Neill joined Coronation in 1998 after completing his articles at Deloitte and working in Luxembourg and New York. He currently co-manages institutional portfolios within Coronation's core equity and balanced portfolio ranges as well as the Coronation Financial and Balanced Defensive funds.
Before joining Coronation in 2003, Godwill completed his articles with Ernst & Young and worked for two years as an audit manager with Moores Rowland CA. He is an investment analyst and co-manager of the Coronation Preference Share and Financial funds. He also co-manages a segregated financial and industrial mandate.
Coronation Financial comment - Sep 17
The financial sector returned 5.1% for the quarter, lagging the JSE All Share Index return of 8.9%. Over the same period the fund returned 4.4%. Over longer periods, the fund performance remains respectable relative to both its benchmark and competitors, delivering per annum compound returns of 13.5% over five years (slightly behind the index), 11.8% over 10 years (roughly 1% ahead of the index) and 13.1% since inception.
Once again banks outperformed life insurers over the quarter. Over a 12- month period, the outperformance is now substantial with banks returning 13% compared to a return of 5.3% from the life insurers. The fund has been well positioned for this, consistently holding a heavier weighting in banks relative to the benchmark than insurers. Contributors to fund performance for the quarter were overweight positions in FirstRand, Standard Bank and Discovery and underweight positions in Barclays Africa Group (BGA) and property stock Hyprop. Detractors from performance included the fund’s holdings in Capital & Counties, MMI, Nedbank, Ethos Private Equity and Brait.
During the quarter, we increased the fund’s position in Nedbank, RMI and HCI and reduced its holding in BGA (sold to zero), Investec and Discovery (both of which remain significant investments in the fund). In addition, we switched some of the FirstRand exposure into its holding company RMH on a widening discount, and switched half of the fund’s shareholding in Capital & Counties into its peers Hammerson and Intu. These three UK property stocks have detracted from fund performance over the past 12 months, but together remain a substantial holding in the fund, at 8% - 9%. Why do we continue to hold them?
· Principally: valuation. A number of factors have impacted the ratings of all three stocks, but uncertainty around the eventual implications of Brexit and the potential for structural changes to the UK retail environment are probably the biggest. It is difficult to know with certainty how these will play out, but there appears to be a very healthy margin of safety in valuation. Intu, Hammerson and CapCo trade at substantial discounts to NAV (43%, 31% and 23% respectively) and the former two produce forward dividend yields of 6.4% and 5.0%. While the disclosed NAV rests on a number of assumptions regarding future events and may fluctuate somewhat over time, the attractive dividend yields afford one the opportunity to wait for the impact of a more stable environment to manifest.
· Within the sector, there are limited opportunities to diversify away from a very challenging domestic macro environment. Certain businesses, such as Old Mutual, Investec, Discovery and Brait provide some diversification in their mix, but it is only Reinet and the UK property stocks that allows one to detach fully from the drivers of the South African economy.
The third quarter is a busy time with most financial companies reporting results (predominantly interim results). The impact of the challenging domestic operating environment is unsurprisingly evident in these numbers. The banks reported low levels of asset growth, but the impact on earnings was partly offset by benign credit impairments, good cost control and strong results from the corporate and investment banking divisions, as well as the ‘rest of Africa’ businesses in the case of BGA and Standard Bank. The domestic life insurers experienced a challenging new business environment and received little help from equity and bond markets, reporting earnings that were broadly flat or down on prior comparable periods.
One of the exceptions to the subdued results tone is Discovery, a business in which the fund has consistently held a significant position (currently 6.3%). Reported earnings grew by only 8% in the period, but this masks a number of encouraging developments. Discovery has been extremely successful in disrupting traditional financial services industries by incentivising consumer behaviour to drive improvements in client wellbeing, as well as customer retention and profitability (what Discovery refers to as its Shared-Value model). Its established businesses in South Africa are strong operations with stable growth prospects, and its short-term insurance business has recently turned profitable.. In the UK, the company is starting to gain good traction in its Vitality Health insurance business, although the Vitality Life insurance business remains challenged by the low interest rate environment. Outside of these two markets, Discovery partners with large established insurers to leverage its intellectual property, either on a profit-share basis in most significant insurance markets, or in the case of China in a JV with Ping An Life, the country’s largest private insurer. These businesses are relatively immature, yet traction is growing strongly and losses are reducing. The opportunity in these markets is significant. By way of example: in the 12 months to June, the Ping An health insurance business increased membership five-fold to 3.7m lives (more than the total lives that the dominant SA health business has gathered in its 25 years of existence) with stable or improved operating metrics, and the Vitality Active Rewards programme was sold to 2.4m Ping An life clients. In addition to these emerging businesses, Discovery continues to invest in new initiatives - it will launch a bank and an umbrella funds business in South Africa as well as an investment business in the UK in 2018.
Discovery is a complex business to analyse - the nature of a growing longterm insurance business is such that it takes some time before earnings are backed by cash flow, and the company makes use of innovative funding structures. At face value, the share often looks expensive on both price to earnings and price to embedded value metrics. However, this ignores the fact that losses from the emerging businesses and investments into the new initiatives are fully expensed, and embedded values are only carried for the established SA and UK businesses. It is difficult to know which of its initiatives will be successful and which will not, but the opportunity for value creation over time by a highly energised and innovative management team that is strongly aligned to shareholders is significant. We remain happy shareholders of this business in the fund.
Portfolio managers Neill Young and Godwill Chahwahwa as at 30 September 2017
Invests in a broad range of financial shares, including banks, insurance and investment companies.