In a negative quarter for financials, the Fund returned -16.7%, bringing the one-year return to 14.4%. The long-term performance of the Fund remains pleasing at 10.6% annualised and alpha of 1.3% since inception.

As the Russian invasion of Ukraine continues, worsening geopolitical tensions have increased the risk of higher global inflation and a faster normalisation in global monetary policy. June saw some developed market central banks tightening monetary policy to curb rising inflation after some upside surprises to inflation data during the quarter. While US data is expected to have peaked, inflation in the euro area and the UK is expected to accelerate further as price pressures associated with the impact of the war in Ukraine continue to be felt. In the US, the Federal Reserve Board raised the target range of the federal funds rate by 75 basis points (bps) moving the range to 1.50% to 1.75%. In the UK, the Bank of England (BOE) raised its policy rate by 25bps to 1.25% at the June Monetary Policy Committee (MPC) meeting. While the European Central Bank (ECB) left policy rates unchanged at the June MPC meeting, the ECB signalled it will raise its policy rates in July and September by implementing a 25bps rate hike at each meeting. The South African Reserve Bank (SARB) is due to meet in July and the expectation is for a 50bps rate hike, taking the repo rate to 5.25%. SA has benefited from a significant terms of trade boost that provides more breathing room for the fiscus, but supply side constraints and high energy prices will place pressure on the SARB to normalise rates at a pace consistent with that of major global central banks.

Against this backdrop, equity markets came under pressure during the quarter. The MSCI World Index declined 16.2%, while the MSCI Emerging Markets Index fell 11.4% in US dollars in the quarter. SA was not spared, with the All Share Index declining 20.8% (in USD) after the rand weakened 10.3% against the US dollar. Within the SA market, basic materials was the weakest sector, declining 21.6% in rands, followed by financials (-15.8%), with industrials outperforming at -4.5%. Within the financial sector, banks (-14.5%) outperformed life insurers (-23.1%).

In a rising interest rate environment, banks will benefit from the widening of interest margins as they earn more on their interest free ‘lazy’ deposits and capital (endowment benefit). Higher rates also drive deterioration in credit quality as customers struggle to make payments and economic activity slows. The SA banks come into the current rate hiking cycle with strong capital ratios and good provision coverage to mitigate against any deterioration in credit quality as rates rise. The sharp fall in bank shares in the last quarter presents an opportunity. At current levels, Absa, Standard Bank and Nedbank trade between 5 and 6 times price-earnings multiples two years out, 8% to 9% dividend yields one year out and between 1 and 1.3 times price-to-book multiples. While FirstRand trades at a meaningful premium to the other three banks, we believe this premium is justified given their higher return on equity.

The sharp fall in equity markets has a significant near-term earnings impact on asset management and wealth businesses that earn revenues as a percentage of their assets under management. However, the longterm franchise value of these businesses remains unchanged, particularly if one takes that markets will ultimately recover over the long term. Some of these businesses continue to grow their assets under management by taking in fund inflows which offsets some of the near-term challenges from the market decline. The Fund has holdings in Quilter, a UK wealth manager, and Ninety One, an asset management company. Shares in these companies have come under some pressure because of the decline in equity markets and now present even more attractive investment opportunities. Quilter has a significant adviser base that positions them strongly in the UK savings market where consumers enjoy more control over their savings. Ninety One has invested in its distribution presence across many markets outside of SA and with the costs now in place, will look to leverage their scale and grow assets. Current share prices do not adequately reflect the opportunities in both businesses.

Contributors to performance for Q2-22 include overweight positions in RMI Holdings, Nedbank, PSG Group, Standard Bank and Santam. Detractors from performance included underweight positions in Investec Bank and HCI, as well as overweight positions in Transaction Capital, Discovery and Quilter. Significant actions in the Fund during the quarter included increasing the banks as valuations became more attractive by adding to Absa, Standard Bank, Nedbank and FirstRand. We also added to holdings in Transaction Capital and Quilter. We funded these from Investec Bank, Momentum Metropolitan Holdings and PSG Group.

The sharp fall in equity markets globally presents opportunities for stock pickers to acquire great franchises at attractive valuations. This opportunity extends into the SA financials universe. We continue to position the Fund to benefit from these opportunities.

In a strong quarter for financial sector stocks, the Fund returned 19.1%, lifting the 12-month return to 44.5% off a Covid-impacted base. The longterm performance of the Fund remains pleasing at 11.6% annualised and alpha of 1.4% since inception.

The war in Ukraine dominated world events during the first quarter of 2022 (Q1-22). This is first and foremost a human tragedy, and Russia’s actions should be condemned in the strongest possible terms. The invasion was not broadly anticipated by market participants, and its effects have been most evident in increases in commodity prices - particularly that of energy-related and agricultural commodities given the region’s importance in the supply of these products - as well as a general increase in risk aversion. This comes after a lengthy period of market gains at a time when developed market equity valuations are elevated and central banks around the world are starting to raise policy rates. It is therefore maybe surprising that global markets declined by only 5.4% in the quarter (as measured by the MSCI All Country World Index).

Events in China also played an important role in markets during Q1-22. Regulatory uncertainty, particularly around the technology sector, continues to weigh on sentiment despite recent attempts to reassure investors. In addition, their government’s determination to enforce a zero-Covid policy has resulted in mass lockdowns in major cities and manufacturing hubs. This, along with tight labour markets in developed economies and supply disruptions resulting from the conflict in Ukraine discussed above, is evident in significant increases in developed market inflation rates. Increasingly, there are concerns that higher levels of inflation will persist for longer and that central banks will tighten more aggressively as a result.

Amidst the global turmoil, South Africa (SA) has emerged as something of an emerging market safe haven. The domestic equity market returned 6.7% for the quarter (Capped SWIX) and the bond market 1.9% (ALBI). When one considers that the rand has appreciated by 9.2% over the same period, translating these returns into dollars places SA as one of the best performing markets globally year to date. The financial sector was a strong contributor to the SA equity market returns for the quarter, with banks (25.2%) once again outperforming the life insurance sector (16.7%).

The banks sector has been one of the strongest performing over the past year. In March, four of the five domestic banks reported results that exceeded market expectations and highlighted their resilience over the Covid period, with 2021 pre-provision operating profits (a more meaningful metric than headline earnings, which can be somewhat distorted by the extent to which impairment provisions were raised and subsequently released) matching or exceeding 2019 levels. Despite sluggish advances growth given fortunes that are largely tied to a low growth SA economy, these businesses are beneficiaries of (moderately) rising interest rates, have well provided lending books, continue to demonstrate good cost control, and are well (if not over-) capitalised. They continue to trade on relatively inexpensive valuation multiples. If asset growth doesn’t accelerate, excess capital is likely to be returned to shareholders in order to improve returns, underpinning attractive dividend yields. Life insurers reported results during the quarter that continue to be impacted by excess mortality claims. The Covid provisions that remain in place suggest that the mortality impact should moderate in future, assuming future waves no worse in severity than those linked to the Omicron variant. Capital levels remain strong despite the elevated claims. The Fund currently holds 57% in banks, and 18% in life insurers.

Contributors to Fund performance for Q1-22 include overweight positions in Nedbank and FirstRand, and underweight positions in Old Mutual, Capitec and Coronation. Detractors from performance included overweight positions in Ninety One, Momentum Metropolitan Holdings and Quilter and an underweight position in Absa. In our previous quarterly commentary, we discussed further actions undertaken by RMI to unlock the holding company discount embedded in their structure. We also wrote about the attractiveness of PSG in a similar context. In March, PSG announced its intention to unbundle the majority of its listed assets and at the same time make an offer to shareholders to take the remaining assets private by way of a share buyback. At the time of the announcement, the value of the transaction implied a 38% premium to the price at which PSG shares were trading. PSG represents a 2.7% holding in the Fund, and despite the actions to unlock value the share underperformed the strong gains of the sector in aggregate and detracted slightly from relative performance.
Significant actions in the Fund during the quarter included increasing holdings in Standard Bank, Santam, Ninety One and Old Mutual, and reductions in holdings of Momentum Metropolitan Holdings and Nedbank.

The global economy finds itself in an uncertain place. While activity continues to return to normal as we learn to live with Covid, inflationary pressures have increased significantly and central banks are in the process of tightening monetary policy. A delicate balancing act is required to ensure that the recovery is not derailed. At the same time, risk premia attached to certain emerging markets - particularly Russia and China - have increased, with the result that SA finds itself as a beneficiary. Anecdotally, we hear that there is increased interest in our market amongst foreign investors. SA banks, as relatively large and liquid stocks, would be obvious beneficiaries of this. Life insurers look as though they have the worst of the pandemic behind them. While the financial sector has performed strongly off a Covid-impacted base, valuations are not particularly demanding and dividend yields are attractive. Over the medium to long term however, low structural growth and high unemployment remain a challenge for domestic-facing businesses.