Market overview
Without a doubt, 2017 was an eventful year full of surprises for South Africans. With elevated levels of government corruption, further cabinet reshuffles, a ballooning budget deficit, business and consumer confidence at extremely low levels, credit downgrades, ailing GDP growth, the Steinhoff debacle and finally, a ray of sunshine with the election of Cyril Ramaphosa as the next ANC president. Although there is a clear split in the top six candidates of the National Executive Committee (NEC), with half in the Ramaphosa camp and half in the Nkosazana Dlamini-Zuma camp, we are hopeful that Ramaphosa will be able to reduce government corruption and influence government policy in the right direction.

With all the challenges we faced in 2017, who would have guessed that the rand would have been the sixth best performing emerging market currency in the world, appreciating by 10.9% relative to the dollar (albeit that 9.5%, was achieved in the fourth quarter). The reality is, as has been evidenced in the past, markets pre-empt bad news so the fear of credit downgrades, political challenges and the weak economy were priced into the rand a while ago.

From an equity market perspective, the FTSE/JSE Capped Shareholders Weighted All Share Index (Capped Swix) was up 16.5% for the year and 8.4% for the quarter. The FTSE/JSE Shareholders Weighted All Share Index (Swix) and the FTSE/JSE All Share Index (Alsi) were up 21.2% and 21% respectively for the year and 9.6% and 7.4% respectively for the quarter. Once again, Naspers had a massive impact on the overall markets return for the year with its share price up 71.8%. Excluding Naspers, the Swix and Alsi returns were 11.26% and 12.96% respectively.

The small and mid-cap sectors lagged the overall returns of the market with small caps up 3% for the year and mid cap shares up 7.4%. This highlights the extent of the concentration of the market’s overall returns in large cap shares, driven by the Top40 shares that were up 23.1% for the year. To further understand the concentration of returns in the market it is important to note that of the 176 stocks that make up the Alsi 41 stocks (i.e. 23%) outperformed the market – this means that 77% of the stocks on the JSE underperformed. A total of 59 stocks (34%) had negative returns in 2017. The median return of the 176 stocks was a meagre 1.35%.

From a sector perspective, the quarter was dominated by the performance of financials post the outcome of the ANC elective conference. A Ramaphosa win saw financials return 16% over the quarter, while resources and industrials agged with returns of 4.9% and 4.7% respectively.

Performance
The portfolio returns lagged the overall market as a result of our underweight position in Naspers and the underperformance of our investment in the Naspers core assets. The announcement by Steinhoff of the resignation of the CEO, Markus Jooste, together with the announcement that they had appointed PWC to perform an independent investigation into accounting irregularities took us and the market by surprise. We acted swiftly and immediately sold out of our investment. Our decision was based on the inability to assess the true value of the business on the basis of not being able to rely on the audited financial statements. We sold out at an average price of approximately 1880 cps. The valuation underpin, in our opinion, was the value of Steinhoff’s holding in PSG, KAP and Steinhoff Africa Retail (three listed investments that it owns). This closely equates to the exit price of our investment.

On a more positive note, Ramaphosa being elected was generally positive for many of the domestic SA stocks that we hold in the portfolio. For the quarter, Barclays Group Africa was up by 29.7%, Foschini was up 44.8%, and Standard Bank rose 24.2%, while Tiger Brands and Pick n Pay rose 21.9% and 21.2% respectively. Some of our small cap holdings like Adcorp and Italtile rose 20.6% and 12% respectively.

Over the 12 month period ending December 2017, two of our core resources holdings performed well. Northam Platinum rose 29.7% and Anglo American was up 34.2%. Our best performing small cap holdings were Altron and Hudaco up 34% and 31% respectively.

Outlook
A Ramaphosa victory was crucial, in our opinion, for South Africa. This is likely to result in a gradual improvement in both business and consumer confidence over time. We must, however, not expect a swift recovery. Much damage has been done to the economy due to the high levels of corruption and poor execution of economic policies that have weighed heavily on the growth outlook in South Africa in a period where the rest of the world has shown synchronised growth. The synchronised global recovery, however, will likely provide much needed support to the SA economy and together with a more stable rand and deft leadership from Ramaphosa, the domestic outlook for 2018 is likely to be more encouraging than 2017.

Commodity prices remain strong with copper prices up 30.5% in 2017, iron ore prices have been surprisingly strong given increased supply and while platinum prices are only up by 2.8% in 2017 ($ prices), the palladium price is up by 56%. The oil price has also been strong, rising by 12.5% in 2017. Commodity prices remain supportive of a more stable rand and we would expect our resource stocks to continue to see earnings upgrades as analysts factor in the higher commodity prices. This should be positive for our holdings in Anglo American, BHP Billiton, Northam Platinum and Sasol.

The many conversations that we had with management teams last year pointed to a “wait and see” approach to the outcome of the ANC elective conference. Corporate SA was reluctant to invest additional capital in an uncertain political environment. Although the ANC elective conference concluded with somewhat of a compromised NEC we believe the Ramaphosa win, and the fact that there is greater certainty now that the elective conference is behind us, will result in Corporate SA being more decisive in their capital allocation decisions. This, we believe will be more supportive of some of the small and mid-cap shares that have lagged the overall markets returns over the last few years. This will be positive for our clients’ portfolios.

Should the rand remain stronger and more stable in 2018, we could expect some of the larger rand hedges to tread water and show more modest returns in 2018. However, this is a general statement and returns will clearly be determined by the underlying performance of the companies we own in the portfolio. We believe that the outlook for British American Tobacco, Reinet and Richemont remain positive and hence support our holdings in these rand hedges.

Overall, we believe that the portfolio is well positioned for 2018, especially in the environment that we have described above. We see significant value in domestic SA stocks, in particular in the small and mid-cap sectors. The portfolio remains well diversified with broad exposure to small, mid and large cap shares as well as domestic SA and select rand hedges where we see long-term value.