Iain joined RMB Asset Management in 1993 after completing his studies and joined the investment team soon thereafter. Iain is the portfolio manager of the RMB Equity Fund, the RMB Industrial Fund and the FNB Growth Fund.
Charles heads the research division of RMB Asset Management. Charles previously spent nine years as a senior partner at a major firm of stockbrokers. During this time he was a member of the JSE and was responsible for portfolio management and research.
Truffle SCI Flexible Fund - Mar 19
Global markets enjoyed a strong 1Q 2019
Global financial markets bounced strongly this quarter, recovering from the weak close to 2018. Global equities made impressive gains, with the MSCI World Equity Index delivering a 12.6% USD return, compared with a decline of 8.2% in the previous quarter.
Emerging market equities were not far behind, producing a 10% USD return for the quarter, having fallen by 14.2% in the previous quarter. Global government bonds returned a positive 1.9% for the quarter in USD's.
South African equity returns for the quarter were strong, but lagged other emerging markets, producing an 8% return for the quarter in Rands, and a 7.7% return in USD. South African Bonds were up 3.8% in the quarter.
The global economy is giving mixed signals
Since late 2018 global developed market bond yields have fallen significantly, signalling the market's expectation of the first synchronised slowdown since the 2008 economic crisis. Already weak numbers have emerged from Germany with the rest of the Euro area likely to follow. More and more company profit updates are warning of slowing sales across many industries. Brexit is also not helping and remains a source of major uncertainty even though it may be delayed.
In the United States, economic growth still remains strong with consumer confidence at high levels and unemployment at record lows. However, business confidence is deteriorating and earnings downgrades have not yet troughed. However, a more dovish FED will help maintain expansionary financial conditions which will aid in extending one of the longest US economic cycles in history.
China's slowdown, which started in the last quarter of 2018, might be nearing its end as fiscal stimulus and a positive credit impulse bring its economy back to the boil. A turn around in Chinese growth would help lift other Asian economies, as well as Europe, which benefits via its export industries.
Despite the possibility of a global turnaround, we remain concerned by the record low unemployment rate and elevated profit margins in the US. Furthermore, the exceptionally low real yields in developed bond markets do not bode well for future financial market returns.
Monetary policy will likely remain accommodative
With the South African repo rate set at over 2.5% above the inflation rate, South African real yields screen as globally attractive. While there is some scope for the SARB to cut interest rates in the quarters ahead, the need to protect the currency, and prevent the knock-on inflation effect, remains.
The South African economy is facing major challenges
South African economic growth has been anaemic for some time now. This has been driven by numerous structural issues. Whilst government spending has remained strong, our lack of employment growth, very high and increasing levels of indebtedness and a tax burden that is already high, are now putting a huge strain on the consumer. Official growth forecasts are all pointing to a very lacklustre economic performance in 2019 that will make the worryingly high inequality gap difficult to address. In addition, the parlous state of many of the country's parastatals, notably Eskom, is making efforts to stimulate growth more challenging.
On the positive side, if President Ramaphosa is returned to power with a strong mandate after the May elections, the country could see a major initiative to tackle corruption and service delivery, issues that have been plaguing the country for some time. If combined with increased policy certainty and fiscal discipline, South Africa could start to meaningfully address the structural issues which have been holding us back. This would no doubt be good for overall business and consumer confidence and could attract higher levels of investment that would raise growth rates and living standards over the medium term.
Domestic equity values continue to improve
In previous commentaries we have observed that domestic equities are not cheap, although value has steadily been improving. Given that the global monetary environment is likely to remain benign and that domestic inflation is under control, domestic interest rates are currently poised for either a cut or at worst, remaining steady. Equity returns, in our view, will be determined less from rating changes than by earnings growth. The poor economic outlook points to earnings growth remaining weak, suggesting that equity returns will, at least in the quarters ahead, continue along the path of subdued returns similar to the last few years. Earnings growth needs to accelerate if equities are to enter a new bull market.
Property returns are expected to be subdued
In line with equities, property returns are also expected to be subdued as the growth in distributions is likely to remain weak for the foreseeable future. Although the running yield appears attractive, this needs to be balanced against the poorer quality earnings we are seeing from the property counters.
The funds underweight positions in many of the highly rated South African focused stocks paid off handsomely as the poor economic environment translated into difficult trading and ultimately resulted in very poor earnings updates from many of these companies. As we have been warning in previous commentaries for quite some time, the market was too optimistic in terms of the expected earnings growth from many of these companies given the above difficult economic environment. This combined with ratings that were still expensive resulted in significant share price underperformance as the companies released their earnings updates.
The fund's overweight positions in many of the cheap industrial and commodity-based Rand hedges generated significant outperformance as year on year Rand weakness and better global growth buoyed their earnings. In particular the funds overweight positions in platinum did particularly well after a significant improvement in the basket price of the Platinum Group Metals (PGM's) over the last year manifested in significant earnings beats as these companies released their results to the market. Our underlying investment thesis for the platinum sector has been that the lack of capital investment over the last decade as a result of poor economics would eventually manifest in a lack of supply. This would ultimately drive PGM basket prices higher to the point where producers were once again incentivised to invest in new supply. South African platinum mines have grappled with a decade of declining profitability largely as a consequence of the excess supply resulting from SA mines historically chasing production at the expense of returns. This realization and the current reduction of unprofitable ounces comes at a time when underlying demand is accelerating and benefitting from tighter global emission standards in both developed market and emerging markets. This has resulted in a significant rise in the PGM basket price, specifically Palladium, which is in a significant deficit position and is expected to remain so for at least the next three years. Even at current PGM basket prices producers are reluctant to invest more capital to meet the current PGM shortages, as long-term concerns around electric vehicles taking more market share from internal combustion engines dominate discussions about the long-term demand outlook. This means we could well see the PGM basket prices move higher and stay elevated for quite some time.
We turned positive on Naspers in November last year. The share price had been weak as a result of a sell-off in Tencent due to concerns around a moratorium by the Chinese gaming regulators on new game approvals. We believed the moratorium would be temporary, and took the opportunity to increase our exposure to Naspers. As expected, the Chinese gaming regulators restarted approval in earnest this year, initially with domestic game approvals. The first batch of international games has just been announced. We think this should manifest in a better performance from the gaming business in 2019. Naspers also unbundled Multichoice this quarter, and announced the intended listing of most of its assets in Amsterdam. All of this bodes well for unlocking a portion of the significant discount on which the share trades.
Over the quarter the fund reduced exposure to Howden, Northam Platinum, Capitec, Vanguard Value ETF, Spar and Vodacom.
Major purchases included Anheuser-Busch, Reinet, Firstrand and Philip Morris. Although a significant portion of the fixed income assets remains invested in floating rate subordinated debt of SA top five banks, we have started to reduce these positions after making significant gains as a result of credit spreads narrowing over the last year. We are looking to increase the liquidity of fixed income holdings at this stage of the cycle as the spread compression seen over the last year is no longer sufficient to justify our current exposure
Contributors and detractors There were some very large share price moves this quarter, but the stand-out performance was undoubtedly the platinum sector, up 49.7%! We have been steadily building a position in this sector since the middle of last year, and our positions in Implats and Northam contributed meaningfully to performance this quarter. We shared with you last quarter our investment thesis on British American Tobacco and why we thought the valuations were now pricing in a significant amount of risk. The share price increased 29.5% this quarter and our holdings in both British American Tobacco and Reinet were positive contributors. Ping An Insurance Group which we purchased last year also contributed to overall performance on the back of a 28% share price rise over the quarter. We sold out of all our Vodacom prior to their December quarterly update as we feared that the pressure on data pricing, combined with a weak macro, would produce weak numbers. Other contributors to performance were Quilter and the Vanguard Value ETF. Our positions in Pepkor, Sappi and Woolworths detracted from performance.
The Truffle MET Flexible Fund shall be a Domestic Asset Allocation Flexible Fund.
The investment manager has substantial flexibility to vary the asset allocation in such a manner as he deems appropriate. The portfolio may also include participatory interest or any other form of participatory interest in collective investment schemes or other similar schemes. Where the aforementioned schemes are operated in territories other than South Africa, participatory interest or any form of participation in these schemes will be included in the portfolio only where the regulatory environment 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.
Nothing contained in this supplemental deed shall preclude the Manager from varying the ratios of the aforementioned instruments relative to each other (except as required by the Act), or the assets themselves, to maximise investment potential, should changing economic factors or market conditions so demand. Provided also that nothing contained in the investment policy shall preclude the Manager from retaining cash in the portfolio and/or placing cash on deposit in terms of the deed. Provided further that the Manager shall ensure that the portfolio includes securities and assets in liquid form, of at least the aggregate value required, from time to time, by the Act.
The Manager will be permitted to invest on behalf of the Truffle Flexible Fund in offshore investments as legislation permits.
The Trustee shall ensure that the investment policy set out in this Supplemental Deed is carried out. For the purpose of this portfolio, the manager shall reserve the right to close the portfolio to new investors on a date determined by the manager. This will be done in order to be able to manage the fund in accordance with its mandate. The manager may, once a portfolio has been closed, open that portfolio again to new investors on a date determined by the manager.