Market review

Global markets Global equity markets performed well over the quarter. On a total US dollar return basis - the S&P 500 Index gained 9.0%, the MSCI World Index 8.6% and the MSCI Emerging Markets Index 11.8%. The surprising decline in long dated developed market bond yields that started in Q1 reversed in the final quarter of the year. Yield on US 10 year maturity government bonds increased from 1.7% at the end of Q3 to 1.9% at the end of Q4. The yield on 10 year German bonds, which had fallen to -0.6% at the end of Q3, closed the year at -0.2%.

In December President Trump became the third president since America’s founding to be impeached. Nearly all Democrats voted in support of the two articles of impeachment - abuse of power and obstruction of Congress – but they failed to attract Republican support. As Republicans control the Senate and a two-thirds majority would be required to remove Trump from office, a conviction seems unlikely.

In the UK election in December, the Conservative Party secured the biggest majority since 1987 - an unexpected landslide after relentless campaigning on the promise to “Get Brexit Done”. The majority will give Prime Minister Boris Johnson greater leeway to steer future trade talks.
South African markets

SA markets outperformed emerging market peers. The FTSE/JSE Capped Swix Index delivered a total return of 5.3% in rand. US dollar investors gained an additional 7.5% as the rand strengthened from R15.13 at the end of Q3 to R13.99 at the end of Q4. SA bonds delivered 1.9% in rand to investors during the quarter.

In October, the Medium Term Budget Policy Statement (MTBPS) projected a large and sustained increase in government’s debt to GDP ratio as large fiscal deficits remained. This reflected a material deterioration relative to the projections published by National Treasury in February. Treasury warned, “…final adjustments will be announced in the 2020 Budget. These measures require difficult decisions that will affect the economy and the distribution of public resources. The short-term costs, however, are outweighed by the need to ensure sustainable public finances”. Following the release of the MTBPS, Moody’s downgraded SA’s credit outlook to negative (but did not cut the rating to junk). Moody’s said that the change “…reflects the material risk that the government will not succeed in arresting the deterioration of its finances through a revival in economic growth and fiscal consolidation measures. The challenges the government faces are evident in the continued deterioration in SA’s trend in growth and public debt burden”.

Performance

Performance in the final quarter of 2019 was dominated by precious metals with the gold and platinum sectors up 26.1% and 47.0% respectively. Consistent with the trends for 2019, resources (+ 13.8%) beat financials (2.8%) and industrials (0%) for the quarter.

Due to the portfolio’s much lower weighting in gold and platinum stocks, returns lagged the benchmark. We have no exposure to the gold sector as South African gold companies generally do not meet our investment criteria in terms of long-term shareholder value creation. One example is Anglo Gold Ashanti which, over the last 20 years, has unperformed the FTSE/JSE All Share Index drastically, with sporadic periods in which it reacted sharply to spikes in the gold price. Due to deteriorating economics and poor capital allocation this business, and others like it, has failed to compound shareholder value over the long term.

Adcorp (-40%) negatively impacted performance. Over the past 18 months the turnaround at Adcorp appeared to be on track with exceptional results and a positive surprise on the dividend declared for the year to February 2019. This was followed by a sharp turn of events which were linked to poor management decisions and a large reported decline in profits for interim financial results. We initiated a full review of the investment case and based on a thorough assessment of the likelihood and timing of a recovery, we exited our position. This was a stark reminder that while turnarounds may have substantial upside, the success rate is low and they often take much longer than anticipated. Grand Parade (+25%), Remgro (+22%) and Combined Motor Holdings (CMH) (+21%) contributed positively to performance.

Grand Parade has continued to recover following an active approach we took in 2018, with four other asset managers, to have changes made to the board to unlock value for shareholders. The company released a cautionary regarding the potential sale of a significant part of its stake in Burger King. Remgro announced the unbundling of its stake in RMH and FirstRand to shareholders. This is the largest component of the Remgro portfolio and has resulted in a reduction of the discount to the value of its underlying investments. CMH recovered on the back of reasonable results in a fairly challenging environment. We have always had a high regard for the management team and the price trades well below our assessment of the intrinsic value.
Portfolio review

Economic recovery in SA remains elusive in the shorter term. There is little evidence of a concrete plan of action in terms of Eskom and the lack of clarity is having a dramatic impact on business confidence - which is at a 34 year low. It seems extremely unlikely that SA will avoid a further credit downgrade by Moody’s. While a downgrade is a lagging indicator, share prices and the bond markets are forward looking and have already started to discount this news.

Real interest rates in SA remain extremely high. This leaves substantial scope for further reductions in interest rates, although it is unlikely this will happen before the rating review by Moody’s in March. Any positive news on interest rates will provide some relief to falling prices and low valuations, especially for businesses relying heavily on consumers.

We remain cautious on the timing of any recovery, but continue to identify opportunities in well managed companies that are able to grow ahead of their industry peers and trade at discounted prices. We added to existing holdings in Curro and Dis-Chem. The only new holding in the portfolio is Mr Price. We sold out of our positions in Adcorp and Stefanutti Stocks.