Karl Leinberger is Chief Investment Officer and has 24 years of investment industry experience.

IN A CHALLENGING environment where most asset classes experienced sharp declines, the portfolio declined 14.3% for the first quarter of 2020 (Q1-20). Despite these trying conditions, the Strategy has performed well against its peer group and over longer periods.

Q1-20 provided investors with very few places to hide. Equity markets around the world expe­rienced record declines during the quarter. Since January, the Covid-19 outbreak has overtaken our lives and transformed our world, presenting a medical, economic and human challenge that is unprecedented in our lifetime. The outbreak of this pandemic has impacted financial markets with a swiftness and ferocity normally only seen in a classic financial crisis. In a matter of weeks, global equity benchmarks fell from record highs into bear markets. The level of volatility experienced during this market sell-off has also been unprecedented; from 19 February to 23 March, the US stock market saw the quickest meltdown in history, with a cumu­lative loss of 33.9% on the S&P 500. The following three trading days saw gains of 17.5%, marking the best three-day stretch since the 1930s.


With investors fleeing risk assets, the MSCI All Country World Index ended the quarter down 21.4% in US dollars, and the MSCI Emerging Markets Index was down 23.6% in US dollars. Developed market bond yields fell to record lows, with investors buying up debt as a safe haven amid fears of a Covid-19-induced recession. The FTSE World Government Bond Index appreci­ated by 2.0% in US dollars for the quarter. These record-low yields come at a time of unparalleled levels of government indebtedness and signifi­cant monetary policy expansion by central banks around the world, which carries the risk of stoking inflation in years to come. At this point, we are very negative on the outlook for global bonds, given their unattractive risk-versus-return payoff profile.

Given the sharp sell-off and their current valuation levels which we find attractive, we were more constructive on global equities during the quarter. While short-term news flow remains poor, once Covid-19 is behind us, corporates will be operating in an environment of unprecedented fiscal stimulus, record-low interest rates and the tailwind of low energy prices. Combined with pent-up consumer demand when lockdown measures are over, we believe that corporate profitability could look very different in 12 months’ time. During the quarter, we moved from an underweight to an overweight total equity position as we closed out put options that protected us from the worst of the early declines, before buying some equity exposure at lower levels. 


The All Bond Index ended the quarter down 8.7%. We are cognisant of the risks around South Africa’s worsening fiscal position but believe that South African government bonds remain a reasonably attractive investment opportunity, given their high yields and absence of near-term inflation pressures in the local economy. The rand (-21.5% versus the US dollar) has been one of the worst-performing currencies this year as the global demand shock compounded South Africa’s existing structural headwinds. Adding to the negative news, Moody’s Investor Service finally joined Fitch and S&P in downgrading South African debt to subinvestment grade, with all three rating agencies also retaining a negative outlook.

The South African Reserve Bank’s commitment to keep liquidity in the system and the National Treasury’s adjustment to the funding profile over this period saw the yield curve flatten aggres­sively past the 20-year area. We took advantage of this flattening and shortened exposure from the longer end of the curve to the belly (10- to 12-year), reducing duration at the same time. Inflation-linked bonds (ILBs) sold off both in sympathy with nominal bonds and due to lower inflation expec­tations. This weak price action offered an oppor­tunity to switch a decent portion of nominal bonds into ILBs, specifically the i2029, at very attractive real yields of c 6%.

Overall, the JSE experienced a very tough quarter, with the FTSE/JSE Capped Shareholder Weighted All Share Index declining by 26.6%, thereby dragging five-year rolling returns for the overall market into negative territory. No asset class was left unscathed, but the economically sensitive sectors, such as property (-48.1%) and financials (-39.5%), bore the brunt of the pain as they sold off aggres­sively. Industrials (-8.4%) and resources (-25.3%) performed relatively better.


While we did not escape the brutal realities of a declining South African equity market, our large weighting in global equities, together with our bias for rand hedge stocks, and low exposure to domestic stocks, contributed to outperformance of the equity portion of the portfolio relative to the index during the quarter. Furthermore, in an envi­ronment with such extreme price moves, individual stock selection proved critical. Our two highest conviction ideas in the portfolio, Naspers/Prosus and British American Tobacco, both came through strongly during the quarter.

Naspers (+11%) and Prosus (+17%) benefited from their exposure to Tencent, whose business proved incredibly resilient during the economic disruption caused by Covid-19. Demand for digital services, such as communication tools, social networking, mobile games, online video, and food and grocery delivery, exploded during the lockdown period. Outside of China, we are very encouraged by Tencent’s growing international gaming business, which now makes up 23% of its total gaming revenues. Tencent has stakes in four of the top game developers in the world (TiMi Studios, Quantum, Riot Games and Supercell) and currently has five of the top 10 daily active user games in the world in their portfolio. We believe Tencent is very well positioned to build a dominant global gaming franchise.

However, the most exciting area within Tencent at present is undoubtedly digital payments and financial services. We think this business will contribute significantly to group profits over the next three to five years. Similarly, Tencent is rolling out other financial services products such as banking, wealth management and insurance. Given Tencent’s distribution capabilities, together with their treasure trove of user data, we think they are very well positioned to build substantial and very profitable businesses.

Outside of Tencent, Prosus is primarily investing in three key areas (online classifieds, food delivery and payments/fintech), all of which are growing very rapidly. Prosus is currently trading at a c.35% discount to its underlying intrinsic net asset value, while Naspers in turn is trading at a c.25% discount to the market value of its Prosus stake. Encouragingly, Naspers announced a share buyback during the quarter after it raised cash from the sale of a small part of its Prosus stake. We believe steps such as this can create meaningful value for Naspers shareholders and help narrow the discount to intrinsic value over time. We continue to believe both Naspers and Prosus are being grossly mispriced by the market at current levels. For more details, please read our Naspers stock analysis on page 16.

British American Tobacco’s share price (+2%) held up very well during the quarter. As expected, consumer demand for cigarettes has remained remarkably defensive during this unanticipated economic shock. British American Tobacco’s steady growth algorithm of high single-digit revenue growth, driven by strong pricing power, continued cost savings and deleveraging, remains intact and is once again being appreciated by investors. The company is still trading on only 7.5 times one-year forward earnings and an 8% dividend yield. We still believe this to be very attractive for a stock of this quality and it remains the second biggest position in the portfolio.

Karl Leinberger is Chief Investment Officer and has 24 years of investment industry experience.

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