COVID-19 cracked the crystal ball

COVID-19 cracked the crystal ball

Tamryn Lamb  - 22 June 2020

Investors and their advisers continue to grapple with the question of what life, and indeed the world economy, will look like in the next one to three years. In a lively Q&A-style Zoom webinar, Duncan Artus from Allan Gray, Clyde Rossouw from Ninety One and Neville Chester from Coronation presented their perspectives on the current situation and thrashed out answers to a number of pertinent investment-related questions. You can watch the 70-minute discussion and read a summary of each fund manager’s key points below. 

Allan Gray: Discipline is key at times of distress 

The headlines about COVID-19 will eventually subside, given the very low mortality rates. The focus will then shift to the economic cost, and the subsequent public sector and central bank response across the world. 

For example, the US Federal Reserve committed to buy at least US$120bn of debt per month. With that money you could buy the whole of Richemont plus British American Tobacco in a month. The numbers are staggering. This is occurring at the same time as an ever-greater portion of US voters are leaning to the left. 

While these distorted markets are frustrating for value investors, we are thinking hard about portfolio risk and constructing a diversified portfolio of undervalued assets. 

In our view, the local asset management industry is extremely positioned, with most managers owning the same large dual-listed shares, combined with a full weighting in large-cap offshore equity, offset by a long SA government bond position. This awakens the contrarian in us, and we observed with much interest the significant price moves in many domestic shares two weeks ago when managers tried to switch into them. It seems as if the potential pain trade is local equities outperforming local government bonds. Just over 40% of the Allan Gray Balanced Fund is allocated to local equities. Within this exposure, we look to balance our dual-listed exposure with what we believe are some depressed local shares that have significant potential upside. 

While in the short term we think markets, especially US, have run ahead of fundamentals, many local shares are cheap in a more normalised world. On a five-year view, we would be disappointed if we can’t achieve real returns more comparable to the Fund’s longer-term history, rather than those of the last few years. 

The key for us, as well as financial advisers and their clients, is to stay disciplined and follow our processes.

Coronation: Reinforcing the value of active management 

While the world comes to grips with potential second wave pandemic risks, coupled with the acceptance that a vaccine remains the only feasible offramp, market sentiment continues to swing between optimism (driven by unprecedented fiscal and monetary stimulus around the world) and pessimism (driven by a severe global recession). The developed world continues to demonstrate its ability to support local economies – this is in stark contrast to the emerging world outside of Asia. Against this backdrop, we remain negative on global bonds, with zero exposure to global sovereign debt in our portfolios. We continue to believe that there is value in select global equities and used the sharp sell-off in March to increase our global equity exposure from an underweight to overweight position, with our emerging market exposure concentrated in Asia. 

Back home, the draconian lockdown imposed on South Africa will have a massive impact on corporates and households on the back of an already fragile economic environment. As a result, we remain very concerned with South Africa’s fiscal discipline and continue to closely watch the monetary finance debate – this will drive our view on SA bonds over time. Despite these concerns, we continue to hold both fixed rate and inflation-linked government bonds given the attractive yield gap over cash. 

While many beaten-up SA Inc shares seem very cheap, we prefer owning the global JSE-listed equities and increased exposure during the indiscriminate sell-off at the peak of the COVID-19 crisis. Where we do own SA Inc stocks, we have prioritised our exposure to only include the very high-quality counters that can protect or grow earnings in a tough operating environment. Listed property is currently in a perfect storm and appears very cheap; however, this sector requires deep research capability to identify individual opportunities. While we think that some specific property counters offer compelling value over the long term, we remain focused on managing position sizes very carefully. 

The last few months have demonstrated, once again, why one shouldn’t try to time markets and reinforced the value of active management during times of extreme volatility. During this period, our approach has been one of both offence and defence across our multi-asset funds. The key consideration for investors should be the long-term impact that financial repression will have across asset classes. Cash rates no longer offer comfortable real returns and we are concerned with the long-term inflationary impact of unprecedented stimulus. As a result, we expect a reversal of the strong de-risking trend in South Africa as global investors look to other asset classes to provide protection against inflation. The good news is that we are much more optimistic about the ability of multi-asset funds to provide real returns going forward. 

Ninety One: Positioned for a range of outcomes

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 high-quality companies that have enduring competitive advantages, formidable barriers to entry and enduring 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 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. 

Despite this low growth outlook and despite the SARB slashing interest to 3.75%, South Africa’s real interest rates (the interest rates after subtracting inflation) remain relatively high. Given 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, the best opportunity remains South African government bonds. With yields of around 9.15%, these instruments offer higher risk-adjusted return potential than most SA shares. While we have been increasing our allocation to South African 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 macro outcomes is almost impossible (as recent events bear testament to). Even if it were, positioning an investment portfolio precisely for such an outcome is even more challenging. We therefore do not believe it appropriate to position the portfolio for any single event. Rather 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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