2019/05/23 00:00:00

After the sharp losses suffered at the end of 2018, investors were able to take heart in the first quarter (Q1) of 2019 with markets rebounding as a few negative factors appeared to reverse themselves. Although evidence of slowing global growth continued to mount, global equities and bonds rallied strongly after the US Federal Reserve announced a substantial change of view and decided to pause (and perhaps even end) its interest rate hiking cycle. At the same time, other developed market central banks undertook more growth-supportive moves, and considerable progress was reportedly made in resolving the US-China trade dispute. On the negative side, an even more chaotic Brexit environment and the uncertainty engendered by Trump's unpredictability remained bearish factors for markets. Emerging markets also benefitted from the more bullish sentiment and the Fed's rate pause, but some like Turkey and Venezuela faced idiosyncratic challenges. However, for South African investors, local equities and bonds posted respectable gains in rand terms thanks to several positive developments. In US$ terms, global equity (the MSCI All Country World Index) returned 12.2% for the quarter, with developed markets posting 12.5% and emerging markets producing 9.9%. Global bonds delivered 2.2% and global property 14.3%, buoyed by the Fed's unexpectedly more dovish interest rate outlook.
In the US, it was the Fed's more dovish rate stance that proved to be the key for turning last year's losses into this quarter's gains. The Bank emphasized that it would be 'patient' when it came to further raising interest rates, given that the case for hiking had weakened in the face of slowing global and US growth. This eased fears that inexorably higher rates could choke off growth. This was very positive for equities, and also helped push longer-dated US Treasury bond yields lower, such that the yield curve 'inverted' for the first time since 2007 (where 3-month interest rates were higher than those for 10-year bonds). For the quarter, the US S&P 500 returned 13.6%, the Nasdaq 16.9% and the Dow Jones Industrial 11.8%. Other developed and emerging markets also benefited. The UK's FTSE 100 returned 11.6% for the quarter, while the Dow Jones Eurostoxx 50 produced 10.2% and the Nikkei 225 returned 6.5% (all in US$). Renewed policy support from the Chinese government plus progress in the US-China trade negotiations helped the MSCI China post a return of 17.7%, making it the best performing large emerging market in Q1. Among other emerging markets, strong performers for the quarter included the MSCI Russia with 12.2% and Brazil's Bovespa at 8.0%. The weakest markets were the MSCI Turkey (-3.0%), South Korea's KOSPI 200 (3.4%) and the MSCI South Africa (4.6%), all in US$.
SA benefits from global and some local positives
South African assets were boosted over the quarter primarily by the easier global monetary outlook, recording gains across all asset classes. This mixed with some still-gloomy sentiment locally. The economy emerged with growth of 0.8% in 2018, slightly above expectations. Still, this was a very weak absolute growth level, and the SARB is now projecting only 1.3% GDP growth for 2019 (down from 1.7% previously), not including the negative impact of any ongoing electricity cuts. In some growth-positive news, retail sales growth recovered somewhat to 1.2% y/y in January from the shocking -1.6% y/y in December . While SA's more global-influenced stocks generally posted strong gains, the subdued local economy weighed on 'SA Inc.' stocks like Financials, Retailers and Listed Property. The FTSE/JSE ALSI returned 8.0% for the quarter, led by Resources stocks with 16.2% and Industrials with 7.4%. Listed Property lagged with a 1.5% return, and Financial counters were in the red with -0.4%. The performance of the FTSE/JSE Capped SWIX All Share Index, which we use as the equity benchmark for the majority of our client mandates, was much less robust, returning 3.9% on the back of its more limited exposure to the larger global stocks like BAT, Naspers and Anglo American, all good performers for the quarter.
Apart from the Fed's rate pause, SA bonds rallied on several local factors, as the BEASSA All Bond Index delivered 3.8% for Q1. These supportive factors included good investor demand, subdued inflation (February CPI at 4.1% y/y, below the SARB's 4.5% midpoint target) and the SARB's decision to keep interest rates on hold at both its January and March MPC meetings. The SARB's latest interest rate projection model showed only one 25bp rate hike this year. Also importantly, Finance Minister Tito Mboweni's February Budget was greeted favourably by most analysts, reinforcing the government's commitment to reining in the budget deficit and cutting spending, while also reforming and reducing wastage at the parastatals.
The bond rally also occurred against the backdrop of the expected 29 March Moody's sovereign credit rating report. While many were pessimistic, Moody's final decision not to review the rating and leave it at investment grade with a stable outlook granted the country a big reprieve on the final trading day of the quarter. Further bond gains were, however, only reflected after quarter-end. SA inflation-linked bonds, meanwhile, again performed rather poorly in the low-inflation environment, returning 0.5% over the three months, while cash (as measured by the STeFI Composite) delivered 1.8%.
However, the SARB remains concerned about future inflationary pressures arising from the weaker rand, as well as higher costs from fuel and electricity, among other sources. Other worries remained Eskom's generation capacity and the negative impact of load-shedding on growth in 2019, the land expropriation debate, nationalisation of the SARB, and last but not least, the upcoming May elections. Despite US dollar strength, the rand lost only 0.5% versus the greenback, but 2.1% against the UK pound sterling, while gaining 1.3% against the euro, which was hit by growth concerns and more dovish interest rate expectations.
PERFORMANCE
The fund returned 6.6% (after fees) for the first quarter of 2019, outperforming its benchmark's 5.8% return, and delivered 6.1% for the 12-month period ending 31 March 2019 versus its benchmark's 5.8% return. Since its inception, the fund has posted a return of 13.5% per annum (after fees), compared to its benchmark's return of 11.5% per annum over the same period. To 31 March 2019 it retains its top-quartile or better performance over all annual periods from 2-10 years, according to Morningstar.
The largest contributor to the fund's absolute performance for the quarter was by far its holdings in SA equities, while international equity exposure also contributed significantly. The fund's SA bond holdings also added value, although to a lesser extent. The only detractor from value was its listed property holdings. Within SA equity, the fund's overweights in resources stocks and industrials with global earnings generally added significant value, including Naspers, BAT, Anglo American, Exxaro, and Glencore. Another notable contribution came from its underweight in Aspen. Detracting from value was the fund's overweight in SA financial shares like Absa, Nedbank and Standard Bank, as well as in Sappi.
STRATEGY AND POSITIONING
Starting with our view on offshore asset portfolios, we remain underweight global bonds and global cash, and overweight global equities, with the latter offering attractive valuations in many markets (particularly when viewed relative to bonds), and much higher potential returns over the medium term. The global equity risk premium on offer remains substantially above historic norms, reflecting the extraordinary low government bond yields, which fell further during the quarter as a result of global interest rate expectations being revised downward. The fund's total offshore exposure remains at around 25%.
In global fixed income, despite the rally over the quarter, US government bonds are still trading at slightly expensive levels, but are less expensive than other developed markets like the UK, EU and Japan, where government bond yields remain at exceptionally low levels. Consequently, the asset class as a whole remains unattractive versus equities. We are underweight global sovereign bonds and underweight duration, preferring to hold investment-grade US and European corporate bonds. These assets are slightly cheap and have the potential for stronger returns going forward now that the US interest rate hiking cycle is on hold.
For global equities, some developed markets have become more expensive after the quarter's gains, but we have maintained our overweight position as a whole given the very high risk premium from equities versus bonds. Emerging markets and currencies continue to be especially well valued on many measures, while the US market is relatively expensive and other markets offer better value.
We continue to prefer the global banking sector, which has underperformed the broader market, as well as certain developed markets where equities are undervalued but fundamentals for earnings growth remain positive, including Germany and Japan, and selected emerging markets such as South Korea, Indonesia and China. These overweight positions are financed primarily by an underweight in global bonds, as well as US equities to a lesser extent.
South African equities gained ground over the three months, but this masked some volatility intra-quarter. In mid-February the JSE fell to very attractive levels relative to SA bonds, and we opted to buy more SA equity exposure in the Prudential Balanced Fund, reducing local cash and some bond holdings (to a lesser degree) to fund the purchases. Despite the positive index return over the quarter, valuations on SA equities actually fell as earnings expectations improved: the Capped SWIX's forward price-to-earnings (P/E) ratio fell to 11.2X at end-March from 11.8X in January. On a price-to-book (P/B) valuation measure, the Capped SWIX's current level of 1.6X is now even cheaper versus its longer-term median of 2.1X.
The fund continues to hold resources stocks with exposure to global growth and foreign currency earnings like Anglo American, BHP, Exxaro, Sasol and Sappi, as well as global giants such as Naspers and British American Tobacco. With the exception of Sappi, these holdings generally benefitted our portfolios for the quarter. We have also maintained our overweight exposure to financial shares including Old Mutual, Standard Bank and Absa, which have offered attractive valuations with relatively high dividend yields. These holdings generally detracted from value over the quarter. Meanwhile, we are still somewhat underweight retail stocks, given the pressure under which local consumers find themselves. We remain cautiously optimistic regarding SA equity market returns over the medium term due to the prevailing excessive levels of pessimism reflected in share prices and valuations.
In SA listed property we are marginally underweight in the fund given the higher risks to earnings going forward compared to the attractive valuations prevailing in the asset class. We remain concerned around the quality of earnings and possibility of further downward revisions to earnings forecasts for listed property. The sector faces headwinds arising from pressure on landlords to reduce their rentals, particularly in the retail space where retailers are facing sluggish consumer spending. Equally, oversupply in office space is negative for listed property earnings currently. This slight underweight generally added value to the fund for the quarter.
In SA nominal bonds, valuations remained cheap over the quarter compared to their longer-term fair value despite the quarter's 3.8% return from the asset class. We continue to be overweight, although we trimmed our position slightly to buy even more attractive SA equity during the quarter. We still prefer longer-dated government bonds due to the more attractive yields on offer. We are also comfortable with the compensation bonds offer given the risk involved, while recognising that the SA government and businesses have not yet done enough to eliminate the prospects of further credit rating downgrades, especially given the deterioration in the country's growth rate.
The fund has a very small holding in inflation-linked bonds. Following the quarter's return of 0.5%, ILBs' real yields remain very attractive, having risen to 3.3% for 10-years.