By browsing our website, you accept the use of cookies. Our use of cookies is explained in our privacy policy.
Click the PRODUCTS & SERVICES button on the left to expand it again.
Ok. Got itOur research team believes that the market volatility experienced in 2020 presented a rare opportunity for our clients.
At the beginning of 2020 it was impossible to imagine that the world would experience a once in a century pandemic that would affect the way we live, decimate whole industries, see the rise of others and create huge volatility in financial markets. While economies have taken massive, abrupt strain due to lockdowns and other Covid-19-related restrictions, financial markets have by and large recovered and in some cases ended the year much higher than one would expect. This disconnect has arisen due to central banks reacting to the crisis by pushing short-term rates close to zero and implementing enormous purchases of government and other debt securities. This cheap money propped up global bond markets and forced money into stock markets.
We had been concerned about equity valuations heading into 2020, and as such have, by and large, entered this period of volatility with higher cash levels than normal across the range. This has mitigated the downside somewhat, although portfolios were certainly not unscathed.
During the market volatility and correction in March, we took the opportunity to look through the noise and apply our valuation-based framework. We are long-term investors, and as such looked to separate out short-term impacts versus long-term structural effects on companies. This recognised the possibility that some business models could be at risk of longer-term disruption as behaviours and preferences change, resulting in a negative impact on the longer-term earnings power of companies. The volatility made valuations attractive, and as a result we added to risk assets at an asset class level and enhanced the quality of portfolios at an equity level. We also increased exposure to non-South African earnings. Notwithstanding the fluid backdrop at the time, we believe that the market volatility presented a rare opportunity to own assets that will generate value for our clients over the long term.
Our property positioning entering 2020 was neutral, but we cautioned that stock selection was vital given the downside risks to valuations at the time. We also highlighted a strong preference for higher-quality counters with strong balance sheets. As tenants struggled to pay rent during lockdown and the move to working from home was forced on office tenants, the future state of real estate was placed into an uncertain situation. Distributions were reduced, delayed or suspended, cutting off a long-standing source of income for investors. The market called into question the underlying net asset values of buildings and those listed companies with significant gearing suffered large retracements in share prices – the South African property index lost 35% of its value in 2020. Given the uncertainty in this sector, we remain on the sidelines for now, but continue to evaluate when it will be appropriate from a valuation perspective to allocate capital to this sector. Stock selection will be key.
The correction in the South African bond market early in the year put us in an optimal position where we could buy local bonds at very attractive valuations in March and April. Given the benign inflationary backdrop in South Africa and broadly accommodative stance of global central banks, we believe South African bonds continue to offer attractive real returns. This is balanced against a difficult fiscal position for the country, which also remains vulnerable to external supply shocks and a volatile currency. Nominal bonds remain attractive on a relative and absolute level and we believe the risk-reward ratio compensates investors for capital volatility and a range of inflation outcomes.
After several years of outstanding returns from this asset class, we began 2020 on a more normalised basis from a valuation perspective. The 300 bps of interest rate cuts over 2020 saw almost a quarter of preference share capital value being eroded. The possibility of further interest rate cuts (even though this may only be 25 bps) and alternative opportunities like equities and bonds could continue to weigh on capital values in the near term. This suggests to us that in a low liquidity market, capital values may only recover once it becomes clear that the interest rate cycle is turning or has bottomed.
The JSE experienced similar drivers of returns as in 2019: Naspers/Prosus and gold miners. Naspers and Prosus continued to rally along with other global tech stocks, returning over 50% and 30% respectively. While we remain constructive on the investment case for Naspers, we restrict the total exposure for risk-management and diversification to 15% of the house-view equity portfolio. Naspers and Prosus combined comprise approximately 40% of the SWIX 40. As a result, when Naspers generates returns in excess of the market, the house view lags. That being said, the Nedgroup Investments Private Wealth Equity Fund has enjoyed attractive relative returns over the second half of the year, ending 15,5% relative to benchmark of 8,3%, and in the 85th percentile relative to the Morningstar General Equity category over the last six months.
In the face of continued global uncertainty in 2020 (this time due to Covid-19), gold miners rose 134% to the end of July, thereafter losing 42,5% from the peak to end the year up 37%. This follows the 108% total return in 2019. We have never been owners of gold miners as they do not measure up to the quality hurdles we require companies to meet. Gold miners exhibit volatile earnings patterns, consume cash and struggle to meet their cost of capital.
We spent some time this year distilling the key items we believe need to happen for South Africa to have a chance of achieving above-trend growth, thereby raising GDP per capita and improving the chances of avoiding a debt trap. These key performance indicators (KPIs) include i) fiscal consolidation and state-owned enterprise reform, ii) deregulation of the energy market, iii) improving governance by addressing corruption and accountability, iv) evidence of increased fixed domestic investment, v) release of spectrum and infrastructure projects, and vi) an improvement in the ease of doing business. We will be monitoring the direction of these KPIs as this will be important in determining the level of allocation to both domestically focused equities as well as where on the bond curve we want to be positioned.
The current positioning is to be neutrally allocated to domestic equities directly as well as retaining a hedged equity position in equity-linked notes. We are conscious that risks in South Africa have increased and have therefore been conservative in position sizing and stock selection. We require an additional margin of safety for investment in counters solely focused on South Africa.
Our current house-view portfolio positioning is to have a neutral to overweight South African-listed equity, small exposure to preference shares, overweight South African bonds, and underweight domestic cash. We advocate some exposure to gold via the Newgold exchange-traded fund. Gold provides a hedge against geopolitical risk, extreme market events, higher-than-expected inflation and a weaker dollar. It also provides rand-hedge qualities if the rand weakens. Given low real rates globally, the opportunity cost of holding gold is negligible.
We enter 2021 with the humility it requires, knowing that the still fluid backdrop will necessarily present more risks and opportunities. As such we will keep an open mind, change our views when the facts change and above all apply our valuation-based framework.
DISCLAIMER AND IMPORTANT NOTICE: This communication is intended for clients of Nedgroup Private Wealth (Pty) Limited and Nedgroup Private Wealth Stockbroking trading as Nedbank Private Wealth (the companies). The communication is proprietary to the companies and is intended for objective and general information purposes only. Any information contained herein should not be relied upon by a recipient as financial advice and any recipient seeking financial advice is requested to contact an authorised representative of the companies. The communication may not be distributed, transmitted or reproduced in whole or in part without the prior permission of the companies and may not be relied upon in any jurisdiction other than South Africa. Information contained in the communication has been obtained from sources believed to be reliable and the companies make no representation as to the accuracy, timeliness, completeness of the information. All opinions expressed and recommendations made are subject to change without notice. The companies accept no liability for any losses or damages (including direct, special, indirect, consequential, incidental or loss of profits) arising from or in connection with any reliance and/or use of the information contained in this communication (including any error, omission, negligence or otherwise). The companies, their directors, officers and/or employees may have positions or other interests in securities mentioned herein. |