Investment Manager Commentary
Abax Investments

The South African equity market continued its rising trend of 2016 into May with the JSE All Share Index rising by 1.8%. The Nedgroup Investments Entrepreneur Fund had an excellent month performing very defensively in May rising by 0.5% substantially ahead of the JSE Mid and Small Cap Indices which declined by -5.7% and -3.6% respectively.

Reflecting a turnaround in the pattern we have highlighted several times this year already, the industrials sector delivered the best performance in May, posting a total return of +5.1%, while the financial sector recorded a loss of 2.0% and resources (-3.8%) posted their first negative return since January as the strong US dollar put pressure on commodity prices.

The South African economy’s inability to generate growth is reflected in the worrying results of the first quarter labour force survey which shows an increase in the unemployment rate to 26.7% - an eight-year high. We can find few reasons to expect any acceleration in economic growth within the South African economy and believe that political reform extending beyond the determined efforts of National Treasury and the Private Business Initiative will be required to avoid a recession. This is a key factor for all the Sovereign Ratings agencies that have for now retained South Africa’s investment grade status. Clearly more needs to be done before December and we will look for progress in the performance and governance of the state-owned enterprises and the outcome of the August local elections as key indicators of how 2016 will end.

A ratings downgrade triggers multiple self-reinforcing negative effects which start with an increase in the cost of borrowing, leading to further credit tightening and deteriorating confidence, which in turn weighs on investment and end user demand all leading to weaker economic growth. Given this scenario, we maintain our bias for industrial rand hedges and only own select domestic consumer focused businesses that we have confidence are reasonably priced and have the ability to grow their profits and dividends despite the macro headwinds.

Having said that we remain open and vigilant to investment opportunities and despite the negative macro outlook have identified three companies which are trading at very attractive long-term valuation levels and which we believe are well equipped to weather these tough times and will emerge well poised to prosper substantially when the dark clouds eventually part. None are currently Top-10 holdings; however we continue to accumulate these positions patiently.

As at the end of May 2016 the Nedgroup Investments Entrepreneur Fund’s weighted Price to Earnings, dividend yield and Price to Book ratios were 15.0X, 2.8% and 1.8X respectively.

It was another very volatile month for local equities and the 2.3% decline recorded by the JSE SWIX for the month masks the impact of the 10% decline that the index recorded up until 21 January, before recovering a substantial part of its losses earlier in the month. The Nedgroup Investments Entrepreneur Fund experienced an equally volatile month, ending at -4% in comparison with the JSE Mid-Cap Index which actually rose 2.7% and the JSE Small Cap Index which declined by 4.6%.

This volatility has continued into February and we expect it to last as investors and the market vacillate over the outlook for many of the fundamental economic drivers. At times like this, we apply our minds to try and look through the noise and headlines and evaluate where we find long-term fundamental value to lie. We retain a negative and heavily under-weight position in commodities as we see little or no likelihood of a recovery in demand while so far little has been done to curtail supply. While many would argue the share prices of these companies largely reflect these realities, without a recovery in underlying commodity prices we find little value.

Under the well-publicised severe constraints facing the domestic consumer which include rising interest rates, low economic growth, employment declines in many industries and food inflation pressures exacerbated by a drought, we are circumspect about the prospects for South African retailers. Despite this the fund holds a reasonably large exposure to the sector which may appear counter-intuitive. The reason is that the four companies we do own are all run by extremely competent management teams, each with a clear strategy to grow despite the macro headwinds confronting some of their client base. It is comforting and fascinating to be able to participate in the growth of businesses that are so capably led and entrepreneurially managed.

As at the end of January 2016 the Nedgroup Investments Entrepreneur Fund's weighted Price to Earnings, dividend yield and Price to Book ratios were 13.7X, 2.8% and 2.1X respectively.