GROWTH ASSETS DISAPPOINTED ...
Many investors are understandably feeling disappointed by the portfolio outcomes reported in their most recent quarterly investment statements. In the early months of 2018 growth assets (equities and property) did not produce the returns investors want. The local All Share Index declined by 6%, global equities by 5.4% (in rands) and the local property index by an eye-watering 20%. The story was different for income assets. Local bonds did exceptionally well, returning 8.1%, and cash delivered the expected 1.7%.
It is perfectly reasonable to expect higher returns from growth assets than from income assets. Historically, equities have produced an average annual return of inflation plus 6% to 7%, while bonds have returned inflation plus 3%. The theoretical explanation for this 3% to 4% return gap is that equity investors require a higher expected return to compensate for the relatively higher risk of equity investing. Herein lies the paradox: while it is highly probable that growth assets will beat income assets in the long run, this quarter again reminds us that short-term outcomes are, quite frankly, all over the place.
The current investment environment is made more testing by an unusually long period of below-trend returns from growth assets, and above-trend returns for bonds. Bonds have outperformed local property over the past five years, local equities over the past four years and global equities over the past three years. This is the sort of environment in which one could easily start to question whether the equity risk premium still exists.
... BUT RETURNS WILL EVENTUALLY MEAN-REVERT
We firmly believe that to lose faith in growth assets would be the wrong lesson for investors. Periods of weaker return typically coincide with an improvement in the fundamentals that underpin future returns. It is no different this time. Lower share prices coupled with underlying earnings growth result in more attractive valuation levels, which are supportive of better future returns. Weak historical returns make better expected returns more likely, not less. Investors are more likely to get what they need if they are able to stay the course.
KEY MARKET EVENTS DURING THE QUARTER
The erratic behaviour of US president Donald Trump remains a key driver of sentiment. Towards the end of 2017, the market celebrated his administration’s corporate tax cuts by bidding up US equities. In 2018, the focus shifted to fears about real wars (in the Middle East or North Korea) and trade wars (mostly with China).
Despite growing concerns, the global economy continues to expand at a brisk pace. While this may sound like a good thing, the positive outlook has led to fears about inflation and higher interest rates, particularly in the US (an economy close to full employment). This in turn led to the return of volatility, with the US market in technical correction territory during February. It also reminded investors that the so-called ‘quality shares’ are not bond proxies after all, with the richly valued consumer staples sector leading the global equity market down with a 5.7% dollar decline. Despite intense scrutiny of Facebook’s unsatisfactory management of user data which led to a congressional hearing, information technology was the best performing global equity sector, recording a 3.5% dollar gain. Read more about the state of international markets in Tony Gibson’s market review.
Ramaphoria continued to define local market outcomes. Decisive action, including changes at Eskom, a mostly constructive cabinet reshuffle and a suitably austere Budget enabled Moody’s to affirm South Africa’s investment grade rating and secure our continued inclusion in the bellwether bond index, the Citigroup World Government Bond Index. This was the driving factor behind the strong performance of the bond market and continued rand strength. It also supported performance from South Africa Inc. stocks such as the banks (up 4.2%) and cyclical retailers (up 9.4%). We reduced exposure to these sectors. While prospects have improved, these shares are priced for very good outcomes which are not necessarily consistent with an environment in which both disposable consumer income and government finances remain under pressure.
The complex issue of land reform also featured prominently on parliament’s passing of a motion to investigate changes to the property clause in the Constitution. While too early to make definitive statements, economist Marie Antelme argues that if the process is well managed it offers not only risk, but opportunity.
A number of local blue-chip shares declined during the quarter. Naspers fell by 16% despite good results announced by Tencent and encouraging signs from some of its other investments. MTN declined by 9% despite a much-improved operating performance, primarily on concerns about its exposure to Iran. British American Tobacco (BAT) also slipped by 16%, partly due to its status as a consumer staple and partly due to concerns about the possible impact of potential regulatory interventions in the US. We continue to hold these shares in our funds as we believe all three to be attractively valued. Read Siphamandla Shozi’s article for a detailed review of the BAT investment case.
GOVERNANCE AND SCANDALS
In the wake of the Steinhoff collapse in December, the market remains intensely focused on companies vulnerable to poor governance and/or aggressive accounting risks. The listed property index came under severe pressure on concerns around valuation levels and accusations of share price manipulation within the Resilient Group. These shares (Resilient, Fortress B, NEPI Rockcastle and Greenbay Properties) declined by between 40% and 70% as a result. At the end of 2017, these companies made up approximately 45% of the index, explaining why property performed so poorly over the quarter. Regulatory investigations into the allegations are ongoing. Capitec Bank was the subject of a short-seller report suggesting that it was technically insolvent, resulting in a 27% fall in late January. After strong support by the South African Reserve Bank and a swift rebuttal from the company, the share price recovered somewhat. Our multi-asset and general equity funds had no exposure to the affected counters at the time of the share price declines.
The audit profession, whose primary responsibility is making sure that all stakeholders have access to reliable financial information, also remains under scrutiny. The debate has moved on from whether reforms are necessary to how the regulatory framework will change. Portfolio manager (and a chartered accountant) Neville Chester shares our views on the matter here.
If you require additional information on a specific Coronation fund, please refer to the fact sheets available on www.coronation.com. You are also welcome to email us at email@example.com if you have any specific questions, concerns or issues that you would like to discuss