Market comments

In the third quarter of 2019, the MSCI Emerging Markets (EM) EMEA Index (Europe, Middle East and Africa, including South Africa) fell 7.02%, which was a worse performance than that of the MSCI EM Index, which posted a negative return of 4.25%, and far behind the MSCI World Index’s return of 0.53%. Year to date, the picture does not change much with the MSCI EMEA at 5.13%, relative to the MSCI EM return of 5.89% and way behind the 17.61% for the MSCI World.

The US Federal Reserve and the European Central Bank (ECB) both eased policies to offset signs of weaker global growth. The US economy has weakened but is not in a recession mainly due to fiscal support offsetting the adverse impact of the trade war. The inversion of the US yield curve is perceived as tolling the bell for a nearterm global recession whilst ECB President Mario Draghi also added to the call for fiscal easing.

Adding to that, commodity prices took a dive with key iron ore benchmark prices plunging some 20% in a matter of weeks and the key industrial metal, copper, hitting two-year lows. The key global manufacturing indices have also dived and are at fiveyear lows - but was at least stable over the last two months.

In the UK, Eurosceptic Boris Johnson has become the prime minister after being elected as leader of the Tories. There appears a greater likelihood of a no-deal Brexit or, at the very least, yet another postponement of the October decision deadline. The market has discounted this in large part with a weaker Sterling. As business decisions get postponed, the UK could dip into a technical recession.

In South Africa the SA Reserve Bank held the policy rate unchanged at 6.5% at its September meeting, but their statement was more dovish than in July when it did cut. For the second quarter, GDP was 3.1% quarter-on-quarter, above the consensus of 2.4% and reversing the first three months’ contraction. SA headline CPI accelerated from 4% in January to 4.5% in March and then settled around 4.3% in August 2019. Forward rate agreements are now pricing in a 25-basis point rate cut in the next six months.

From an SA asset allocation perspective, cash (STeFI +1.8%) outperformed SA Bonds (ALBI +0.8%) and the FTSE/JSE All Share Index returned a negative 4.2% (Capped SWIX -5.1%) in the third quarter of 2019. In Dollars, the MSCI SA (- 12.60%) continued to underperform the MSCI EM (-4.25%) mainly due to a weak Rand (-6.9%). SA equities and SA bonds saw outflows of $5.7 billion and $2.4 billion respectively year to date. Property, after stabilising somewhat over the first half of 2019, experienced a tough three months, losing about -4.4%.
On the corporate side the most important news was the Naspers spin-off of Prosus, which listed on 11 September 2019. Prosus is now the largest listed EU consumer internet company.

Portfolio performance, attribution and strategy

Globally, factor performance has continued the general trend for the year with Low Volatility and Momentum outperforming and Value underperforming up to the end of August. In September there was a significant rotation from Momentum, Quality and Low Volatility into Value, but this was short-lived and it does not seem like a structural shift in trends has occurred. It is interesting to note that historically there has been no structural relationship between Value and Low Volatility, but in 2019 has been no structural relationship between Value and Low Volatility, but in 2019 these two factors behaved like polar opposites, which was especially true from May onward, where Low Volatility generated strongly positive returns and Value significantly negative returns.

Domestically, Quality continues to experience profit-taking as profitability factors such as Return on Equity continue to underperform over the quarter, while Debt to Equity marginally offset the underperformance. Investors have been favouring more cyclical mining stocks, which are growing its margins off a low base, instead of more stable high-margin local companies. The tough local economic sentiment has contributed negatively to the Rand over the quarter, which had an impact on the relative performance of the fund over the quarter.

In terms of stock selection, the largest contributions to outperformance over the quarter came from overweight positions in Woolworths, Clicks and Anglo Platinum, while underweight positions in Sasol and Shoprite also added value. Detractors in relative performance came from overweight positions in Mr Price, Truworths, Kumba Iron Ore and Assore, as well as an underweight position in British American Tobacco.

There were no additions and deletions as the index only rebalances in June and December each year. Having said that, Naspers listed its internet assets in Amsterdam via Prosus (PRX), which the fund holds as a result of the corporate action.

The index and portfolio remain focused in its extraction of Quality and should markets give way to further risk aversion, the defensive character of the basket should prove rewarding while not meaningfully compromising returns during up markets.

Market comments

Global equities rebounded in June as the US-China trade war ebbed and Trump backed off on some of his threats. Global growth data remained negative with further declines in PMIs. Although the 19 June Federal Open Market Committee meeting saw no rate change, it delivered a strong statement virtually promising a rate cut at the 31 July meeting.

During the second quarter of 2019, the MSCI World Index realised a gross return of just more than 4%, outperforming the MSCI Emerging Markets Index, which managed a very modest return of 0.6% over the same period. Global bond yields continued to rally with US 10-year yields down to 2.01% and trading sub-2% for the first time since late 2016. US 10-year yields are down more than 125 basis points since November 2018. In the first half of 2019, the MSCI World Index delivered a total return of 17.4%, outperforming Emerging Markets (+10.8%). Within the MSCI World, North America was the best performing region with a return of 18.9%, followed by Europe’s 16.5% and the Pacific region’s 11.3%. In South Africa weak economic data dominated the post-election headlines with firstquarter GDP falling 3.2% quarter on quarter, worse than the -1.6% Bloomberg consensus. The President’s State of the Nation Address promised little more than further Eskom bailouts and progress on spectrum auctions with few details/deadlines. During the second quarter of 2019, the FTSE/JSE All Share Index (ALSI) posted a total return of 3.9% versus the 8% for the first three months of 2019. SA Financials was the best performer, returning 5.4%, followed by SA Industrials with a total return of 4%. SA Resources only managed a gain of 2.4% in the second quarter after the large 17.8% total return in the previous quarter. The FTSE/JSE All Bond Index (ALBI) returned 3.7% after posting a similar return of 3.8% in the first quarter. SA Property managed to outperform bonds, posting a total return of 4.5%. Among the other important indices the FTSE/JSE Shareholder Weighted Index (SWIX) (+2.86%) performed in line with the FTSE/JSE Capped Shareholder Weighted All Share Index (Capped SWIX) (+2.90%).

In the first half of 2019, SA Equities was the best performing asset class, with the ALSI delivering a total return of 12.2%. SA Bonds gained 7.7%, whilst SA Property was the worst performing asset class with a total return of 6%. Cash posted a total return of 3.6%.

Portfolio performance, attribution and strategy

Globally, factor performance has reflected investor risk aversion but not in such a clear way that sectors have, as style volatility has increased masking trends in performance. Putting aside Growth, which has clearly been a consistent performer across markets, the poor performance year to date of both Value and Low Risk has been curious. Value is typically seen as the pro-risk/cyclical style, while Low Risk is the opposite and indeed, over the past six months, they have been negatively correlated. However, what we have seen is more rotation in these two styles as investor risk aversion has changed, but they have both been trending down. On a short-term basis, exposure in both styles has provided diversification but over the longer term this has been more problematic. The negative performance trend in these styles mirrors the general risk-on positioning of markets of the past six months.

Domestically, in a reversal of fortunes, Quality continues to experience profit-taking as the equity market turnaround has shown a preference to cyclical shares. This after an extended period of a risk-off environment which provided a fertile ground for Quality factors, in particular profitability factors such as Return on Equity. Investors have been favouring stocks with high profits in order to mitigate macro challenges, and even though economic sentiment has recently been soft domestically, global sentiment has buoyed cyclical stocks and ignored stocks that have durable competitive advantages. Debt to Equity delivered a negative return over the quarter, as the factor’s defensive role continues to be tested during both periods of corrections and recovery.

In terms of stock selection, the largest contributions to outperformance over the quarter came from overweight positions in Sanlam (SLM), Clicks (CLS), RMB Holdings (RMH) and Kumba Iron Ore (KIO), while underweight positions in Sasol (SOL) and British American Tobacco (BTI) also added value. Detractors in relative performance came from overweight positions in Naspers (NPN), Old Mutual (OMU) and Tiger Brands (TBS), as well as underweight positions in Standard Bank (SBK), MTN (MTN) and ABSA (ABG).

There were numerous changes to the index over the first quarter. Additions included Anglo American Platinum (AMS), Liberty (LBH), Quilter (QLT), Standard Bank (SBK) and Woolworths (WHL). Deletions included Alexander Forbes (AFH), Adcock Ingram (AIP), Capitec (CPI), Grindrod (GND), Peregrine (PGR), Pick n Pay (PIK), Reunert (RLO), Sanlam (SLM), Santam (SNT) and Trencor (TRE).

The index and portfolio remain focused in its extraction of Quality and should markets give way to further risk aversion, the defensive character of the basket should prove rewarding while not meaningfully compromising returns during up markets.