Quarterly Review – Q4 2020
With appreciation to PortfolioMetrix
Asset Class Returns
2020 was a year of unprecedented events that would shape a year like no other. Thinking back to the backdrop coming into this same period a year ago – there was much optimism, for the global economy and markets alike. The US-China phase one trade deal had been signed, central banks had cut interest rates to ridiculously low levels to counter the synchronised global slowdown and a no-deal Brexit had been temporarily averted with an extension to work on exit details. Little would prepare us for the global Covid-19 pandemic and the severity of the lockdowns that ensued across the globe. Yet with all that happened and with no foresight of these black swan events, global risk assets ultimately did end the year as winners across the asset class spectrum. The JSE was slightly late to this developed risk rally, but recorded sharp gains in the final quarter that erased all earlier year losses. Why you ask?
Finding the Vaccine Holy Grail
Stock markets around the world looked through escalating second wave Covid contagions and stricter lockdowns and concentrated on the idea of the vaccine Holy Grail midway through the fourth quarter. In early November, we learned that the interim analysis of Phase III clinical trials from Pfizer/BioNTech and Moderna showed each to be about 95% effective; AstraZeneca and the University of Oxford’s vaccine was found to be between 62-90%, depending on the delivery mechanism. All groups quickly sought Emergency Use Authorization with the UK regulators, the first to grant authority to Pfizer/BioNTech on December 2nd and began vaccinations on December 8th. The USA followed suit just over a week later and by year end all three of the above vaccines were authorised for rollout across the wealthier nations. It is interesting to note that both China (with its SinoVac vaccine) and Russia (with its Sputnik V) had authorized their own shots in as early as July and August, but without waiting for the immunizations to complete their final round of tests. Since then, these two countries have administered millions of doses, although very little news or updates on efficacy have been reported.
Stimulus, more stimulus and even more to come
Not a new theme, but one that hasn’t quite reached full potential or impact yet – stimulus, more stimulus and even more stimulus expected in 2021. Across the G20 countries, governments remained committed to providing fiscal support to combat the impact that Covid-19 has had on economies. The US Trump administration kicked off with a $3 trillion economic aid package in the second quarter, supplementing it again in December with a further $900 billion plan. However following the very recent US political changing of the guard and Biden’s clean sweep of Presidency, House and Senate, a further $1.9 trillion has been pitched for 2021. It is even forecast that should this latest round of stimulus be granted, it could boost the US economy by 2 percentage points, according to Bank of America’s economics team.
Perhaps even more impactful, Japan’s fiscal aid has topped leader boards as a percent of GDP. Earlier in the year, former Japanese Prime Minister, Shinzō Abe, had unveiled two stimulus packages worth a combined $2.2 trillion, including cash payments to households and small business loans. Again, with a change in leadership in September, the incoming Prime Minister Yoshihide Suga, announced a fresh round of stimulus in the fourth quarter that extended the total stimulus aid to approximately $3 trillion or over 40% of Japan’s GDP.
The ECB has also been proactively involved in a variety of stimulus measures and in the last month has extended their €500 billion Pandemic Emergency Purchase Program (PEPP) to €1.85 trillion to at least the end of March 2022. Favourable terms on bank lending will be extended to June 2022 with new offers under the program expected in 2021.
Most of these fiscal packages have propelled government debt levels into the stratosphere, US debt now stands at levels last seen post World War II and well over 100% of GDP. However the one caveat to the concerns surrounding this gargantuan amount of debt is that owing to ultra-low interest rates and real yields, debt servicing levels remain manageable.
Low rates addiction
We’ve become well accustomed and to a large extent addicted to the current low rate environment with all major central banks, including the SA Reserve Bank, keeping rates on hold in the fourth quarter and liquidity taps open. However the question at the back of many investors’ minds is for how much longer can rates stay at zero (ZIRP) or close to zero with central banks continuing to inject massive amounts of liquidity into the developed nations. One only has to remember the 2013 taper tantrum that sent treasury yields spiking, as people worried that the lack of easy money will trigger market instability. We saw hints of this occurring over the Q4 and more so in the past couple of weeks as US treasury yields began to rise following the Democrats blue wave sweep and expectations of more fiscal stimulus bringing recovery and reflation faster than previously forecast. However Federal Reserve members including Chairman, Jerome Powell, were very quick to quash this notion saying “now is not the time to be talking about exit”. That said, forward-looking markets were further supported into the back end of 2020 on the reassurance that monetary policy and quantitative easing is unlikely to be stepped back in the short-term and will continue to support the appetite for risk into a recovery period.
High risk events come and go in Q4 – US elections and Brexit finality
Volatility remained elevated all throughout 2020 and not solely owing to the global pandemic. US elections on November 3rd highlighted a very divided and unsettled country with extremism growing in popularity. However risk markets reacted positively to what a Biden Presidential and Democrat House victory may bring in terms of sanity and more rational policy responses particularly in their efforts to eradicate Covid-19; debt markets were less enthusiastic. Even when the Democratic Senate win came down to the wire on January 6th, markets repositioned slightly but global debt markets sold-off although have since steadied. US and global investors are seemingly glad to see the back of Donald Trump.
Similarly the UK Brexit negotiations hung over the UK economy and markets for the entire year. It wasn’t until December 24th that UK investors could finally breathe a final sigh of relief after an UK-EU deal was struck ahead of the breakup on 1 January 2021. With this cloud lifted, UK and European markets received their kick up into year end.
A weak US dollar, strong commodity prices and no cracks in China’s recovery
The effects of the global pandemic plus the US Federal Reserve’s low interest rates have dragged down the US dollar from its 15 year dollar bull run. The story is slightly more complex because currencies tend to move in long cycles. The US dollar entered the pandemic near its highest levels in its 15 year rally, which made it more vulnerable to a pullback. Conditions have also brightened in other countries; China’s recovery has been nothing short of stellar and Europe and the UK have finally moved past Brexit. The combination of US domestic weakness and improvements abroad is helping push the dollar lower.
A weak dollar typically benefits both commodity prices (that are priced in dollars, with costs in local currencies) and Emerging Markets that generally borrow money in dollar denominations, thus making their borrowing costs cheaper. Put simply, if the dollar is weak, then the world’s reserve currency is cheap and global monetary conditions are nice and loose.
This dollar weakness was another strong draw towards riskier markets into the fourth quarter, the added impetus being the rising commodity complex and lest not forget the significant recovery in the Chinese economy. These three factors are interrelated and helped spur demand for South African equities by foreign investors. The MSCI SA Index rallied sharply in Q4 by 22.4% and the JSE All Share rose almost 25% in US$ terms.
SOUTH AFRICAN drivers
Domestic asset classes – the JSE and Bond market – posted strong and broad gains in the fourth quarter largely supported by the unfolding global drivers. The weak dollar, strong commodity complex and rising risk appetite for Emerging Markets bode well for SA assets. Property stocks in particular showed exceptionally strong quarterly and December returns as the rand strengthened by 14% and cheap valuations attracted rotation towards this cyclical sector. However the 22.2% quarterly return did not come close to erasing the earlier year losses on the Property sector which still shows the worst annual performance of down 34%. Also noteworthy were the gains seen in the smaller capitalization stocks with investors willing to take on more risk and picking up these previously unloved and cheaper stocks.
South African high real yields (approximately 4-5%) finally caught the attention of foreigners in the global hunt for yield in the fourth quarter and resulted in strong demand in Q4. The potential of higher debt issuance of government bonds owing to the country’s exceptionally weak fiscal position has somewhat steepened the yield curve and is enticing investors to lock in these attractive lower risk returns. Although not completely without risk given the rising debt to GDP levels and weak growth, fundamentals are improving and the juicy real yield is likely to compensate for this added risk.
QUARTERLY MACROECONOMIC DATA
MONETARY POLICY (RATES & EXTRAORDINARY MEASURES)
Providing an outlook for 2021, after a year like 2020, may be a futile exercise, but it’s important to weigh up where we stand and provide some context and thoughts on the economy, markets and portfolio strategy:
- Ballooning COVID-19 cases could pose a short-term economic setback
- Efficacy and the distribution of vaccines are paving a way back to economic normalcy, although risks remain
- Pent up consumer demand could ignite growth in 2021
- Covid relief and stimulatory fiscal aid among the G7 nations will speed up global recovery
- Rising government debt makes government finances vulnerable to rising interest rates, but not yet
- The globe is in the early post-recession recovery phase of the cycle
- This stage typically favours equities over bonds as rates remain low and inflation slowly begins to rise
- Cyclical and value stocks tend to outperform through the early stage recovery
- Low interest rates (dovish monetary policies) will remain for the foreseeable future
- US politics and policy response is likely to be more rational and less volatile
- Valuations in the US stock market are not cheap, but markets are pricing in a swift US recovery
- With Brexit behind them, the UK and EU can better define future trading relationships
- Diversifying your portfolio is crucial for long-term investment success
- Stay nimble but rely on fundamentals, don’t become an all-in or all-out market extremist
- Align your risk tolerance and investment objectives with your portfolio allocations 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 5.0% over the past 12 months (0.0% vs 5.0% for the fund) relative to its FTSE JSE Capped SWIX benchmark,
- Over the quarter the fund outperformed by 1.1%, as the index returned 11.4% and the fund generated 12.5%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE Capped SWIX):
- Ninety One SA Equity: outperformed by 0.82%
- 36ONE BCI SA Equity: underperformed by -2.31%
- Laurium Equity: outperformed by 1.01%
- Fairtree Equity: outperformed by 2.71%
- Coronation Top 20: outperformed by 1.45%
- Satrix Mid Cap Index: outperformed by 2.16%
- The PortfolioMetrix BCI SA Equity Fund finished the year off with a strong quarter of absolute and relative returns. All things considered this building block performed relatively well for the year producing a positive return of 5% against its benchmark return of 0%.
- It was a tricky year to navigate with the resources sector (+21%) significantly outperforming the financials (-19.7%) and industrials sectors (+12%). The last quarter was the opposite with financials (+19.5%) bouncing back strongly and industrials (+7.4%) and resources (+8.3%) lagging. The PortfolioMetrix fund outperformed in both periods.
- South African consensus earnings expectations for 2021 improved in the fourth quarter, led by resources (platinum-group miners (PGMs) and diversified miners), banks, insurers, media, beverages and telecoms. In contrast, industrials, healthcare and REITs continued to be downgraded.
- Generally, companies with offshore earnings fared significantly better than those that are more domestically focussed. Pro-cyclical sectors such as retail, real estate and banks remain substantially below their 2019 levels.
- This divergence in performance is where potential opportunities lie for South African equity fund managers. Assessing the translation of pandemic related economic effects on company earnings and balance sheet is pivotal. The question of how much is priced in and the relative strength of companies in this space is pivotal.
- This decision is by no means a certainty with many risks abound and much of the return to ‘normal’ relying on the successful rollout of vaccines to reach herd immunity.
- The cyclical upswing in the fourth quarter benefitted emerging markets and South Africa in particular. This global backdrop is positive for the local bourse and, in particular, domestically oriented companies that carry favourable valuation metrics, low base effects and improving earnings.
- South Africa has significantly lagged its EM peer group over the last year, and relative to EM, the MSCI SA forward multiple has opened up to a 29% discount, which is the largest relative discount to EM since mid-July 2000.
South African Bonds Commentary
The PortfolioMetrix BCI Bond FoF fund outperformed by 0.7% over the past 12 months (8.7% vs 9.4% for the fund) relative to its FTSE JSE All Bond Index benchmark,
- Over the quarter the fund outperformed by 0.1%, as the index returned 6.7% and the fund generated 6.8%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE All Bond Index):
- Coronation Bond: underperformed by -0.21%
- Ninety One Gilt: outperformed by 0.19%
- South African Bonds benefitted from a risk-on sentiment in the last quarter of 2020, this is evidenced by the yield on the FTSE/JSE All Bond Index rallying from 10.2% to 9.6% and the SA Government Bond 10-year bond yield falling a similar amount.
- The stronger rand (largely a product of a weaker US Dollar) assisted in maintaining a low inflation outlook, market expectations indicate an average inflation rate of 3.2% p.a. over the next five years.
- The low and stable inflationary outlook is key in determining where the South African Reserve Bank sets the Repo rate (which is currently 3.5%) and has anchored the short-term fixed-interest rates at a similar, low, level.
- Despite this, however, the longer-end remains elevated and provides some of the largest real-yields on offer across all sovereign bonds globally. This area of the curve could potentially reprice significantly after the upcoming budget speech in February.
- The South African Yield curve is exceptionally steep, indicating the fiscal risk that the government finances present. The conundrum that most investors face at this point is that short-end rates are too low to provide a meaningful income, whilst the longer-end of the yield curve provides a significant yield pickup but with interest rate and fiscal risk.
South African Cash and Stable Income Commentary
The PortfolioMetrix BCI Income fund underperformed by -1.9% over the past 12 months (6.4% vs 4.5% for the fund) relative to its STeFi + 1% benchmark,
- Over the quarter the fund outperformed by 1.0%, as the index returned 1.2% and the fund generated 2.2%
Underlying funds over the quarter produced the following relative returns (vs STeFi + 1%):
- Coronation Strategic Income: outperformed by 1.26%
- Ninety One Diversified Income: outperformed by 0.72%
- BCI Income Plus: outperformed by 2.30%
- Nedgroup Investments Flexible Income: outperformed by 0.75%
- Matrix NCIS Stable Income: underperformed by -0.48%
- The PortfolioMetrix BCI Income Fund successfully converted to a standard fund in Q3 2020.
- The economic turmoil surrounding the Covid-19 pandemic, has resulted in the SARB cutting interest rates from 6.5% at the beginning of 2020 to 3.5% today. With the prospects of any meaningful hikes being extremely unlikely anytime soon. Current rates are at the lowest levels since inflation targeting was introduced in 1998. This means the hurdle for income funds to generate real returns has been raised considerably higher.
- Real yield remains on offer in longer dated SA bonds, however Income managers need to trade-off chasing yield and introducing risk. Our underlying managers selectively make this decision based on their investment philosophy and process.
- The asset class has seen considerable inflows in recent years. This has been fuelled by the lacklustre performance of risk assets and the very attractive inflation beating returns on offer prior to the pandemic. With these attributes being less entrenched there are growing concerns of a flight from the asset class and liquidity drying up. Diversification across funds and strategies is therefore paramount.
- The Ninety One Diversified Income fund and Matrix Stable Income fund were added to the portfolio in Q2 2020. Exposure to Coronation Strategic Income, BCI Income Plus and Nedgroup Flexible Income were all lowered proportionately.
- Matrix’s underperformance in the quarter needs to be considered in context. Firstly, over the long-term, the fund’s expected return due to its unique process is expected to be lower than the peers and STeFi+1% comparator provided. The fund has intentionally been included for its more defensive process. Secondly, the fund was the best relative performer in Q2 outperforming STeFi +1% and although not invested in for the entire year it was the best performer in 2020.
South African Property Commentary
The PortfolioMetrix BCI SA Property fund outperformed by 6.6% over the past 12 months (-34.5% vs -27.9% for the fund) relative to its FTSE JSE SA Listed Property benchmark,
- Over the quarter the fund underperformed by -2.3%, as the index returned 22.2% and the fund generated 19.9%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE SA Listed Property):
- Sesfikile BCI Property: underperformed by -2.16%
- Absa Property Equity: outperformed by 0.71%
- South African Listed Property finished a tumultuous year off with a bang, returning more than 20% in the last quarter, this was however not enough to fully recoup losses for the full year,
- The 12-month dividend yield of the index fell significantly, from 12.7% to 8.2%. This would traditionally be good news, but the reality is mixed; the falling yield is partially the result of a solid fourth quarter rally, but also smaller dividend payments as companies either cut or suspended dividends due to the crippling impact of Covid-19 and lockdowns,
- The rally was primarily driven by news around a Covid-19 vaccine which is essential to getting people back into public spaces, particularly office and retail.
Global Equity Commentary
The PortfolioMetrix BCI Global Equity FoF fund underperformed by -4.0% over the past 12 months (22.1% vs 18.2% for the fund) relative to its MSCI ACWI benchmark,
- Over the quarter the fund outperformed by 1.0%, as the index returned 1.0% and the fund generated 1.9%
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.
- The last quarter of 2020 saw a cyclical upswing in global markets which led to outperformance of emerging markets and certain “value” sectors (e.g. Financials and Energy) that had significantly underperformed earlier in the year. A meaningful outperformance of small caps rewarded those that had exposure and in a rare event North American equities and big Tech lagged the rest of the market.
- The risk-on environment was buoyed by vaccination approvals and the rollout of vaccines in developed markets. The market began pricing in a recovering economy and an accompanying recovery in earnings.
- The US election also provided more certainty on a political front and the democratic clean sweep of the White House, the Senate and the House of Representatives enforced expectations of more stimulus into the US economy.
- The US dollar is typically counter cyclical to global growth and this was indeed the case in the quarter as the dollar continued to weaken. This environment is typically favourable to emerging markets and supportive of commodity prices. US Real rates collapsed into negative territory over the year and should remain low as the Fed is expected to remain on hold even if inflation starts rising. This is an accommodative environment for risk assets.
- China drove demand for commodities as the country continued its strong economic outperformance. As the rest of the world struggled with second waves, lockdowns and restrictions, the Chinese were able to keep their manufacturing facilities operational supporting PMI’s across most developed markets, particularly Japan.
- Funds that were more exposed to these themes significantly outperformed over the quarter, however, over the full year it certainly remained a very good strategy to be all-in on big Tech.
- Over the quarter the following fund changes were made:
- Merian North America was sold in favour of the Invesco MSCI USA Swap UCITS ETF tracker fund. The ETF tracker is significantly cheaper (5bps vs 80bps) and benefits from favourable dividend withholding tax treatment.
Global Bonds Commentary
The PortfolioMetrix BCI Global Bond fund underperformed by -0.6% over the past quarter (-9.0% vs -9.6% 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 -1.52%
- iShares Global Corp Bond: outperformed by 0.84%
- 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% ratio.
- 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
- Global Bonds were affected late in the quarter by a rising inflation expectation by the market, this expectation has largely been driven by the Democratic Party’s victory in the US elections and the subsequent stimulus and Infrastructure spend plans.
- US Breakeven rates point to an all-important 2% inflation level, at the start of the quarter this indicated 1.5%. As such the US yield curve steepened by around 25bps.
- Capital also sought out higher yielding currencies and bonds, in a world where a third of all developed market bonds have a negative yield, Emerging Markets and High Yield debt offer some respite. They were the major beneficiaries whilst US Treasuries lagged over the quarter.
- The strength of the rand dominated the return otherwise generated by global bonds over the quarter.
Global Property Commentary
The PortfolioMetrix BCI Global Property fund outperformed by 4.5% over the past 12 months (-3.3% vs 1.2% for the fund) relative to its FTSE EPRA Nareit Developed Rental benchmark,
- Over the quarter the fund underperformed by -5.2%, as the index returned -0.1% 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 -5.52%
- Sesfikile BCI Global Property: underperformed by -4.47%
- In 2020, Global Property lost -7.9% in USD, making it the fifth consecutive year the asset class underperformed Global equities.
- Worth noting was the sizeable double-digit dispersion in share price returns due to the Covid-19 pandemic. Benefactors included industrial, data centres and German residential, whilst casualties included hotels, shopping centres and malls.
- Although we are still in the early days of vaccine roll-out, progress in this regard is believed to be supportive to the asset class. A vaccinated population should start returning to their normal daily activities, although you must ask what is the new normal?
- Catalyst and Sesfikile performed well on a relative basis in 2020, the mangers outperforming their benchmark by 2.7% and 6.6% respectively. Both managers attribute this to taking a longer-term outlook than the short-termism presented by the Covid-19 pandemic. A focus on balance sheet strength and market liquidity was also extremely important.
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