Ninety One Opportunity Fund update

It’s astounding to think that at the start of 2020 we were musing over how the US’s continued economic expansion was the longest uninterrupted period of growth in its history. The novel coronavirus SARS-CoV-2 has turned the world upside down. With the majority of the world under some form of lockdown, the global economy has ground to a halt, while economists scramble to gauge the severity of this sudden stop on the global economy. How are we responding in the Opportunity strategy?

Apr 28, 2020

6 minutes

It’s astounding to think that at the start of 2020 we were musing over how the US’s continued economic expansion was the longest uninterrupted period of growth in its history. The novel coronavirus SARS-CoV-2 has turned the world upside down. With the majority of the world under some form of lockdown, the global economy has ground to a halt, while economists scramble to gauge the severity of this sudden stop on the global economy. How are we responding in the Opportunity strategy?

Market background

It’s astounding to think that at the start of 2020 we were musing over how the US’s continued economic expansion was the longest uninterrupted period of growth in its history. Things certainly have changed a lot in a very short space of time.

The novel coronavirus SARS-CoV-2 has turned the world upside down. With the majority of the world under some form of lockdown, the global economy has ground to a halt, while economists scramble to gauge the severity of this sudden stop on the global economy. Will the global economy shrink by 3% or 10% in 2020? There is a lot of uncertainly and no one with all the answers. What we do know is that the toll is going to be high, not only in crude economic terms but also in terms of our humanity, with many losing loved ones and even more losing their livelihoods.

The response of governments and central banks has been immense. Central banks have led the charge, slashing rates and pumping liquidity into capital markets to ensure their smooth operation. Earlier in March, the US Federal Reserve (Fed) off proceedings with an emergency 0.5% rate cut – the first since October 2008 at the height of the global financial crisis (GFC). Governments have also brought out the heavy artillery, fiscally-speaking. The US alone is planning to spend US$2 trillion as part of its economic rescue package. The total extra global fiscal stimulus is estimated to be greater than what was doled out during the GFC. To fund this stimulus, government debt levels are set to soar to unchartered levels. How this debt is going to be repaid is a question few are asking.

Financial markets reflect this turmoil in the wider economy. Equity markets have fallen by significant amounts. The US benchmark S&P 500 Index fell by 20% over the quarter in US dollars, with investors flocking to the perceived safety of government bonds. The yield on the US 10-year Treasury dropped below 1% for the first time, ending the quarter at 0.7% (yields fall as prices rise).

South Africa has not been spared from the carnage. In addition to the pain inflicted by the COVID-19 pandemic, the country suffered an additional blow as Moody’s Investors Service downgraded the country’s sovereign credit rating to one notch below investment grade. As a result, South Africa will no longer form part of the FTSE World Investment Grade Bond Index (WGBI) as of 1 May 2020. After starting the year yielding 9%, the yield on the benchmark SA 10-year government bond spiked to 13% before pulling back to end the quarter at 11%. The JSE ASSA All Bond Index closed 9% lower for the quarter. Local equities were left reeling, in line with the worldwide selloff in risk assets. The South African benchmark FTSE/JSE All Share Index lost 21% over the quarter, while the Capped SWIX closed even lower, down 27% for the quarter. It was a brutal three months for the listed property sector, which almost halved in value.

Performance review

It is precisely during these challenging times when the merits of the Quality investment philosophy manifest. While the portfolio delivered a negative absolute return, we are pleased with how it held up amid the turmoil in global financial markets over the quarter.

Offshore equities and Gold provided double-digit returns in rands, and outperformed broader market indices as well as returns in excess of local cash.

Within the offshore equity component, absolute performance was largely driven by quality companies such as Microsoft, Nestle and Verisign.

Locally, listings such as Assore, Naspers and British American Tobacco also contributed to performance. In addition, a depreciating rand resulted in an extra boost in gains for our offshore and rand-hedge holdings.

Diversified miner Assore, deserves special mention. The position has been in client portfolios for more than 20 years, and has been an impeccable example of capital allocation, a sound financial model and secular outperformance despite being in the cyclical resource sector. The company will delist in May from the Johannesburg Securities Exchange with management taking the business private.

Our meaningful commodity holding in the NewGold exchange-traded fund (ETF) provided counter-correlated performance as bullion benefitted from the risk-off environment. The cash holding in the portfolio also added value.

These positive gains were more than offset by the negative performance of our local equity holdings, namely; Sasol, Bid Corp, Standard Bank and Distell. The significant sell-off of local bonds over the period also resulted in our bond component detracting from absolute performance.

Portfolio Activity

We are not short-term traders. Instead, we prefer owning positions in high quality companies that offer good value. Typically, these positions are held over long periods of time. During this quarter we opportunistically added to existing positions in Naspers, Mondi, PSG and Bid Corp. The small remaining position in Sasol was sold.

The movement in bond yields surprised us to the upside with record real yields on offer. We used the spike in bond yields as an opportunity to increase the fund’s holding in South African government bonds.

Outlook and strategy

The unfolding turmoil in financial markets has highlighted, among many things, the merit in our investment philosophy’s deliberate avoidance of companies with a lot of debt. Highly indebted companies the world over, have come under pressure and many have been forced to withhold dividends.

Our preferred asset class remains global equities. However, as-bottom up stock pickers, we are highly selective in the individual assets we hold. Our preference is for what we perceive as high-quality companies that have enduring competitive advantages, form barriers to entry and provide pricing power. This in turn enables these companies to generate long-term growth and generate sustainably high levels of profitability. The global equities we hold, while trading on similar valuation metrics to the MSCI All Countries World Index, collectively generate significantly higher returns on capital than the other companies in the market.

The outlook for the South African economy has worsened further. While it may be convenient, South Africans should be careful of laying the blame for our troubles solely on COVID-19. Long before COVID-19 reached our shores, South Africa’s economy was already in recession. The fiscal situation in South Africa had been deteriorating steadily over the past decade. Coronavirus was merely the straw that broke the camel’s back.

The sovereign credit rating downgrade by Moody’s, relegating South African bonds to junk status, is a strong signal that we are fast approaching a fiscal cliff. Government debt is rising to dangerous levels. The South African economy is crying out for structural reforms that will spur growth and curtail expenditure. Factors such as policy uncertainty, an inflexible labour market and the lack of a reliable electricity/water supply do not inspire investor confidence. Business confidence is at multi-decade lows and consumer confidence, too, is on the decline. COVID-19 is a massive setback for the economy. GDP in 2020 will likely shrink by more than 5%.

Despite this low growth outlook and despite the South African Reserve Bank (SARB) cutting interest rates by 1% at March’s policy meeting, South Africa’s real interest rates (the interest rates after subtracting inflation) remain among the highest in the world. Given these high real rates, the weak outlook for economic growth and the low inflation expectations (helped in part by the collapse in the oil price), we remain of the view that there is room for the SARB to cut interest rates further.

Locally, we believe the best opportunity remains South African government bonds. With yields of around 11%, these instruments offer higher risk-adjusted return potential than most South African stocks. While we have been increasing our allocation to domestic equities, we remain cautious and believe the local equity market may not be adequately pricing in the risks that companies may face in the coming months.

The correct forecasting of complex global macroeconomic outcomes is almost impossible (as evidenced by recent events). Even if it were, positioning an investment portfolio precisely for such an outcome is even more challenging. We thus do not believe it appropriate to position the portfolio for any particular event. Instead, we maintain a balance of exposures which offers protection against a range of potential outcomes. 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 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. 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.