Corospondent - July 2021
Coronation Top 20 and Market Plus funds - July 2021
Market Plus returned 1.7% for the second quarter of 2021 (Q2-21), resulting in a return of 26% over the last year. Top 20 returned -1.7% for Q2-21 and 28.6% over the last year. For the quarter, the funds benefited from being overweight certain South Africa (SA) Inc. holdings, such as Nedbank and Momentum Metropolitan. At a portfolio level, being underweight SA Inc. detracted. Naspers also detracted from performance. We always strive to manage the funds with a long-term time horizon in mind. For Top 20, alpha since inception has been 3.6% p.a., net of fees.
The end of June 2021 marked the 20th anniversary of the launch of the Coronation Market Plus Fund. It was conceived as a balanced fund unconstrained by Regulation 28 of the Pension Funds Act, allowing it greater freedom around equity holdings and more flexibility on offshore allocation. The idea was that this would allow the Fund to outperform a traditional balanced fund and achieve meaningful real growth over time.
It is therefore pleasing to report that, over the past 20 years, Market Plus did achieve these objectives through what has been a tumultuous time. Over the past two decades, the Fund has delivered an annualised return of 14.9% compared to the quantitative benchmark return of 13.2% and the median balanced fund return of 11.3%. What is particularly pleasing is that over this period, despite never being fully invested in equities, the Fund has also managed to outperform the JSE All Share Index’s (ALSI) performance of 13.8% p.a., net of fees. The objective was also to grow real capital over time, which the Fund also achieved, having delivered an annualised real return of 9.4% p.a.
Over the past 20 years, investors have suffered some tumultuous moves. Shortly after the launch of Market Plus, SA experienced a massive selloff post the 9/11 attacks, where the rand and local markets were punished. It’s unbelievable to think of it now, but the rand moved from just over R8 to the dollar to peak at R13.50 (which is where it was recently trading, 20 years later), only to retrace all those losses and more over the following years.
Shortly thereafter, the Dot.com bubble burst, with the S&P 500 Index collapsing 37% from its highs (the losses for SA investors were much higher, given that the rand strengthened significantly over this period, with peak-to-trough losses of 58% for those who rushed offshore at the height of the 2001 panic).
Then, after a few years of relative stability and a strong upward trend in resource prices, the local market and the world were impacted by the near collapse of the US banking system, which was quickly named the Global Financial Crisis as the linkages from the US housing market permeated into global developed financial institutions. The S&P 500 fell by 57% peak to trough, the rand to dollar once again blew out from levels around R6.50 to R11.40, and the resource-dominant JSE ALSI fell 47% from peak to trough.
The recovery that followed was quick and fast as global central banks introduced a term that we would all come to know as QE (quantitative easing). Equity and bond markets around the world responded well to this. But, in SA, it wasn’t plain sailing as the Zuma decade started, and we experienced bouts of volatility, none more so than the firing of the Finance Minister in 2015, where the rand moved from R13 levels to R17, exacerbating a market already struggling under the weight of a commodity bear market. Global markets also had periods of volatility with the first ‘taper tantrum’, various forecasts of the EU collapsing, Brexit and Donald Trump.
And then finally, the recent Covid-19 disaster, where, once again, volatility records were broken, with the S&P 500 Index falling 37% and recovering it all within six months! The rand, again a casualty of global risk appetite, moved from R14 to over R19 to the dollar, and the ALSI fell by over 23%. As global central banks worldwide printed money and cut interest rates on a scale not seen outside of world wars, markets have recovered strongly, and the rand is back at around the R14 level.
What can one learn from this journey? It has certainly highlighted that investing should always be done with a long-term time horizon! Short-term reactions to market moves can often end up damaging long-term returns. As much as we bemoan the fluctuations of the rand, the fact that it floats freely often protects us from the extremes of market moves and changes in risk appetite and, typically, over time, we never see the extreme moves continue but generally retrace as terms of trade adjust to the changed rand levels. And that, despite all the volatility and complete left-field events, black swans and 100-year events (which seem to happen every seven years), a well-managed multi-asset fund can deliver solid, consistent market- and inflation-beating returns.
What do the next 20 years hold? After living through these past two decades, it would be foolish to hazard a guess, given the surprises and shocks that we have experienced. But undoubtedly, the defining factor for the period ahead is the vast amount of debt issued by (mainly) the developed world and the record level of monetary easing implemented by central banks to deal with the impacts of the Covid-19 lockdowns. It is impossible to believe that there won’t be serious repercussions; from inflation, already very evident in asset prices, higher taxes and, ultimately, higher interest rates. The pandemic has also given massive impetus to the push towards a more sustainable world, and this has very meaningful effects on the demand for the ‘green’ commodities that will be required for this transition.
Market Plus is positioned to deal with these two megatrends. First, regarding inflation, the best asset class remains equities, in particular those with pricing power. The Fund is still holding a relatively high weighting to equities despite the market moves, because they should still deliver real growth in an era of rising inflation. We have avoided owning global bonds. Interest rates are all still trading at artificially low levels, impacted by global central bank buying. And, with inflation spiking, with most regions above the top end of their inflation ranges, these bonds are all yielding negative real returns. The only exception to this is SA.
In SA, our yields are still stubbornly high, with real yields of over 6% in the longer-dated bonds. This is because the South African Reserve Bank is one of the few independent central banks left and has refused to manipulate the yield curve. While concerns around our debt position remain relevant, this is more than reflected in the price. Renewed fiscal discipline from the National Treasury, as evidenced through its approach to wage negotiations, as well as some unexpected windfall tax gains from the commodity sector, should be able to move us back to a sustainable debt reduction path. It remains relevant to consider that SA’s total outstanding debt is lower than most developed nations; it is the cost of funding that debt that is the biggest problem. Should that cost come down, the recovery path becomes much more obvious, and bonds will continue to re-rate. Buying the R214, which matures in 2041, you are locking in a return of 10.5% p.a. for the next 20 years – a compelling investment opportunity.
On the trend towards a greener future, the funds have a significant exposure to global miners with meaningful copper production. Anglo American is the only diversified miner to have initiated the development of a new copper mine in the past few years. This production should be coming to the market in 2023, well timed for a huge increase in demand for this metal. Glencore is the diversified miner with the largest percentage of its revenue coming from copper; it also has exposure to battery metals, such as cobalt and nickel. To drive renewable electricity production as well as the rollout of electric vehicles, copper demand will increase dramatically. With a combined allocation of around 20% of Top 20 and Market Plus’s SA equity exposure to these two companies, the funds are well positioned to benefit from this trend.
On the commodity front, recent newsflow has been dominated by the Chinese government’s attempts to cool commodity prices. High iron ore, steel and coal prices benefit producers of those minerals, but lead to inflation and other imbalances that China is attempting to manage. The two main levers they have used is to a) talk down commodity prices by cracking down on ‘excessive’ financial speculation in commodity markets, and b) sell strategic stockpiles of certain metals. The prices of most metals and minerals have corrected over the quarter, suggesting they have had some success. On point a), our views are that the financial speculation introduces price noise, with prices overshooting and undershooting ‘the real price’, i.e. the one set by underlying supply and demand factors. To this end, demand has remained robust (if slowing a bit off a strong base) and supply discipline remains intact. As such, we expect China’s attempts to show only moderate and short-term success. To truly cool prices, China would need to demand fewer metals and minerals. This requires lower growth, with growth being sacrosanct to the Chinese government. On point b), stockpile sales have been small. Ultimately, they would need to be replaced in future, resulting in ‘excess’ demand.
Despite the fact that we view commodity prices as high, we don’t view the share prices as high. The market has taken quite a sceptical approach to this cycle, with share prices lagging commodity prices, resulting in shares trading on undemanding multiples. Put differently, the share prices are discounting commodity prices well below spot (and in many cases below our base case for where they settle). Supply discipline and generous free cash flow yields add to the appeal of the investment cases.
We were net buyers of SA Inc. shares over the quarter, increasing our exposure to Sanlam and the banks. On the back of the strong turnaround in the banking sector’s operating performances and, yet, the poor performance by their share prices, we increased our exposure to the sector. Given our meaningful positions in Nedbank and Standard Bank, we chose to increase the exposure through a new position in FirstRand. As always, we seek to build portfolios that can withstand a range of outcomes. Our SA Inc. holdings sit alongside great global businesses, growing strongly at attractive valuations, as well as mining shares, which also have attractive valuations and material free cash flow yields.
We are still not overweight SA, as we do see the need to temper some of the SA Inc. enthusiasm. The slow pace of our vaccine rollout puts us at a disadvantage compared to other nations, which are seeing returns to normalisation and a more meaningful economic rebound. SA has large tourism, leisure and hospitality sectors, which employ many workers. These sectors remain depressed, with a long, drawn-out recovery ahead.
We continued adding to our gold position. We view gold as cheap insurance at a time of heightened risk and find valuations compelling. We have long seen gold equities trade at multiples of net present value. We now see them at discounts using spot prices and see upside risks to the gold price.
Naspers declined 15.1% over the last quarter. This decline followed a strong run in Q1-21, which left Naspers flat for the first six months of the year. Two factors have been the dominant contributors to this underperformance. The first is the Naspers/Prosus share swap announced in May and the second is that the Chinese authorities have placed tighter controls on technology firms when it comes to deemed monopolistic behaviour and data security. There is a concern in the market that the Naspers/Prosus share swap creates added complexity and may orphan the Naspers asset. We believe that it will not be the final iteration and that, down the line, more steps will be taken specifically to unlock the discount at the Naspers level should it persist.
While there has been no direct action by the Chinese regulators on Tencent, some subsidiary companies have been reviewed, and the risk remains that, at some point, Tencent receives similar attention. We do not dismiss this risk but believe that the impact on Tencent’s three key business verticals is unlikely to materially reduce the asset's long-term value, especially when bought at a large discount through Naspers/Prosus. In the gaming business, the Chinese government has already tightened regulations, and Tencent is compliant; the company also has a strong international component to this business. Stringent consumer data protection within Weixin and the open nature of this platform reduce the likelihood that its advertising business will be targeted. We see the risk of regulatory intervention as highest in the fintech business. Here, we gain comfort that payments, which carry a lower regulatory risk than other financial products, make up 70% of the business and the non-payments business is in line with new regulations. There is a lot of uncertainty, but our analysis leads us to believe that Tencent is on the right side of the regulatory bodies.
An asset class with a very uncertain future is property. The slow shift from physical retail to online was given a huge boost during the lockdowns, resulting in certain retail properties no longer generating rentals. Over and above this, working from home became a reality through lockdown as technologies enabled this. Certain industries are now contemplating this being the future, even in a more normal environment. This has impacted rental tension on these two major property segments, making it difficult to forecast what yields and values these assets will trade at in future. It's too soon to tell. As society reverts to normal, we see that the desire to socialise is as strong as ever, meaning that certain venues will continue to attract footfall. The challenges of maintaining corporate culture and teamwork in a distributed environment will also become more evident as time goes on. As a result, Market Plus has not invested heavily into the property sector, locally or globally, but maintained a small exposure to high-quality, low-geared names. Top 20 has no property exposure.
One of Coronation’s core tenets is that without clients, we have no business. Indeed, without the loyal support of the investors in our funds, none of our achievements would have been possible. We never take our responsibility to grow our clients’ capital lightly. It is a privilege we are conscious of, and we strive to maintain and improve our performance every day.