Performance was driven by strong returns from offshore, mining and technology
Fund managers needed to get three things right to maximise returns over the past three years. Firstly, offshore exposure was critical, not only due to the strong Rand returns delivered by offshore equities (up 18%), but also because of the relative poor performance of SA equities, especially those with businesses geared to the local economy.
Secondly, SA resources stocks returned 25%, benefitting from a weaker Rand and secular global themes supporting gold, platinum group metals (PGMs) and basic materials prices. Local non-mining stocks did poorly, with industrials returning 2.5% over three years and financials falling by 8.5%.
Finally, tech stocks: Naspers/Prosus, listed locally with a strong offshore tech focus, accounted for a large part of the return from industrials and stripping it out of the industrial index leaves the sector down 9%. The MSCI World Index total return of 18% comprised 10% from Rand depreciation and 8% from global equity returns, more than half of which (4%) is attributable to global tech stocks. In particular, there were extremely strong performances from the FAANGs+M – Facebook (+50%), Amazon (+185%), Apple (+164%), Netflix (+205%), Alphabet/Google (+53%) and Microsoft (+210%).
Chart 4: Scenario analysis – 3 year annual returns
Source: Morningstar & Northstar (30 June 2020)
In Chart 4 above, our analysis indicates that the 3.6% returned by the average SA Multi Asset High Equity Fund over the last three years would have been reduced to 2.3% had the average fund not invested in Naspers/Prosus, 1.7% had it not held resources and 0.3% if only exposed to SA assets.
Increased risk doesn’t automatically mean increased returns
SA fund managers have not necessarily been rewarded for taking increased risk over the last three years, especially those that backed high risk SA equities, which have meaningfully underperformed local fixed income and global assets.
Chart 5 below shows that the Northstar SCI* Managed Fund (the Fund) was able to navigate these markets well and delivered above-average returns at lower volatility than most of its peers, outperforming its benchmark over one, three and five years. This was achieved by refusing to bet on binary events while taking a measured probabilistic approach to asset class allocation.
Chart 5: Alexander Forbes Manager Watch TM Series of Surveys – risk versus return (3 years ended 30 June 2020)
Source: Alexander Forbes Global Manager Watch survey – Best Investment View (30 June 2020)
The Fund maintained full exposure (30%) to offshore assets, stayed overweight global equities and underweight local equities. We achieved high hit-rate and win/loss ratios in global equities, although good stock selection in local equities was offset to some degree by our underweight position in mining stocks. Returns benefited from exposure to global tech, mainly through Naspers/Prosus, Alphabet/Google, Microsoft, Apple, Alibaba and Amazon. We avoided the local property sector and held an overweight position in SA fixed income.
Have these trends now run their course?
The SA macroeconomic environment remains very challenging, with business confidence at all-time lows. Corporate earnings growth is extremely weak and trending down, in line with nominal gross domestic product (GDP). Per Chart 6, inflation-adjusted earnings are at 2006 levels despite the positive impact of the strong performances of basic materials and Naspers/Prosus. The market is cheap, trading on a low price to earnings (PE) ratio on depressed earnings. Yet a few relatively simple developments could more than double the potential GDP growth rate from 1.5% to 3.7%. These include reforms to the telecoms and transport industries, removing barriers to entry to the economy, prioritising tourism and agriculture and improving confidence levels. There is definite risk in backing a SA recovery, but the payoff could be significant. Even though valuations are starting to look attractive, we think a local recovery will take time and have adjusted our bet size accordingly.
Chart 6 : FTSE/JSE inflation adjusted earnings (indexed to 100)
Source: Iress & Northstar (30 June 2020)
We believe that the easy money has been made in commodity stocks and it is hard to justify further investment as this point. The valuations of mining companies are rational at current spot commodity prices but spot prices are very high, both in comparison to their own histories and to their respective cost curves.
Global tech companies have run strongly, with returns over the past decade justified by robust free cash flows. Current valuations are baking in strong growth, but if consensus expectations are right, valuations are not unreasonable, although at bull case levels in our opinion. While we think global tech stocks still have some potential, we have reduced our exposure.
Exposure to offshore assets and high quality global franchises maintained
The Fund has kept its maximum exposure to offshore assets and remains underweight local equity. Both the offshore equities component and the core local holdings comprise high quality global franchises, such as New York Stock Exchange-listed VISA and Oracle, and JSE-listed Naspers, BAT and Richemont. The Fund has a smaller exposure to high-quality cyclical SA stocks to retain optionality should the SA economy recover sooner and more strongly than expected. We are overweight local fixed income of low duration, with high exposure to short-dated RSA inflation-linked bonds, which offer strong real yields. We do not expect the fundamentals of the local property sector to improve meaningfully over the short to medium term and have no exposure in that sector.
Northstar will continue to take a measured approach that prioritises strong returns with effective risk management by focusing on quality at a reasonable price and diversifying exposure across asset classes.