February 2018 Update

Making the News

The resignation of Jacob Zuma as president was the big news during February and which was received positively by almost all South Africans and investors in South African assets. However, it appears that most asset classes (other than local bonds) had already priced-in this outcome, given the modest response in markets.

A bigger driver of returns globally was the volatility driven correction experienced across most global markets, which saw global equities pull back by 9% in US Dollars, before bouncing off the lows before month end.

Locally, the sell-off in the Resilient group of listed property companies continued into February pulling the SA Listed Property market down another 9.9%.

Digesting the News

Local investors might be surprised to see their portfolios struggling to grow in 2018 given the positivity surrounding the political changes in the country.

This is a function of both macro issues (strong Rand, US interest rates, global correction etc.), as well as the large number of company specific issues we have seen over the last few months, including:

• Steinhoff and related entities,
• Viceroy (and suspected targets) Capitec and Aspen,
• EOH,
• Resilient and related entities
• And most importantly, the largest share on the JSE (Naspers) is also down more than -10% YTD (20% below its all time high)

We are not surprised to see higher volatility (at both an asset class and individual stock level) this late in the market cycle, especially after 2017 saw historically low risk.

Depending on the risk profile and time horizon for specific strategies (or clients), some of this volatility is creating attractive long-term opportunities in certain asset classes, such as:

• The strong rand may allow increasing offshore exposure in portfolios where they have been tactically underweight, or
• Increasing exposure to SA facing listed property or mid/small cap shares that have yet to see a pick-up in performance, but should benefit over the long-term from an improvement in the domestic economy.

Markets in the Month

Despite the positivity stemming from the change in political power, the local equity market as measure by the FTSE/JSE was down 2.0% for the month of February. On a 12-month rolling basis the market’s performance is materially stronger +17.4%. These returns are largely on the back of Naspers which is up +56.4% over this period.

Listed property (SAPY) plunged 9.9% in a repeat of January’s performance. The index is now down 18.8% in 2018, although longer-term returns remain comfortably ahead of inflation (Inflation +7.6% p.a. and +14.2% p.a. over the last 10 and 15 years respectively).

This highlights an important feature of growth assets. Returns in the short-term can be very poor, or even frightening, but patient long-term investors will more often than not be rewarded for sitting through these difficult periods.

Impact on Our Portfolios

Model portfolio performance was soft in February given weak growth asset returns and a strong Rand. The range of returns across the local CWM Model portfolios was -2.0% to +0.6% in February with CWM Income performing best during the month. Our Global Houseviews, CWM Foreign Balanced and CWM Foreign Equity were down -3.6% and -4.7% respectively given the market correction and Rand strength.

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

With local equity only delivering inflation +0.3% p.a. over the last three years, returns across the local model portfolios remain modest. Similarly, the Rand has weakened by just 0.8% p.a. over the last three years, also suppressing the returns from both the Foreign Balanced and Foreign Equity Houseview managers.

Despite the modest Rand depreciation over this period, the CWM preferred Foreign Equity managers have delivered +10.4% p.a., benefitting from reasonably strong global equity markets over the period (+9.0% p.a.) as well as from good manager selection which added an additional +1.4% p.a.

Looking Forward

Given the age of this bull market (now 9 years+) and how stretched valuations are in certain major markets, we are becoming more circumspect when allocating capital to growth assets across all portfolios. Much of the “easy” money is now off the table and the value-add going forward will likely come from managers avoiding big mistakes and ensuring a sufficient margin of safety when selecting underlying securities.

Historically we have preferred using valuation driven managers, and believe current market conditions and the expectation of higher interest rates in the US make these managers even more attractive relative to an index or market cap weighted benchmark at this point in time. Utilising these managers allows us to maintain sufficient exposure to growth assets to ensure long-term returns will be in excess of inflation, with the comfort of knowing that we are not overpaying for the underlying exposures within their portfolios.