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Ok. Got itWe look back at 2017: Our local credit rating came to the brink of a downgrade, while our foreign currency credit rating was downgraded to non-investment grade.
Another gripping year for South African investors
Last year turned out to be another eventful year for South African investors. Local political dynamics contributed to some of the rand and local market volatility that we experienced in 2017. South Africa saw another dramatic change in the finance ministry, as well as a fiercely contested ANC leadership race. Our local credit rating came to the brink of a downgrade, whereas our foreign currency credit rating was downgraded to non-investment grade. The rand touched lows of R14.50 to the dollar during the year, before ending the year at R12.36. The accounting irregularities at Steinhoff International and the immediate resignation of its long-standing CEO could potentially go down as South Africa’s largest corporate scandal.
Lively international politics
International events were less dramatic than the year before. Nevertheless, it still included lively episodes, such as President Trump and North Korean leader Kim Jong-Un having a public spat and making threatening comments regarding nuclear weapons. The election of moderate and market-friendly Emmanuel Macron as President of France was a welcome surprise. Before the election there were significant concerns that Europe was also moving in a more right-leaning and populist direction, following Brexit and Trump’s election as US President.
Risk on
Against this backdrop, local and global markets had a good year. Global markets returned 23%, boosted by dollar weakness, which also contributed to the MSCI Emerging Markets Index gain of 37.8% in 2017 in dollar terms. Locally, the FTSE/JSE All Share Index (ALSI) returned 20.9% and South African bonds returned 10.2%. Naspers was a significant contributor to the JSE’s performance, after its stellar 72% run over the year.
How we were positioned and how we performed
Nedbank Private Wealth’s house view asset allocation positioning performed reasonably well in 2017 and continued a 14-year track record of delivering returns ahead of inflation. We were positioned cautiously, which included a significant allocation to offshore assets and a fairly neutral position across the various domestic asset classes. This prudent approach was primarily driven by the relatively elevated valuations in risk assets combined with significant uncertainties that prevailed for most of last year, especially in South Africa. While the recent strength of the rand has offset some of the returns from our offshore investments, it is always sensible for investors in small emerging markets to diversify their wealth internationally. In the year under review, the binary outcome of the unpredictable but structurally and directionally important ANC Elective Conference that loomed over South Africa for most of the year only added to this consideration.
We were underweight in our direct South African equity exposure, but our portfolios included downside-protected equity-linked notes, which benefitted from the rising markets. Preference shares gave back some of the stellar return of 18% delivered in 2016, and the last few months of 2017 saw weakness in this asset class. Bonds were volatile over the year, driven by political news flow and nervousness about potential credit rating downgrades, but posted a strong rally in December to end the year 10.2% higher. Property had a good year, and the index returned 17%, although there was significant divergence between the performances of the various property shares.
Nedbank Private Wealth Balanced Strategy performance
The Nedbank Private Wealth Balanced Fund of Funds was the top-performing fund in its category over 10 years to the end of December 2017.
December 2017 | 1-year | Inflation | 5-year (per year) |
Inflation (per year) |
10-year (per year) |
Inflation (per year) |
Nedbank Private Wealth Balanced Fund of Funds | 7.0% | 4.2% | 9.6% | 5.4% | 10.1% | 5.8% |
Source: Morningstar
Nedbank Private Wealth Equity Strategy performance
Although the Nedbank Private Wealth Equity Fund’s performance over one year was disappointing, the fund remains in the top quartile relative to its peers over five, seven and ten years to the end of December 2017.
While we delivered positive absolute returns, our equity portfolios underperformed the market. This was due to a combination of factors. Some of our long-standing winning positions went through a consolidation year, but at the same time, we got some things wrong. Our large underweight position in Naspers (due to risk management reasons) also detracted from our relative performance.
December 2017 | 1-year | Benchmark | 5-year (per year) |
Benchmark (per year) |
10-year (per year) |
Benchmark (per year) |
Private Client Model Portfolio* | 9.0% | 24.0% | 14.0% | 12.8% | 12.8% | 11.3% |
Non-tax Model Portfolio* | 4.9% | 24.0% | 14.7% | 12.8% | 13.3% | 11.3% |
Nedbank Private Wealth Equity Fund | 3.3% | 24.0% | 12.9% | 12.8% | 11.6% | 11.3% |
*Excludes fees and trading costs
Source: Morningstar
Last year’s performance needs to be considered in the context of our long-term track record. Over the medium to long term, our equity portfolios have delivered solid absolute and relative returns. The gap between intrinsic value and the market price of an investment varies continuously and materially at times. We focus our efforts on the fundamentals of the companies we invest in, to determine a fair value. At times, market noise can dominate the fundamentals in determining the market price, especially in an era of social media. This is why investing is ultimately a long-term endeavour, and we will have good years and some not-so-good years from time to time. We were pleased that our Nedbank Private Wealth Equity Fund was awarded the Raging Bull Award in 2017 for being the best-performing South African general equity fund over the previous five years. It’s important to stick to one’s investment strategy and not to become short-term focused after a difficult year. In the next section, we discuss the short-term performance and some of our equity holdings in more detail.
Unfortunately, we made some mistakes in 2017, which detracted from our performance. We invested in Brait after Brexit, where we took advantage of the weak pound and the weak sentiment towards UK assets. However, we overestimated the resilience of Brait’s largest investment, the UK retailer, New Look. This asset subsequently underperformed and was written down to zero. The remainder of Brait’s portfolio performed in line with expectations. Although Brait has been a disappointing investment, the return outlook for Brait is attractive from current levels. With New Look currently valued at zero, the rest of the portfolio is trading at a ~40% discount to net asset value. It seems unlikely that New Look will recover to its previous form but returns for Brait from current levels could be attractive given the low starting point.
Our investment in Steinhoff disappointed in 2017. The company announced in December that it uncovered accounting irregularities and would have to restate its financial results.
The full impact of this on the company is not yet known, but the market has reacted very negatively towards the news. When it comes to fraud, it is difficult to uncover this as an outside investor, given that we have to place some reliance on the board and independent auditors for accurate financial statements. Although uncommon, fraud does occur, and is a risk when investing. We therefore make sure that we construct diversified portfolios. Steinhoff is one of approximately 25 different positions in our equity portfolios that span different industries and geographies to limit the potential negative impact of any single event on our overall portfolios.
Some of our large holdings like BAT, Remgro, ABI, Reinet and Curro moved sideways over the last year. For some, this was due to rand strength, and others, like Curro, consolidated some gains from previous years. However, these businesses continued to perform well operationally over the year; we remain long-term investors in these companies and expect good returns from current levels.
Technology counters EOH and Adapt IT detracted from our performance in 2017. Despite these two businesses performing well operationally (both grew their earnings by mid-teens over the year) their share prices did not perform well. In Adapt IT’s case, it appears that general negative market sentiment overshadowed the company’s solid operational performance, attractive valuation and good growth prospects. Market sentiment is cyclical and we expect Adapt IT’s share price to correct and track the company’s fundamentals in time.
Adapt IT’s share price and earnings (2012-2017)
Sources: Reuters, Adapt IT
EOH experienced a confidence crisis towards the end of last year, following corruption allegations that were levelled against FDA, a company that EOH acquired in 2015. FDA contributed around 7% to EOH’s earnings. EOH has subsequently unwound this transaction, but the market has taken a cautious view towards EOH. This coincided with significant share price volatility at the time. We own EOH for its strong strategic position as the leading IT services firm in South Africa, and its resulting exposure to the growing IT services industry in South Africa and Africa.
Counters in our portfolios that outperformed in 2017 included Naspers, Imperial, Bidcorp, Bidvest, Glencore and Standard Bank. The best-performing share was Naspers, which gained 72% last year, and is also our largest equity holding. Naspers’s performance was negative in 2016, which illustrates how volatile returns are in the short term. We remain constructive on the outlook for Naspers but have taken profits during 2017 for risk management purposes to ensure that Naspers does not create too much concentration risk in our portfolios. This has increased our underweight position compared to the benchmark and affected our relative performance negatively.
Looking ahead
The South African market is subject to the rewards and risks specific to South Africa as well as global events and actions, such as the US currency and interest rates as well as global risk appetite.
Our portfolios are positioned for a recovery in economic activity in South Africa, while maintaining a significant offshore allocation. The outlook for South Africa has improved following the election of Cyril Ramaphosa as the new ANC President, but there are still significant fault lines. These include our precarious fiscal position, the poor state of our state-owned enterprises, and structurally embedded social and economic challenges like high unemployment, persistent inequality, poor educational outcomes and labour productivity.
On the international front, the global economy has good momentum with synchronised economic growth and inflation remaining under control. The US tax cuts that were agreed towards the end of 2017 will provide a boost to the earnings of US-based companies. This is however not new news, and markets have discounted this, as evidenced by the healthy returns of risk assets in 2017. As a result, global markets are on the expensive side, and this unfortunately does reduce long-term return expectations.
One of the main risks for 2018 and beyond, in our view, is the normalisation of global interest rates. After a decade of ultra-low interest rates, the UK and US have started to unwind their highly accommodative monetary policy stances by slowly starting to raise interest rates. The European Central Bank (the EU’s monetary authority) and the Japanese authorities have not raised rates but have started to moderate their quantitative easing programmes. Given the health of the global economy, we expect global interest rates, especially US rates, to continue to rise in 2018. Rising rates and expensive markets have historically not been a good combination for future investment returns. While conditions remain favourable for now, longer-term investors should keep an eye on these developments.
While we expect a less dramatic year than the previous two years, it is impossible to predict this with certainty. We therefore maintain a diversified, balanced position at an asset allocation and equity level. We will be looking to take advantage of any long-term investment opportunities that may arise during the year. We remain focused on growing our clients’ wealth ahead of inflation in a sensible manner, over time, and thank you for your continued support.
This communication has been issued by Nedgroup Private Wealth (Pty) Limited trading as Nedbank Private Wealth (“the Company”), and its subsidiaries, and is proprietary to the Company. If forwarded, distributed or transmitted to any person other than an employee of the Company, such transmission is for objective and general information purposes only and the information contained therein should not be relied upon by the recipient as financial advice. Any recipient seeking financial advice is strongly urged to contact an authorised representative of the Company. This communication may not be reproduced in whole or in part without the permission of the Company. The information contained herein has been obtained from sources which and persons whom we believe to be reliable but is not guaranteed for accuracy, completeness or otherwise. All opinions expressed and recommendations made are subject to change without notice. The portfolio holdings of the Company and its employees may from time to time include securities mentioned herein.