The Market Plus Fund, a multi-asset fund aimed at long-term investors growing wealth outside the retirement system, delivered a return of 2.9% in the third quarter of 2020 (Q3-20), which is 1.1% ahead of benchmark. Over the past decade, the Fund returned 9.6% p.a. net of A-class fees. Top 20, our concentrated South African equity fund, returned 1.3% in Q3-20 and is ahead of benchmark year to date. Top 20 celebrates its 20th anniversary this month and has delivered compelling alpha of 3.6% p.a., net of A-class fees, since inception.
Given the extreme moves in many asset classes and currencies earlier this year, there have been significant opportunities for adding value as markets recovered from the lockdown-driven collapses around the world. The flooding of developed markets by central bank monetary easing and enormous fiscal stimulus programmes is still having an enormous impact on capital markets. In this environment, one must be wary of getting caught up in short-term price moves, when the underlying economic conditions remain treacherous.
JSE-LISTED EQUITY COMPELLING
In Market Plus, we increased overall equity exposure to 67%, mainly focused on South African equities, which now make up 45% of the portfolio. We trimmed the global position and re-established some put protection before the US election period, given the high levels of markets and uncertainty around the potential outcome. In contrast to global markets, the South African equity market looks extremely cheap. While we have successfully avoided owning a lot of South Africa-specific shares that have performed really poorly, their valuations are now such that we cannot ignore the compelling investment opportunities. In addition, recent results indicate that operating performance has not been as poor as we initially expected, although we are cautious reading too much into this, as the economic damage from the harsh government lockdown will be felt for many years to come. Emerging market economies like South Africa have limited financial resources and institutional capacity to withstand the tough economic outlook we expect to prevail.
The global shares that are listed on the JSE, both industrial and mining, are also generally still cheap, making the decision to own more JSE-listed shares an easy one. Of course, the path to achieving the expected returns will be bumpy, and any global selloff will still impact the local bourse, even if our shares are not as richly rated as those on developed market exchanges. However, as long-term investors, the ability to own businesses on earnings yields in excess of 10%, when short-term interest rates are below 4%, makes compelling sense in the long term.
Our two largest locally listed global holdings remain Naspers and British American Tobacco. We wrote about Naspers and Prosus last quarter. We used Prosus as a funding source during Q3-20, including switching some of our Prosus shares into Naspers. The Naspers discount to Prosus continued to widen, reaching 30%. While we expect some discount to persist, we think the quantum is too wide and that management will take action to deal with the discount in due course.
In a world starved of yield, we find British American Tobacco’s 8% dividend yield to be very compelling. In addition, unlike a government bond, we would expect this yield to grow over time. The market remains concerned around a possible menthol ban in the US (US menthol is responsible for c.25% of group profits). However, tobacco legislation tends to play itself out over periods of many years in the US. A menthol ban in Canada saw a limited reduction in smoker numbers and 99% remained with their current cigarette brand. British American Tobacco is also well placed to be one of the winning companies in next-generation products, such as e-vapour and heated tobacco.
We remain constructive on the miners. We believe that the commodity sector has several elements to it that are unprecedented versus historical cycles, which, when combined, present a unique investment opportunity. We continued adding to our Glencore position during the quarter.
A TILT TO DEFENSIVE STOCKS
Our exposure to local companies remains largely tilted towards defensive businesses with strong economics. A tough economic climate will see strong companies getting stronger and companies with pricing power outperforming weaker ones. This was well highlighted by the results reported by Shoprite. Shoprite grew earnings strongly, increasing its market share from an already impressive position. The retailer also announced its intention to exit its loss-making Nigerian operations. Cash flow improved meaningfully as inventory levels were optimised after implementing better IT systems. We trimmed our holding given the strong share price performance and reduced margin of safety.
Sanlam is also a new position in Top 20, as explained in Karl Leinberger’s, commentary.
In the Market Plus Fund’s global equity allocation, we have trimmed the developed market exposure but still maintain a large exposure to emerging markets. The rampant printing of US dollars, a disruptive and divisive election, and general mismanagement of the Covid-19 crisis does not bode well for the strength of the US dollar. After a decade of dollar strength, we expect a significant period of dollar weakness, as the US Federal Reserve Board follows a policy of maintaining negative real interest rates and relaxing its inflation-targeting policy. This bodes well for emerging markets and for commodities. We have therefore increased the weighting to commodities within Market Plus, and own gold, platinum and copper exchange-traded funds. Gold should continue to benefit from flows related to dollar weakness, whereas platinum and copper stand to benefit from looming deficits as supply has been impacted by better supply discipline and growing industrial demand.
FIXED INCOME EXPOSURE
Fixed income exposure in Market Plus continues to be focused on South African government bonds, where yields have remained stubbornly high, despite virtually no yield elsewhere in global markets. Such is the lack of demand for domestic government bonds, even corporate credits are now trading at yields below those of the sovereigns. There is a greater expectation that a South African corporate will repay its debt than the State will. While disappointment is always a possibility, most South African debt is denominated in rands and not dollars, which means, in our view, a very low probability of an actual default under the current government. The Finance Minister, Tito Mboweni, has made himself very unpopular by pushing back hard on the fiscal profligacy that marked the prior decade under then-President Jacob Zuma and is certainly proposing cost-cutting never before spoken about by an ANC Finance Minister.
With real yields in excess of 6% for longer-dated government bonds, any potential negatives are mostly accounted for and any positive news could create opportunities for meaningful capital gains. Global bonds continue to look incredibly expensive and guarantee the holders negative real returns for the foreseeable future.
Property is a difficult asset class in the current environment. Virtually all properties outside of logistics have been negatively impacted by lockdowns, with retail properties the worst, followed closely by office properties. It is difficult to see exactly how the world returns to normal and what this means for rentals in a market where, undoubtedly, demand for space will have reduced. While prices optically show great value, balance sheet strength is the only game in town, and we are being cautious to ensure that any exposure we have is to those companies with robust balance sheets able to resist significant declines in property values.
Looking ahead, we are still very excited about the potential return opportunities from the various asset class building blocks. Yields from just holding the existing assets in Market Plus should enable double-digit returns for the foreseeable future, with capital gains potential on top of that. While there is always risk in markets, the return potential is such that we have significantly increased the risk asset exposures in the Fund to take advantage of this mispricing.
The world remains an uncertain and volatile place. This does unearth good opportunities for stock-pickers with long time horizons. We track the upside of the Top 20 portfolio over time. Current upside levels remain high relative to history and suggest that future returns from the portfolio should be good.