Willem is the Joint Head of Investments and one of the founding members of Sygnia Asset Management. Prior to joining Sygnia in 2003 he was Head of Quantitative Management at Coronation Fund Managers for six years. At Coronation he developed a proprietary risk management framework for the internally managed hedge fund product, and designed and implemented the quantitative and qualitative analysis processes and software for their international fund of hedge funds operation.
Sygnia CPI + 2% Comment - Mar 17
2017 started on a nervous note, with newsflow dominated by the actions of the newly-minted US President, Donald Trump. From the White House's embrace of 'alternative facts' to Trump's Twitter feed, a new crop of risks had investors on edge. On the other hand, Trump's agenda of infrastructure spend, tax cuts and looser regulation has spurred expectations of stronger US growth and lit a fire under the US stock markets, pulling up global sentiment. The market remained choppy in February, oscillating on the one hand between strong upturns on good global economic data and Trump's promises of cutting taxes and relaxing regulation, and on the other, concerns about political risks in Europe with looming elections in the Netherlands and France, and weakness in commodity prices. March brought more sobriety to the table as uncertainty about whether Trump would be able to implement his policies surfaced after he failed to get the Affordable Care Act, a key campaign promise, repealed. However, the stock markets held up relatively well, with levels of volatility at record lows.
The biggest risk in the US is the country's increasingly protectionist stance on trade, including withdrawal from the TPP trade deal and the announcement of plans to renegotiate trade agreements with Canada and Mexico. The biggest risk in the eurozone is the resurgence of right-wing politics after the UK officially triggered Article 50, formalising its exit from the European Union.
On the economic front, despite recording its slowest growth in five years in 2016 at 1.6%, the US's economic expansion is now officially the third longest on record and shows no signs of abating, with robust hiring, falling unemployment and firmer wage growth. The unemployment rate fell to 4.7%, while inflation rose to 1.9% in January from a year earlier, close to the central bank's 2.0% objective.
As expected, the US Federal Reserve increased the target range for the federal funds rate from 0.75% to 1.0% and signalled two more increases this year, albeit gradually paced. The US Fed's forecasts for growth and inflation remained unchanged at 2.1% and 1.9% respectively.
The eurozone also looked healthier, with business sentiment, growth rates and unemployment all surprising on the upside. The economy has now posted 14 consecutive quarters of growth, the unemployment rate has returned to single digits and consumer confidence has reached its highest level in six years. February's year-on-year inflation came in at 2.0%, the highest level since January 2013, putting pressure on the ECB to limit quantitative easing.
Economic data from China pointed to sustained growth momentum in the first two months of the year, after growth for 2016 came in at 6.7%. China's central bank lifted interest rates for the second time this year, hours after the US Fed, and continued to prop up the yuan and stem capital outflows.
Emerging markets continued to benefit from the unpredictability of Trump's policies as investors looked for higher returns elsewhere. Economic fundamentals in developing markets are expected to improve in 2017, leading to the highest inflows into emerging markets' bonds in any one quarter on record.
In South Africa, despite weak economic fundamentals and political risk, the rand enjoyed a period of unusual strength relative to the US dollar, a function of strong emerging markets' inflows. The Reserve Bank left the repo rate unchanged at 7.0%, raised its inflation expectation for 2017 to 6.2% and kept its 2017 growth forecast unchanged at 0.4%. The unemployment rate dropped to 26.5% in the fourth quarter, while inflation fell to 6.3% in February from 6.6% in January.
The budget largely balanced the books by increasing individual taxes and the dividend withholding tax, while avoiding touching the capital gains tax and VAT. The budget targets a deficit of 3.1% of GDP for 2017/18. GDP growth for 2017/18 has been projected at 1.3%, up from 0.5% in 2016/17.
Unfortunately there was a lull before a storm, as in March, in a shock move, President Jacob Zuma replaced Finance Minister Pravin Gordhan and Deputy Finance Minister Mcebisi Jonas with Malusi Gigaba and Sifiso Buthelezi. Equities and bonds dropped sharply, with banks bearing the brunt of the sell-off, while the rand depreciated. Credit rating agencies S&P and Fitch downgraded South Africa almost immediately. S&P cut the rating of foreign-denominated debt to below investment grade, or junk, while Fitch cut both local and foreign debt to junk. This has very serious implications for South Africa's ability to attract foreign inflows and investment, as well as the higher interest that the government will have to pay on future borrowings and roll-over debt, money that could be better used helping to lift South Africans out of poverty. The political instability is a bitter pill to swallow after the weak economic data of 2016. The GDP contracted by 0.3% quarter-on-quarter in the fourth quarter, bringing annual growth to just 0.3%. Mining and manufacturing were the main culprits.
Oil prices oscillated between US$51 and US$56 a barrel as output cuts by OPEC were counterbalanced by rising US shale oil production and the fact that non-OPEC members are only cutting production by 50.0% of what they pledged.
We expect a precarious quarter ahead as South African politics and economics become invariably interwoven. We expect a weakening of the fiscal framework, as well as of the regulatory banking framework, and hence negative economic sentiment towards South Africa will continue. The flow of money into emerging markets is softening the landing, but even over the short term volatility is likely to pick up in both equity and bond markets. The rand is also likely to weaken over the next quarter; this should help the resources sector. Sygnia has thus significantly reduced risk across all portfolios, with maximum exposure to offshore investments and a higher exposure to rand hedge counters.
The FTSE/JSE Capped SWIX Index ended the quarter 2.4% up, with the Resources sector up 1.9%, Industrials 7.1% up and Financials down 1.9%. The bond market delivered a return of 2.5%, while the rand depreciated by 2.0% relative to the US dollar.
During the quarter the Sygnia CPI + 2% Fund returned 2.1% compared to its long-term target, CPI + 2% per annum, which was 2.6%. Underperformance was driven by a strong rand, which detracted from the Fund’s offshore performance, while the Fund’s equity and domestic bond exposure benefited performance. The rand strengthened for the quarter despite its sharp depreciation at the end of March.
At the beginning of the quarter we added to the Fund’s fixed-interest position as a hedge against a strengthening rand. Given the political risks we were facing, we did not feel it was prudent to reduce the Fund’s offshore exposure and therefore increased domestic bonds, which do well in a strong rand environment. We also increased the Fund’s exposure to domestic equity and domestic property early in the quarter. In the offshore component of the Fund we reduced its bias to US equities, cut global property and developed-market bonds to zero and increased exposure to emerging markets.
The Fund remains true to its mandate of delivering strong long-term returns with a focus on longerterm capital preservation.
The portfolio may consist of financially sound equity securities, property shares and property related securities listed on exchanges, fixed interest instruments (bonds) and assets in liquid form. In selecting securities for this portfolio, where possible, the manager shall seek to sustain long-term capital growth. The portfolio may also invest in participatory interests and other forms of participation in portfolios of collective investment schemes, registered in South Africa and other similar schemes operated in territories with a regulatory environment which is to the satisfaction of the manager and trustee of a sufficient standard to provide investor protection at least equivalent to that in South Africa and which is consistent with the portfolio's primary objective. The effective equity exposure (including foreign equities) will always be below 40%. The portfolio aims to achieve its investment objectives with low levels of volatility and aims to protect capital over the medium term. The Portfolio will be managed to be compliant with regulation 28 of the Pension Funds Act.