Sanlam Select Optimised Equity comment - Sep 18
Global markets started the month of September on a downward trend with the MSCI EM reaching an intra-month low on the 12th of September, but rebounding to end largely flat with a US dollar total return of -0.5%. MSCI Frontier Markets also ended the month unchanged, while MSCI World Markets managed to eke out a positive US dollar total return of 0.6%. Within MSCI World markets, the Pacific region posted a US Dollar total return of 1.9%, while the European and North American region each gained 0.4%. Those market moves came about as the US imposed 10% tariffs on the roughly $200bn of Chinese imports and the retaliatory Chinese differential tariffs on $60bn of US products. At the same time, and after a very volatile negotiation period, the US agreed a new trade deal with Mexico and Canada, replacing the original NAFTA agreement. In Europe, concerns about the health of the EU/euro flared up again as the Italian government agreed on a 2.4% of GDP budget deficit target for the next three years, higher than the prudential limits agreed within the Euro area. September also saw continued tightening by central banks in the US and major emerging markets. Among the commodity complex, oil was one of the best performers, as US sanctions on Iran took its toll, with supply side concerns driving crude prices higher. As a result of those macro headwinds, within emerging markets (EM) MSCI Asia (-1.7%) was the worst performing region, dragged down by losses from heavyweights India (-9.1%), Malaysia (-1.6%), Indonesia (-1.6%) and China (-1.4%). Thailand outperformed with a total return of 3.2%. MSCI LatAm (4.7%) was the best performing EM region in September, with heavyweight Brazil returning 7.0%. MSCI EMEA gained 1.9% in September. Turkey rebounded from the sharp losses in August, gaining 20.6%. Russia returned 9.9%. MSCI Greece and Egypt shed 8.2% and 6.3% respectively, while MSCI SA posted a loss of 1.9%. As a result of the sharp oil price move, Energy was the top performing equity sector within World and Emerging markets in September, while Real Estate was the worst performer in both. In the third quarter of 2018, MSCI EM returned -0.9% vs -7.9% in the second quarter. The MSCI World index returned 5.1% over the third quarter vs 1.9% in the second quarter. Within MSCI EM, the best third quarter performance came from the LatAm region (4.9%). Heavyweights China (-7.4%) and South Africa (-7.2%) were a drag on their respective regions over the quarter, with Asia being 1.7% lower and EMEA 1.4% lower. Year-to-date, MSCI South Africa has lost around 21%, with the rand depreciating by 12.5% against the US dollar. Looking at September in rand terms, the South African equity market fell across the board, with the ALSI losing 4.2%. Large Cap and Mid Cap stocks shed 4.4% and 3.7% respectively, while the Small Caps shed 1.7%. Property was also under pressure, losing 2.6%. SA Bonds, however, managed to eke out a small positive total return of 0.3%. On the macro front, President Ramaphosa outlined a stimulus package in September that aims to kick-start the economy by reprioritising the current expenditure mix to target growth- and employment-generating projects. The key aim of the package is to improve implementation using existing resources. It is deemed positive that the drive for successful implementation of all these goals is coming directly from the president. In terms of growth, however, the impact of this package might only be judged in hindsight, as a lot will depend on the speed and efficacy of implementing many of the promised projects in the plan. September’s release of SA’s CPI inflation eased to 4.9% year-on-year in August, from 5.1% in July, and was better than the consensus of 5.2%, contributing to the SA Reserve Bank keeping interest rates on hold, while the vote was close. After big losses in previous months, the USDZAR strengthened by almost 4% in September as risk sentiment improved and the US dollar weakened. However, the rand was quite volatile in the interim, weakening above R15.50/USD, but coming back sharply as risk sentiment towards emerging markets improved and volatility eased. With all of the above, the largest negative equity performance came from SA Industrials (-7.7%), which posted its worst monthly performance since February 2009. The downturn was led by Pharmaceuticals (-39.7%), Personal Goods (-9.7%) and Food Producers (-8.0%), amongst others. SA Financials lost 2.0% in September, with the worst performance coming from Equity Investments (-6.6%), Banks (-3.4%) and REITs (-2.9%). Non-life and Life Insurance posted positive total returns of 9.8% and 1.1% respectively. SA Resources once again outperformed over the month, returning 1.0%, with Platinum returning 16.5%. In the third quarter of 2018, the ALSI posted a rand total return of -2.2% vs 4.5% for the second quarter and -6.0% for the first quarter. SA Resources and SA Financials outperformed in the third quarter with total returns of 5.2% and 2.8% respectively, while SA Industrials was the drag on the index, shedding 7.8% over the quarter. The All Bond index was virtually flat with a total return of 0.8% in the third quarter vs -3.8% in the second quarter and 8.1% in the first quarter. The SAPY returned -1.0% in the third quarter vs -2.2% in the second quarter and -19.6% in the first quarter. The Optimised Equity Fund outperformed again during the month, with Aspen being the biggest positive contributor as our zero-weight position due to balance sheet concerns of the company played out and the stock dropped more than 40%. Our overweight position in select resources, namely Anglo American, BHP Billiton and Impala, as well as select offshore holdings, all contributed positively, despite the strengthening rand. Detractors included some select small- and midcaps, but here we are comfortable with our positioning due to a strong value underpin, in our view. One more word on avoiding Aspen: The fund has been able to generate significant alpha over the past 12 months by being able to avoid “stock bombs” like Steinhoff, EOH, Resilient, and most recently MTN and Aspen, all stocks where the fund had mostly zero holdings due to ESG or significant balance sheet concerns. While we also successfully avoided Lonmin and ABIL in the past for the same reasons, we are not claiming to be able to avoid stock bombs all the time, particularly if fraud by insiders is involved. However, while we certainly sometimes make investments which don’t generate the desired returns, we do believe that our detailed and disciplined approach to investing in general, and ESG in particular, gives us the confidence to make sometimes contrarian decisions (often those “bombs” are particularly popular), to protect our clients’ assets and obtain the alpha we are mandated to generate. During September our investment team also attended a major investment conference with 12 keynote speakers and over 160 representatives from 65 JSElisted corporates. While the mood at the conference was still considerably subdued, given the current political and economic challenges here in South Africa and globally, the macro environment for SA listed stocks seems to have improved versus a year ago. Thus, our team noted opportunities in stocks where either the self-help element is strong, or where a strong business model and execution helped gain market share from weaker competitors, strengthening their overall positioning. Opportunities in the mining sector also started to show up, as a tough environment over the past few years forced companies to focus on cost efficiencies and repairing balance sheets. Looking ahead, we believe that the outlook is far from smooth sailing, and while we continue to believe that we are in a late cycle bull market where some good returns and alpha can still be obtained, this comes at a cost: volatility. Sellside research shows that over the last quarter two-thirds of all ALSI constituents saw a 5% intraday move! As a reminder VIX is still at 12 vs an average of 17.07 post the financial crisis. If it normalises as central banks rein in liquidity, this is only the beginning.
Return and risk are two inseparable sides of the same coin. Therefore, we continue to advocate a disciplined and balanced portfolio construction approach, to protect the alpha which is the result of careful stock selection.