up 0.4%. Our managers have overweight duration exposure as they look to take advantage of the steepness of the yield curve.
- Property continued its bullish trend, rising 5.9% over the quarter. While Coronation, Ninety One and Nedgroup do have some property exposure, they remain relatively underweight the sector due to its volatile nature.
South African Property Commentary
The PortfolioMetrix BCI SA Property fund underperformed by 0.4% over the past 12 months (54.4% vs 54% for the fund) relative to its FTSE JSE SA Listed Property benchmark,
- Over the quarter the fund outperformed by 0.4%, as the index returned 5.9% and the fund generated 6.3%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE SA Listed Property):
- Sesfikile BCI Property: outperformed by 0.54%
- Absa Property Equity: underperformed by 1.14%
- The SA listed property has continued to deliver strong performance, outperforming equities, bonds and cash YTD, and over the last quarter.
- As lockdown levels decrease and the economy begins to open up, conditions are getting better for SA property companies. It should be borne in mind that the underlying property market remains under pressure from Covid Lockdowns, however this seems to be fully captured in underlying share prices.
- Most tenants that were forced to close their businesses at the start of the lockdown are now operational, generating revenues and in a position to start honouring their rental commitments.
- The property sector continues to recover from the deep discounted valuations seen throughout 2020 in line with the normalization of rental collections and declining rental discounts to tenants affected by Covid restrictions.
- The results season has gathered momentum, confirming fears of significant pressure in the office sector, evidenced by the rising amount of space available for sublet, further adoption of WFH policies, a further delay to a return to the office due to the stubborn third wave and limited confidence in the service-based industry for expansion.
- Encouragingly, the domestic retail and industrial sectors, as well as a range of offshore counters with exposure to office and industrial property, are performing well.
- Sesfikile view the sector as currently overvalued with price momentum outpacing operational health, anticipating a cooling off as likely to occur. Be that as it may, they still see the sector as well diversified with several pockets of opportunity.
- The Absa fund is currently positioned to avoid exposure to overly leveraged companies where income and NAV dilutionary measures will likely continue to be undertaken to repair balance sheets over the coming years. Despite this, many of these companies have been amongst the best performers over 12 months off low bases in the second half of 2020, which means that these companies valuations now look stretched relative to their medium term expectations.
Global Equity Commentary
The PortfolioMetrix BCI Global Equity FoF fund outperformed by 2.8% over the past 12 months (14.9% vs 17.8% for the fund) relative to its MSCI ACWI benchmark,
- Over the quarter the fund outperformed by 0.9%, as the index returned 4.3% and the fund generated 5.2%.
The performance of the underlying funds (versus their respective regional indices) for the quarter is shown below (in ZAR). Strong outperformance in developed Europe drove alpha as all fund selections in the region outperformed. Main alpha drivers were Jupiter European, Miton European and Liontrust Special Situations. Matthews Asia continued to perform well in the emerging Asia region despite difficult conditions given China’s dominance of the market. The biggest underperformer was the Baillie Gifford Japanese fund followed by the Brown Advisory Mid Cap Growth fund.
- Developed markets (DM) outperformed emerging markets (EM) as regulatory uncertainty out of China and a stronger U.S. dollar dampened risk taking and appetite for EM equity.
- Japanese equity was the best performing DM region over the quarter with political change and vaccine progress boosting prospects for its economy.
- In the EM space emerging Europe performed strongly but the dominant Asian region dragged down the overall asset class.
- Latin American equities were very volatile and again showed their high beta nature and sensitivity to China due to the regions outsized reliance on commodities
- Value underperformed growth for the quarter as growth expectations started to fade and market participants favored those stocks that can grow earnings in a weak environment.
- Momentum was the best performing factor for the quarter with small caps and quality the worst performing.
- Although China was generally under pressure, there was an extreme dislocation in the onshore and offshore market with the offshore market (typically dominated by offshore investors) underperforming by 14%.
- The above speaks to offshore investors dissatisfaction of regulatory uncertainty and the effects of this on growth in the short to medium term.
- Active fund implementation drove outperformance over the quarter and the year for the fund.
Global Bonds Commentary
The PortfolioMetrix BCI Global Bond fund underperformed by 0.9% over the past 12 months (-10.6% vs -11.5% for the fund) relative to its Bloomberg Barclays Global Aggregate benchmark,
- Over the quarter the fund underperformed by 0.4%, as the index returned 4.4% and the fund generated 4.0%
Underlying funds over the quarter produced the following relative returns (vs Bloomberg Barclays Global Aggregate):
- iShares Global Govt Bond: underperformed by 0.2%
- iShares Global Corp Bond: outperformed by 0.11%
- The past quarter served as a mirror of the previous; fixed income sold off, fears of higher global inflation outpacing growth, and a withdrawal of the addictive central bank stimulus (or at the very least a reduction thereof). Returns of the high-level sectors (in USD):
- Global Treasuries -1.11%
- Global Corporates -0.76%
- Global High Yield -0.37%
- Emerging Markets -3.10%
- The inflation equation is threatening markets on an “expected” basis, however the various indicators point to a more sustained impact as global PMIs rise. According to JP Morgan Developed markets PMI rose to 58.3, Emerging Markets PMI rose to 49.6.
- The inflation equation is down to the rates action taken by central banks around the globe, particularly since consumption has been the largest driver behind the elevated levels of inflation over the last quarter. The first major central bank to move is likely to be the US Federal Reserve who will look to taper their $120bn per month bond purchase programme. Thereafter raising rates to reduce the negative policy.
- The road to “normalization” has already shown to be a bumpy one as investors come to grasps with the lower levels of stimulus, the state of the global economy, and of course the relative valuation between fixed income sectors, and risk assets. Despite this the reward for taking on fixed income risk has been diluted dramatically over the past 20 years, using spreads as indicators of this (and comparing to their 5-year average), followed by a chart of absolute yields of different fixed income sectors:
- IG Corporate 88% (1.19%)
- High Yield 82% (4.42%)
- Emerging Markets 24% (3.56%)
Source: JPM Morgan Guide to the Markets 2021Q3
Global Property Commentary
The PortfolioMetrix BCI Global Property fund underperformed by 4.6% over the past 12 months (18.8% vs 14.2% for the fund) relative to its FTSE EPRA Nareit Developed Rental benchmark,
- Over the quarter the fund outperformed by 2.1%, as the index returned 5.0% and the fund generated 7.1%
Underlying funds over the quarter produced the following relative returns (vs FTSE EPRA Nareit Developed Rental):
- Catalyst Global Real Estate: outperformed by 1.99%
- Sesfikile BCI Global Property: outperformed by 2.84%
- Global listed property has delivered approximately 22.9% in USD in the first eight months of 2021 the best year-to-date returns on record for the sector.
- The Biden administration unsuccessfully tried to extend the moratorium on evictions beyond 31 July 2021 with an estimated 2.5-3.5 million households behind on rent amounting to $12- 17bn due to landlords.
- It’s not just last year’s trend pieces that have fallen out of favour – so have the once-loved malls who sell them. Online shopping has led to a somewhat redundant customer offering, and malls no longer serve the purpose in society they once did. Foot traffic, retail sales and tenant demand continue to fall, and shopping malls are experiencing higher natural levels of vacancy, lower market rents, cash flows and valuations.
- Most of the real estate sectors that are set to boom have technology driven societal change at their core. Logistics warehousing, manufactured housing, detached housing, medical office buildings, private hospitals, self-storage facilities, data centres, and biotech laboratories are among the sectors set-up for strong future growth.
- Falling home ownership rates with societal change, are leading to a greater propensity to rent rather than own, with rental housing being a major beneficiary.
- At the end of the quarter, Catalyst had material overweights in the Industrial and Residential sectors, with meaningful underweights to the Retail and Office sectors relative to the benchmark.
This document is only for professional financial advisers, their clients and their prospective clients. The information given here is for information purposes only and is not intended to constitute financial, legal, tax, investment or other professional advice. It should not be relied upon as such and PortfolioMetrix cannot accept any liability for loss for doing so. Any forecasts, expected future returns or expected future volatilities are not guaranteed and should not be relied upon. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Past performance is not a reliable indicator of future performance. Portfolio holdings and asset allocation can change at any time without notice. PortfolioMetrix Asset Management SA (Pty) Ltd is an Authorised Financial Services Provider in South Africa.
Boutique Collective Investments (RF) (Pty) Ltd (“BCI”) and PortfolioMetrix Asset Management SA (Pty) Ltd (“PMX”) are the registered Manager of the following Collective Investments Schemes.
- PortfolioMetrix BCI SA Equity Fund
- PortfolioMetrix BCI Global Equity FoF
- PortfolioMetrix BCI Bond FoF
- PortfolioMetrix BCI Income Fund
- PortfolioMetrix BCI SA Property Fund
- PortfolioMetrix BCI Global Property FoF
- PortfolioMetrix BCI Global Bond FoF
BCI & PMX are approved in terms of the Collective Investments Schemes Control Act, No 45 of 2002 and is a full member of the Association for Savings and Investment SA.
Collective Investment Schemes in securities are generally medium to long term investments. The value of participatory interests may go up or down and past performance is not necessarily an indication of future performance. The Manager does not guarantee the capital or the return of a portfolio. Collective Investments are traded at ruling prices and can engage in borrowing and scrip lending. A schedule of fees, charges and maximum commissions is available on request. PMX reserves the right to close the portfolio to new investors and reopen certain portfolios from time to time in order to manage them more efficiently. Additional information, including application forms, annual or quarterly reports can be obtained from BCI & PMX, free of charge. Performance fees will be calculated and accrued on a daily basis based upon the daily outperformance, in excess of the benchmark, multiplied by the share rate and paid over to the manager monthly.
Performance figures quoted for collective investment schemes or indexes is sourced from Financial Express Ltd, Bloomberg and/or Morningstar, as at the date of this document for a lump sum investment, using NAV-NAV with income reinvested and do not take any upfront manager’s charge into account. Income distributions are declared on the ex-dividend date. Actual investment performance will differ based on the initial fees charge applicable, the actual investment date, the date of reinvestment and dividend withholding tax.
Investments in foreign securities may include additional risks such as potential constraints on liquidity and repatriation of funds, macroeconomic risk, political risk, foreign exchange risk, tax risk, settlement risk as well as potential limitations on the availability of market information.
Boutique Collective Investments (RF) Pty Ltd retains full legal responsibility for the third party named portfolio.
Although reasonable steps have been taken to ensure the validity and accuracy of the information in this document, BCI and PMX does not accept any responsibility for any claim, damages, loss or expense, however it arises, out of or in connection with the information in this document, whether by a client, investor or intermediary. This document should not be seen as an offer to purchase any specific product and is not to be construed as advice or guidance in any form whatsoever. Investors are encouraged to obtain independent professional investment and taxation advice before investing with or in any of BCI/PMX products.
A fund of funds is a portfolio that invests in portfolios of collective investment schemes that levy their own charges, which could result in a higher fee structure.
A feeder fund is a portfolio that invests in a single portfolio of collective investment schemes, which levies its own charges and which could result in a higher fee structure for the feeder fund.