NAVIGATING VOLATILITY WITHOUT THE WHIPLASH

Transcription

1 MACROSOLUTIONS NAVIGATING VOLATILITY WITHOUT THE WHIPLASH ALIDA JORDAAN SENIOR PORTFOLIO MANAGER AUGUST 2016 In everyday terms volatility refers to instability, unpredictability, impulsiveness and explosiveness. In market terms we define volatility as the up and down movements of a price (or of returns). Volatility in markets is measured using the standard deviation of returns, which measures how widely returns move from their average (or mean), implying negative and positive returns around the mean. Standard deviation is widely used as a measure to help understand the risk associated with an asset. THE BIGGER PICTURE The mean return of the FTSE/JSE All Share Index (not taking dividends into account) over the past two decades has been 1. a month, while one standard deviation has been 5.4%. Looking at the chart, we see the Asian Crisis in 1998 as an outlier event more than three standard deviations! In 2001/2002 we experienced the meltdown of the Dotcom Crash and, more recently, the Global Financial Crisis in Living through these events was daunting, but the market recovered every time. FTSE/JSE ALL SHARE INDEX: Mean: 1. Standard Deviation: 5.4% GLOBAL FINANCIAL CRISIS Given that these are all global events impacting our local market, we can conclude that the volatility is largely the result of macro events. However, this is not the complete picture and volatility affecting our market can also be a local industry (or sector) phenomenon. ADDING A MIX OF LOCAL EVENTS Think of our banks in December last year as a case in point. Our financial sector was hard hit when David van Rooyen replaced Nhlanhla Nene as Finance Minister. While the so-called Nenegate was short-lived, the volatility caused by this event continued to play out in some market sectors for a while thereafter. BANK INDEX: Mean: 1.1% Standard Deviation: 7.3% GLOBAL FINANCIAL CRISIS NENEGATE -5 Another example of local events impacting our market can be seen in our building & construction sector returns impacted by specific industry factors. The run-up to the Soccer World Cup in 2010 was a major boost for the sector. This was followed by a slump in returns when the Competition Commission imposed hefty fines on construction companies involved in collusive tendering. More recently, the sector has been affected by the knock-on effects of the slump in the mining industry.

2 BUILDING & CONSTRUCTION INDEX: Mean: 0.4% Standard Deviation: 7.8% SOCCER WORLD CUP DRILLING DOWN In the same way that it s important to look at broader industry events, we also need to understand a single share s volatility. One would expect a mining company like Anglo American to be driven by cyclicality in commodity prices and to be more volatile than a GLOBAL FINANCIAL CRISIS COMPETITION COMMISSION COMMODITIES SLUMP KNOCK-ON defensive beverage company like SABMiller. This is indeed the case! Anglo shows an average monthly return of 1. over the past 20 years, with a mean variability of 11.4%. SABMiller, on the other hand, has an average monthly return of 1.3% and a mean variability of 7.. This kind of risk information, ANGLO AMERICAN: 7 COMMODITY RALLY though simple, is used in portfolio construction to manage the risk exposure by and large through considering the appropriate position size and through diversification Mean: 1. Standard Deviation: 11.4% THERE S NO ESCAPE No share trades in isolation and is not affected by market events. Not even a quality name, Clicks, with a good track record of returns, escaped the Asian Crisis (see the chart below). However, over the past decade the share s standard deviation actually declined. This is partly attributable to the share buy-back programme over recent -2-32% years an alternative to reward shareholders as it supports the earnings per share growth. SABMILLER: Mean: 1.3% Standard Deviation: 7. ANHEUSER-BUSCH INBEV TAKE-OUT CLICKS: Mean: 1.8% Standard Deviation: 8.7% -2 GLOBAL FINANCIAL CRISIS

3 Another share that has performed exceptionally well over the years is Naspers. From the chart below, we see that it does not come without higher risk over the 20-year period, the standard deviation of monthly returns is 11.7%, more than double that of the overall market (FTSE/JSE All Share Index s standard deviation is 5.4%). Yet, its average monthly return is also more than double that of the market. In this case, the higher level of risk has translated into good returns that can be ascribed to the nature of the Naspers business and its underlying investment in Tencent offering "new" applications for an online and a mobile world. NASPERS: 5 Never forget that volatility creates opportunities to invest at cheaper prices if negative returns have been posted. By the same token and as can be seen from the charts, variability of returns also implies positive returns (that is, the recovery after the fall)! Our approach at MacroSolutions is to identify themes at a macroeconomic level, an industry level and a company level. At the same time, we consider the risk of the macro themes, sector (or industry) themes and company specific themes. This helps us to better manage risk exposure in our clients portfolios. Volatility is managed through diversification by putting together a portfolio using different investment instruments across different asset classes. As an investor s risk tolerance declines over his/her life span, the mix of assets will naturally change accordingly Mean: 2.4% Standard Deviation: 11.7% Best of all is to remember that time in the market is most important, in spite of volatility. May I remind you how market volatility reduces over time: GLOBAL FINANCIAL CRISIS OVER TIME RETURNS BECOME LESS VOLATILE RANGE OF ANNUALISED REAL RETURNS FROM SA EQUITES (DECEMBER 1924 DECEMBER 2015) 31% -5 21% MANAGING MARKET WHIPLASH Volatility instability and unpredictability is part of the equity market place. Whether we are talking about the market, specific sectors or industries, or individual shares, volatility cannot be avoided or escaped. 8% 8% 8% 7% -6% 16% 13% 11% 11% 9% 7% 8% 7% 7% 7% 7% 7% 7% 7% 7% 4% 4% 2% 2% 2% -2% Running away driven by fear (selling when prices have fallen) or chasing returns driven by greed (buying at the end of a strong rally) will certainly cause whiplash of some kind. -14% 5 Years 10 Years 15 Years 20 Years 25 Years 30 Years 35 Years 40 Years Source: MacroSolutions Long-Term Perspectives Yearbook, FactSet

4 MARKET COMMENTARY AS AT 31 JULY 2016 Risk assets advanced in July despite the surprise outcome of the UK Brexit referendum at the end of June. Global equity markets were over 4% higher in aggregate in US dollar terms, while global property saw a 5% gain over the month. The local equity market rose by nearly 2%, local property by over 3% and the rand strengthened by around 5% against the major currencies. Although Brexit causes some uncertainty over the future of the UK, and possibly the European Union, the one certainty appears to be central banks responses given the potential impact on growth and recent mixed data, central banks are expected to maintain very accommodative monetary policies for the foreseeable future. At the start of 2016 there was an expectation that the US Federal Reserve (the Fed) would be hiking interest rates four times in To date, there have been none, and even one rate hike looks doubtful. There is a growing expectation that we will see a fiscal response from several countries in order to address the sub-par growth and inflation problems. This emboldened investors to buy risk assets. That said, there remains a fair amount of caution in investors minds, as evidenced by sizeable cash holdings. This caution extended locally ahead of the local government elections and the next round of ratings agency reviews before the end of the year. While we were expecting the elections to have a limited direct impact on our markets, there is the risk of some disappointment in the events that follow. The ratings agencies have been clear about what steps are required in order to avoid a downgrade address the problems with the state-owned enterprises, maintain disciplined fiscal expenditure and initiate growth-enhancing reforms. In our view, Government will need to demonstrate that progress has been made on these issues in the coming months. OLD MUTUAL MAXIMUM RETURN FUND OF FUNDS (Peter Brooke) (Classification category: Worldwide Multi-Asset Flexible) The Maximum Return of s delivered a positive return in July, despite the strength of the rand. The rand strengthened by 5.3% against the US dollar, which was a powerful headwind to the fund s international assets and for many of its competitors in the worldwide unit trust category. This is one of the major risks of international exposure in a rand-denominated fund and is why we brought money back to South Africa in January. The fund also benefited from its exposure to more rand-sensitive assets like South African bonds, listed property and financials. Returns over the three years are 12.6% a year, which is the longest period we can report on as the fund is relatively young. During the month, we added a new position in the fund. We bought a holding in the High Yield Opportunity. This fund has performed poorly in the last 12 months, falling 5.4%. However, we think it is well positioned looking forward, as it has more exposure to locally orientated shares and has a much higher dividend yield. Brexit accelerated the quest for yield, which is one of our enduring themes, and we think this has the potential to re-rate a number of the counters that the fund owns. OLD MUTUAL FLEXIBLE FUND (Peter Brooke) (Classification category: South African Multi-Asset Flexible) The Flexible had a good month in July, delivering a positive performance and significantly closing the gap on its performance objective over one year. The fund remains well ahead of its benchmark over three- and five-year periods. The fund benefited from investments in domestic bonds and listed property, while global equity was a drag on performance as the rand strengthened. The domestic equity portfolio had a strong month, with gold and platinum shares the star performers. The fund has no exposure to Sasol or Richemont, two of the weakest large cap equities over the month and year to date. Along with domestic bonds, local banks continue to recover from the effects of Nenegate, but the impact of the Brexit vote continues to linger for duallisted financial shares. Consequently, our position in Investec underperformed and the share price had an indifferent month. While financial markets appear volatile and uncertain, our investment process remains relevant. The ability to assess valuations from a longterm perspective, while rigorously examining the themes at play, continues to yield good results for the Flexible. The lack of clear direction in investment markets and economies, coupled with volatile politics in many geographies, does not discourage us from identifying opportunities to earn benchmark-beating returns. The fund continues to be overweight to mining stocks, including SA gold and platinum mines. We are hesitant to forecast an improving global mining cycle, but valuations hit long-term lows earlier this year. After many years of overinvestment, miners are starting to shrink their balance sheets. Combined with extensive self-help programmes, this makes for a powerful positive catalyst for the resources companies. We have also started to skew our portfolio towards sectors that will benefit from falling SA interest rates, as we believe that the rate hiking cycle is now behind us. As a result, we have added to our listed property and SA consumer shareholdings. Our existing SA bank position should also benefit from this scenario. From a risk management perspective, it is useful to think of the rand as a lever with the miners at one end and the domestic bonds along with bank, consumer and property shares, at the other. We are not forecasting further weakness in the rand (hence our increased domestic exposure), but should we be mistaken, the mining shares will provide a strong hedge. This is important as the portfolio is also underweight to the global defensives, which we regard as expensive. Along with South Africa, we are also increasing exposure to other emerging markets at the expense of developed market exposure. We believe that the Flexible is well positioned to navigate the current environment. OLD MUTUAL BALANCED FUND (Graham Tucker) (Classification category: South African Multi-Asset High Equity) We are in the midst of a lower return and more volatile world. However, the fund delivered a healthy return in July, following on from a good second quarter of The three- and five-year returns remain healthy and well above inflation, driven by the large global exposure, both directly and indirectly through the likes of Naspers and Steinhoff. The world is caught in a period defined by low growth and low inflation. As such, most interest rates around the world are low and being cut lower. The US Fed is looking to hike rates, but has been forced to delay their hiking cycle due to the weak growth observed in recent months. Australia have recently cut rates again and the UK halved their interest rates from 0.5% to 0.25%. In this environment, emerging market debt looks fairly attractive offering an attractive return in real terms and relative to developed market bonds. Emerging market currencies have been weakening for a number of years (you need only think of the experience of the rand), hence making

5 MARKET COMMENTARY CONTINUED the asset class more appealing. Accordingly, the fund has been building a position in emerging market debt to complement the position in South African bonds. The improving outlook for emerging markets extends to South Africa. We believe that, barring a shock, the South African Reserve Bank will not be required to hike interest rates again in this cycle. Inflation will likely remain above the target band for a few months still, but after that we would expect a move to within the 3%-6% target range. The most likely move in interest rates will be lower, although our view is that this is some way off. The trade deficit has been narrowing as we ve seen improvement from both sides of the equation (exports and imports). This should flow through into a better current account balance, which, in turn, makes the country and the rand less susceptible to foreign flows and puts South Africa on a sounder footing. The fund has been tilting towards this theme, rotating away from global plays towards local plays, for example property and select retailers. Overall, the fund remains cautiously positioned on total growth asset exposure. We have held cash for some time now in short-term debt offering attractive yields, but have, more recently, been putting some of it to work as opportunities have arisen. We will continue to hunt for these opportunities, but will also be prepared to step back if we don t see value in these investments for our clients. The world remains fragile; hence a cautious approach is warranted. OLD MUTUAL MODERATE BALANCED FUND (John Orford) (Classification category: South African Multi-Asset Medium Equity) The fund had a reasonable month and has performed well over the past three months. While the fund s recent performance has been better, it has lagged its benchmark over the past year. Over the year, the fund has been cautiously positioned with an overweight allocation to cash. That has proved to be a reasonable allocation, with cash outperforming local equities and bonds over that period. In the longer term, however, cash will not deliver the real returns required by the fund s mandate. Therefore, we have recently been using our cash to add to investments that we think will deliver better medium-term returns than cash on a forward-looking basis. Earlier this year, we made a considerable investment in Eskom US dollar debt at distressed yields. This has delivered a considerable short-term gain as the yield on the debt has fallen sharply. More importantly, however, the investment will lock in an excellent yield for the fund (over 13% a year in rand terms) over the duration of the investment. Indeed, we are very focused on adding to investments with attractive yield to the fund. Following the UK s decision to leave the European Union, we think global central bankers commitment to keeping interest rates low has, if anything, increased. This creates a world starved of yield and one in which the yield on offer in emerging market countries, such as South Africa, is increasingly attractive. We have used our cash to add to domestic companies offering attractive yields, including property companies, some of the banks and some of the domestically focused industrial companies. These companies offer reasonable yield with some growth and should benefit from a likely peak in inflation, which means interest rates are unlikely to rise further and that the outlook for domestic consumers should stabilise and possibly improve in the next year. We have also added some exposure to emerging market debt in the portfolio. Like South African bond yields, emerging market bond yields are high relative to those of developed market bonds. Overall, while the fund is still relatively cautiously positioned, we have gradually increased our exposure to South African growth assets, particularly where they offer good yield with some growth. Over time, we expect this to deliver good returns in line with the fund s mandate. OLD MUTUAL STABLE GROWTH FUND (John Orford) (Classification category: South African Multi-Asset Low Equity) The fund had a good month, benefiting from the strong performance by bonds. While the fund s recent performance has been better, it is lagging its benchmark over one year. Despite this, it continues to deliver good long-term returns, with real returns in line with or better than its target over three or more years. It is important to remember that successful investing takes long-term commitment. The fund has been cautiously positioned with an overweight allocation to cash over the past year. That has proven to be a good decision, with cash outperforming both local equities and bonds over the period. In the longer term, however, cash will not deliver the returns required by the fund s mandate. Therefore, we have recently been using our cash to add to investments that we think will deliver better medium-term returns than cash on a forward-looking basis. Earlier this year, we added positions in both plc debt and Eskom US dollar debt at distressed yields. Not only do these investments lock in an excellent yield for the fund, but they have also delivered good short-term capital gains as the yields on both instruments have fallen sharply since we invested in them. We also used the post-brexit market turmoil to add to our positions in local property and equity and, more recently, to emerging market debt. The UK s decision to exit the European Union has increased global uncertainty, but it has also strengthened the commitment of global central bankers to keep interest rates at record low levels. The result is that global investors are starved of yield and growth, making emerging market and South African assets relatively attractive, particularly given how much emerging market currencies have depreciated over the past few years. Overall, while the fund is still relatively cautiously positioned, we have increased our exposure to South African equities and bonds and have, in particular, looked to add assets offering attractive yield emerging market bonds and South African property and equities offering attractive dividend yields. OLD MUTUAL REAL INCOME FUND (John Orford) (Classification category: South African Multi-Asset Low Equity) The fund aims to provide income that grows in line with inflation, while minimising capital volatility. The fund s performance year to date has been good, beating cash over the period. Over the past year, the fund has lagged its benchmark, but over the longer term it has consistently delivered to or exceeded its target of CPI plus 1%-2% net of fees. Year to date, the fund has benefited from its exposure to bonds and listed property, which have both performed well. The fund has also benefited from having significantly reduced its offshore exposure earlier this year, given the more attractive yields on offer in South African fixed-income assets. The fund remains relatively cautiously positioned. However, we have recently added some equity exposure. Two of the companies we added to the fund are AVI and Woolworths. Both are high quality South African companies offering reasonably growing dividends and should benefit from a likely peak in inflation (which means further rate hikes are unlikely and should result in a gradually improving outlook for the domestic consumer). Since adding these companies to the fund, both have seen their share price move higher, which is pleasing. Over time, the Real Income has successfully invested in equities to drive higher than average performance compared with funds designed to deliver a steady income stream. We have also recently added to our emerging market debt exposure. We continue to think that global interest rates will remain low and emerging market debt offers an attractive spread over developed market bond yields. In a world starved of yield, we expect this asset class to continue to deliver reasonable returns, which will benefit the fund s performance.

6 THREE-YEAR PERFORMANCE: (TO 31 JULY 2016) ASSET ANALYSIS: (TO 31 JULY 2016) 10 14% 12% 12.2% p.a. 12.4% p.a. 9.9% p.a. 12.6% p.a. 75% 9.7% p.a. 8% 8.3% p.a. 8.5% p.a. 7.8% p.a. 8. p.a. 5 6% CPI 4% 25% 2% Flexible Flexible Life Balanced Balanced Life Stable Growth Stable Growth Life Real Income Real Income Life Maximum Return of s Sources: Investment Group & Morningstar Real Stable Moderate Maximum Income Growth Balanced Balanced Flexible Return Real Stable Income Life Growth Life Balanced Life Flexible Life SA Equities Property Preference Shares Commodities Convertible Bonds Nominal Bonds Inflation-linked Bonds Cash International Africa Sources: Investment Group & Morningstar Performance 30 June year 3 years (p.a.) 5 years (p.a.) Highest** Average** Lowest** Description TER* TC* Flexible A 4.3% 12.2% 13.5% % 2.21% 0.2 Flexible Life 4.5% 12.4% 14.1% 2.03% Target: CPI + 5% to 7% p.a. 10.8% 10.7% 10.7% CPI + 5% p.a. over rolling 3 years UT Peer Average 2.2% 9.5% 11.7% South African - Multi-Asset - Flexible Balanced A 3.1% 9.7% % % 2.17% 0.11% Balanced Life 3.3% 9.9% 12.1% 2.02% Target: CPI + 4% to 5% p.a. 9.8% 9.7% 9.7% CPI + 4% p.a. over rolling 3 years UT Peer Average 5.1% % South African - Multi-Asset - High Equity Moderate Balanced A 5.1% 5.4% 3.4% 1.6% 2.06% 0.33% Target: CPI + 3% to 4% p.a. 8.8% CPI + 3% p.a. over rolling 3 years UT Peer Average 5.2% South African - Multi-Asset - Medium Equity Stable Growth A 5.2% 8.3% 10.1% 18.6% 8.8% -5.3% 1.88% 0.06% Stable Growth Life 5.4% 8.5% 10.4% 1.8 Target: CPI + 2% to 3% p.a. 7.8% 7.7% 7.7% CPI + 2% p.a. over rolling 3 years UT Peer Average 6.2% 8.5% 9.8% South African - Multi-Asset - Low Equity Real Income A 6.1% 7.8% % 9.2% -0.7% 1.43% 0. Real Income Life 6.2% % Target: CPI + 1% to 2% p.a. 6.8% 6.7% 6.7% CPI + 1% p.a. over rolling 3 years UT Peer Average 6.2% 8.5% 9.8% South African - Multi-Asset - Low Equity Maximum Return of 3.8% 12.6% 23.6% 12.8% 2.1% 2.28% 0.12% s A Benchmark*** % UT Peer Average 6.6% 12.6% Worldwide - Multi-Asset - Flexible CPI 5.8% 5.7% 5.7% * TER is a historic measure and includes the annual service fee. A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The current TER may not necessarily be an accurate indication of future TERs. Transaction Cost (TC) is a necessary cost in administering the fund and impacts fund returns. It should not be considered in isolation as returns may be impacted by many other factors over time including market returns, the type of fund, the investment decisions of the investment manager and the TER. TERs as at 30 June ** Rolling 12-month returns (Since inception) *** 6 FTSE/JSE Shareholder Weighted All Share Index, 35% MSCI All Country World Index, 5% STeFI Composite Index Sources: Morningstar and FOR MORE INFORMATION, VISIT: Investment Group (Pty) Limited PO Box 878, Cape Town 8000 Tel: Fax: Investment Group (Pty) Limited is a licensed financial services provider, FSP 604, approved by the Registrar of Financial Services Providers ( to provide intermediary services and advice in terms of the Financial Advisory and Intermediary Services Act 37 of Investment Group is a wholly owned subsidiary of Limited. Reg No 1993/003023/07. The investment portfolios are market linked. Products are either policy based or unitised in collective investment schemes. Investors rights and obligations are set out in the relevant contracts. In respect of pooled, life wrapped products, the underlying assets are owned by Life Assurance Company (South Africa) Limited, who may elect to exercise any votes on these underlying assets independently of Investment Group. In respect of these products, no fees or charges will be deducted if the policy is terminated within the first 30 days. Returns on these products depend on the performance of the underlying assets. Investment Group has comprehensive crime and professional indemnity insurance, as part of the Group cover. For more detail, as well as for information on how to contact us and on how to access information, please visit STATUTORY INFORMATION You should ideally see the funds as medium- to long-term investments. The fluctuations of particular investment strategies affect how a fund performs. Your fund value may go up or down. Therefore, we cannot guarantee the investment capital or return of your investment. How a fund has performed in the past does not necessarily indicate how it will perform in the future. The fees and costs that we charge for managing your investment are disclosed in the relevant fund s minimum disclosure document or table of fees and charges, both available on our public website or from our contact centre. The cut-off time for client instructions (e.g. buying and selling unit trusts) is at 15:00 each working day. This is also the time we value our funds to determine the daily ruling price. Daily prices for Unit Trust Managers (RF) (Pty) Ltd (OMUT) funds are available on the OMUT public website and in the media. Unit trusts are traded at ruling prices, may borrow to fund client disinvestments and may engage in scrip lending. The daily price is based on the current market value of the fund s assets plus income minus expenses (NAV of the portfolio) divided by the number of units in issue. Income funds derive their income primarily from interest-bearing instruments as defined. The yield is a current yield and is calculated daily. A fund of funds is a portfolio that invests in other funds which levy their own charges, which could result in a higher fee structure for the fund of funds. Some funds hold assets in foreign countries and therefore may have risks regarding liquidity, the repatriation of funds, political and macroeconomic situations, foreign exchange, tax, settlement, and the availability of information. The Net Asset Value to Net Asset Value figures are used for the performance calculations. The performance quoted is for a lump sum investment. The performance calculation includes income distributions prior to the deduction of taxes and distributions are reinvested on the ex-dividend date. Performances may differ as a result of actual initial fees, the actual investment date, the date of reinvestment and dividend withholding tax. Annualised returns are the weighted average compound growth rates over the performance period measured. Performances are in ZAR and as at 31 July Sources: Morningstar and Investment Group. Unit Trust Managers (RF) (Pty) Ltd (OMUT) is a registered manager in terms of the Collective Investment Schemes Control Act 45 of is a member of the Association for Savings and Investment South Africa (ASISA). OMUT has the right to close the portfolio to new investors in order to manage it more efficiently in accordance with its mandate. August 2016