The funds had a good start to the year, with Market Plus delivering a return of 9.8% for the first quarter (Q1-21) and Top 20 returning 14.3% against the benchmark return of 12.8%. This marks the first 12-month period since the collapse of most markets due to the Covid-19 crisis. It also explains why the funds’ 12-month returns are so strong, at 45.3% and 56.7%, respectively. Market Plus is well ahead of the benchmark return of 35.5% over this period, showing how many of the active allocation and investment decisions made during this tumultuous period have paid off.
For the quarter, the funds benefited from overweight positions in the diversified miners and platinum group metal (PGM) stocks, while domestic shares detracted.
Commodity prices (with the exception of gold) had a strong quarter. Iron ore was well supported as Chinese infrastructure spend remains strong, the rest of world’s steel demand rebounds and Vale’s production continues to ramp up slowly. Increasing awareness is being brought to battery metals (primarily copper, nickel, lithium and cobalt) and their role in assisting the world to decarbonise. This theme has been enhanced by the Joe Biden presidency in the US. President Biden is likely to recommit the US as a global leader in transitioning economies away from fossil fuels. We expect persistent deficits in the latter half of the decade, particularly in copper and cobalt. Anglo American and Glencore are well positioned for this scenario. We exited BHP Billiton after a strong run in its share price and concerns around the longer-term sustainability of iron ore prices.
We think Exxaro’s capital allocation track record exceeds its reputation. This was further demonstrated by a well-timed sale of non-core Tronox, with most of the proceeds being returned to shareholders via buybacks and a special dividend. We expect further capital returns should the sale processes at Exxaro Coal Central and Leeuwpan conclude successfully. Including ordinary dividends, Exxaro would then have returned c.25% of its market cap to shareholders in a 12-month window.
PGMs performed well this quarter on the back of a strong PGM basket price, led by rhodium. A decade of underinvestment cannot be remedied quickly. Companies have started to announce expansion projects, but these will take time to land. Demand for the metals remains robust on increasing PGM loadings in the autocatalyst industry. The supply issues at Norilsk Nickel, the world’s largest palladium producer, while temporary, will further tighten the market.
We think gold shares look increasingly attractive. Government balance sheets around the world are becoming more stressed as debt is piled on to support the global recovery from Covid-19-induced economic stress. The global printing presses are running hot. For example, 25% of dollars in circulation were issued in the last year. As a centuries-old store of value, gold should thrive in these conditions where fiat money is being debased. However, it seems all the action is taking place in new (untested) stores of value, such as cryptocurrencies. We see upside risk to the gold price, while most of the equities are pricing in a gold price well below spot. We initiated a new position in AngloGold.
Our domestic stance is little changed. After strong share price performance, we sold out of Woolworths as the market accepted the company would no longer put additional funding into its Australian operations. Our domestic holdings are centred around the food retailers (Shoprite and Spar), banks (Standard Bank and Nedbank) and the life insurers (Sanlam and Momentum Metropolitan). While we are encouraged by recent ANC National Executive Committee announcements that suggest continued progress by the President, our defensive stance is informed by the slow pace of delivery, poor electricity availability, the lagging pace of the vaccine rollout, and worries that consumer stress will pick up rather than decrease this year. More importantly, we feel valuations of the rand hedges that happen to be listed here are very compelling.
Both Aspen and Bidcorp (a new position) should be beneficiaries of global vaccine rollouts. Johnson & Johnson’s likely approval for Aspen to fill and finish its Covid-19 vaccine at its Port Elizabeth facility highlights the quality of Aspen’s manufacturing facilities. It should aid the company’s ambition to boost manufacturing earnings before interest rates, tax, depreciation and amortisation (EBITDA) by R1.5 billion. Regarding Bidcorp, after each Covid-19 wave, we see how people are desperate to resume their normal lives by dining out and socialising in public venues. With the vaccine rollout in developed markets going at a reasonable pace, we think Bidcorp’s earnings will bounce back nicely. It is a very well-managed business and should have merger and acquisition opportunities through which to pick up players hurt by the crisis. We expect it will be a strong compounder in hard currency.
We sold out of our MTN position. Management are doing a good job executing the business’s operational turnaround and asset disposal programme to drive up returns on equity. Unfortunately, it cannot escape the fact that 40% of its EBITDA comes from Nigeria. Covid-19 has exacerbated a tough macroeconomic backdrop going into the pandemic. A low oil price, difficulty repatriating foreign exchange and a regulator hellbent on shaking MTN down on a regular basis saw us conclude that there is better risk-adjusted opportunity in the new positions we have initiated.
We see good value in the asset management space. The UK wealth market should benefit from a secular shift away from defined benefit retirement solutions to defined contribution retirement solutions (which increases the need for financial advice). Quilter remains extremely well placed to capitalise on this shift. We ascribe three reasons to Quilter’s low current rating:
- a fairly recent spin-off that wasn’t well covered by the market;
- Brexit fears; and
- Quilter re-platforming its retail advised platform to a new technology provider.
All three of these factors are largely in the rearview mirror, and we expect strong net flows to drive a re-rating in its share price. We also initiated a position in asset manager Ninety One, which has built strong investment franchises in a number of territories over time. Despite good fund performance, which should aid future flows, the share trades on a compelling rating (10 times our assessment of normal earnings and a 7% dividend yield).
In the case of Market Plus, the key driver of the returns for Q1-21 has been an overweight position in equities and very good alpha generated within the equity portfolio. We have been steadily reducing this overweight position into the very strong markets, especially the offshore component, where markets have been exceptionally robust and valuations are starting to look stretched. We have not reduced the domestic equity allocation as much, as we continue to see significant value in the domestic market.
Within Market Plus’s domestic equity allocation, our positive alpha has continued to be driven by a meaningful position in resources shares. In Q1-21, in particular, our holdings of the PGM shares and Exxaro made a big contribution to the Fund’s return. All the PGM shares have reported financial results, and all showed prodigious cash generation and de-gearing. With a general commitment to maintaining a disciplined approach to investing new capital, the majority of this cash is being returned to shareholders. Our investment in Royal Bafokeng Platinum was a standout in this regard, declaring an enormous maiden dividend. After many years of supporting this mine through equity and bond raises, it is a fantastic conclusion to see it generating meaningful returns, having created jobs, having a positive impact on the surrounding communities and now returning cash to shareholders.
The other driver of our alpha in this period was our holding in Naspers. While historically the share price has just tracked its main underlying holding, Tencent, it significantly outperformed in Q1-21, driven by the announced share repurchases being conducted by Prosus as a means to reduce the substantial discount at which Naspers trades to its underlying holdings.
Market Plus is still underweight pure domestic South African businesses, though we continue to add to the high-quality names that we think can continue to grow in a tough domestic environment.
We added to a couple of smaller industrial businesses, such as KAP, Metair and Alexander Forbes, a financial services business that should still benefit from higher market levels, even though formal employed numbers are down.
Our offshore equity holdings are more overweight emerging markets than developed markets. The investment thesis that the rampant printing of US dollars will result in a weaker dollar and much stronger economic growth for the more industrialised emerging markets still holds. While global emerging markets were a beneficiary of this last year, we have seen a small reversal this year as the dollar has stabilised as the yields on longer-dated US bonds have ticked up. We don’t expect this to last for long, and still believe the relative valuation gap justifies a much bigger investment in the emerging market universe.
Our stance not to hold any global government bonds has paid off nicely. The big kick-up in yields on US government bonds saw that sector deliver the first meaningful negative quarter in many years. The expectation of a strong return to growth, coupled with high commodity prices, exacerbated by supply chain issues, should all lead to much higher inflation. The market is starting to price some of this in. We still think the risk is further to the downside and continue to avoid any meaningful holding in global bonds.
We have supplemented our holding in gold by adding a position in the platinum exchange-traded fund. While we held some last year, we had sold out when the rand price spiked in 2020. With the rand strength and an earlier pullback in platinum prices, we have added a small position, as we believe the metal is likely to head into deficits as the pace at which platinum substitutes the more expensive palladium gathers steam.
We have added to our holdings of South African government bonds. Finance Minister Mboweni delivered a second solid, and as fiscally conservative as the trying times allow, Budget for the year ahead. We have seen better revenue collection as well, reducing the projected overall deficits for the years ahead. With much more conservative forecasts by the National Treasury team, we expect these baseline numbers to be beaten in the period ahead. Continued good metal prices and agricultural conditions will see better revenue outcomes for the year ahead. This makes the potential debt burden more sustainable, and our significant outlier yields on bonds that much more attractive. Inflation continues to be well controlled, meaning the real yields on the government bonds are very attractive for long-term savers.
Finally, we have added some small property positions, being very careful to ensure exposure only to quality properties with strong enough balance sheets to ride out the uncertain times ahead. In the short term, they have delivered a nice bounce-back, although they are still trading on very deeply discounted levels.
We remain encouraged by the risk-adjusted opportunities we see and the potential upside within the funds. The current upside remains high relative to history and suggests compelling future returns from the portfolios.+