October 2018 Update
Making the News
Globally risk assets were sold-off aggressively as higher interest rates in the US, coupled with continued trade war concerns and signs of a slowing global economy resulted in risk-off across the board.
Locally, Finance Minister Nene lost his job for the second time in three years after it emerged that he held multiple meetings with the Guptas while serving as Finance Minister the first time. However, unlike in 2015 when markets reacted extremely negatively towards the change at treasury, President Ramaphosa managed to find a replacement that most would agree has the credentials (and importantly is untainted by state capture) to manage the country’s finances.
Previous governor of the Reserve Bank Tito Mboweni returned to public service as Finance Minister and delivered a soberingly honest Medium-Term Budget Policy Statement to parliament. While the weak economy and the current fiscal position leaves him little wiggle room, his views on State Owned Enterprises (SOEs), the public sector wage bill and bloated cabinet were well received by most.
Digesting the News
October was not a positive month from a news flow or market performance perspective. Lower global risk appetite left most equity markets down (Developed, Emerging and South African) offering very few places for investors to hide.
This widespread market weakness can be seen in the chart below, where the returns from several key global equity markets in October ranged between -2.8% (the US) to -5.8% from SA Equity.
Looking at the performance of these markets in 2018 and over the last twelve months, we can make two key observations:
- SA and Emerging Market Equities have lagged Developed Market Equities considerably (14.0%-14.3% respectively), delivering a similar return over the last twelve months. This would suggest that the recent weakness in returns for SA investors has been driven more by external factors as opposed to any self-inflicted damage (which we have become very accustomed to).
- The US Equity market has driven global returns. US Equities have outperformed Non-US Global Equity Markets by 14.8% over the last year. This suggests that while clients would have benefitted from holding a diverse global equity portfolio relative to a pure SA Equity portfolio (always advisable) over the last twelve months, had you been underweight US Equities, that benefit would have been materially lower.
Looking at the longer-term figures, we see that the US Equities have been the clear driver of global equity returns over the last five years (US Equities account for more than 55% of global indices), benefitting from an incredible run in large cap tech stocks, a stronger US Dollar, and more recently the tax cuts.
Importantly, when we look at returns over the full market cycle (15 years) we see that returns delivered across markets were quite similar. In fact, SA Equities delivered 0.7% p.a. more than US Equities over the last 15 years, this is despite the 32.3% underperformance over the last ten months, and despite the aforementioned self-inflicted damage during the Zuma era. This would suggest to us that while it might seem “obvious” that higher foreign exposure will mean higher returns in the future, past returns and investor sentiment are not the best indicators of future returns.
Markets in the Month
The Rand weakened against the major hard currencies in October (most notably by 3.8% against the USD) as the global risk-off sentiment hurt emerging market currencies. This weakness pushed the Rand’s performance against the USD to -19.2%, a significant re-rating given the improvements we have seen locally.
SA Cash was the only major local asset class to deliver a positive return in October (0.5%), and remains the best performer year-to-date (YTD), up 5.9%.
SA Equity lost 5.8% during October pushing YTD performance to -9.4%. This weak short-term performance has pushed the three-year return from SA Equity to just 2.0%. Despite being extremely weak, even this figure underestimates the poor returns achieved by investors as this figure is gross of any fees that may be incurred to achieve an equity return.
SA Listed Property held up slightly better than Equity in October, losing 1.8% in the month, However, YTD performance remains well behind (-23.5%) given the company specific issues (i.e. Resilient) as well as the negative sentiment around this asset class due to the weak economy and very poor outlook for company earnings going forward.
Impact on Our Portfolios
As was the situation in September, the market conditions in October resulted in weak returns from most strategies (both local and foreign), with the most conservative portfolio (CWM Income) being the only portfolio to deliver a positive return in the month (up 0.7%).
The returns from the more aggressive local strategies were all weak (down between 1.5% and 2.8%) for the month. These portfolios were unable to shake off the impact of the SA and Global Equity markets being down 5.8% and 3.5% respectively.
The Foreign Balanced and Equity Houseviews were hurt by weak global equity markets and lost 1.9% and 3.7% respectively. These low returns (measured in Rands) were despite the Rand weakening by between 1.5% and 3.8% against the three major hard currencies, highlighting just how weak global markets were in October.
3 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
SA Equity and SA Listed Property have done nothing to assist local investors to grow their wealth over the last three years. SA Equity is up 2.0% p.a. over this period, while SA Listed Property is down 2.6% p.a. This creates a major issue for those investors who require local asset class exposure to help meet future Rand based liabilities over the longer-term. This has resulted in returns from most local strategies falling below inflation (5.4% p.a. over the three year period), with the only exception being the CWM Income model portfolio (8.5% p.a.) that invests mainly in SA Cash and Bonds.
Simply having money offshore in a US Dollar or Pound Sterling bank account would have also not helped, as the Rand only lost 2.0% p.a. against the USD and strengthened by 4.1% against the GBP over the last three years (which would have been negative for returns when measured in Rands).
The best performing major asset class over the last three years was global equities (10.2% p.a.) largely driven by US Equities (up 14.0% p.a.) as this market represents more than 55% of global equities. In fact, 75% of the return from Global Equities can be attributed to the performance of US listed Equities.
As a consequence of the weakness in local growth asset markets over the last three years, returns from the local model portfolios have been modest in absolute terms. However, performance relative to the average fund in their respective peer groups has been strong, with all local model portfolios outperforming their respective peer group averages since their respective inceptions in 2012/13, with only CWM Defensive underperforming over the last three years.
While it may not feel like local investors should be more optimistic about future returns after a difficult 2018, an objective evaluation of the current risks, valuations and growth may indicate that investors could reasonably expect higher returns over the next 5 years.
We expect markets (especially local growth assets) to remain volatile as South Africa works its way through the destruction caused by nearly 10 years of rampant corruption and maladministration, especially leading up to the elections in 2019. The prospect of this volatility and the political noise is likely to keep many investors away from these assets, allowing patient long-term investors who can ride out the storm the opportunity to invest in cheaply priced assets, reaping the benefits in the long-term.
It is not surprising to see valuations on risk-assets becoming more attractive during a market pull-back (like we have seen over the last while) despite an improving economic environment as investors shun opportunities with uncertain outcomes for the security of more conservative assets such as cash.
Our investment process aims to construct robust portfolios to not only withstand difficult market conditions but more importantly to grow our clients’ wealth over the long-term. We do this by diversifying across a variety of asset classes and managers, as well as across regions and currencies, with the goal of ensuring that the portfolio’s return is not completely dependent on any one investment view or allocation.
This strategy has stood our clients in good stead over the last ten years through several major markets, political and natural events. We will continue to implement this process in a disciplined manner to ensure our clients continue to benefit in the years to come.