NEDGROUP INVESTMENTS BALANCED FUND Quarter 2, 2018 For the period ended 30 June 2018
MARKET OVERVIEW A BETTER QUARTER FOR EQUITIES The second quarter of 2018 was a significantly better quarter for domestic equities than the first, largely driven by currency weakness. Although the steep losses incurred in the first quarter were not fully recovered in the second, the 2.8% positive return from the ALSI in June, and the 4.5% return for the quarter, reduced the year-to-date contraction in equity prices to only 1.7%. The SWIX continues to lag the ALSI as the 2.7% return for June and the second quarter return of 2.1% reduced the year-to-date contraction to a still disappointing 4.8%, reflecting weakness in domestic South African stocks such as banks and retailers. Yields remained roughly unchanged as indices advanced more-or-less in line with earnings but still remained slightly on the expensive side of history. Global equities also recovered in the second quarter but were flat for the year measured in US dollars. Developed markets significantly outperformed emerging markets. Weighed down by global emerging market fears and potentially rising inflation, bonds did not fare well in the quarter. The ALBI contracted by 3.8% in the quarter but the year-to-date return of 4.0% remains positive and well ahead of equities. The property sector, like bonds, had a difficult quarter which saw the Property Index decline by 2.2% making it the worst performing sector for the year to date, declining by 21.7%. GLOBAL GROWTH IS BECOMING LESS SYNCHRONISED The global economic scenario appears very unsettled. The US economy is performing well and creating jobs at an encouraging rate, but the Trump Administration seems to be heading for a trade tariff confrontation with its trading partners that would not suit anybody. Europe is bogged down by slowing growth and growing anti-migrant sentiment is rising almost everywhere, but particularly within the newly elected anti-euro government in Italy. In addition, the Brexit negotiations are not progressing as well as had been hoped. China s growth remains stable but the sheer size of the economy dictates that, in the long run, growth rates should slow. Globally, geopolitical risks remain high although political tensions in Korea have eased somewhat post the recent US/North Korea summit to discuss the denuclearisation of the Korean peninsula. THE SOUTH AFRICAN ECONOMY IS CURRENTLY FACING SIGNIFICANT POLITICAL AND ECONOMIC CHALLENGES On the political side, the scale of state capture and corruption continues to astound, as new revelations of abuse of the system come to light almost daily. President Ramaphosa must be applauded for his serious and urgent efforts to route out this problem. The nation can only hope that all these efforts will eventually bear fruit but the task at hand cannot be underestimated. On the economic side, administered price increases such as VAT, fuel and municipal rates and services mean that the consumer will be under significant pressure in the second half of the year. The weaker rand will also put pressure on other non-fuel imports. Although public sector wage growth is expected to exceed inflation, it is unlikely that employees in the private sector will enjoy large salary increases. With consumer spending under pressure, local companies will struggle to grow earnings and dividends. Given where yields are now it is difficult to identify a strong driver of equity performance in the months ahead. While South Africa s economic performance will continue to recover off last year s low base, we will need to see broader structural reforms before the economy can reach its true growth potential. EMERGING MARKETS ARE MOVING OUT OF FAVOUR Globally, emerging market sentiment weakened in the second quarter. Unfortunately, South Africa was one of the hardest hit resulting in the currency weakening 14% against the US dollar over the quarter, and a full 8% in the month of June alone. Against the crosses it was also weak. This will have the effect of boosting export industries, notably the mining industry, but no significant increase in commodity prices will pare sustainable gains. Page 2
The weakness seen in emerging market currencies is largely the result of rising interest rate expectations in the US and a global increase in risk aversion, mainly around concerns of a global trade war. If the global trade war escalates it will be more negative for emerging markets given the open nature of their economies. In addition, global economic indicators look to have peaked, which means we are likely to see global growth rates start to slow from 2019 onwards. This also poses a risk for emerging markets which are seen as a geared play on the global growth cycle. THE STEINHOFF ACCOUNTING IRREGULARITIES SCANDAL REMAINS UNRESOLVED Steinhoff released an update on 18 May 2018 detailing the group s current debt levels, as well as giving an indication of the underlying profitability of the existing operations. Indicative margins disclosed suggested that the underlying profitability was significantly less than was historically disclosed. Given the high debt levels, coupled with extremely low levels of profitability, the solvency of the business is significantly at risk. As a result, based on our analysis there is a high probability that the equity value of Steinhoff is close to zero, and in the absence of an additional capital raise the business will struggle to repay their debts with the existing cash flow from operations. This valuation does not take into account all the claims against the company - the biggest so far being the claim by Christo Wiese, the previous Chairman of the Steinhoff Supervisory Board, who has instituted a claim of R59bn against Steinhoff in an attempt to put himself in the position of a contingent creditor at the expense of equity shareholders. As a result of our above analysis Truffle took the decision to exit our remaining holding in Steinhoff with the final trades being completed on 24 May 2018. The decision to exit Steinhoff was further validated by the release of the Steinhoff unaudited results for 6 months to March 2018. Steinhoff stated that the PWC forensic investigation is only likely to be completed by the end of the year. In addition, PWC have identified certain transactions that may not have been entered into on an arm s length basis and that all information disclosed so far could be affected by or contradicted by new information arising from the investigation. This implies the asset impairments and debt levels as currently disclosed may still increase by the time PWC finalises their report. PORTFOLIO POSITIONING EQUITIES The repositioning of the portfolio earlier in the year, post the Ramaphosa victory, out of domestically focused companies which had done well, into attractively priced and ignored foreign and rand-hedge counters, has started to bear fruit over the last 6 weeks. Not only did our rand-hedge shares get the benefit of the weaker rand exchange rate, but disappointing earnings updates from the majority of the domestically focussed companies resulted in significant share price declines as the markets optimism for a strong earnings recovery faded. While we believe that the South African economy will deliver a better performance in 2018, it is still well below what many of the domestically focussed companies were pricing in, in terms of their earnings expectations. Sasol, one of the biggest positions in the fund, performed well over the quarter with the share price increasing 24.7%. Despite its good performance, we still see significant upside in the stock, as very little value is being placed on their ethane cracker project. To put it in perspective, the ethane cracker, which will be commissioned at the end of this year, will result in an additional $1.4bn of EBITDA for the group. This compares to Sasol s 2017 full year EBITDA of $3.6bn (at today s Rand/$ exchange rate). So the ethane cracker will add almost 38% to their earnings on a full year basis. Old Mutual plc completed the first step of their managed separation by listing their UK wealth business Quilter plc. The separation will see significant rebalancing from all the respective Index trackers as they reposition their portfolios. We expect this rebalancing process to take about a month, after which we should see the respective share prices settle at their market values. Both Old Mutual SA and Quilter plc look very attractively priced on forward PE multiples of 7 and 14 times respectively. Page 3
We increased our exposure to British American Tobacco plc which is trading on a forward PE multiple of 12.6 times and a dividend yield of 5.3% in British Pound. The current uncertainty in the sector is giving us a great opportunity to increase exposure to a solid business at an attractive valuation. We also added to our exposures in Sappi and Naspers, which struggled over the first quarter of the year. The fund also initiated a position in Capitec Bank Holdings Limited, after significant share price underperformance earlier in the year. The fund took profits in Richemont, Life Healthcare, Vodacom and Barclays Group Africa. We also sold out of our entire position in Glencore on corporate governance concerns. This proved prescient as on the 3 July 2018 Glencore were issued with a subpoena by the US Department of Justice after a press article stated that the company was being investigated by the UK Serious Fraud Office. FIXED INCOME From a fixed-income perspective the fund remains short duration and has no exposure to fixed-rate, long-duration bonds. We remain focussed on the shorter end of the yield curve through floating rate notes where we continue to earn a significant premium to the longer end of the curve without the same duration risk. The recent selloff in longer-dated bonds has improved their overall valuation but is still not compelling enough for us to up our duration. Inflation risks both domestically and globally are building with risks to the upside especially if the oil price remains high. From a domestic perspective the recent weakness in the rand exchange rate will also put upward pressure on inflation if the currency remains at current levels. FOREIGN ASSETS We have continued to reduce our foreign equity largely through the sale of Royal Dutch Shell, which was up almost 20% during the quarter. Overall we remain cautious on global equities given the higher valuations especially in the United States. Headwinds of tighter US monetary policy and an escalating trade war could see risk aversion increase in the months ahead. We invested 4% of the funds capital in certain high quality South African offshore corporate bonds at yields of close to 7% in US dollars. We also took the opportunity during the rand strength earlier in the year to increase our direct offshore exposure, which currently stands at 29.1% of assets. We expect increased volatility to provide us with better entry points into global equities in the months ahead. KEY CONTRIBUTORS AND DETRACTORS From a performance perspective, contributors included Sasol, Naspers, Spire Healthcare plc, and BHP Billiton plc. Detractors included Old Mutual plc, Standard Bank, Growthpoint and Banco Santander. Page 4
WHO WE ARE Nedgroup Collective Investments (RF) Proprietary Limited, is the company that is authorised in terms of the Collective Investment Schemes Control Act to administer the Nedgroup Investments unit trust funds. It is a member of the Association of Savings & Investment South Africa (ASISA). OUR TRUSTEE The Standard Bank of South Africa Limited is the registered trustee. Contact details: Standard Bank, Po Box 54, Cape Town 8000, Trustee-compliance@standardbank.co.za, Tel 021 401 2002. PERFORMANCE Unit trusts are generally medium to long-term investments. The value of your investment may go down as well as up. Certain unit trust funds may be subject to currency fluctuations due to its international exposure. Past performance is not necessarily a guide to future performance. Nedgroup Investments does not guarantee the performance of your investment and even if forecasts about the expected future performance are included you will carry the investment and market risk, which includes the possibility of losing capital. PRICING Funds are valued daily at 15:00. Instructions must reach us before 14:00 (12:00 for Nedgroup Money Market Fund) to ensure same day value. Prices are published daily on our website and in selected major newspapers. FEES Certain Nedgroup Investments unit trust funds apply a performance fee. For the Nedgroup Investments Flexible Income Fund and Nedgroup Investments Stable Fund, it is calculated daily as a percentage (the sharing rate) of total positive performance, with the high watermark principle applying. For the Nedgroup Investments Bravata World Wide Flexible Fund it is calculated monthly as a percentage (the sharing rate) of outperformance relative to the fund s benchmark, with the high watermark principle applying. All performance fees are capped per fund over a rolling 12-month period. A schedule of fees and charges and maximum commissions is available on request from Nedgroup Investments. DISCLAIMER Unit trusts are traded at ruling prices and can engage in borrowing and scrip lending. Nedgroup Investments has the right to close unit trust funds to new investors in order to manage it more efficiently. For further additional information on the fund, including but not limited to, brochures, application forms and the annual report please contact Nedgroup Investments. NEDGROUP INVESTMENTS CONTACT DETAILS Tel: 0860 123 263 (RSA only) Tel: +27 21 416 6011 (Outside RSA) Fax: 0861 119 733 (RSA only) Email: info@nedgroupinvestments.co.za For further information on the fund please visit: www.nedgroupinvestments.co.za OUR OFFICES ARE LOCATED AT Nedbank Clocktower, Clocktower Precinct, V&A Waterfront, Cape Town, 8001 WRITE TO US PO Box 1510, Cape Town, 8000 Page 5