April 2017 Update
Markets continue to digest the recent cabinet reshuffle which was followed by two credit rating downgrades and renewed calls from some government officials for radical economic transformation. The immediate effect of all this has been a weaker rand. Over this relatively short-term period, the Rand has actually held-up relatively well. However longer-term, material and sustained currency depreciation creates an environment which promotes higher inflation and higher interest rates. It imposes a cost on all South Africans and has unreasonably negative consequences for the poor because it increases the cost of basic goods the most. In the longer run the erosion of business confidence has a cost in the form of less investment and slower economic growth.
Digesting the News
Given the importance of an independent treasury and having the experienced guidance of a well-respected finance team to control expenditure across government, the new finance minister would do well to assure investors that they will maintain these values.
The concerns raised by rating agencies are not beyond the control of South Africa, these are issues which the government, business and key decision makers can largely correct. If South Africa manages to deal with these issues it would possibly prevent further downgrades and probably restore investor confidence over the medium-term.
Bold political and economic reforms are immediately required. This is a direct call for cathartic, and transformative leaders who are willing to break rank from the clusters and myopic views of their parties, and present a different course that delivers real change. While this appears to be the least likely path for South Africa, one cannot completely discount this as a potential possibility.
In times like these, it becomes increasingly difficult to convince investors to stick to their planned investment strategy, especially when this involves remaining invested in portfolios while the market is very volatile. It is for this reason that we continuously advocate for a diversified portfolio which limits the impact of any one event (no matter how severe) on the overall portfolio’s performance.
Markets in the Month
Most surprising during April was the relatively strong rand (which even strengthened against the US Dollar, although this is more as a result of Dollar weakness). We believe that this currency strength might not be permanent considering the real effects of the downgrade will be felt in the medium to long-term and is expected to be overwhelmingly negative.
Other than the USD/ZAR, all other major asset classes delivered positive returns during the month, with the local stock market (as measured by the FTSE/JSE All Share Index), delivering strong growth (+3.6%) in April, buoyed by Rand hedge counters such as Naspers (+9.7%), Steinhoff (+6.1%) and Capco (+13.2%).
Impact on Our Portfolios
Core Wealth has always managed our portfolios with a high level of diversification across asset classes and managers. Given our assessment that the recent reshuffle signals a fundamental change in our countries future prospects (and therefore prospective returns from local asset classes) we have increased offshore exposure (where appropriate) to a level close to maximum, to ensure our clients are sufficiently protected from the negative potential consequences of the downgrade.
In the short-term our funds have performed, weathering the volatility in April well. All our model portfolios were positive in April (up between +0.8% and +2.9%). We attribute this to having built portfolios based on a careful assessment of maximising returns at an appropriate level of risk.
3 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Houseview Strategies
The chart above shows that the foreign houseviews have performed strongest over the last three years, helped by the weaker Rand (+8.0% p.a.) over this period. Within the domestic model portfolios, the majority of the model portfolios are all comfortably ahead of inflation. As the real returns are behind long-term expected returns due to the weak local equity markets over the last 3 years, we do see the potential for some improvement as local equity markets normalise.
As said in our March report, there is better global growth which is more synchronised, meaning it’s not just China, but also the US and Europe. This is supportive of stronger returns from South African assets should the political landscape stabilise. There is also incredible surge in agricultural production, which is expected to increase following the end of the drought. In this regard, inflation is expected to be contained in its range of (4% to 6%) if the Rand can stabilise. In addition, there has been improved sentiment towards emerging markets which has helped South Africa.
We do acknowledge that the credit downgrades are very discomforting and might derail the positive prospects of our economy. In this regard, we have rebalanced our portfolios and increased our offshore exposure to account for this increased risk in a measured manner. At CWM, the risk of the recent downgrade is somewhat mitigated by our philosophy of constructing diversified portfolios which includes exposure to different asset classes and managers.