INVESTOR NEED: LONG-TERM GROWTH
Domestic general equity funds
Top 20 and Equity
After a torrid 2018, in which global and local capital markets collapsed, we saw a complete reversal in the first quarter of 2019 (Q1-19), with very strong returns from all capital markets. Against this backdrop, our Top 20 and Equity funds enjoyed a good start to the year, returning 10.2% and 10.7% respectively in Q1-19. These funds’ longer-term performance remains compelling, delivering annualised alpha of 3.8% and 2.6% since their respective launch dates.
Top 20 is a concentrated portfolio of locally listed shares only, while Equity is more diversified, with 80% invested locally and 20% in offshore shares.
Both funds benefited from strong performance by the mining sector over the quarter, particularly that of platinum group metals (PGMs), as well as being underweight domestic-facing South African stocks. The latter came under significant pressure over the period as the realities of operating in a no-growth economic environment filtered through into corporate earnings. In Coronation Equity, the fund’s large exposure to global equities contributed to its performance over Q1-19 and the past 12 months, with a very strong performance from Airbus.
After a long and frustrating wait, PGM shares have finally started to rally strongly, with fund holdings such as Northam Platinum (+47%), Anglo American Platinum (+38%), Impala Platinum (+66%) and our position in the Palladium Exchange-Trade Fund (ETF) (+12% in US dollars) all contributing meaningfully to returns for the quarter. We feel that this is a good example of our disciplined, long-term approach to investing in action, where our aim is to assess information objectively and dispassionately and to avoid being swayed by the news and sentiment of the day.
Naspers, a major holding in both funds, added 19% over Q1-19, benefiting from a strong recovery in the Tencent share price as sentiment towards China shifted positively on the back of reduced trade war fears and Chinese authorities resuming the online gaming licensing approval process. Naspers also surprised the market in March by announcing the offshore listing and part unbundling of its offshore internet portfolio (i.e. Tencent, Mail.ru, OLX, its food delivery businesses, et al.) to reduce the discount at which it trades relative to its underlying intrinsic value. While this is certainly no ‘silver bullet’ that will immediately remove the entire discount, we nevertheless view it as a marginally positive step in the evolution of the group into a global consumer internet powerhouse and one that will allow it access to a wider investor base.
The share price of another major holding in both funds, British American Tobacco, recovered strongly in Q1-19 (+27% in ZAR) on the back of good results which allayed market fears around US volume declines, the company’s debt levels and the outlook for its next-generation products. It also appears that investor anxiety about the regulatory headwinds facing its US business is abating and sentiment is finally starting to turn positive on the share. Notwithstanding this short-term price rally, British American Tobacco continues to trade on only 9.5 times one-year forward earnings and a 7% dividend yield, which we regard as very attractive for a share of this quality.
Quilter, another holding of both funds, also performed very well over the period (+28%) as its maiden full-year results materially exceeded market expectations. The long-term outlook for UK-focused integrated wealth managers with advice forces at scale remains very attractive. This positive outlook is driven by a decline in advisers following the UK’s adoption of the Retail Distribution Review, ‘pension freedom’ boosting demand for advice and opening up the post-retirement market to wealth managers, and a shift away from defined benefit funds to defined contribution funds.
Notwithstanding the uncertainties that abound, we are comfortable with the current portfolio positioning of both funds and remain positive about future return prospects. We remain focused on valuation and will seek to take advantage of attractive opportunities the market may present to us, and in so doing generate inflation-beating returns for our investors over the long term.
Multi-asset class funds
Balanced Plus and Market Plus
The Balanced Plus and Market Plus funds too had been well positioned to benefit from the bounce-back in domestic and global equity markets, delivering returns of 8.5% and 8.6% respectively in Q1-19. Since inception, the funds delivered annualised alpha of 1.2% and 1.9% respectively.
The MSCI All Country World Index ended the quarter up 12.2% in US dollar terms, despite the deteriorating macroeconomic environment in which central banks have become meaningfully more dovish than they were late last year. Developed equity markets, and in particular the US, performed strongly and recorded their best quarter in nearly 20 years. The funds have benefited from their large exposure to global equities and their overweight positions in emerging market equities contributed meaningfully to performance during the quarter. We have retained this overweight position in emerging markets, as the more accommodative monetary stance in the US is supportive of emerging market equity performance and currencies. While the start to the year has been strong, we continue to find opportunities in these markets that are very cheap, with good underlying growth prospects.
South African equity markets also delivered a pleasing recovery in Q1-19, though not to the same extent as global markets. The impacts of Eskom’s rolling blackouts and a poor consumer environment have continued to weigh on local businesses, resulting in a swathe of profit warnings in the quarter, reducing some of the potential market returns. Fortunately, we have avoided owning most of those companies that are struggling, and our portfolios, which are overweight resources companies and global businesses, performed well ahead of the market.
While valuations for local businesses have come down significantly over the past few years as growth has severely disappointed, we are cautious about adding too much exposure here. The growth outlook remains anaemic and the prospects of a pick-up in consumer spending is poor, given a lack of job creation, renewed fiscal discipline at government level, and above-inflationary increases in administered prices and fuel.
We have not made significant changes to our fixed-income positioning. Our domestic property exposure has declined at the margin as we have reduced some of our positions. While yields are still attractive, the environment for property remains challenged, especially in light of the Edcon restructure announcement this quarter, which saw landlords having to forego half their rent for two years.
On the international front, we have continued to avoid fixed income, given no prospect of real returns, but kept up a reasonable exposure to European property that trades on attractive yields relative to bonds.
All in, the funds have made a pleasing recovery this quarter, and are well positioned and exposed to sound portfolios of assets that will drive future returns in line with their mandates of delivering real capital growth over the medium to long term.
INVESTOR NEED: INCOME AND GROWTH
Capital Plus and Balanced Defensive
Despite a more cautious growth outlook, Capital Plus and Balanced Defensive continued to hold large positions, mostly in fixed income, in domestic assets over Q1-19. While bonds have reacted positively to Moody’s decision not to change its credit outlook at the end of March, we think this is a stay of execution rather than an absolute pardon. While the risk of a downgrade may still re-emerge in the coming months, for now the real yields on our portfolio of fixed-income assets remain attractive, given a benign inflation outlook.
We have kept our South African equity exposure fairly constant in both portfolios, with a high weighting to rand-hedge shares. Some of the funds’ large equity positions, such as British American Tobacco and MTN posted robust recoveries after delivering good financial results. Resource counters in particular have had a big re-rating, and we took the opportunity of share price strength to sell out of our Anglo American Platinum position. We have also taken up select small exposures to domestically focused defensive businesses. While we are cautious about the South African growth outlook, our investment discipline is to focus on valuations. If an attractive opportunity presents itself at the right price, we will act accordingly.
South African property shares have continued to deliver a lacklustre performance. Landlords have now finalised an agreement to support Edcon, either via rental reduction or with a recapitalisation. These actions will result in muted distribution growth going forward. While yields are looking reasonable, we have chosen to largely maintain our exposure to domestic property.
At the start of the year, the two funds’ international exposure was relatively low at 22.5% (Capital Plus) and 17% (Balanced Defensive). We bought currency futures to take advantage of attractive exchange rates and exposure now sits at 25% (Capital Plus) and 23.9% (Balanced Defensive). Our offshore exposure is still mainly allocated to global equities, and all of the underlying international investments have delivered good alpha in the last quarter, further assisted by rand weakness.
In summary, the funds have had an encouraging start to the year. Over the last 12 months, both portfolios have managed to beat inflation and Balanced Defensive also ended the period ahead of its real return benchmarks. While the ongoing global uncertainties create much volatility and can result in a range of positive or adverse growth outcomes, our unwavering focus is to build diversified portfolios that can absorb unanticipated shocks.
INVESTOR NEED: IMMEDIATE INCOME
The fund returned 2.5% in Q1-19, bringing its total return for the 12-month period to 7.9%. This return is ahead of that delivered by cash (6.9%) and its benchmark (7.6%) over the same one-year period.
Globally, there has been a complete U-turn by central banks on monetary policy normalisation, leading to an inversion of the US yield curve, which has stoked concerns of an imminent US recession, not to mention the continuing uncertainty about the outcome of US-China trade negotiations and total paralysis surrounding the Brexit process.
Locally, emotions have been running high in South Africa over Q1-19. The Zondo Commission continues to reveal shocking details of alleged corruption in government and its associated institutions. Evidence strongly suggests that years of mismanagement and looting are now resulting in the intensification of load shedding, contributing to an already sombre mood locally. Consumers and corporates have continued to tighten their belts, deepening concerns of continued low growth in South Africa.
The rand was down 1% over Q1-19, ending at 14.40 to the US dollar. Sentiment towards South Africa continues to swing with emerging market sentiment. The fund maintains a small exposure to offshore assets and, when valuations are stretched, it will hedge/unhedge portions of its exposure back into rands/US dollars by selling/buying JSE-traded currency futures (US dollar, UK pound and euro).
The sustainability of South Africa’s investment-grade rating remains a key concern. Credible monetary policy has caused inflation and inflation expectations to gravitate towards the midpoint of the band (4.5%), yet it remains adequately accommodative given the subdued growth profile. Growth, or the lack thereof, remains at the core of the country’s structural problems. Cyclically, growth should pick up to approximately 1.3% in 2019 and 1.8% in 2020. However, the risk to this outcome is to the downside, given the threat of load shedding, the effect it has on business and consumer confidence, and how rising electricity-related costs affect corporate profitability. Unfortunately, given Eskom’s precarious financial and operational position, the state-owned enterprise still poses immense risk to both the fiscus and the economy. (Refer to our analysis and investment impact of the Eskom issue)
The spreads of floating-rate non-convertible debentures (NCDs) have dulled in appeal over the last few quarters because of a compression in credit spreads. This is due to the reduced need for funding from banks in South Africa, given the low-growth environment. Fixed-rate NCDs continue to hold appeal because of the inherent protection offered by their yields and relative to our expectations for a stable repo rate. However, credit spreads remain in expensive territory (less than 100 basis points [bps] in the three-year area and 110 bps in the five-year area). The fund continues to hold decent exposure to these instruments (less floating than fixed) and we will remain cautious and selective when increasing exposure. NCDs have the added benefit of being liquid, thus aligning the liquidity of the fund with the needs of its investors.
Inflation should remain under control, allowing policy rates to remain stable. Global monetary policy has once again turned more supportive for risk sentiment, which should help buoy emerging market valuations over the shorter term. At current levels, local government bonds are trading cheap to fair value estimates. However, given the longer-term risks posed to the economy from further SOE deterioration, allocations are kept at a neutral level. While nominal bonds continue to compare favourably to inflation-linked bonds (ILBs), the balance in the front end of the curve has shifted towards ILBs.
The local listed property sector was up 1.3% over Q1-19, bringing its return for the rolling 12-month period to -7%. Listed property has been the largest drag on the fund, primarily due to generalised equity weakness and idiosyncratic domestic issues related to the possible closure of Edcon, its impact on the broader property sector and lower real GDP growth. However, from an income perspective, distribution growth and expectations around future distribution growth remain sound. Despite the underperformance, from a valuation perspective, the sector is very attractive. The fund maintains holdings in counters that offer strong distribution and income growth, with upside to their net asset value. In the event of a moderation in listed property valuations (which may be triggered by further risk asset or bond market weakness), we will look to increase the fund’s exposure to this sector at more attractive levels.
We believe that the fund’s current cautious positioning correctly reflects appropriate levels of caution. The fund’s yield of 8.9% remains attractive relative to its duration risk. We continue to believe that this yield is an adequate proxy for expected fund performance over the next 12 months.
INVESTOR NEED: OFFSHORE DIVERSIFICATION
No sooner had the dust settled on 2018 than global investors changed their focus from recessionary fears to the more dovish commentary from both the US and European central banks in response to the weaker global economic outlook. Expectations around future interest rate moves re-priced significantly, with investors now expecting the next move to be a decline in short rates in the US. We continue to hold a slightly more hawkish view with regards to interest rates and believe the market has become too complacent about inflationary pressures as well as interest rates. Long bonds rallied, with 10-year Treasuries now trading around 2.5% after touching 3.2% in Q4-18).
Global equities performed well, almost fully erasing the declines of Q4-18, with the MSCI All Country World Index returning 12.2% over the quarter (Q1-19). As a result, the lagging 12-month performance has turned positive again, achieving 2.6%. The US outperformed Europe by about 3% over Q1-19 and by 12.5% over the last year. Japan was a notable laggard over these periods, returning 6.6% over Q1-19, and negative 7.6% over the last year. Emerging markets (as measured by the MSCI Emerging Markets Index) also underperformed their developed market peers by generating 9.9% over Q1-19 and negative 7.4% over the year. China bounced back strongly, as would have been expected given the slightly improved macroeconomic backdrop, but still performed poorly over the last 12 months. Information technology was the best-performing sector, given the reduced long-term discount rate, while interest rate-sensitive sectors such as real estate and consumer discretionary also did well. Energy rebounded on the back of the stronger oil price. Healthcare and financials were the laggards, with financials suffering from the flattening of, and drop in, the yield curve.
Surprisingly, the US dollar also strengthened by 2.2% against the euro and by 1.1% against the yen, contributing to the underperformance of the other regions. Gold was marginally positive over Q1-19.
As alluded to above, global bonds (as measured by the Bloomberg Barclays Global Aggregated Bond Index) had a good quarter, producing a positive return of 2.2% despite the stronger US dollar suppressing non-US asset returns. Over the last 12 months though, the total return for global bonds was still marginally negative. Global listed property performed well against the more benign outlook for interest rates, returning almost 15% over Q1-19. All regions were strong, led by the US, although Japan again lagged the rest of the world. Retail property stocks rebounded from their oversold levels.
The fund had a strong quarter, generating alpha of 3.1% and a fund return of 11.2% in US dollar, the best performance in absolute terms since its inception and close to the best performance on a relative basis. Over the last one, three and five years, the fund is now marginally behind its benchmark.
While we increased the fund’s equity exposure over Q1-19, we averaged an equity exposure of 60% so far this year, thus not fully benefiting from the sharp bounce in equity prices. Our property exposure, while lagging the overall property index returns, still contributed strongly to the good performance. Our fixed interest component was very conservatively positioned, thus not participating in the downward move in long bonds. Over the last 12 months the major detractors were our UK property holdings.
Within equities, it was pleasing that some of our detractors in previous quarters turned around strongly in Q1-19 to contribute to performance. British American Tobacco was the biggest contributor, followed by Altice USA, which has re-rated on slightly better than expected results and rumours of an asset sale that will help the company de-lever quicker than expected. Airbus continued to perform well, aided of late by the misfortunes of its biggest competitor, Boeing. Philip Morris, Charter Communications and Pershing Square Holdings (Pershing) also materially added to the fund’s outperformance.
Pershing is a stock we have held in the portfolio for a long time. We received some questions about this holding, as it represents an investment into a fund that is actively managed by Bill Ackman, an activist investment manager with a great track record, until a few years ago. The fund is a permanent capital vehicle with a relatively high fee structure. This means that unless Ackman performs very well, the fund will tend to perform worse than the market after fees. At the time of investing, Ackman’s fortunes have turned for the worse, following some high-profile disasters, such as investing in Valeant Pharmaceuticals and shorting Herbalife. We bought into the fund, which consists only of listed equities, at a discount to net asset value (NAV) of about 15% to 20%.
Interventions by Ackman since we established our holding included buying back 10% of the fund at a 15% discount to NAV and investing another 10% into the fund in his personal capacity. Over the last 12 to 18 months, his fortunes started changing materially, to the extent that the fund has outperformed the Standard and Poor’s (S&P) 500 Index by more than 20% over this time. Investors have continued to remain on the sidelines though, as is evidenced by the current discount to NAV of 27%. We believe this level of discount is unsustainable, and that a number of alternative actions could help realise some or all of this value. In all of these outcomes, investors will benefit substantially. At the same time though, we have reduced exposure to the stock somewhat, as we are worried that the asset values are now at challengingly high levels. This experience has again highlighted the benefit of taking a longer-term investment view. While these high-conviction ideas do not always work out as well as Pershing, we will continue to look for ideas across the investment spectrum, in both conventional and unconventional sectors and circumstances.
We have somewhat reduced both our equity and listed-property exposure into the rally, and hence the fund is marginally conservatively positioned. While equity valuations are not high, we remain circumspect regarding US interest rates while also keeping an eye on geopolitical developments.
For more information, please refer to the fund fact sheets available on www.coronation.com