THE MARKET PLUS FUND, a multi-asset fund aimed at long-term investors growing wealth outside the retirement system, delivered a return of 17.3% in the second quarter of 2020 (Q2-20), against the benchmark return of 16.7%. Top 20, our concentrated South African equity fund, returned 20% in Q2-20 and is ahead of benchmark year to date. The aim of Top 20 is to deliver outperformance over longer time periods, and the since-inception return remains compelling, with alpha of 3.7% per annum, net of fees.
While our domestic equity holdings continue to be more exposed to global businesses than to local businesses, we added to the latter in Q2-20. South African equities are unloved, and a lot of bad news is now discounted in the price. Foreign investors have been exiting South Africa and several good-quality defensive businesses are now priced at attractive levels. Given the ongoing Covid-19 pandemic, near-term earnings forecasting is difficult. Our focus is on assessing the quality of the franchise and balance-sheet strength to find the domestic businesses most able to resume robust earnings delivery once the economic situation normalises. We now own meaningful positions in the food retailers, hospitals and some of the more defensive retailers.
We also added exposure to the insurance and specialised finance sector. As markets rebounded very rapidly, asset bases are close to where they were at the start of the year, while many of these companies are still trading well below their intrinsic value. We hold UK-based wealth manager, Quilter, and insurer, Momentum, in both funds. In Market Plus, we added exposure to the life insurance sector, buying Sanlam and Liberty as well as Ninety One, the recently listed asset manager. While all will face a much tougher economic environment, financial services businesses can operate under lockdown conditions with more ease than many other industries.
AUTOMOTIVE METALS ATTRACTIVE
The strongest performance in Q2-20 came from the platinum group metal (PGM) miners. Last quarter, we wrote about our surprise at the divergence between PGM share prices and the underlying fundamentals, with Northam Platinum and Impala Platinum having fallen 44% and 46%, respectively. This reversed in Q2-20, with the shares rising 69% and 54%, respectively. South Africa is the largest source of primary mine supply. While the lockdown will hurt near-term earnings, the shutting of mines helped to keep supply-demand balances in check. We continue to forecast meaningful deficits in the coming years, which underpins our expectations of strong PGM pricing. The diversified miners also performed strongly over the quarter. Anglo American, Exxaro and Glencore all increased over 30%.
We added Glencore to Top 20’s portfolio. The company has attractive commodity exposure, with over 40% of normal earnings exposed to the so-called electric vehicle metals (copper, nickel and cobalt). The long-term supply-demand outlook for each is promising.
We also believe the supply-demand fundamentals for thermal coal, another key commodity for Glencore, remain favourable. The current low thermal coal price makes a large portion of supply loss-making. With limited investment in new mines and growth in power station demand from India and Southeast Asia, thermal coal prices should trend higher. Glencore’s marketing business, which sources and supplies commodities globally, earns a consistently high return on assets.
The reason why the company trades at a discount to the other major diversified miners are concerns related to governance. We have done significant research into this area and are pleased that it has taken several steps to improve governance since listing in 2011. Some risk remains from the investigation into past practices related to the acquisition of a mine in the Democratic Republic of Congo, particu-larly relating to the vendor Glencore bought it from. While impossible to forecast, we believe most of the risks related to this are reflected in the price. Glencore trades on around six times our assessment of normal free cash flow, which we consider compelling.
INTERNATIONAL EXPOSURE BENEFITS
Aspen shares delivered a 55% return in Q2-20 after announcing good free cash flow generation at interim results stage. Coupled with the disposal of its Japanese business, this allayed investor fears over its levels of debt. Demand for Aspen’s products has remained robust throughout the Covid-19 pandemic. Upside optionality is provided by two products in Aspen’s portfolio.
There is evidence of increased blood clotting in some Covid-19 patients, which can be treated with anticoagulants. Secondly, early evidence from a UK trial testing the drug Dexamethasone on Covid-19 patients has displayed promising results. Despite the recovery from 2019 lows, the share still only trades on eight times our assessment of normal earnings, which do not factor in any of the upside optionality.
The strong share price performance of both Naspers and Prosus continued this quarter, rising 23% and 30%, respectively. Tencent has been a beneficiary of Covid-19, which is accelerating the switch to a digital economy. Recent results were well ahead of market expectations, with games performing strongly. Naspers/Prosus is still the biggest holding in both funds. We reduced our exposure marginally towards the end of the quarter as the shares performed strongly.
DEBT VERSUS EQUITY
In Market Plus, we remain very underweight global government bonds. Currently, 90% of developed market bonds offer yields below 1%. Should any inflation return to the system (always a risk given unprecedent money printing), there will be significant losses in this asset class. We continued adding exposure to our South African government bond (SAGB) holding. This is a market with two strong counteracting forces. The uncertain state of South Africa’s fiscal position is top of mind for global investors who have significantly reduced their holdings of SAGBs. Against this, real yields are at record highs, as rising nominal yields (due to increased supply) and falling inflation combine to offer a compelling opportunity.
At the longer end of the curve, real yields are more than 6% under all but the most extreme inflation scenarios. While the short end of the curve is anchored by the exceptionally low repo rate, the long end reflects the lack of appetite to take on long-dated South African government risk. Given that South Africa has managed its existing debt well and is not very exposed to US dollar liabilities, we think the possibility of a local currency default is unlikely. As a hold-to-maturity investor, the only downside we can see is the risk of inflation reaching double digits for a meaningful time over the coming decade. In our opinion, with the current South African Reserve Bank leadership in place, this is a fairly low probability risk.
We also cut our put protection and raised our global equity weighting as markets fell. Our view was that the significant support offered by developed market governments would allow their businesses to survive the lockdown, in contrast to South Africa, where limited resources mean little support for the corporate sector, implying that any domestic bounce back will be marginal at best. And this is how it played out in Q2-20.
While the S&P 500 Index has recovered to close to its all-time high levels, the FTSE/JSE All Share Index, excluding the global companies that happen to be listed in Johannesburg (e.g. Naspers and Prosus), is still down closer to 20%. While we we are now cutting exposure. There is a battle between the vast amounts of liquidity provided by global central banks trying to find investment destinations and the reality of a tougher economic outlook, coupled with concerns about how the cost of the relief efforts will ultimately be paid for. For now, the liquidity is winning, but the gravitational pull of delivered earnings will see reality reassert itself over time. We expect some normalisation of ratings on global equities.
A DISRUPTED SECTOR
Listed property has been the economic ‘ground zero’ of the global lockdowns. Behavioural changes and shelter-in-place instructions have a large impact on retail centres and office blocks. While it is too soon to tell when life will return to normal, and to what extent work-from-home and online purchasing has become the new normal, we can identify some of the likely winners and losers. Property owners with sufficiently strong balance sheets or defensively positioned assets will survive. In Market Plus, we have included small positions in this sector, but very much on a case-by-case basis. This is a sector where more opportunities will present themselves over time, as stressed balance sheets result in distressed selling of quality assets.
We have reached the halfway mark of the year with the funds down marginally year to date, which we would not have seen as a win at the beginning of the year, but it is undoubtedly better than where we would have expected to be at the end of the first quarter of this year. While the recovery in stock prices has reduced the margin of safety, we are confident in the holdings in our funds, which still show meaningful upside from current levels. +
Coronation Market Plus: Highest annual return 50.0% Aug 2004 - Jul 2005; Lowest annual return (20.1%) Mar 2008 - Feb 2009
Coronation Top 20: Highest annual return 68.9% May 2005 - Apr 2006; Lowest annual return (31.7%) May 2002 - Apr 2003