Balanced Plus and Equity declined by 15.4% and 17.5%, respectively in the first quarter of 2020 (Q1-2020). While we did not escape the brutal realities of declining markets, our domestic equity exposure declined less than the benchmarks due to a bias to rand hedge shares and low exposure to South African domestic shares.
In Balanced Plus, we became more constructive on global equities during the quarter, given the sharp sell-off and more attractive valuation levels. While short-term news flow remains poor, once Covid-19 is behind us, corporates will be operating in an environment of unprecedented fiscal stimulus and record-low interest rates, with 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 equity position as we closed out puts that protected us from the worst of the early declines, before adding some equity exposure at lower levels.
The Equity Fund’s large weighting in global equities also helped relative performance. One of its largest international holdings, ecommerce retailer JD.com, delivered very strong returns over the past quarter (+46% in rand). While many traditional brick-and-mortar retailers in China were left reeling, as the Covid-19 lockdown in that country brought consumer demand to a near standstill, JD.com stepped into the void and demonstrated the resilience of its business model and its self-run internal logistics network, ensuring that they were one of the few players that could offer ’locked-down’ consumers an uninterrupted supply of essential goods and services. This demonstration of its competitive advantage has allowed the company to build significant goodwill, which bodes well for its future. During the first quarter of 2020, JD.com released excellent fourth-quarter results in which revenues grew 27% and operating profit grew 125%.. We continue to believe this is a high-quality business with a long runway for growth and, notwithstanding its strong performance, it remains one of the funds’ largest positions.
In an environment with extreme price moves, individual stock selection proved critical. Our two highest conviction local equity ideas in the funds – 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. This is just one reason why we continue to be positive on Naspers. (For more details, please read Adrian Zetler’s article)
British American Tobacco (+2%) held up well during the quarter. As expected, consumer demand for cigarettes has remained remarkably defensive during this unanticipated economic shock. It’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 believe this to be very attractive for a share of this quality and it remains the second biggest local equity position in the funds.
Shares exposed to the domestic economy came under significant pressure during the quarter as the announcement of South Africa’s national lockdown was another body blow for businesses already struggling in a ‘no-growth’ economic environment. Our preference for holding the high-quality defensive food retailers (Shoprite, Spar and Pick n Pay), together with Dis-Chem, rather than the more economically sensitive clothing retailers contributed to relative performance. The food and drug retail sector was down only 13% for the quarter, while the general retailer sector was down a whopping 44%. Our underweight position in the banks also helped during the quarter. Although there is no doubt that their earnings will come under pressure as they struggle to grow advances and their net interest margins will contract on the back of lower interest rates, their real pain will come in the form of higher credit losses, as consumers and businesses buckle under the strain of being leveraged in a very weak economy. However, we have full confidence in the stability of our banking system and, given their conservative past lending practices together with their healthy capital adequacy levels, we believe the banks are well placed to handle the economic shock we are currently experiencing. Our preferred bank holding is FirstRand, which trades at nine times our assessment of normal earnings.
One of the big buys for the funds during the quarter was Anheuser-Busch InBev. Its share price collapsed on the back of poor results, which were then compounded by the impact of Covid-19 (reduced beer consumption and weaker emerging market currencies), coupled with concerns around its high debt levels, which we still think are easily manageable. We bought our position at a price of less than 10 times our assessment of normal earnings. This is an incredible price for one of the world’s best businesses, which is engaged in a stable and long-lived industry that has superior economics. Other buying for the quarter was focused on adding to our existing high-conviction ideas such as Quilter, Anglo American and Shoprite on share price weakness. As funding, we sold down our Pick n Pay position and exited our Richemont position.
We are cognisant of the risks around South Africa’s worsening fiscal position but believe that South African government bonds (SAGBs) remain a reasonably attractive investment opportunity, given their high yields and absence of near-term inflation pressures in the local economy. Balanced Plus therefore continues to hold healthy exposure to SAGBs. Globally, record-low bond yields come at a time of record 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.
Notwithstanding the uncertainties that abound, we remain focused on building diversified portfolios for the long term. We will seek to take advantage of this extreme market volatility to invest in attractive opportunities that the market may present to us, and in so doing, generate inflation-beating returns for our investors over the long term. We are satisfied with the current portfolio positioning and, given compelling valuations, we are optimistic about future return prospects.