Corospondent - October 2020
Coronation Balanced Plus and Coronation Equity funds - October 2020
Both the Equity Fund (our diversified general equity fund) and the Balanced Plus Fund (our flagship multi-asset fund for pre-retirement investors) had a satisfactory Q3-20, returning 3.0% and 2.7%, respectively. Both funds continue to perform well against their peer groups over all meaningful, longer-term periods, which aligns to our long-term investment horizon.
Our large global equity weighting added to performance in both funds during the quarter. Although global equity markets have recovered strongly off their lows, we continue to believe that valuations look reasonable – especially relative to other asset classes. Balanced Plus also benefited in Q3-20 from no international government bond exposure and a meaningful position in gold. Although we reduced the gold position during the quarter, we believe that in a world characterised by ongoing pressure on policymakers across the globe to print and spend, zero interest rates and heightened geopolitical risks, gold has a unique role to play in protecting the portfolio.
STREAMING OFFERS ATTRACTIVE FLOWS
One of the new additions to the Equity Fund is Tencent Music Entertainment Group (TME). TME is a subsidiary of Tencent and owns the leading music streaming platform in China, with a staggering 650 million monthly active users. TME also owns a suite of cash-generative social entertainment businesses, including the dominant online karaoke app and various live streaming apps on which users interact with performers online. There are significant synergies between these platforms.
TME is well positioned to play a leading role in the multi-year development of the Chinese audio industry. The nascent music market is growing off a low base, with consumers increasingly willing to pay for digital content. While TME’s proportion of paying users is growing rapidly, it remains low (7%) when compared to global peers, such as Spotify (c.50%). Average revenues per user are also very low with significant scope to increase. The group has also moved into adjacent areas, such as record label activities, thus offering artists the full spectrum of services from music creation to distribution. More recent initiatives, such as live concerts and a broader push into audio, including podcasts, provide additional future revenue streams.
TME has an excellent management team and a fortress-like balance sheet, with over $3 billion of net cash (13% of market cap), which positions the company well to execute its strategy. We expect healthy revenue growth of around 20% p.a. over the medium term, with even faster earnings growth as the music platforms and new initiatives turn profitable. TME trades on 22 times free cash flow adjusting for its cash balance and stake in Spotify (worth over $1 billion), a level we view as attractive given the earnings growth profile of the business.
DOMESTIC EQUITY ATTRACTIVE
Although we are cognisant of the risks around South Africa’s worsening fiscal position and the risk of a debt trap, we believe that South African government bonds remain a reasonably attractive investment opportunity given their high yields and the absence of near-term inflation pressures in the local economy.
Good stock selection in the funds added to local equity market returns. Given the compelling value on offer, we increased our domestic equity exposure during the quarter. While the domestic equity holdings remain skewed to rand-hedge stocks, which are attractive for stock-specific reasons, we have also been increasing our exposure to domestic-facing stocks, many of which we believe are very attractively priced.
One example is the local life insurance sector. Life companies have appealing attributes, including ‘sticky’ product (retirement savings and life insurance); extensive and hard-to-replicate distribution networks; c.30% to 40% earnings exposure to equity markets, which we think offer good value; the ability to generate fees during lockdowns; diversified earnings streams; and strong capital positions.
Embedded value is a reasonable proxy for life insurance valuations. Life company share prices have derated meaningfully relative to embedded value, with, for example, the Momentum Metropolitan share price moving from a premium to embedded value in 2015 to a 40% discount today. New management has impressed us through their implementation of a turnaround and has placed the business on a firmer footing, as evidenced in Metropolitan Life’s recent results. We don’t think the market gives enough credit to the turnaround that is under way. Meaningful earnings pain was taken now in the form of Covid-19 provisions. We believe these will support robust earnings growth in future periods.
Sanlam is another recent addition to the funds. We have long admired the business for its strong growth profile, high-calibre management team and high levels of accounting prudence. Historically, we haven’t owned Sanlam, given a stretched valuation and the lack of a margin of safety. The recent selloff has allowed us to buy this quality compounder at an attractive valuation.
The funds also benefited from exposure to Shoprite, Anglo American, Northam Platinum and Impala Platinum, as described more fully in Neville Chester's commentary. We have also added to our Glencore position on share price weakness
Other material activity during Q3-20 was the switching of our remaining Prosus holding into Naspers because we believe the additional discount to intrinsic value is highly attractive. We also trimmed our Anheuser-Busch InBev position on share price strength and opportunistically added to our FirstRand position, along with some other domestic stocks.
In this uncertain world, our objective remains on building diversified portfolios that can absorb unanticipated shocks. We will remain focused on valuation and will seek to take advantage of attractive opportunities that the market may present to us. We are excited by the current portfolios and, given compelling valuations, we are excited about future return prospects.