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Can the JSE sustain momentum ahead of elections?

Headwinds to equity market performance in SA ‘largely dependent’ on election period, says Fatima Vawda, MD of 27four Investment Managers.

RYK VAN NIEKERK: Welcome to this Market Commentator podcast – my weekly podcast where I speak to leading investment professionals. My guest today is Fatima Vawda: she’s the managing director of 27four Investment Managers. Fatima, welcome to the show.

We are currently seeing a lot of volatility in the market. This is not new and is probably the new normal, but we are also seeing some potentially explosive political developments – not only in South Africa but also in the rest of the world, especially the US and the UK. How do you think this will impact equity markets?

FATIMA VAWDA: Ryk, thank you very much for having me on your show. There’s a lot that’s going on geopolitically. Domestically we’re sitting in the middle of an election year; we are two months away from voting. So that’s going to be a serious determining factor on the performance of both our debt and equity markets this year. Having said that, last year was a disaster for global financial markets across the board, domestically and internationally. So we’re seeing a lot of good earnings coming through – we’re quite excited about the domestic equity market.

But you are 100% right – the headwinds to the performance of both our equity and other capital markets in South Africa is largely dependent on whether we go through a smooth election period.

Internationally, we’ve had the tariff wars impacting the relationship between China and the United States; we’ve got Brexit, where Theresa May is taking it right to the critical end and we’re going to wait and see whether the UK is going to go for the next referendum or what is going to happen. So there are a lot of things going on that we’ve got to be cognisant about that are driving a lot of the macro sentiment across the board.

RYK VAN NIEKERK: Are you trying to be a bit more conservative, maybe move money from equities into other asset classes?

FATIMA VAWDA: No, we’re actually very excited about the South African equity market. If you look at 2018, we had only 31 shares listed on the All Share Index that ended the year without having lost investors’ money. The selloff was so wide and broad that there were really good-quality companies on the board that were really hurt. Yes, we’ve seen earnings come through this year and some of them have been good, and some of them have been bad, but largely the bad earnings results came out of the retailers, which is naturally expected, given that they are aligned to the economic fundamentals of South Africa. But basically on a PE [price-to-earnings] basis we are trading well below our five-year and 10-year average.

From an asset allocation perspective we think that there’s opportunity on the JSE, so towards the end of last year we actually went on a slightly overweight position relative to our long-term strategic asset allocation to domestic equities because we’ve seen opportunities. Earnings have not surprised. There are still a lot of attractive opportunities from earnings and we saw that come through this month. We saw AECI delivering good earnings; we saw that Richemont didn’t come out with that bad earnings. Italtile, for example, came out with very strong earnings. So where we did see not [such] great numbers come out – and that was totally expected – was largely from the likes of Shoprite, Mr Price and the retail counters.

The JSE has shown stellar performance over the last two months, so we’re quite excited about domestic equities. We do hold a slightly overweight position in domestic equities.

Can the JSE sustain its momentum?

RYK VAN NIEKERK: The key question is where do you see value currently? Can the JSE or the All Share Index sustain the momentum it has built up since the beginning of the year?

FATIMA VAWDA: Yes, you’re seeing dividend yields on the All Share Index currently sit at around 3.5%. We’re seeing earnings growth expectation for the market in composite coming in between 7.5% and 8% over the next 12 months – this provides a really strong base return of between potentially 11.5%to 12%. Given equity multiples on a forward basis are around 13 times earnings, which is well below the long-run average multiple of the JSE, there is no derating in multiples that is expected to impair this return – whereas in 2018 we did see a significant rerating. So a conservative approach is adopted and, I think, – assuming no multiple rerating – supporting a higher return this year, that’s where we are basically seeing the opportunity; based entirely on forward dividend yield earnings growth expectations and forward PE multiples.

So outside of the retail sector there’s a lot of opportunity outside of that and generally as an asset allocator, as a multi-manager, we really focus our attention on styles – and where we’re seeing opportunity between value, quality, low volatility, momentum and – for the first time in a very long time – we’re seeing style mergers. [This is] because stocks have been sold off and there are opportunities, as long as some of the sentiment-driven macro geopolitical factors stay in tune and we don’t get those headwinds destroying sentiment, particularly because we are also a very liquid emerging market and emerging markets were sold off aggressively last year.

So there is that relative opportunity gap that exists between developed markets and emerging markets, and South Africa is well positioned to be able to absorb some of those international flows. We’ve seen that come through quite strongly in January and February. A lot of the resources have bounced and they’ve gone through a nice bounce for a while now because of the momentum play that supports that particular sector. But overall we think that there’s opportunity on the JSE and for that reason we are slightly overweight.

We still maintain our weighting internationally on equities and, given that we are an emerging market, we wouldn’t want to place our offshore risk budget towards other emerging markets. So from an offshore perspective we’re still going to see mid to high single-digit earnings growth come out largely from the US on a composite basis. We’ve got a current dividend yield on the MSCI World Index of around 2%. So in dollar terms, in the absence of any material change to ratings, PE multiples have moderated from elevated levels through the back end of 2018, but we’re still holding our maximum position offshore and we’ve got the currency play against that.

Is there going to be a massive appreciation of the rand? I don’t think so – and so, from a currency perspective and a valuation perspective, we’re going to maintain our offshore weighting.

RYK VAN NIEKERK: 27four is, of course, a multi-manager, so you invest in other collective investment schemes. I’m looking at your 27four Balanced Prescient Fund of Funds – it’s a pretty significant fund, nearly R800 million under management. And looking at the funds in which you have invested, it’s quite diverse – Bateleur Equity Prescient Fund, BCI, ClucasGray, Coronation, Denker, Sesfikile. How do you actually pick these fund managers, and how then do you pick the specific fund you invest in?

FATIMA VAWDA: We follow largely a multi-manager investment process and the first part of the process is really to get our asset allocation right. That asset allocation is based on a quantitative modelling process with qualitative input. Quantitative analysis can only get you to a certain level, but from that you’ve got to make logical sense on how you weight the different asset classes.

So the first step of the process is really building a lot of confidence through our various internal processes, to get to an asset allocation to the different asset classes that we believe will have a strong expectation and a strong probability of meeting the expectation of investment return. That portfolio in particular sits in the multi-asset medium equity category; based on that – it’s a categorisation of unit trust portfolios – it can only have a maximum allocation of 60% to equities domestically and internationally, so it is what one would refer to in the risk spectrum as a medium-risk portfolio. It’s also Regulation 28 compliant. So the asset allocation is built on the expectation of delivering the investment return based on that multi-asset medium category.

The next part of the process is really to now decide on the asset managers within each of the different asset classes who you believe are best suited to deliver the expectation of investment return within the building block. So if you look at the equity building block on its own, we need to make sure that from a style perspective we are style-neutral and that if we take any steps to go back to any particular style we have a strong conviction that that style is going to do well. If you look at the blend of managers in that portfolio they tend to complement each other; we don’t want to have four managers who are doing exactly the same thing and, therefore, land up with concentration risk in any particular sector or security or, for that matter, any specific style. So we try and understand the managers, their performance signatures, what is their competitive edge and how do they perform in the different cycles of the market, and then create blends within the different asset class building blocks that can deliver returns within those building blocks.

So on the equity side we are style-neutral. We’ve got a combination of value, momentum and quality plays. In the other asset classes it doesn’t matter that much because the level of style blending doesn’t impact that much, so in the listed property space we’ve got a manager who we believe has consistently performed quite well: that’s Sesfikile. In the bond space we have managers, in the cash space we have managers and then on the global side we have a blend of six offshore managers that sit within that portfolio. Those portfolios are all about consistency and repeatability of performance, and that’s what we treasure. It’s one of our flagship portfolios and it has consistently performed quite well over the last decade.

Reviewing investment allocation

RYK VAN NIEKERK: How often do you change or reweight the allocation of investment in these funds?

FATIMA VAWDA: We have a two-to-one personal investment team that’s largely driven by our chief investment officer, Claire Rentzke, and they have quarterly investment committee meetings where we revisit the risk budgeting and the allocations to the different asset classes, and the allocation to the different asset managers. So typically small rebalancing takes place on a quarterly basis; it’s also largely dependent on cash flows.

But we are long-term performers, so we strongly believe that treating your portfolio like an ATM impacts performance because of client spend out of the market, as well as the cost associated with regular trading.

So we are not managers that trade in and out of portfolios regularly. We’ll do small rebalances but we’ve got to make sure that when we create our portfolio and construct our portfolio we’ve got strong conviction of what we’re including in the portfolio, because we’re not going to add a manager and then fire them after three months or a year.

We stay with managers for the long road and we’ll terminate managers only if we have lost confidence in the house or if their style or performance signature no longer makes sense in the current environment.

So some rebalancing perspective on a quarterly basis, and then terminations and additions generally happen once or twice every three years.

RYK VAN NIEKERK: Just lastly, 27four: it’s an interesting name, where does it come from?

FATIMA VAWDA: 27four comes from April 27 1994, it was the date of South Africa’s first democratic election. It’s a day that represents massive change for South Africans, for the ordinary person in South Africa. We are really a business that is aligned to transforming the South African financial services sector; we believe in financial inclusivity [and] that every South African has a fair chance of living a life of dignity. So financial inclusivity is very important and we believe in diversity of thought and we believe that the strength of diversity of thought is what grows successful enterprises. Based on that DNA we chose the name 27four. We have just celebrated our 11th anniversary of being in business and we continue to contribute to society and contribute to the people of South Africa in terms of job creation and growing financial wealth.

RYK VAN NIEKERK: We’ll have to leave it there. Thank you Fatima and thanks for sharing your thoughts.

FATIMA VAWDA: It’s a wonderful pleasure, thank you for having me.

RYK VAN NIEKERK: That was Fatima Vawda – she’s the managing director of 27four Investment Managers.

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