The funds finished the year on a strong note, driven by a very good recovery in local and global equity markets. Market Plus returned 9.6% for the fourth quarter of 2020 (Q4-20), which brought the full year return to 8.9%, while Top 20 ended its 20th anniversary year with a very strong 12.8% in Q4-20, resulting in a 9% return for the year. Since inception, Top 20 has returned 16.7% per annum. We are very proud to have delivered this over the years to our loyal clients. An investment at the inception of the Fund would have delivered a return double that of an equivalent investment in its benchmark.
COMMODITIES ADDED VALUE
The big driver behind Top 20’s performance for the quarter was the commodity exposure in the portfolio, which remained high throughout the year, despite the extreme volatility we have seen. The key premise behind our commodity view has remained that of improved discipline by the global commodity producers, which means we have not seen the usual supply response to higher prices. On top of this, the rampant money printing by central banks around the world and various stimulus plans to offset lockdowns have resulted in commodity prices moving up rapidly as the dollar weakened and expectations for further weakness remain. Despite the record-high commodity prices in key metals and the very strong cash flows that mining companies are producing, we initially did not see much movement in mining share prices. Markets have remained sceptical about the investment case for mining shares after previous boom-bust cycles. As it becomes evident that there is no significant new supply coming in and that mining companies will reward shareholders with strong cash flows from higher prices, you are likely to see a further re-rating of the commodity sector, in our view.
Our exposures in the Fund are predominantly in the diversified major commodity miners – Anglo American, Glencore and BHP Billiton. On spot prices (which we do think are above normal prices), these companies are all trading on high single-digit or even double-digit cash flow yields. Therefore, even though we think commodity prices will eventually retrace towards more normal levels, there is the prospect of very good dividends to shareholders in the medium term, and there is still upside to the miners, even based on our assessment of normal commodity prices, which is lower than where they are today.
While not a major diversified miner, Exxaro offers exposure to iron ore, thermal and coking coal, and mineral sands. South Africa will remain a major user of thermal coal to power its fleet of coal power stations for the foreseeable future, and it is imperative that coal supply remains intact to ensure a stable electricity supply. Therefore, despite the pressure on coal assets in developed markets, we still think it is important to support a well-managed and responsibly run supplier of coal to the local market. Based on the current Exxaro share price, all that one is paying for today is the iron ore assets; all the other assets are received for free. We think this is an overly pessimistic view on the stock and remain supportive investors in Exxaro to enable it to manage down its coal business in a socially responsible manner, while providing great returns to shareholders.
Our other big commodity exposure remains the platinum group metal (PGM) miners. The current deficit in palladium supply and the increasing recognition of a deficit looming in platinum have seen the prices of these metals move up significantly. Despite this recovery in metal prices and some movement in share prices, the PGM miners’ share prices are still trading on single-digit earnings multiples. Much like the trend we have seen with the diversified miners, none of this cashflow is being invested in new mine expansions, but rather being returned to shareholders. This means prices should remain higher for longer and that investors stand to benefit from the strong earnings being delivered by these companies.
FINANCIAL SERVICES EXPOSURE
The last quarter also saw the beginning of a re-rating for some of the very hard-hit domestic shares that Top 20 owns. As the rand started to strengthen and the gloom over the general economy started to lift, we saw a sharp rise in the prices of the banks in particular. A lot of this happened in tandem with the improvement in the valuation of the South African government bond curve. Our two large bank holdings, Nedbank and Standard Bank were up 28% and 17%, respectively, in this period. Despite this recovery, they are still offering significant value. Our recently purchased position in Bidvest also increased by 13% in the quarter, also benefiting from improved sentiment to the South African economy. However, as the new lockdown takes effect and the virus appears to be hitting a second wave, we are still very circumspect around our exposure to the local economy. We prefer more defensive businesses with the ability to drive earnings growth, even under constrained conditions.
Top 20’s holding in Quilter, the UK-domiciled fund platform and advice business, has performed well, even though the rand strengthened in Q4-20. This has been driven predominantly by the successful conclusion of the largest part of the company’s IT transformation journey, having re-platformed its main system to a new, significantly improved, functionality provider. With the project completed, the company should again be able to focus on growing its market share, especially as it is able to offer a very compelling solution to clients. In the meantime, the shareholder-friendly management team has continued with share buy-backs, enhancing the overall return for remaining shareholders.
Looking forward into 2021, we believe Top 20 remains very well positioned to continue to deliver long-term returns ahead of the market. 2020 gave us the opportunity to reposition the Fund into high-quality investments at very attractive prices. While markets have recovered to pre-Covid-19 levels, this recovery has been very uneven, and, as a result, we still see significant value in specific shares, making this environment very attractive to active managers.
This was also a year where well-managed asset allocation funds could prove their mettle, and we are glad that Market Plus succeeded in minimising losses during the aggressive market selloff and benefited during the sharp recovery experienced thereafter. Use of active protection strategies, such as put options and owning non-correlated investments, as well as tactical increases in cheap equity and domestic bonds after the initial selloff, helped the Fund weather the storm and deliver inflation-beating returns.
Heading into Q4-20, we added to our domestic equity exposure in Market Plus. While most equity markets around the world were already above their pre-Covid-19 starting levels, the domestic market had lagged due to country-specific reasons. After months of holding off, we felt it was the right time to increase our local exposure, and this paid off in the period. Over and above the broad move up in the market, our funds benefited from the significant alpha generated by Coronation in its domestic equity allocations this year (as described above). Exposure to the resources sector saw our equity allocations deliver a stand-out year of outperformance, well ahead of the benchmark.
While the funds have been underweight the more South Africa-specific stocks during 2020, we reduced this underweight in Q4-20, and benefited from some of the recovery that we saw in the very cheap South Africa-specific stocks. These stocks remain cheap, given the very uncertain outlook for the local economy for 2021 as a second wave of Covid-19 infections has necessitated further lockdowns and restrictions.
Market Plus’s global equity allocation benefited from a high exposure to emerging markets. This exposure is held via the Coronation Emerging Markets Fund, which had another great year, producing a return well ahead of the benchmark, which itself was ahead of the global market index. With the prospect of a weaker dollar remaining a high probability, given the US Federal Reserve Board’s position on rates and Democratic Party control of both the House and the Senate, emerging markets should continue to outperform in the period ahead.
We have remained very circumspect on property, given the significant disruption that lockdowns have had on property usage and rentals. In Market Plus, we made small tactical moves, benefiting from very extreme valuations, but overall, the strategy has been to ensure only very defensive allocations to companies with strong balance sheets. With interest rates likely to remain lower for longer, there will ultimately come a time when the high yields available from property stocks will be viewed as attractive again. The opportunity for great returns is evident, but one needs to be extremely careful to avoid those companies with stretched balance sheets or fundamentally overvalued portfolios.
The one asset class still offering good yield is South African government bonds. South Africa has one of the steepest yield curves in the world, where overnight money is earning 3.5%, while 16-year bonds are still offering a return in excess of 10%. Markets are clearly worried about the fiscal situation in South Africa, but the state of our fiscus is not significantly worse than that of many other emerging markets, and it is actually a lot better than that of many developed markets. The main issue, in a kind of chicken-and-egg conundrum, is the high interest rates on South African debt. Were yields to be a lot lower, our debt burden would not be such an issue. What is needed is a return of confidence in the South African government, its budgeting and the country’s economic outlook. If that can be achieved, it will drive a virtuous circle of reducing our funding costs, improving the outlook for the fiscus, which would further drive rates lower.
In the meantime, earning a real return of 6% while one waits compensates for a lot of the risk, in our view. In contrast to this, credit in the local market has rallied very hard, such that good quality corporates are trading below the yield of equivalent tenor government bonds. This market has been overdone and, barring special situations, there is very little upside in the credit market. An example of where some special situations have played out well for Market Plus is our exposure to convertible bonds. The Fund benefited from early investments in Impala and Royal Bafokeng convertible bonds. With the share prices up significantly, the embedded call options in these bonds have become very valuable. In Q4-20, we also invested in a Sappi convertible and a convertible issued by Capital and Counties in the UK.
Other alternative investments have also added to Market Plus’s returns this year. We have benefited from direct commodity exposure, mainly to platinum and gold, but also from a smaller position in copper. These investments are still in place and we expect there to be continued price appreciation, given our view on the US dollar.
After a number of tough years, it is pleasing to be able to have delivered a decent absolute return to our clients for the second consecutive year. Given the yields and valuations in the current Market Plus portfolio, we expect to be able to continue to show good returns well ahead of inflation for the medium term.