Allan Gray Stable comment - Mar 19
The Fund had a strong start to the year following a difficult 2018. Global stock markets rallied during the quarter, with the benchmark S&P 500 Index in the US recording the strongest single quarterly return since 2009. The local FTSE/JSE All Share Index followed suit, with an 8% total return. The Fund benefited from these higher moves, as well as a weaker rand exchange rate that boosted the value of its offshore holdings.
The Fund has an enviable track record of delivering above-inflation returns with a strong secondary objective of capital preservation. This has been achieved by dynamic asset allocation and stock selection decisions over time. At present, the Fund holds an above-average equity exposure relative to history. Furthermore, the relaxation in recent years of South African exchange control regulations allows exposure to offshore assets that is higher than history. We are deeply conscious of the fact that, combined, these two factors may result in higher short-term return volatility than in the past. Nonetheless, we believe this is the right positioning for long-term investors and remains consistent with our capital preservation objective.
Consider each decision in turn:
1) South African shares have performed no better than cash over the past five years. This is well below the average 6% outperformance per year historically. Likewise, emerging markets (including South Africa) have underperformed against developed markets and are out of favour with global money managers. It should, therefore, be no surprise that we are currently finding more shares through our bottom-up investment process that we believe will beat cash over the long term.
2) Foreign exposure adds the benefit of further diversification to the portfolio as it expands the universe of assets we can select to include in the Fund. It also protects investors against potential rand weakness, a considerable risk in our opinion given the economic, political and social conditions experienced in South Africa at present.
Reported local inflation remains relatively benign and a prudent Reserve Bank has kept a policy of maintaining positive real interest rates in place. In this context, longer duration bonds look attractive. Although the Fund has increased its duration slightly, adding too much interest rate risk in addition to existing market and currency exposure is not desirable.
Given the Fund’s current positioning, a negative scenario will involve a sharp correction in global and/or local equities and a simultaneous strengthening of the rand against foreign currencies. Though not impossible, history suggests that during such risk-off scenarios, the opposite tends to occur, that is, rand weakness accompanies equity weakness.
As managers of the Stable Fund, we think about the risks to the Fund as much as we do about prospective returns. In the current environment, holding more real assets than fixed-rate rand bonds and cash is preferable. Measuring risk in terms of short-term return volatility, it may appear higher than in the past. However, measuring risk in terms of protecting your investment against long-term loss of purchasing power, it is quite the opposite in our view. The Fund was a net seller of local equities during the quarter, partially selling holdings in Naspers, Remgro and the banks.
Commentary contributed by Leonard Krüger.
The Fund invests in a mix of shares, bonds, property, commodities and cash. The Fund may buy foreign assets up to a maximum of 25% of the Fund (with an additional 5% for African ex-SA investments). The Fund typically invests the bulk of its foreign allowance in a mix of funds managed by Orbis Investment Management Limited, our offshore investment partner. The maximum net equity exposure of the Fund is 40%. The Fund's net equity exposure may be reduced from time to time using exchange-traded derivative contracts on stock market indices. The Fund is managed to comply with the investment limits governing retirement funds. Returns are likely to be less volatile than those of an equity-only fund or a balanced fund.