Coronation Financial comment - Sep 02 - Fund Manager Comment28 Oct 2002
A further unexpected interest rate hike, coupled with large price falls in international markets resulted in only three financial stocks producing positive returns for the quarter (PSG Investment Bank, Investment Solutions and Discovery Health). The average price decline for the large cap financials was in excess of 15%.
The major decliners in the portfolio were African Bank and Investec. However, the fund managers remain confident that the attractive valuation and quality of management of African Bank will vindicate the funds overweight position over time. In addition, the funds holding in the Coronation Global Financial Fund hurt the fund, particularly in September when South African financials were steady. Nevertheless, this fund's performance for the quarter was good relative to the global financial index, -13.8% against -21% in US$.
In terms of valuations, financials are now lower than at the end of the first quarter of 2002 when, as now, they approached valuation levels last seen in 1974, 1982 and 1989. Although the dividend yields are not yet as attractive, inflation and interest rates then were not as they are currently.
The three major calls that investors now need to make are:
- Will the US and UK/European equity markets fall further?
- Have we reached the peak in the interest rate cycle?
- Will the rand remain stable for some time?
Equity markets: The fund managers believe that the international equity bear market will continue for some time, and are therefore negative on Investec and Old Mutual despite their attractive valuations.
Interest rate cycle: Historically, the peak in the interest rate cycle has been a very rewarding time to invest in financial shares (due to the risk premium of financial shares reducing when interest rates stabilise). It would appear that the SARB will once again increase prime due to continued inflationary pressures. Thereafter, if inflation shows signs of abating, equity markets will respond and re-rate financial shares.
The rand: Government is not taking steps to attract fixed direct investment (needed to create jobs) or portfolio flows, which is negative for the rand over the longer term. However, historically, the rand has always been stable after a large fall such as that in December 2001. In the short term, it is almost impossible to call the direction of the rand, and as such the fund managers favour those financial stocks that will provide protection against possible further rand weakness.
New entrants to the financial index, Remgro and Venfin, have been added to the portfolio (interestingly, Remgro and Liberty International now have very large weightings in the new index).
In conclusion, it is important to remember that SA interest rates are at a peak whilst US and UK/European interest rates are at a low. This may result in a separation of our market from overseas markets for a period when our interest rate cycle turns. The factors affecting interest rates: currency; wage negotiations, and food and transport inflation, will be the key variables for SA investors to watch over the next three months.
Coronation Financial slipping in ranks - Media Comment19 Aug 2002
The Coronation Financial Fund has slipped down the rankings for its shorter-term performance. It has built up exposure to Absa, African Bank and New Africa Capital, all still dogged by negative sentiment. A positive international performance was spoilt by rand strength in the past quarter. Financials are undervalued, an opportunity for the patient investor.
Coronation Financial comment - Jun 02 - Fund Manager Comment30 Jul 2002
This quarter's positive 10.3% return must be seen within the context of last quarter's negative return of -12.1% (year to date the fund has returned -3.1%). Investors will recall that during the first quarter of the year, financial shares were negatively impacted due to fears of high inflation, and hence interest rates.
Over the past quarter we saw a continuation of the rand strengthening, which resulted in a very strong rally in financial shares in April, taking the financial index up 15.7% for the month. However, in June, the market focused on secondary inflation fears and the risk of further interest rate hikes, added to which the financial distress in Brazil and the continued US bear market (fed by almost weekly poor corporate governance exposures) helped drag down financial stocks.
The only significant actions taken in the fund were further purchases of Absa (now the fund's 7th largest holding) and African Bank. These shares, as with NAC, are excellent examples of where investor expectations are now very low. Historically, it has always been profitable to invest when expectations are poor. With regards to Absa and NAC, one can understand the reasons for the poor ratings, however, African Bank's management team, in our opinion, deserves a much higher rating.
Capital Alliance dropped to 11th position in the fund, but this is simply due to price action. The fund manager's believe that this share will prove to be yet another example of a strong management team that will continue to grow the embedded value at a higher rate than market expectation. The largest price fall this quarter was recorded by Old Mutual (-16%) where the fund had an almost zero weighting.
The funds' holding in the Coronation Global Financial Fund (listed in Dublin) performed well in US$ terms (+4.6%, and up +9.6% for the year to date). However, the stronger rand translated to a poor performance within the local fund (-5.2%).
Over the next six months, we will see the peak of inflation, followed by the peak in the interest rate cycle (if we haven't already passed the peak). Historically, this has been the best time to invest in financial shares, with the following 18-24 months producing strong returns as interest rates come down and the bad debt risk premium recedes.
Unfortunately, the "dead ground" in between is the period July to October, which in each of the past four years has been plagued by emerging markets or other concerns, with October the "suicide month" at the end! Protection on the downside will come from the fund being underweight life assurers (especially the more expensive Liberty and Old Mutual). However, the fund manager's do know that financial shares are cheap on a historical and relative basis, generating a continuously growing cash dividend with an entry point that is now almost 5% (tax free). In addition, financials have always performed well in a declining interest rate environment.
On balance of probabilities, the next four months should provide an ideal investing opportunity.
Coronation Financial comment - March 02 - Fund Manager Comment15 May 2002
The quarter was characterised by continued negativity towards financial shares. A response that was largely predictable in light of the decline in the Tand, higher than expected inflation and the recent spate of interest rate hikes.
"Panic" selling drove many shares down (Abil -38%; NAC -28%; Sanlam -18% and Investec -16%). While the price movement on Old Mutual was totally confounding, belying the share's underlying fundamentals (Nedcors' 6% fall and the difficult markets faced by their US and UK operations). This share is now very expensive relative to its embedded value.
As SA's PCE growth prospects diminished, we gradually increased our exposure to those shares with offshore growth (Forbes, SBIC, Investec), compelling stories (Abil and Capital Alliance) and those that had simply become too cheap (NAC, Sanlam and Absa).
The fund marginally underperformed its benchmark for the period due to a low weighting in Old Mutual. The 20% holding in Coronation Global Financial Fund contributed positively, however its 6% return in US Dollar terms was negated by the 6% strengthening of the Rand.
The performance of the Coronation Global Financial Fund holding in the portfolio may be negatively impacted by further Rand strength. However, the greater threat to the fund's performance is higher inflation and the attendant interest rate hikes. While history shows that this will not necessarily affect the earnings of many of the financials, it could further negatively impact ratings. But to wait for the peak in the interest rate cycle before investing means taking the risk that the market anticipates the cycle due to what historically are very attractive valuations.
For those investors with a 2 - 3 year time horizon, the 5% (and growing) dividend yield of the sector is extremely attractive.