Market participants needed a strong stomach in 2016 as politics dominated the investment landscape. Global markets remained fixated on Donald Trump and Brexit risk, while in South Africa, a potential sovereign debt rating downgrade and fraud charges against Finance Minister Pravin Gordhan, sparked turmoil and uncertainty in our markets. South Africa avoided a sovereign credit rating downgrade from Standard & Poor’s, emerging market risk sentiment improved and markets began pricing in an improving inflation and growth outlook for 2017. All these factors bolstered South African bonds, which were the best-performing domestic asset class last year.
Globally, the year 2016 was a tale of two halves. The first half of the year favoured defensive stocks such as consumer staples, utilities and telecommunication services, and government bonds. The second half of the year saw a rapid rotation away from defensive yielding assets to lower-quality, ‘cheap’, leveraged, capital intensive and more cyclical sectors (notably financials, materials and consumer discretionary). The move in the second half of the year was sparked by expectations of rising prices, higher global bond yields and fiscal stimulus.
Quality is a long-term investment strategy and may lag the market during periods of rapid rotation. The past year was no exception, and hence the Investec Opportunity and Cautious Managed Funds experienced volatility in performance over the quarter and year. While politics and event risk undoubtedly impact asset prices in the short term, we believe that over the long term, fundamentals drive markets.
In terms of portfolio construction, we seek a balance of exposures with sufficient levers and shock absorbers that can generate consistent returns irrespective of the environment. For example, over the past year, we substantially increased our holdings in nominal bonds as they offered the potential to provide a healthy real return relative to cash, in an environment of declining inflation expectations. While some of our offshore equity holdings came under pressure in 2016, our bond exposure acted as a natural hedge against rand strength and equity weakness, contributing positively to performance as local political developments took a turn for the better.
Within local equities, our exposure to resources and quality cyclicals (Assore, Santam and Standard Bank Group) enhanced gains. On the other hand, our largest equity position, British American Tobacco, weighed on returns. British American Tobacco continued to deliver exceptional results, with strong volume growth. However, the stock came under pressure mainly due to the stronger rand. We believe the fundamentals of the business remain strong.
We are not short-term traders. Instead, we prefer to take positions in high quality companies that offer good value. Typically, these positions are held over the medium to long term. On the back of weaker performance, we added to our portfolios’ positions in Richemont, Sasol and Steinhoff International Holdings at very attractive prices. Given Sappi’s favourable free cash-flow prospects and improving capital discipline, we initiated a position in the Investec Cautious Managed Fund during the fourth quarter.
We are still digesting the Trump presidential victory, and its possible consequences. What was originally considered a calamity for global markets has, in fact, turned into a catalyst for rising equity prices, the potential normalisation of developed world yield curves and tightening monetary policy.
While fiscal policy may indeed be expansionary over the medium term, higher interest rates affect the economy today. Global bond yields are tracking higher on expectations of increased borrowing, better growth and higher inflation (which may, in turn, limit the compression of South African bond yields). The US Federal Reserve (the Fed) has turned more hawkish on the trajectory for interest rates, with policymakers now projecting three increases in 2017.
The sustainability of the growth currently being delivered by two of the largest drivers of the world’s economic engine is questionable. In the US, the only real growth has come from consumption fuelled by a strong jobs market. In China, growth appears to have been boosted by a significant increase in debt. Higher interest rates do not support either driver.
Locally, growth remains anaemic. We continue to experience declines in mining and manufacturing production, deteriorating employment figures, and, as a result, weaker retail and vehicle sales. The potential for declining inflation off the back of lower food prices has created some hope for interest rate relief. When investors get excited about 1.5% real growth in our economy, it paints a disturbing picture.
Worryingly, volatility is low across global equity and currency markets. In other words, there is an underappreciation of risk and an expectation that markets will continue to trend higher from their current elevated levels. High interest rates and stronger equity markets are not mutually exclusive if economic growth is strong. But, at present, global economic growth is merely a promise; it has not materialised in the earnings of the average company. While macroeconomic risks impact asset prices in the short term, we believe that company fundamentals drive markets over the long term.
We are far less optimistic on the prospects for broad equity markets and global economies. We continue to focus on those equity opportunities that have the highest probability of generating a sustainable and growing free cash flow. In this environment, we believe the best opportunity remains global equities generating high returns on invested capital, followed by select local equities. Both opportunity sets provide significant exposure to currencies other than the rand, with a strong valuation underpin in the form of free cash flow.
South African bonds continue to offer value and a natural hedge against any potential rand strength or equity weakness. While the near-term risk of a sovereign credit rating downgrade has been reduced, a substantial compression in yields is unlikely if global bond yields continue to rise. As a result, we remain focused on short- to medium-term bonds offering high coupons and limited duration risk. Cash remains a significant portion of the portfolio and we are taking advantage of attractive floating-rate notes when they are issued.
Annualised performance (%)
Fund statistics (%)
|Highest annualised return||23.8||28.02.10|
|Lowest annualised return||-6.8||28.02.09|
|*12-month rolling performance|
|Annualised volatility (%)||7.0|
Annualised performance (%)
Fund statistics (%)
|Highest annualised return||43.8||31.07.05|
|Lowest annualised return||-15.7||28.02.09|
|*12-month rolling performance|
|Annualised volatility (%)||9.4|
Source: Morningstar, dates to 31.12.16, performance figures are based on a lump sum investment, NAV to NAV, inclusive of all management fees but excluding any initial charges, gross income reinvested. CPI inflation lags by one month. A Inc ZAR class unit inception date of the Investec Cautious Managed Fund and Investec Opportunity Fund: 02.04.06 and 02.04.00, respectively. TER of the Investec Cautious Managed Fund and Investec Opportunity Fund (A class): 1.78% and 2.11%, respectively.
Our focus is on providing dependable, inflation-beating returns over the long term. Since inception, the Investec Opportunity and Investec Cautious Managed Funds have provided returns well in excess of inflation. As quality investors, we stick to our investment strategy and are not swayed by short-term political news flow and currency movements, as well as unforecastable event risks. We believe our balance of exposures provide us with sufficient levers and shock absorbers to help us generate consistent returns over time. As always, we remain unwavering in our commitment to grow investors’ capital in a prudent manner. We are confident of creating wealth over the long term, despite potential near-term setbacks.
Collective investment schemes (CIS) are traded at ruling prices and can engage in borrowing, up to 10% of portfolio net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the Manager, Investec Fund Managers SA (RF) (Pty) Ltd (IFMSA) which is registered under the CIS Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. CISs are generally medium to long term investments and the manager gives no guarantee with respect to the capital or the return of the Fund. The value of participatory interests (units) may go down as well as up. Individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. Different classes of units apply to the fund and the information presented is for the most expensive class. Fund valuations and transaction cut-off time are 16h00 SA time each business day. These portfolios may be closed in order to be managed in accordance with the mandate. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where portfolios invest in the participatory interests of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. Fund prices are published each business day in selected media. Additional information on the Funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. Investec Asset Management (Pty) Ltd (“Investec”) is a member of the Association for Savings and Investment SA (ASISA). The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. IFMSA products are subject to the terms contained in the IFMSA Terms Document, as well as the Minimum Disclosure Document, which is available from our website www.investecassetmanagement.com.
All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. Past performance of investments is not necessarily a guide to future performance. This is not a recommendation to buy, sell or hold securities. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management is an authorised Financial Services Provider. Issued by Investec Asset Management, February 2017.