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Emerging markets fall out of favour

Local market hit two-fold by domestic policy uncertainty and geopolitical pressures.

RYK VAN NIEKERK: Welcome to this Market Commentator podcast, in this weekly podcast I speak with leading investment professionals. My guest today is Nkareng Mpobane, she is the chief investment officer at Ashburton Investments. Nkareng, welcome to the show. We’re seeing a lot of volatility in the market, which is not different to what we’ve seen over the last few years but most of the volatility on the JSE comes from foreign developments, especially the potential trade war between the US and China. That seems to have died down a bit – but overall, what is your view on the local and international market?

NKARENG MPOBANE: I think emerging markets are under pressure generally and to a large extent driven by what’s happening with, as you mentioned, the trade wars. I think the risks there … investors and market participants shouldn’t take what’s developing there too lightly. So it seems that the sentiment is that this potentially continues as you see Trump flexing his muscles towards the mid-term elections, which is towards the end of this year, and it’s seen a lot of market participants placing greater weight on the likelihood of that outcome, rather than tempers calming down and both China and the US pulling back. The sentiment is that this potentially grows into the Eurozone. It’s all very challenging and there’s obviously the Brexit conclusion, which we are all watching for. So you’re unlikely to see an uplift in markets as long as this political uncertainty doesn’t find its feet and it’s going to be largely driven by developed markets.

RYK VAN NIEKERK: On the local market we are seeing an interesting trend developing, where the JSE All Share Index is down around 3.5% for the first six months of the year and over the same period the rand/dollar exchange rate weakened by 11%. One would expect that the JSE would’ve traded higher because of our rand hedges.

NKARENG MPOBANE: As you rightly say, a name like Naspers is a chunky weighting on the All Share and it’s really considered a rand hedge. You’ve got British American Tobacco, Richemont and all those kinds of names expecting that they will realise a boost. But I really think that there is a lot of negative sentiment that I talked about around emerging markets and we see the JSE as trading in fair value to somewhat expensive territory at the moment and market participants probably realising that on our index as well. So not the flavour at the moment.

Naspers worse off

RYK VAN NIEKERK: But if you look at Naspers, which is the dominant share on the JSE, the first six months of the year saw the share rise by about 35%, which does indicate that it’s actually a lot worse off if you take that share out of the index.

NKARENG MPOBANE: Yes, then the index is really down quite a bit. As you rightly mentioned, while portfolios would have realised a boost from a name like Naspers I think most funds are underweight the share because it’s so challenging to try and attain that kind of weighting in a portfolio, so most managers are probably doing worse because of the underweight allocation to a name like Naspers.

RYK VAN NIEKERK: When should this trend normalise, surely it is an outlier?

NKARENG MPOBANE: You mean the … ?

RYK VAN NIEKERK: The fact that the rand hedges are not reacting to a weakening currency.

NKARENG MPOBANE: I do think, or what I mentioned earlier about stabilisation across the developed markets, I think then emerging markets come back into favour and we would be expected to deliver growth here – economic output relative to developed markets – so I think if you see stability in developed markets then you could potentially see investors starting to pick up some of our markets again.

RYK VAN NIEKERK: Looking at the first half of the year, performance of other markets, Southeast Asia was hit a lot harder than South Africa, the Shanghai Index down 17% – it is in bear market territory, the Hang Seng down 5% and the Nikkei also got hit just around 3%. So the performance of the JSE is not out of kilter with other international emerging markets.

NKARENG MPOBANE: Are those in local currency?

RYK VAN NIEKERK: Rand, yes.

NKARENG MPOBANE: I think while a lot of the shine has come off South Africa and the political uncertainty that we went through last year and a few years ago, so a lot of that halo effect has come off but we’re still seen as being on positive footing relative to where we were. Obviously there is the whole uncertainty around land reform, and until [President] Cyril Ramaphosa is better able to demonstrate what he has planned for on policy, then there is likely to be this overhang on our market, so you’re probably not going to see it rise as meaningfully as it could into the 2019 election and at that time we think that he’d be better able to stamp his authority and drive policy a lot more definitively and clearly.

Political climate impact on markets 

RYK VAN NIEKERK: We’ve seen political developments locally have a less and less severe impact on local markets and when there’s a bombshell like we have – three finance ministers over a weekend – there is a reaction, but in terms of the international norm and the correlation with international markets, how significant or severe do you think is the local political scene and the uncertainty we are currently seeing, which is not new, on markets?

NKARENG MPOBANE: I think that metric also fluctuates, as you made the point, that with a change in finance minister obviously we saw massive reactions on our market, but once everything is seemingly stable then our bigger driver on the market is more your developed markets and what’s happening externally. So I think at the moment we are in a period where our market is really determined by what’s happening outside our borders but as you get closer to an event like an election I think that sensitivity increases the sensitivity of the influence of political outcomes on our market. So I think you are likely to see that influence into 2019, rather than currently where we are.

RYK VAN NIEKERK: Let’s talk about some of the Ashburton funds, I’m looking at the balanced fund and you have exposure to Naspers, it is the third-largest holding within the fund, around 6% of the fund is Naspers. That had a nice jump, as we said earlier, in the first half of the year, but it’s underweight. Obviously to have the full weighting of the share on the JSE in the portfolio would increase risk, how do you determine at what level to actually keep your interest in this share?

NKARENG MPOBANE: Obviously as the share outperforms it drifts higher and it becomes a slightly more elevated weighting in your portfolio, so we try to keep it at around the 10% level, the CAPI Index that caps the weighting of Naspers on that particular index, so we do refer to it and pull it back as it drifts higher. So at 14% it’s starting to get quite significant in absolute terms and we would probably trim it back at those levels.

RYK VAN NIEKERK: Your equity fund also has a lot of exposure to commodities, as well as financial shares, Standard Bank is in there, Sanlam, FirstRand, and those sectors seem to be under pressure. Do you think it still offers opportunity in the short to medium term?

NKARENG MPOBANE: I think, firstly, on resources we are underweight relative to the index but that underweight is really demonstrated in no exposure to single commodity companies like the platinum and gold sectors, so we do have an overweight position to your basic materials. So names like Anglo and Billiton we hold. Mondi, although we are kind of regarded as an industrial company, is classified under resources, so that’s exposure that we also have. Then within financials we think that they still look relatively attractive from a valuation perspective. Do we think that earnings and profitability are going to come in very strongly this year? Unlikely, simply because of the period that we’ve come through and we’ve obviously seen pressure in first quarter GDP. I think management teams across the banks are still a little bit nervous to open the taps a little bit and we’re only likely to see more meaningful earnings growth into next year.

RYK VAN NIEKERK: But PEs are really attractive, even with single-digit Heps growth.

NKARENG MPOBANE: Absolutely, and then those dividends are also presenting very well, so I think a lot of investors are also holding the banks for that particular reason.

Glencore, Anglo and Billiton

RYK VAN NIEKERK: Do you have any Glencore in your portfolio? Because it got really smacked this week …

NKARENG MPOBANE: Thankfully no. We held it probably two years ago but on a quality basis when we looked at its balance sheet and some of the assets that it had on its portfolio relative to its peer group, like Anglo and Billiton, we sold it out of our portfolios and preferred those two names relative to Glencore and thankfully so. So even from a quality perspective, having all the noise in the market, their current troubles, it’s not the first time they are going through this, so it’s not a name that we really favoured in the past.

RYK VAN NIEKERK: But although the market is moving sideways relatively it still remains a stock pickers’ market and I just want to bring in the debate between passive and active. As you’ve said, the active managers are mostly underweight in Naspers and that is a big tick-mark for passive funds that are not always underweight and it just puts more pressure on fund managers to pick the right shares, and it’s not that easy in the current market. How do you go about looking for those shares that may outperform the index?

NKARENG MPOBANE: So our philosophy I suppose is really a top-down macro approach, so we talk about investing through the business cycle. So we really start at the top where we look at what are the economic drivers in a particular economy, South Africa for instance, what’s our view on the interest rate cycle, what do we think about supply-and-demand dynamics globally, and that is basically what drives the resource sector or interest rates would drive more the financials and so on. So we begin there and from a bottom-up perspective, then we look at stocks that offer good value that will play into whatever our view is of economic outcomes. So it’s really about picking the sector, given your economic views, and then you pick the best counter from a balance sheet perspective, from market dominance … so we talk about sizeable companies that are unlikely to get easily displaced and we try to focus on those and expect that at decent valuations you could realise some upside.

RYK VAN NIEKERK: Just lastly, we are seeing some outflows from foreign investors, are you concerned about those?

NKARENG MPOBANE: We know that those kinds of flows have generally been quite fickle, so as much as you would see outflows and chunks of it, you are also likely, in time, to realise decent inflows. Again, as soon as you start realising stability and certainty around what’s happening from a developed market perspective, then you are likely to see the inflows coming back in again.

RYK VAN NIEKERK: Thank you so much for joining us in studio and hopefully the market can make a bit of a U-turn in the second half of the year.

NKARENG MPOBANE: Good luck to all of us, thank you.

RYK VAN NIEKERK: That was Nkareng Mpobane, she is the chief investment officer at Ashburton Investments.

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