Quarterly Review – Q4 2021
With appreciation to PortfolioMetrix
SOUTH AFRICAN PORTFOLIOS EDITION
Asset Class Returns
Source: Bloomberg and PortfolioMetrix
The fourth quarter saw extremely strong performance from western developed equity markets on the back of expectation-beating corporate profit upgrades, with the US leading the way. Asian equities and emerging markets struggled, dragged down by China which continued to push ahead with industry reforms and regulatory crackdowns resulting in headwinds for economic growth and investor sentiment (particularly the international community). Bond markets struggled under multi-decade high inflation prints raising market participant fears of inflation running ahead of central bankers. The increase in bond yields resulted in capital losses for bonds. Despite this, real yields remain deeply negative in most developed markets when comparing year-on-year inflation numbers to longer term 10-year bond yields.
The South African equity market performed well over the quarter, although the choice of benchmark made a significant difference in realised returns. The FTSE/JSE ALSI enjoyed a quarterly return which was almost twice that of the SWIX and Capped SWIX partly explained by extraordinary performance from its biggest holding, Richemont, and strong returns from resources. Richemont’s weight in the ALSI index moved from 10% in September 2021 to 14% at the end of December 2021 as the stock returned 55% over the three months (it accounts for 16% of the Top 40 index now too). The Naspers/Prosus stable fell from a combined weight of 11.5% in September to 9.8% in December, illustrating the direct link of the China tech crackdown on the South African markets. The strength of equities completely outshone returns available from local fixed income markets with the quarterly returns of local cash and bonds offering a “meagre” 1% and 2.9% (in rands) respectively.
Omicron variant throws a spanner in the works
The discovery of the Omicron variant in November 2021 initially sparked a selloff in markets for the following reasons:
- It coincided with a Delta wave in the Northern hemisphere which had already resulted in tighter lockdown restrictions in many European countries.
- Uncertainty around Omicron’s severity (virulence), transmissibility, and its ability to evade vaccinations raised concerns of further economic disruption due to tighter restrictions globally.
As further data came in over the quarter, markets brushed aside these risks delivering strong returns in the last month of the quarter.
Source: Financial Express, PortfolioMetrix
That said, the Omicron variant and other potential variants still pose a risk to economic and market outcomes in the coming year. Supply side bottlenecks have created first round inflationary pressures globally due to labour shortages and disruptions to the global supply chain. Although the progression of the virus looks to be evolving into a more endemic disease, guidance from WHO and others in the scientific community warn of this being too early to call.
“Zero-COVID” strategies, followed most notably by China, make for a volatile path of output in these countries. It also poses risks of localised lockdowns leading to further disruption to economic activity and the production of goods needed further down the supply chain (a good example of this was the lockdown of Xian in China which happens to be a large chip producing region, directly affecting companies such as Samsung Electronics and Micron Technologies).
China’s year of the Tiger
2021 was a difficult year for Chinese investors. Monetary and policy tightening coincided with a year of regulatory reconfiguration for the internet industry. A hopeful easing of tensions between the US and China under a Biden-led administration turned out to be overly optimistic with pressure from both sides continuing unabated. China’s offshore equity market lagged significantly throughout the year whilst mainland stocks (A-shares market), enjoyed better performance. The stark contrast in performance highlighted the difference in mood of the investor base with the offshore market predominantly traded by offshore investors and the mainland market dominated by Chinese local investors.
Source: Financial Express, PortfolioMetrix. Data in US dollars
Moving into the year of the Tiger, it seems that the Chinese government seeks a “more stable and healthy economic environment” which coincides with steps already taken to loosen financial conditions. It is an important year politically for China as Beijing hosts the winter Olympics in February and Xi Jinping seeks a third term as president towards the latter part of 2022. Rapid fire regulatory change experienced in 2021 is expected to cool down as stability and certainty around quality growth in China is prioritised.
The Fed starts singing a different tune
As US inflation broadens and accelerates (the last reading was 7% for 2021, core prices were up 5.5%) the Fed has turned more hawkish. Policymakers have acknowledged that their assessments of inflation may have been a bit too optimistic requiring a more aggressive tightening of monetary policy.
In its December Federal Open Market Committee (FOMC) meeting, the Fed doubled the pace of its asset purchase tapering and guided on three rate hikes in 2022.
Markets were expecting a gradual tightening of financial conditions, however, the change in tune from the Fed creates concern of the more acute risk of rates needing to move higher and faster than the Fed and market expect.
Source: JP Morgan Guide to the Markets Q1 2022
QUARTERLY MACROECONOMIC DATA
GDP figures released in the fourth quarter were for Q3 2021 and continue to be volatile given different patterns of COVID disruption and government support. They generally show reasonable growth though. Inflation increased during the fourth quarter almost universally whilst unemployment generally fell as restrictions were lifted and economies continued recovering.
MONETARY POLICY (RATES & EXTRAORDINARY MEASURES)
A few developed market central banks, including the Bank of England, joined emerging market central banks in raising interest rates to combat inflation. In addition, the US Federal Reserve and ECB started tapering their bond purchases as a prelude to likely raising interest rates sooner than markets had previously anticipated.
As we move from 2021 to 2022, market concerns over COVID are diminishing to be replaced with inflation worries and fears over monetary tightening by central banks to deal with inflation. Uncertainty in the withdrawals of central bank stimulus in the form of reduced central bank bond buying and higher interest rates (in the US and Europe) should result in elevated risk across markets. The things we will be looking out for include:
- Policy divergence between the US, Europe and Asia as central banks unwind stimulatory measures into different localised economic conditions. This coincides with China on a different monetary trajectory as it looks to ease financial conditions.
- Inflationary pressures continue to pose a risk but should moderate somewhat as supply side bottlenecks ease and base effects roll into the numbers. That said, it is still expected for inflation to remain above pre-COVID levels in 2022. The outlook for inflation is likely to drive market returns this year.
- Higher wage growth across developed markets is a key indicator to look out for as it relates to inflationary pressures persisting for longer than anticipated.
- Developments in the US-China economic rivalry is a risk that will remain with us for the foreseeable future. The level of hostility between the two countries will remain a key focal point and developments in trade relations could have a material impact on corporate investment and capital markets.
- Emerging markets are vulnerable to external shocks as it relates to the progression of the pandemic, inflation, and interest rates. China’s comparative shift to a more accommodative stance should cushion risks of a severely negative macro backdrop for emerging markets, however.
- The continued themes of decarbonisation and net zero targets should remain a powerful force guiding investment patterns and shorter term effects on energy availability and price stability.
- Geopolitical tension particularly surrounding developments on the Russia-Ukraine border.
Our portfolios are built to withstand any number of scenarios through the judicious use of diversification by providing exposure to multiple return sources across the risk curve. Risk mitigation through sound portfolio engineering and portfolio construction provides our portfolios with the necessary defensive and offensive characteristics to weather the inevitable uncertainties associated with investing in capital markets.
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 0.7% over the past 12 months (26.1% vs 26.8% for the fund) relative to its FTSE JSE Capped SWIX benchmark,
- Over the quarter the fund underperformed by 1.3%%, as the index returned 8.6% and the fund generated 7.2%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE Capped SWIX):
- Ninety One SA Equity: underperformed by 0.10%
- 36ONE BCI SA Equity: outperformed by 0.34%
- Matrix SCI Equity: underperformed by 5.60%
- Fairtree Equity: outperformed by 2.70%
- Coronation Top 20: underperformed by 1.43%
- Satrix Mid Cap Index: underperformed by 4.79%
- Once again, the performance of various South African equity indices was materially different over the quarter highlighting the stark differences in these indices:
- ALSI +15.13%
- SWIX +8.31%
- Capped ALSI +14.38%
- Capped SWIX +8.56%
- At a super sector level there was a very strong rotation that took place during the quarter with the resources sector significantly outperforming the industrials and financials sectors. Performances for the quarter of these indices are as follows:
- FTSE/JSE Resources +21.62%
- FTSE/JSE Industrials +16.09%
- FTSE/JSE Financials +2.50%
- Large caps significantly outperformed over the quarter up 16.25% followed by small caps +8.75% and mid-caps +3.83%
- Active performance in the fund was negatively affected by a relative overweight to the financial sector and the mid cap market segment on a look-through basis.
- The funds sector distribution is shown below:
Please note that due to data availability this is as at 30 October 2021
- The Top 10 holdings of the fund vs benchmark are shown below:
Please note that due to data availability this is as at 30 October 2021
- Detractors to active performance came mainly from Matrix SA Equity and the Satrix Mid Cap Index fund. This was driven by overweight positions to the lagging mid-cap segment and an overweight to financials.
- Fairtree and 36One were the top performers given their bias towards basic materials. However, this was not the only driver of returns with certain stock picks in the industrials super sector also providing positive alpha.
- Coronation and Ninety One provided return’s reasonably in line with the benchmark.
- The complimentary nature of positions across the fund managers in this fund has provided a stable return path for the overall fund. Its diversified portfolio of holdings also reduces the risk of blowouts relative to the benchmark.
- Relative sector positioning remains in line with overall portfolio risk control.
South African Bonds Commentary
The PortfolioMetrix BCI Bond FoF fund outperformed by 0.3% over the past 12 months (8.4% vs 8.7% for the fund) relative to its FTSE JSE All Bond Index benchmark,
- Over the quarter the fund underperformed by 0.1%, as the index returned 2.9% and the fund generated 2.8%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE All Bond Index):
- Coronation Bond: outperformed by 0.65%
- Ninety One Gilt: underperformed by 0.28%
- Ninety One Corporate Bond outperformed by 0.12%
- Stanlib Bond: outperformed by 0.29%
- PMX Core Bond: outperformed by 1.17%
During the course of 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 17%
- Stanlib Bond Fund 17%
- Ninety One Gilt Fund 16%
- Ninety One Corp. Bond Fund 5% (new)
- PMX Core Bond Seg. Mandate 30% (new)
- The last quarter of 2021 was an eventful one where the South African Reserve Bank (SARB) raised the Repo rate by 25 basis points (0.25%). This hike presented as pre-emptive action and was very much expected by the market. The hike also marked the first change in the policy rate since it was aggressively cut 18 months ago.
- The rate hike by the SARB resulted in the South African Government Yield curve rising (selling off) on the shorter end and falling on the longer end. This resulted in a yield curve that was 40 basis points flatter by the end of the quarter.
- The US yield curve demonstrated similar behaviour as short-end yields rose higher, this came as the Federal Reserve (the FED) indicated that they would taper their stimulus program more aggressively than originally thought. This appears to be in response to the higher and more stubborn inflation prints in the US.
- The Dollar Index strengthened in anticipation of the FED raising interest rates early in 2022, emerging market currencies weakened and so too did the South African rand (-5.5%), bidding a cautious risk environment.
- The flattening of the SA yield curve mostly took place on the long end as the SA 10-year yield rose by 21 bps from 9.6% to 9.81% (a real yield of 4.3%), however, the cost to insure against the SA government (SA 5-year CDS) ended the quarter 10 bps stronger at 203 basis points.
- SA bonds remain poised to perform well due to their absolute and relative attractiveness, despite all indications of a rising interest rate environment.
South African Cash and Stable Income Commentary
The PortfolioMetrix BCI Income fund outperformed by 2.0% over the past 12 months (4.9% vs 6.8% for the fund) relative to its STeFi + 1% benchmark,
- Over the quarter the fund outperformed by 0.4%, as the index returned 1.2% and the fund generated 1.6%
Underlying funds over the quarter produced the following relative returns (vs STeFi + 1%):
- Coronation Strategic Income: outperformed by 0.76%
- Ninety One Diversified Income: outperformed by 0.34%
- BCI Income Plus: outperformed by 0.57%
- Nedgroup Investments Flexible Income: outperformed by 1.11%
- Matrix NCIS Stable Income: underperformed by 0.23%
- The South African Reserve Bank raised its benchmark repo rate by 25 bps to 3.75% at its November 2021 meeting, against market expectations of 3.5%. The decision was however not unanimous, with three MPC members in favour of a hike, while two preferred an unchanged stance.
- This is the first rate hike in three years due to increased inflation risks and despite a fragile economic recovery. The Committee believes a gradual rise in the repo rate will be sufficient to keep inflation expectations well anchored and moderate the future path of interest rates.
- The embedded repo rate path generated by the SARB’s Quarterly Projection Model was unchanged in the near term, with hikes of 25bps expected in each quarter through 2022 and 2023.
- SA government bonds had a strong quarter, rising 2.9%, benefitting our managers who are seeking to exploit the steepness of the yield curve and are overweight duration.
- Local property had another exceptional quarter, increasing 8.3%. While the fund does have some exposure to the sector, it is a relatively small position due to the volatile characteristics of the asset class.
- Inflation linked bonds continued to strengthen, returning 5.1% over the three months. However, this was mainly due to a rally in longer dated instruments which are extremely volatile, and where the fund has little to no exposure.
South African Property Commentary
The PortfolioMetrix BCI SA Property fund outperformed by 1.7% over the past 12 months (36.9% vs 38.6% for the fund) relative to its FTSE JSE SA Listed Property benchmark,
- Over the quarter the fund underperformed by 0.4%, as the index returned 8.3% and the fund generated 7.9%
Underlying funds over the quarter produced the following relative returns (vs FTSE JSE SA Listed Property):
- Sesfikile BCI Property: underperformed by 0.11%
- Absa Property Equity: underperformed by 0.99%
- Over the previous year, South African listed property has performed well, up 36.9% in total return terms; well ahead of the official rate of inflation which is currently just north of 5%, also outshining local equities, bonds and cash. The property market is not out of the woods just yet, as the economy has yet to reach 2019 levels. The sector continues to recover from the deeply discounted valuations seen throughout 2020 as rental collections have largely normalized and rental discounts have declined materially.
- SA listed property historical dividend yield, at 7.6%, is nicely up from its August 2021 lows of 4.3% and is almost the same as its historical average since 2011 of 7.4%. In late March 2020, during the height of the Covid pandemic, local listed property offered a dividend yield north of 20%. This was largely because prices had fallen significantly and the future path of dividends at that point was highly uncertain.
- The future of office space appears to be less certain. More remote work means a reduced amount of space will be needed but this may be offset by less dense office space to cater for greater social distancing. The work-from-home trend has been a killer blow for the sector and its impact will still be felt over the next few years and the large (and growing) amount of available space means that tenants are spoilt for choice and clinching eye-popping deals.
- The industrial property market continues to remain ‘best placed’ at this stage due to its low vacancies and recovering rental growth, ending 2021 ahead of house prices, which have slowed to date, to be the top-performing property market.
- Increasing levels of corporate action are also taking place with notable transactions within the sector being the Arrowhead and Fairvest merger together with Redefine’s offer to buy out the remaining stake in Polish EPP it doesn’t already own.
- The ABSA property 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. From current valuations, the ABSA team view outperformance over the medium term being driven by stock selection as they expect relative performance of companies within the sector to deviate meaningfully.
- The Sesfikile team has noted that the composition of property companies currently provides a level of diversification (both geographically and by sector) that wasn’t previously offered a decade ago. They view several healthy growth opportunities in local specialised stocks, with the belief that while beta (absolute sector return) in the short-run may be hard to come by, alpha (outperformance) should be more achievable.
Global Equity Commentary
The PortfolioMetrix BCI Global Equity FoF fund underperformed by 1.7% over the past 12 months (28.8% vs 27.1% for the fund) relative to its MSCI ACWI benchmark,
- Over the quarter the fund underperformed by 3.2%, as the index returned 13.2% and the fund generated 10.0%.
The performance of the underlying funds (versus their respective regional indices) for the quarter is shown below (in USD). Unfortunately, active performance was the biggest attributor to underperformance over the quarter. Most active managers underperformed with the biggest laggard, Brown Advisory Mid Cap Growth fund, contributing most to negative alpha. On an absolute basis, exposure to Japanese equity and emerging markets also contributed meaningfully to underperformance. Unfortunately, it was not a good quarter from an active return’s perspective for the global equity building block.
- Global equities closed off a good year of performance with strong returns in the final quarter despite concerns surrounding the Omicron variant surfacing towards the end of November.
- Developed equities once again significantly outperformed emerging market equities with North America continuing its dominance as the top performing region.
- Japanese equities underperformed developed markets by a significant margin over the quarter after outperforming slightly in the third quarter.
- Emerging markets struggled over the quarter led by a pullback in EM Europe and Latin America.
- The divergence in return between China onshore and offshore markets continued with the offshore market significantly underperforming the onshore market.
- Quality / Growth stocks outperformed value, momentum and small cap stocks. However, the regional return differential between developed and emerging market stocks was by far the biggest driver of relative returns in global equities.
- From a sector perspective real estate, information technology and materials outperformed whereas communication services, financials and energy stocks lagged.
- Active fund implementation drove underperformance over the quarter with most active managers underperforming their respective benchmarks.
- The biggest contributors to the negative excess return were Brown Advisory, both Japanese equity managers (Baillie Gifford and Man GLG) and Matthews Asia Pacific Tiger.
- There were no fund changes over the quarter.
Global Bonds Commentary
The PortfolioMetrix BCI Global Bond fund underperformed by 0.4% over the past 12 months (3.5% vs 3.1% for the fund) relative to its Bloomberg Barclays Global Aggregate benchmark,
- Over the quarter the fund underperformed by 0.1%, as the index returned 5.4% and the fund generated 5.3%
Underlying funds over the quarter produced the following relative returns (vs Bloomberg Barclays Global Aggregate):
- iShares Global Govt Bond: underperformed by 0.40%
- iShares Global Corp Bond: outperformed by 0.09%
- Global Fixed Income sector returns were all negative over the last quarter, this as US inflation printed stubbornly high and unemployment trended lower. Much of this has prompted a review of the Federal Reserve’s quantitative easing program and brought forward expected rate hikes. Returns by sector (in USD):
- Global Treasuries -0.99%
- Global Corporates -0.46%
- Global High Yield -0.71%
- EM Glob. Div. -2.53%
- During the course of 2021 yields rose across fixed income markets; the US saw a rise of 63bps, Global ex-US went up 39 bps, and local EM debt yields climbed 50bps.
- Despite the “sudden” rise in rates in many cases inflation climbed higher and as such forced real interest rates further into negative territory. This is stimulatory and traditionally pushes more capital into risk assets in order to seek a real return.
- The negative returns across fixed income are reflective of the rising yield environment and is a manifestation of growing duration exposure, as governments and corporates alike have been able to secure funding at low rates and very long maturities.
- This low-reward for high-risk emphasizes that the central bank provided liquidity has inflated both equity and fixed income valuations, making them more expensive. It is however the pending withdrawal of liquidity that may make fixed income ever so slightly more attractive, on a relative basis. The figure below demonstrates the current percentage yield earned for each year of duration (measure of interest rate risk).
Source: JPM Morgan Guide to the Markets 2021Q4
Global Property Commentary
The PortfolioMetrix BCI Global Property fund outperformed by 0.2% over the past 12 months (41.3% vs 41.4% for the fund) relative to its FTSE EPRA Nareit Developed Rental benchmark,
- Over the quarter the fund underperformed by 1.5%, as the index returned 18.7% and the fund generated 17.2%
Underlying funds over the quarter produced the following relative returns (vs FTSE EPRA Nareit Developed Rental):
- Catalyst Global Real Estate: underperformed by 2.07%
- Sesfikile BCI Global Property: underperformed by 1.74%
- 2021 has been a year of recovery and a degree of normalisation, both for global economies and equity markets. This also holds true for global real estate stocks, where global listed property was the top performing asset class of 2021, delivering 41.3% for the year in ZAR terms or 30% in USD, as measured by the FTSE EPRA NAREIT Developed Rental Index.
- From an Asset Class perspective, 2021 proved to be a rebound year for the real estate sector. Overall, listed real estate companies achieved significant share price appreciation, driven by stronger economic recovery than initially anticipated, allowing most companies to deliver financial results that met or exceeded market expectations.
- The best performing listed real estate market in USD for the year was the US (42.83%), whilst Hong Kong was the worst with the lowest total USD return of -0.88%. Globally, the top performing sectors in USD were Storage (77.62%), Single Family Housing (53.49%) and Industrial (46.38%), while the lowest performing sectors were Developers (-1.93%), Offices (9.94%) and Hotels (10.64%).
- The switch to remote collaboration models has challenged office valuations, and the transition to a hybrid experience leaves many questions unanswered. The shift towards e-Commerce and new omni-channel shopping habits (like online purchases and in-store pickups) has been a headwind for retail but a tailwind for industrial; resulting in convergence happening between these two sectors.
- 2021 has been a truly transitionary year, with economies re-opening and a semblance of normalcy in sight. Society has been resilient adapting to more isolated living with a greater reliance on technology to enable new ways of working and collaborating. This has had material impacts on the economy and the various real-estate subsectors comprising it.
- Catalyst believes that, all considered, the broader real estate sector is well positioned to align with the new normal that lies ahead, and that listed real estate remains an ideal vehicle to take part in this evolution.
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- 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
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