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August 2018 Update

Making the News

While most global investors were on holiday in August (those based in the Northern Hemisphere at least), US President Donald Trump found the time to tweet adding further fuel to the trade war fire.

Because of the trade war tensions as well as the crisis in Turkey, most emerging markets including South Africa, had a difficult August.

The issues above have done little to assist South Africa that is in the process of working through its own domestic issues, resulting in a material slump in the Rand against all three major currencies.

The month ended on a negative note for another JSE Blue Chip company, namely MTN who had the Nigerian central bank claim back US$8.1bn due to the repatriation of dividends between 2007 and 2015.

Digesting the News

The noise around the risks in South Africa and other emerging markets is deafening now, with any good news being overlooked or laughed off as fake-news. The overall negativity and pessimism appears to be widespread and some local investors are showing signs of capitulation, choosing to forego the better prospective returns from local assets for the comfort of being invested in safe assets, denominated in safe currencies such as the US Dollar or Euro.

Warren Buffet famously said that to be a successful investor, “One must be greedy when others are fearful and fearful when others are greedy”.

Applying the above principle to the current market conditions would suggest that a long-term investor should be combing the local markets for attractively priced opportunities that are being overlooked by those investors in search of a more comfortable ride in other markets.

If one looks at both the SA Listed Property and SA Equity market, there are a significant number of quality businesses that have been sold-off to levels last seen in the Financial crisis 10 years ago, or in the Emerging Market crisis 20 years ago. Looking at the returns that followed those periods of increased fear and volatility, one must realize that prospective returns from some local asset classes are poised to surprise investors materially on the upside.

While this is not a forgone conclusion and South Africa is facing an uphill battle, investors would be ill advised to have zero exposure to such opportunities, especially if they have a long enough investment horizon and/or enough risk appetite.

Markets in the Month

The extremely weak Rand during August resulted in strong returns from global asset classes when measured in Rands. Global equity was up 12.7%, largely on the back of developed markets (13.2%), as emerging markets (EM) lagged (8.8%) during the month.

South African Equity lagged both Developed and EM equity in the month (up only 2.3%), delivering a disappointing return on the back of weakness from both Naspers (up only 1.0%) and the Financial sector, which ended the month down.

The strong negativity towards EM asset classes resulted in foreign investor outflows from the SA Equity and Bond markets. SA Bonds were the hardest hit, losing 1.9% during the month.

In 2018 SA Money Market is outperforming the other major local asset classes (Bonds, Listed Property and Equity), however lags the riskier assets over 5, 10 and 15 years, as one would expect.

Impact on Our Portfolios

A weak Rand and positively performing Equity markets (SA and global) acted as a strong tailwind for local portfolios, with the more aggressive strategies up strongly in August. The more defensive CWM Income strategy which holds more SA Cash and Bonds and less foreign asset classes delivered the lowest return during the month (up 0.8%). The slightly more aggressive, CWM Defensive was up 3.0% in August, benefitting from the weaker currency.

The longer-term strategies with higher SA and Global Equity exposure (CWM Balanced, Retirement Growth, and Flexible) were up between 3.3% and 4.8% in August and are all now ahead of inflation over the last year.

Our Global Houseviews, CWM Foreign Balanced and CWM Foreign Equity were up 11.5% and 11.0% respectively, with returns driven higher by the weaker Rand.

3 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies

With inflation averaging 5.3% p.a. over the last three years, all the local model portfolios have delivered real returns (above inflation).

With SA Cash, Bonds and Equity all delivering between 7.3% and 8.5% p.a. over this period, only SA Listed Property (-0.3% p.a.) failed to deliver inflation beating returns over the period. Funds with more foreign exposure benefitted from strong global equity markets over the period (15.6% p.a. of which approximately 3.2% p.a. was from the weaker Rand).

Both Foreign Houseviews are materially ahead of SA inflation over the last three years, with the CWM Foreign Balanced Houseview returning 10.5% p.a., and the CWM Foreign Equity Houseview returning 16.0% p.a.

As mentioned last month, all six of the above local strategies remain ahead of inflation since their respective inceptions in 2012/13 and five of the six strategies are in the first quartile of their respective peer groups (Retirement Growth is 2nd quartile) since their respective inceptions.

While some of the absolute returns have been more modest than our long-term expectations, these peer comparisons are pleasing and demonstrate the value add of having a disciplined and well researched investment process.

Looking Forward

In our opinion local markets are beginning to reflect the risks present, and in some cases, too much risk is being priced in (i.e. some assets are looking cheap on a risk-adjusted basis). This suggests that disciplined valuation driven investors may be rewarded in the coming years should South Africa experience the turn-around we all hope for.

While we are not blind to risks, we know that if there is enough margin of safety in the price one pays for an investment, a patient investor will be rewarded in the long-term.

In our client portfolios we continually apply our process of looking for attractively priced assets that will stack the odds of success in our favour, while moving out of those assets that have become expensive and therefore offering lower prospective returns.

This philosophy is not always easy to implement, as it requires going against popular sentiment at times. Experience however, has shown us that the long-term payoff often dwarfs the short-term pain.

July 2018 Update
September 2018 Update