PSG Equity comment - Dec 22 - Fund Manager Comment20 Mar 2023
2022 in review
At the start of the new year, we find ourselves reflecting on 2022… a year like no other, a year of pain. To better appreciate outcomes experienced in the year gone by, it is helpful to briefly note the historical context preceding the start of 2022. In the aftermath of the Global Financial Crisis (GFC) (which ended around midway through 2009), developed world countries adopted unprecedented, exceptional and coordinated policy actions. What followed, among other things, was an extended era of ultra-low or negative interest rates. By midway through the 2010s, it was thought that the unconventional policies would be temporary but, ultimately, they continued through the entire decade. By the end of the decade, naturally, the status quo thinking became heavily entrenched, and the asset classes and strategies that continued to be relative beneficiaries of such an environment became very crowded and expensive – they were everyone’s go-to when building a portfolio. With the arrival of the Covid-19 pandemic in early 2020 and the deflationary demand shock that followed (which again reinforced the entrenched view that low inflation and low interest rates would persist, boosting already very expensive assets even more), these ‘longin- the-tooth’ policies were further extended, and even intensified with the addition of enormous developed market fiscal policy stimulus. Fuel was added to the fire, so to speak. As 2022 began, an unexpected war started in Ukraine, resulting in shortages of agricultural commodities and an energy crisis in Europe. Chinese regulatory uncertainty and a property crisis further jangled market nerves. Global supply chains started transforming from ‘just in time’ to ‘just in case’, relocating more business processes and suppliers closer to home, ushering in a new era of reverse globalisation. As pandemic lockdowns eased, long, dormant inflation started picking up. While inflation had initially been deemed as ‘transitory’, it soon became clear that high inflation was likely going to be more persistent and that policymakers would have to unwind their ultraaccommodative policies. Markets began to slide. Mid-way through 2022, the world was wrestling with the highest inflation rates in 40 years, and central banks around the world responded with an unprecedented series of interest rate hikes, sending stocks and bonds into a correction that continued into the end of the year. In retrospect, 2022 was indeed a stomach-churning year. Looking at the returns produced from major global asset classes: the World MSCI Equity Index lost 18% in USD terms, the fourth worst annual performance since 1970; the Bloomberg Aggregate Global Bond Index lost 16% in USD terms, easily the worst year ever, dating back to 1976; a 60:40 combination of the former lost 17.4%, and you would have to look back to 1931 during the Great Depression and the 1937 crash to see worse annual performance numbers from the magical 60:40 formula. Locally, performance numbers were more measured, as emerging and commodity-producing economies share a very different dynamic to the large, developed world economies. With the local currency depreciating by 7% versus the US dollar during the year, the FTSE/JSE SWIX All Share Index and the All Bond Index (ALBI) each returned a positive 4% in local currency terms. Looking forward The likely cause for most of the uncertainty experienced in 2022 is the build-up to a very important inflection point the market is in the process of assessing. We believe the market is trying to find a new equilibrium in a world where money is no longer easy to come by. The era of low inflation is likely behind us, as we start to see the effects of deglobalisation and underinvestment in the real sectors of the global economy manifesting. The period of ultra-low global interest rates is most likely also over for now, and the assets that have fared well in the low inflation environment are unlikely to be the same ones that will fare well in a high inflation world. We believe investors need to reassess the market with a fresh mindset. The shares and sectors that are likely to fare well going forward may surprise some, and are likely to come from areas that have been deeply unpopular for a long time. It’s important to note that market volatility is likely to continue, and while dislocations are never pleasant, they present attractive opportunities for patient, long-term investors. We are encouraged by the performance we have been able to provide in our funds due to our early positioning for the big changes that have taken place in the investment environment. More importantly, we remain excited about the rich opportunity set that this adjustment period and the accompanying bouts of volatility bring, as it allows us to continue applying our proven 3M process and play a crucial part in building robust long-term portfolio strategies for our investors. Portfolio performance and positioning- Over the quarter the PSG Equity Fund returned 13.5% versus the benchmark return of 10.7%. The largest contributors over this period were foreign equities (4.8%), resources (3.5%) and industrials (2.7%). The fund outperformed the equity market both for the fourth quarter and for the 2022 calendar year. The fund continued to profit from its positioning in counters that benefit from supply constraints in real assets and mid-caps. Glencore plc, Grindrod Shipping Holdings Limited, Grindrod Limited and Hosken Consolidated Investments were the top contributors to performance from a stock perspective. In aggregate, the standout performance in 2022 was delivered by the fund’s foreign equities holdings which considerably outperformed global indices. This performance is a testament to the integrated global process followed in our funds. We believe the foreign equities we own will be a continued positive differentiator for the fund. The fund is well positioned for the current market environment. The fund is suitable for investors with an investment term of 7 years and longer. Over the short-term, returns can be volatile and for this reason it is important to measure fund returns over the relevant investment term. Over the 7-year time horizon, the fund and benchmark produced an annualized return of 8.7% p.a. Since inception, the fund has performed in the top quartile and produced an annual return of 15.2% versus the benchmark return of 13.0%.