Current context
Global equities continued displaying strong positive momentum since markets reached a low in March 2020. By the end of the first quarter of 2021, the MSCI World Index had recovered 79% from its March 2020 low and returned 5% during the quarter under review (in US dollar including dividends). Some of the factors contributing to the sharp recovery are continued record central bank liquidity injections, accelerating global vaccine rollouts, a gradual re-opening of economies and speculative behaviour in pockets of the market. On the domestic front, the JSE All Share Index (ALSI) finally broke through its pre-pandemic record high set in 2018 and delivered its strongest first quarter performance in 15 years, posting a quarterly total return of 13.2% in rand. Given the recovery of the local currency over the past year, which as recently as in April 2020 traded above R19 per US dollar, ALSI total returns of 79% in rand since the March 2020 lows translate to an impressive 115% when measured in US dollars. 10-year South African government bonds yielded 9.5% at the end of March, up from 8.75% at the end of December 2020, holding their own against rapidly rising US 10-year bonds (arguably off low levels) which saw yields increase from 0.9% in December to above 1.7% at the end of the quarter.

Our perspective
Different parts of the market continue to dominate performance. The initial sharp recovery after the March 2020 crash was largely driven by technology and staples companies that received a boost from pandemic-driven demand and ‘work-from-home’ arrangements. However, markets have recently seen a major rotation away from what had previously worked (mostly growth stocks) into investments that have not performed well to date, and which were harder hit by the pandemic. These include value funds, cheap and smaller companies, emerging markets, contrarian investment strategies and companies positively correlated to rising rates and global reflation in particular. We have previously written about the large valuation divergences evident across markets as a result of the extraordinary levels of crowding into past winners and the capitulation out of what had not worked, and we have advocated for different positioning to the consensus view. The key question on many investors’ minds, given this sharp recent rotation, is: where to from here? It is hard to deny that index levels are high and given the valuation backdrop across many major markets, prudent future return expectations from major indices should be relatively low. While PSG Asset Management is macro aware, we are bottom-up investors and tend to favour opportunities in less popular areas. Given the uncertainty about the ultimate impact of the pandemic on many economies and industries, and the potential path of inflation and interest rates, pockets of the market still provide highly fertile conditions to construct a portfolio of mispriced securities.

Portfolio performance and positioning
Over the quarter the PSG Stable Fund returned 6.30% versus the benchmark return of 1.91%. The contributors over this period were foreign equities (2.83%), industrials (2.28%), resources (0.60%) and the detractors were foreign cash (-0.06%). The fund is suitable for investors with an investment term of 3 years and longer. Since inception, the fund has produced annualised returns of 7.72% versus benchmark return of 8.01% per annum.

The PSG Stable Fund has diversified exposure across offshore equity and property (13%), SA shares (including shares with rand-hedgecharacteristics, 26%), domestic bonds (50%), and cash and negotiable certificates of deposit (7%). Domestic bonds comprise sovereign nominal bonds (14%), sovereign inflation-linked bonds (22%), fixed-rate bonds (including government guaranteed, 6%), and floating rate bonds (8%). The fund is positioned to take advantage of the attractive opportunity set across most asset classes, while still being cognisant of the risks. Cash exposure remained fairly stable at relatively low levels, as we continue to prefer shorter-dated inflation-linked bonds which offer better yields than cash instruments at relatively low levels of risk. Domestic equity exposure was decreased slightly, while global equity exposure increased despite sales of global shares that had risen to our estimates of intrinsic value. We are incrementally adding to select local property shares, while foreign property decreased on the back of opportunistic sales when a counter spiked to levels well above our intrinsic value. We have made use of global and local equity derivatives to manage the downside risk. Aggregate liquidity in the fund remains healthy. Cash and liquid short-dated government bonds provide ample firepower which can be used in the event of further market disruption, or if we see opportunities to deploy capital further into assets trading at wide margins of safety to their intrinsic value.