Macro review

In the US, economic growth remained robust, and this ultimately overshadowed simmering concerns around the escalating US-China trade war. Stability in growth and employment figures allowed the Federal Reserve (Fed) to enact its widely anticipated increase in the federal funds rate by 25 basis points. The committee dropped its long-standing description of monetary policy as “accommodative” and reaffirmed its outlook for further gradual hikes into 2019. Data released in September showed wages to be growing at the fastest rate since 2009, while additions to non-farm payrolls remain above 185 000 on a three-month average. As yet, industrial activity indicators show little impact from the trade wars.

In Europe, worries over trade wars and potential US tariffs on cars were a feature of the period. On the economic front, growth for the second quarter of 2018 was revised up to 0.4% quarter-on-quarter, compared to the initial estimate of 0.3%. Forward-looking activity indicators continued to point towards expansion, albeit at a more subdued pace than at the start of 2018. The flash eurozone composite purchasing managers’ index1 for September fell to a four-month low of 54.2. Eurozone inflation was estimated at 2.1% for September, up from 2.0% in August. There was no change in policy from the European Central Bank, which reiterated that interest rates would remain on hold “at least through the summer of 2019”.

In emerging markets (EM), there was little progress in bilateral trade negotiations and China responded with tariffs on $110 billion of US goods. Meanwhile, Chinese macroeconomic data disappointed. Turkey experience a sharp sell-off in the Lira, as geopolitical tensions with the US exacerbated ongoing concerns over its wide current account deficit, above-target inflation and central bank independence. South Africa’s macro backdrop deteriorated as global liquidity tightened given the economy’s twin deficits, and second-quarter GDP growth disappointed, slowing to 0.4% year-on-year. Mexico saw positive general elections and an agreement with the US on NAFTA renegotiation. Despite ongoing risk of new US sanctions, Russian benefitted from crude oil price strength.

Global and local market review

The MSCI World posted a dollar total return of 5.1% (1.9% for the second quarter of 2018), once again outperforming MSCI EM (-0.9% in the third quarter vs -7.9% in the second quarter). In the US, despite political uncertainty and trade concerns, the US equity bull market became the longest in history on 22 August, and advanced in the third quarter to significantly outperform other major regions. Over the quarter, the information technology and healthcare sectors were boosted by a slew of robust earnings. Eurozone equities posted a modest gain in the third quarter with the MSCI EMU index returning 0.4%. Energy and industrials stocks were among the leading gainers. The FTSE/JSE All Share Index fell 0.8% amid Brexit uncertainty and a tempering of the global growth outlook, as a result of the escalating trade war between the US and China. Although trade tensions continued to escalate during the quarter, the Japanese stock market ended September above its recent range to show a total return of 5.9% for the quarter.

EM equities lost value in what was a volatile third quarter, with US Dollar strength and the US China trade dispute weighing on risk appetite. China underperformed as the US implemented tariffs on a total of $250 billion of Chinese goods, some of which are set to increase in January, and threatened tariffs on a further $267 billion. of goods. There was little progress in bilateral trade negotiations and China responded with tariffs on $110 billion of US goods. Turkey was the weakest index market amid a sharp sell-off in the Lira. South Africa also underperformed. The market is vulnerable to global liquidity tightening given the economy’s twin deficits, and second-quarter GDP growth disappointed, slowing to 0.4% year-on-year. SA Resources and SA Financials outperformed in the third quarter with total returns of 5.2% and 2.8% respectively, while the SA Industrials sector was the drag on the index, shedding 7.8% over the same period.

Portfolio performance, attribution and strategy

Global trade uncertainties and other geo-political risks once again weighed heavily on investor minds over the prior quarter. This resulted in rotation between Momentum/Growth and Value during the quarter as the slope of yield curve gyrated. The yield curve slope remains is the key driver for Value performance, which was the best performing factor based on MSCI World Index in September.

Domestically, Value has strung together two strong quarters after a poor last quarter of 2017 and first quarter of 2018. Deep value factors such as Price to Book and Price to Earnings seemed to rekindle its 2016 performance where cyclical value was favoured. To some extent the unwinding of Momentum has benefitted these cyclical value measures in the short term, but should macro uncertainty continue and deepen, we may see a shift toward more defensive Value or Quality strategies. Dividend Yield (a strategy which focuses on high dividend paying stocks) in particular experienced a corker of a quarter, as the environment was primed for stocks that provided a more defensive type of Value.

Top contributors to performance predominantly once again originated within the Resource sectors, where the fund held overweight positions in African Rainbow Minerals (ARI), Exxaro (EXX), South32 (S32) and Kumba Iron Ore (KIO). Despite this sector impact, the largest drawdowns were generated by not holding Rand sensitive stocks such as Sasol (SOL) and Old Mutual (OMU), as well as overweights in more domestic orientated companies such as Coronation Fund Managers (CML), Woolworths (WHL) and Imperial (IPL). In contrast to the second quarter, where not holding Naspers (NPN) severely detracted from relative performance, during the third quarter this positioning contributed around half of the positive excess returns. This stock-specific risk has been significant, as any relative performance in Naspers has a meaningful impact on the portfolio regardless of the Yield characteristic.

In terms of constituent changes during the September rebalance, there was one addition and one deletion for the Divi+ index. The addition was Tiger Brands (TBS) whereas the deletion was MMI.

Macro review
In the US, equities began 2018 strongly, buoyed by ongoing strength in economic data, robust earnings and the confirmation of a major tax reform package. US business confidence reached an unexpected, multi-decade high in March, while GDP for Q4 2017 was revised upwards to show growth of 2.9%. The latter part of the quarter, however, saw a marked increase in volatility as investors first digested the destabilising potential of an elevated US inflation reading and the possibility that the Fed may need to become more proactive in raising interest rates, as well as escalating US-China trade sanctions, which precipitated a renewed bout of turbulence in March.

In the Eurozone, the economic backdrop remained encouraging over the three months. GDP growth for Q4 2017 was confirmed at 0.6% quarter-on-quarter. Unemployment was stable at 8.6% in January 2018. However, forward-looking surveys painted a picture of slower future growth. The composite PMI hit a 14-month low in March, albeit the reading of 55.3 still implies solid growth. European Central Bank chairman Mario Draghi reiterated that interest rates would not rise until well past the end of the quantitative easing programme. On the political front, the key event of the quarter was Italy’s election, which yielded no overall winner. Germany formed a new government after its inconclusive elections in September 2017. Angela Merkel remains as chancellor after her centre-right CDU/CSU agreed another grand coalition with the centre-left SPD.

Emerging markets saw positive returns in the first quarter despite a rise in market volatility stemming from tensions over global trade. Brazil former president Luiz Inácio Lula da Silva saw his criminal conviction upheld, while in Russia the central bank cut interest rates and the country’s debt was upgraded to investment grade by ratings agency S&P. In China, macroeconomic data remained broadly stable, albeit there were ongoing signs of a gradual slowing in momentum, with official PMI easing to 50.3. By contrast, there was concern in India over a reported fraud case at a state-owned bank.

Global and local market review
Global equity markets declined in Q1 2018 with investors unnerved first by concerns about the path of US interest rate rises and then worries over trade. US equities began the year strongly, boosted by tax reforms, but ended the quarter lower amid concerns over inflation and the impact of US-China trade sanctions. Following a 10% correction from its January highs and rallying back 8% by early March, the S&P 500 Index suffered another 5% pullback in the last few weeks, ending the month of March down 2.5% and losing 0.8% over the last three months, which was the first negative quarter since the third quarter of 2015. Eurozone equities posted negative returns as worries over US rates and trade affected other markets. Italy’s election was inconclusive but had limited impact on the equity market.

Emerging market equities outperformed, delivering a positive return in US dollars. The MSCI Emerging Markets Index was up +1.5% (total returns) in Q1 2018, ahead of the MSCI World (Developed Market) Index, which was down 1.2% - the first quarterly loss in two years. Over the last three months the FTSE/JSE All Share Index posted a total return of -6.0%. This has been its worst quarterly performance in eight years (Q2 2010: -8.2%). SA Industrials were the worst performer, returning - 8.0% (Naspers and Tiger Brands were both down 12%). SA Resources lost 3.8% (rising global uncertainty) and SA Financials lost 3.6%.

Of the equity sectors, the top first-quarter performance came from Non-life Insurance (+24.4%), Fixed Line Telecoms (+10.0%) and General Retailers (+9.2%). The worst performance came from Real Estate Development and Services (-31.2%), Software (-30.5%) and Household Goods (-29.0%).

Portfolio performance, attribution and strategy
After a fantastic performance during the 2016 calendar year, Value measures have experienced a disparate 2017 and start to 2018. The divergence between deep value measures (e.g. price-to-book) and yield measures (e.g. dividend yield) has been substantial, with the former struggling, and the latter continuing to perform well as investors seek defensive qualities during a period of high levels of uncertainty and flight to safety.

The impact of the news in December regarding the accounting irregularity at Steinhoff still has investors on edge, with further speculation surrounding Capitec and technology shares continuing to weigh on market sentiment. Further to these stock-specific issues, global forward macro momentum has slowed, which has largely favoured defensive shares with high dividend yields, in particular domesticorientated shares, of which the Stable Dividend strategy has significant exposure to.

During Q1 2018, exposure to Foschini (TFG), Nedbank (NED), Truworths (TRU) and Telkom (TKG) played a strong positive role here, while an underweight position in Naspers (NPN) added a significant amount of excess return. Holdings in Exxaro (EXX), African Rainbow Minerals (ARI) and Kumba Iron Ore (KIO) detracted from the index’s relative performance.

In terms of changes to the FTSE/JSE Dividend Plus Index over the prior quarter, Coronation (CML), Glencore (GLN) and MMI Holdings (MMI) were additions in March, while Bidvest (BID), Mr Price (MRP) and Sibanye Gold (SGL) were deletions.

Macro review
In the US, the fourth quarter saw two Republican defeats in Senate contests spur House and Senate Republicans into action, resulting in the long-awaited tax reform bill. Markets rallied on the news, with big permanent cuts for corporations as the centrepiece of the package. US equities were largely also supported by generally positive macroeconomic data, including better-than-expected third-quarter GDP growth of 3.0% (annualised) and stronger-than-expected non-farm payrolls. As had been widely anticipated, the US Federal Reserve (Fed) lifted interest rates by 25 basis points (bps) in December. The Fed also raised its growth forecasts for 2018 to 2.5% from 2.1%. The quarter also saw robust corporate earnings, particularly from the technology sector.

In the Eurozone, data showed the region’s economic recovery continuing. GDP grew by 0.6% in the third quarter, albeit a slight slowdown from 0.7% in the second quarter. In October, the European Central Bank (ECB) announced that quantitative easing would be extended to September 2018 but that the pace of purchases would be reduced from €60 billion per month currently to €30 billion. In Germany, coalition talks collapsed, while in Spain, Catalonia held a regional election which failed to resolve the independence issue. In the UK, despite a sluggish economy, the Bank of England (BoE)’s monetary policy committee raised interest rates for the first time in 10 years as annual CPI reached 3.1% in November, breaching the BoE’s upper target. Furthermore, hopes rose around progress with Brexit negotiations, with an agreement struck to allow talks to proceed to the future of trade arrangements.

Emerging markets experienced largely positive political developments. In South Africa, pro-reform candidate, Cyril Ramaphosa, was elected as leader of the African National Congress. This development increased the prospect for a return to more orthodox policy after elections in 2019. In Greece, agreement was reached with international creditors over reforms, paving the way for the dispersal of further bailout funds, while India also announced plans for a major recapitalisation for statecontrolled banks.

Global and local market review
For the first time on record, global equity markets rallied in all 12 months of a year, advancing +5.8% in US dollars during the fourth quarter and 24.6% over 2017, one of the strongest years since 2009. The S&P 500 Index ended a strong year with a fourth-quarter gain of +6.6%, buoyed by hopes of tax reform, while Eurozone equities declined amid some profit-taking and simmering political risk, although economic data remained positive. The UK’s FTSE All Share Index also saw positive returns, supported by gains for resource stocks and progress on Brexit negotiations.

Emerging market (EM) equities however outperformed their developed world counterparts, returning +7.5% during the fourth quarter and 37.8% in 2017. Top EM performers in the fourth quarter were South Africa (+21.5%), Greece (+13.6%) and India (+11.8%). The MSCI South Africa Index rallied +36.8% in US dollar terms in 2017 broadly in line with EM, driven by Media (Naspers), a metals rally, while a Ramaphosa win buoyed SA domestic-demand sectors into year-end. However, the MSCI SA ex Naspers was up only +16%.

In rand terms, SA equities (Capped SWIX) delivered a healthy 16.5% during 2017, outperforming bonds (+10.2%) and cash (+7.5%). Over the quarter, the CappedSWIX return was +8.4%, driven by Industrial Metals (+62.7%), Banks (+27.1%) and General Retail (+22.3%). Underperforming sectors over the quarter were Household Goods (-92.3%), Fixed Line Telecommunications (-18.8%) and Paper (-9.9%). In 2017, SA equities recorded outflows of US$2.5 billion, significantly lagging inflows into EM equities of US$77.2 billion. However, dissecting the flows, it appears that, excluding the outflows from dual-listed stocks, the Barclays and Vodacom sell-down, SA equities saw inflows of just more than R60 billion in 2017.

Portfolio performance, attribution and strategy

After a fantastic performance during the 2016 calendar year, Value measures have experienced a disparate 2017. The divergence between deep value measures (e.g. price to book) and yield measures (e.g. dividend yield) has been substantial, with the former struggling and the latter continuing to perform well as investors seek defensive qualities during a period of high levels of uncertainty and flight to safety, particularly during the fourth quarter.

The reasons for these are multiple. Firstly, the emergence of news in December that an accounting irregularity had occurred at Steinhoff had investors scrambling. Not often has one stock moved the entire benchmark that much, as companies with defensive characteristics and high dividend yields benefited from this uncertain environment. Notwithstanding this seismic shift, any portfolios (such as the Dividend Plus strategy) that managed to have less exposure than benchmarks - or even better, zero exposure - were treated to substantial relative performance outcomes after the Steinhoff share price plummeted.

Secondly, leading up and subsequent to Cyril Ramaphosa’s election as the new ANC president, the rand rallied strongly relative to the dollar (appreciating 10.9% over 2017), with investors beginning to price in a positive macroeconomic impact supporting a cyclical recovery. To this end, shares with domestic cyclical exposure rallied hard during the fourth quarter, including General Retail (+15.9%), Banks (+15.2%) and Industrial Transportation (+8.9%). The Dividend Plus strategy had substantial exposure to all these sectors through its strong rand exposure.

During the fourth quarter, exposure to Kumba Iron Ore (KIO), Foschini (TFG), Barclays (BGA) and Imperial (IPL) played a strong positive role here, while an underweight position in Steinhoff (SNH) added a significant amount of excess return. The concentrated nature of our market index proxies and its Naspers exposure also largely contributed to the relative underperformance; this index holds no Naspers exposure. Holdings in Telkom (TKG), Vodacom (VOD) and Mondi (MND) detracted from the index’s relative performance. There were no changes to the FTSE/JSE Dividend Plus Index during the prior quarter.