Ninety One Cautious Managed Fund update

The US-China trade spat has been replaced by a global pandemic and its unforecastable economic consequences. As a result, the first quarter of 2020 has been abysmal for markets; the worst we have experienced since the Global Financial Crisis (GFC). Read more about our strategy.

Apr 28, 2020

6 minutes

The US-China trade spat has been replaced by a global pandemic and its unforecastable economic consequences. As a result, the first quarter of 2020 has been abysmal for markets; the worst we have experienced since the Global Financial Crisis (GFC). Read more about our strategy.

Market background

As we write this, we are in the midst of a 21-day lockdown to help stem the spread of the coronavirus (COVID-19) in South Africa. The US-China trade spat of the previous year is a distant memory of a less volatile time. It has been replaced by fears of a global pandemic and its unforecastable economic consequences. As a result, the first quarter of 2020 has been abysmal for markets; the worst we have experienced since the Global Financial Crisis (GFC). To add to the gloom, ratings agency Moody’s Investors Service finally downgraded South Africa’s sovereign credit to sub-investment grade.

Policy responses from governments across the world have been swift. Entire countries are on lockdown or have severely limited movement, while both monetary and fiscal stimulus are being utilised to prop up economies, prevent businesses and individuals going bankrupt, and to provide much needed liquidity to fragile financial markets. However, we are first and foremost dealing with a health crisis that has completely suppressed consumption (other than staples). Stimulus may prevent the collapse of institutions and individuals, but we expect growth will be severely impacted by the complete cessation of global economic activity.

In financial markets, risk assets endured one of the worst quarters on record. Global equities (MSCI ACWI) plunged -21.4%, lows last seen during the GFC. Developed market equities (MSCI Developed Market Index) closed 21.1% lower, while emerging market equities (MSCI Emerging Market Index) came worst off, down 23.6%. Yield-oriented assets fared relatively better, helped by the US Federal Reserve’s (Fed) rollout of unlimited quantitative easing (QE) and pledge to snap up as many government bonds and corporate bonds as necessary. The Bloomberg Barclays Global Aggregate Bond Index ended the quarter flat at -0.3%.

In South Africa, the JSE All Share Index was down 21.4%, with the All Bond Index down a disappointing 8.7%. While the rand was initially resilient, it weakened 21.7% over the period.

Performance review

In this extreme environment, your portfolio delivered a slightly negative absolute return, lagging its inflation-plus benchmark. However, more importantly, it maintained a positive absolute return over the 18 months to the end of March 2020, the period over which we target capital preservation.

Performance over the quarter was largely driven by positive contributions the offshore equity component, notably, high-quality names such as Microsoft, Nestlé and Verisign. Locally, British American Tobacco and the NewGold exchange-traded funds (ETF) added value. Diversified miner Assore was the standout contributor following the announcement that the Sacco family intend to take the business private. The share rallied 82% on the news.

These gains were partially offset by negative contributions from our small property component (Capital & Counties and Growthpoint Properties), as well as exposure PSG Group, Standard Bank Group and Distell. The portfolio’s local bond component was the biggest detractor from absolute performance. Interestingly, yields rose before the Moody’s rating downgrade as investors sought capital amid a liquidity freeze. The downgrade itself seemed to have little impact on the local bond market.

Portfolio activity

We are not short-term traders. Instead, we prefer to buy what we perceive to be high-quality companies that offer good value, and we hold these positions over the medium to long term. As such, activity over the quarter was muted.

We added slightly to the South African government bond allocation on the back of more attractive valuations. In equities, we made small reductions to holdings in luxury goods maker Richemont and food service operator Bid Corp.

Outlook and strategy

The question on most investors’ minds seems to be: Is it time to buy depressed assets? Our concern is that it is almost impossible to determine if asset prices are depressed if there is uncertainty around the future cash flows of companies. At the best of times, forecasts are difficult; in the current environment, they’re almost impossible. Ultimately, growth and profits will depend on the extent of the pandemic and the length of time that economies remain under lockdown. The spread and impact of COVID-19 has been far worse than most anticipated. But the slowdown in economic activity is self-imposed as governments have curtailed movement, and therefore only we as a global collective can determine when the infection rate has been reduced and contained to the extent that it is safe enough to return to our normal, productive lives. In the short term, we are therefore preserving cash in the portfolio and will only deploy it if we find attractive opportunities.

Looking beyond the medium-term uncertainty, there are further risks that we will need to navigate. The pandemic may accelerate deglobalisation as nations become increasingly inwardly focused. Supply chains may need to be diversified away from China. Comparative advantage may have to suffer to ensure the security of supply. Some industries may be permanently impacted by changed patterns of consumption. And a steady diet of increasing leverage among corporates in a low interest rate world may have to be reassessed in light of plummeting revenues.

This medium -to-longer-term uncertainty highlights the importance of focusing on Quality, especially in a low-risk portfolio. At its core, Quality investing means buying businesses with low leverage that produce goods and services that are fundamental to society. When balanced with appropriate income-generating assets, this creates a safe harbour portfolio that is able to weather extreme movements in markets, while generating inflation-beating returns over the medium to long term. On this basis, the best driver of growth in the portfolio remains what we perceive as high-quality global businesses with limited sensitivity to the economic cycle. We favour those businesses that generate high and sustainable returns on invested capital in excess of their costs of capital. These businesses have not suffered to the same extent as the rest of the market and have provided South African investors with positive returns once the depreciating rand is accounted for.

On the income front, the best opportunity remains South African government bonds generating real returns just north of 6% over 10 years. A lack of global liquidity has pushed local bonds to these levels, with some relief now on offer in the form of QE from the South African Reserve Bank. It is easy to be pessimistic about local bonds given the fiscal and growth outlooks and resultant rising debt- to-GDP ratio. However, at current levels, yields are more-than pricing in this risk and provide far greater certainty than businesses that are only exposed to the local economy. Given that interest rates in South Africa have been cut by 1% (and there are expectations of more cuts to come) and inflation expectations continue to fall (especially given the fall in oil prices), bonds remain a core holding.

Considering property’s high correlation to bonds and the non-existent prospects for rental growth in the near term, exposure in the portfolio remains low. We continue to maintain a small holding in the highest quality stock in South Africa, Growthpoint, as well as exposure to the undervalued Capital & Counties.

We maintain a balance of exposures in the portfolio that offer protection in different investment environments. In light of prevailing risks in this fluid environment, we do not believe it is appropriate to position the portfolio for a particular outcome. As always, we remain unwavering in our commitment to growing your capital in a judicious and discriminate manner.

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Important information

All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. Additional information on the funds may be obtained, free of charge, at Ninety One SA (Pty) Ltd (“Ninety One SA”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). Investment Team: There is no assurance that the persons referenced herein will continue to be involved with investing for this Fund, or that other persons not identified herein will become involved with investing assets for the Manager or assets of the Fund at any time without notice. Investment Process: Any description or information regarding investment process or strategies is provided for illustrative purposes only, may not be fully indicative of any present or future investments and may be changed at the discretion of the manager without notice. References to specific investments, strategies or investment vehicles are for illustrative purposes only and should not be relied upon as a recommendation to purchase or sell such investments or to engage in any particular strategy. Portfolio data is expected to change and there is no assurance that the actual portfolio will remain as described herein. There is no assurance that the investments presented will be available in the future at the levels presented, with the same characteristics or be available at all. Past performance is no guarantee of future results and has no bearing upon the ability of Manager to construct the illustrative portfolio and implement its investment strategy or investment objective. A feeder fund is a fund that, apart from assets in liquid form, consists solely of units in a single fund of a CIS which levies its own charges which could then result in a higher fee structure for the feeder fund. In the event that specific funds are mentioned please refer to the relevant minimum disclosure document in order to obtain all the necessary information in regard to that fund. This presentation is the copyright of Ninety One SA and its contents may not be re-used without Ninety One SA’s prior permission.