Equity Fund update

Mar 20, 2020

5 minutes

The events of Monday, 9 March were the biggest ‘risk event’ in global markets since the global financial crisis (GFC). Thus far, there have been three key contributors to the current turmoil in markets:

Firstly, a quarantine that began in northern Italy crystallised fears around the spread of the coronavirus. Then, Italy placed the whole country under lockdown. Fears have centred on the life-threatening effects of the virus globally, and the economic impact of control measures to impede or stop the spread of the virus.

Secondly, the fallout between Saudi Arabia and Russia has resulted in the collapse of the oil price as ‘OPEC+’ effectively fell apart. Saudi Arabia has vowed to regain lost market share in the oil market by slashing prices.

Thirdly, we witnessed another major collapse in equity markets following the US suspension of travel from Europe, while the World Health Organisation finally declared the coronavirus outbreak a pandemic. Markets sold off as investors began to assess the potential damage to the world economy from the stringent lockdown measures being employed as well as the lack of detail and clarity on the US fiscal front to limit the economic malaise.

It is fair to say that the market reactions we witnessed in recent weeks were initially a product of investor sentiment rather than any evidenced appraisal of the economic impacts. While the outbreak began in China and as such, the infection and mortality statistics were heavily skewed to China, significant outbreaks have since spread across the globe. In a highly interconnected world and facing a virus with such a long, contagious incubation period, this was perhaps inevitable. The fact that other governments have had far greater warning than China may prove beneficial in managing the fallout, but recent evidence paints a mixed picture. The daily infection rate in other regions is currently trending upward. Governments around the world have enforced stricter containment measures.

One positive takeaway is that the situation in China appears to be stabilising, with the rate of new infections reported by the health authorities falling. Temporary treatment clinics in Wuhan have been shut down as people have begun to recover. For now, it seems China may be past the point of maximum pessimism as the government switches focus from fighting the virus to getting the economy back on track, which could influence the return of some positive sentiment in the Chinese market at least.

For broader market positivity, we may have to wait until we see evidence of infection rates in other parts of the world similarly shift from growth to decline.

What are the implications for your portfolios? How are we positioned?

From a portfolio perspective, we are cognisant of the potential implications of this outbreak on some of our portfolio positions. That said, we believe it is paramount for us not to deviate from our disciplined investment process – picking stocks with positive earnings revisions at a reasonable valuation – even in the face of such event risks. The combination of objective factor-based screening and bottom-up fundamental research allows us to cut through inefficiencies, enabling us to avoid behavioural biases and to deliver repeatable and dependable returns.

In fact, we believe thorough bottom-up fundamental analysis is required to understand the source of earnings revisions. It is important to establish whether changes to earnings estimates are due to permanent or temporary factors. This is key to the successful implementation of our investment philosophy.

Some of our key positions include:

Naspers/Prosus
We expect the advertising and payments businesses to be negatively impacted due to the disruptions of overall economic activities in China, while the mobile gaming and subscription video business should benefit from people staying at home with little else to do. Although it is hard to quantify the overall effect on Tencent’s earnings at this stage, any potential impact on its earnings revisions profile should be temporary. We do not believe the coronavirus has changed the earnings power of the Tencent platform, one which the market underestimates in our view.

Resources
The virus outbreak is expected to have a negative impact on steel production in Q1 and Q2 of 2020 as reportedly six provinces remain under quarantine, while the entire country has been slow to resume work after the extended lunar new year holidays. After having spoken to commodity traders and analysts in China, we expect weak Q1 2020 production data as port inventories are rising for various commodities and manufacturing has ground to a halt. The government has, however, reportedly instructed provinces and financial institutions to inject liquidity into the economy, including the issuing of infrastructure-specific bonds. This added liquidity is likely to benefit steel manufacturing commodities such as iron ore, coking coal and manganese, which will be supportive for prices as seaborne supply remains very disciplined. Our assessment is that the demand disruption for commodities is non-permanent and we should see a strong recovery in demand in Q3 2020. As such, we have not made any changes to our portfolio as a result of the coronavirus outbreak. We continue to evaluate our investment decisions based on the fundamentals for each commodity and stock-specific investment cases.

Where do we go from here?

When building and managing our portfolios, we believe the best approach to mitigate company-specific risk is through:

  • Constructing well diversified portfolios
  • Sticking to our investment risk management framework guided by the below four pillars:
    • Staying true to the investment philosophy and process
    • Positioning/quality of research: Is appropriate research, analysis and portfolio construction underpinning the investment outcome?
    • Concentration and liquidity: Are the concentration and liquidity characteristics of the portfolios consistent with their mandates?
    • Risk statistics: Is risk being measured appropriately e.g. VaR, tracking error, stress testing?
  • ESG integration: Analysing factors pertaining to corporate governance is an integral part of our investment process. This does not guarantee the detection of fraud, but it is a focused effort for the promotion of good corporate governance and a conscious ‘measurement’ of ESG risks being undertaken. Companies that score poorly on governance criteria will be ascribed lower valuation multiples in recognition of the prevalent risks.

Macro variables and event risk all have a significant impact on stock returns. It is thus tempting to forecast these and position the portfolio accordingly. Our experience, however, is that these variables and risks are extremely difficult to forecast. Further, there is insufficient breadth in this type of risk taking – the outcome is typically binary. We prefer the breadth of a stock-picking strategy where we are able to diversify risk across a wide range of individual stock positions.

Our aim is to maximise the benefits of our individual stock insights; hence, we closely monitor macro risks which may unintentionally be embedded in the portfolio as a result of the aggregate individual stock selections. Where necessary, we take action to avoid macro risk.

The composition of our portfolio is diversified, with some capital invested in global cyclical companies geared to the global economic cycle and exhibiting favourable earnings revisions profiles such as Naspers (and Prosus) as well as platinum group metals (PGM) investments. More defensive positions include AngloGold Ashanti, Bid Corp, British American Tobacco and Reinet Investments. We also have exposure to select ‘SA Inc.’ plays, including Capitec Bank, FirstRand and Sanlam.

 

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Disclaimer

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 www.NinetyOne.com. 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.

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