SA entered this quarter under the cosh and it got worse! Lingering global trade tensions, accompanied by the realisation that Covid-19 was spreading rapidly, did not help as our sovereign rating was junked and we headed for lock-down towards the end of the quarter. The longer-term effect on our fragile economy is still to be determined as contagion sets in. The global aversion to risk that became entrenched, coupled with the need to satisfy margin calls on debt-fuelled investment portfolios, resulted in the manic selling of both SA’s bonds and equities. In response, the SA Reserve Bank cut interest rates further and the ZAR closed out the quarter at 17.86 / USD, some 27% weaker. SA’s reaction to the risks that Covid-19 poses to human life has been swift, admirable despite feeling draconian at times. Consequently, this has had the effect of moving attention away from the structural reforms required if we are to have any expectation of emerging on the other side of this tragedy with any confidence in resurrecting an economy on a ventilator, in ICU and without any PPE’s.

Table 1: Total return of selected SA indices at 31 March 2020

Returns in ZAR

Qtr %

1 Yr % 2 Yr %* 3 Yr %*

5 Yr %*

SA Equity (J203T)

-21.4

-18.4 -7.4 -2.1

-0.1

SA Property (J253T)

-48.2

-47.9 -29.9 -23.0

-13.5

SA Bonds (ALBI)

-8.7

-3.0 0.2 5.3

5.2

SA Preference Shares (J251T)

-30.4

-22.3 -4.0 -3.2

2.6

SA Cash (Call Deposit)

1.6

6.6 6.6 6.7

6.6

SA Cons Inflation (CPI) **

1.5

4.6 4.4 4.2

5.2

* Returns are annualised / Source: Morningstar Direct / **Inflation lags by 1 month due to data availability

 The SA Reserve Bank is mandated to ensure the stability of our financial system and in sync with global colleagues, cut rates and stepped in to provide liquidity to ensure capital markets functioned, never mind “in an orderly manner”.  Under pressure, given the competing demands of economic, social and SOE requirements, the increase in debt required due to falling tax revenues, an increase in the cost of debt as SA was junked and the expenses to be incurred in preparing for and navigating through Covid-19 related expenses, could be a bridge too far.

The ZAR is reflecting this reality. Money Market rates have fallen and are likely to disappoint those with income needs as we expect the SARB to cut rates further as we navigate the rest of 2020. We have been waiting patiently for our Government bond market to reflect our new (or any period in the last decade) status and used the sell-off in yields to build positions in our Fund range. The All Bond Index fell 8.7% during the quarter as yields rose to above 11%. The ZAR lost a whopping 27.5% against a strong USD during the quarter after entering 2020 on the back foot as the woes of ESKOM, SAA, etc and limited ability to get the economy revived while under constant threat of a downgrade to junk status.

The ZAR is now significantly undervalued and as more formal PPP (Purchasing Power Parity) measures can be quite technical a simple example using the Big Mac methodology gets to the same point. [i.e. A Big Mac Meal cost R59 in Cape Town and R161 in New York (US$ 9 x 17.86) at quarter-end. This equates to the ZAR being 63% undervalued relative to the value required to maintain price parity when buying a Big Mac Meal in the USA].

Of all the asset classes we evaluate for investors when constructing portfolios, the ZAR has an emotive factor that defies traditional measurement which leads investors to hold on to a variety of biases. We have been repatriating non-equity offshore assets in small amounts with our unit trust funds as the ZAR started “colouring outside of the lines”, aligning with neutral long-term strategic asset allocation parameters.

Table 2: ZAR movement against selected currencies at 31 March 2020 

ZAR vs

Rate

Qtr % 1 Yr % 2 Yr %* 3 Yr %*

5 Yr %*

USD

17.86

-27.6 -23.2 -22.9 -10.3

-8.0

EUR

19.71

-25.7 -21.3 -16.3 -11.6

-8.4

GBP

22.17

-19.5 -17.3 -15.6 -10.4

-4.3

AUD

10.97

-11.6 -6.7 -9.8 -2.4

-3.4

* Returns are annualised / Source: Iress

Domestic listed property fundamentals remain weak as deteriorating economic growth, high unemployment, depressed sentiment and Covid-19 related closures keep consumers and tenants under pressure. Income streams out of listed property shares are expected to disappoint as REITs are forced to preserve balance sheets through reducing, deferring or just not paying dividends to preserve cash for short-term requirements. We remain underweight the sector in the short-term as growth forecasts in the sector continue to be downgraded. The SA Listed Property index fell 47.9% during the quarter.

SA listed preference shares, an important component of portfolios for tax-sensitive income investors, were treated like an ugly stepchild in March as investors liquidated positions on the back of mass (irrational) panic. The sector is now offering a fantastic opportunity to pick-up high-quality banking prefs at an after-tax yield of close to 10%! The yield is compelling, and prices have fallen to attractive levels. The Listed Preference Share index fell 30.4% during the quarter.

Table 3: Cordatus Balanced Fund Performance 31/12/2019 – 31/03/2020

Quarter

Cordatus Balanced Fund A1

-9.5%

Cordatus Balanced Fund Benchmark *

-12.9%

Average High Equity Balanced Fund

-13.5%

FTSE/JSE All Share Index TR

-21.4%

Source: Morningstar / * 50% JSE All Share Index. 25% JSE All Bond Index, 15% MSCI World Index, 10% SA Cash Index

With aggregate sentiment low and economic growth already below par, falling commodity prices, followed by an oil price collapse and Covid-19 panic, was a toxic combination this quarter. The JSE All Share Index fell 21.4% during the quarter and no sector / stock (bar Gold Mining & Naspers) was spared. Real Estate, Travel & Leisure, Sasol, Platinum Miners, Banks and general Retailers were particularly hard hit as investors scrambled to liquidate positions. We were not asleep at the wheel while this was playing out in real time, with real money!

Going through portfolios and funds stock by stock, we added to cyclical stocks (Anglo’s, Glencore and Impala Platinum). We also added to Prosus, Anheuser and Richemont as prices declined to relatively attractive levels. With a more local flavour, we added small amounts to Woolworths, Hudaco, KAP and Foschini. Our Gold ETF increased without any intervention, benefitting from a falling ZAR and higher gold price.

Stocks with strong balance sheets and future relevance are preferred as we try and understand the impact and cost of limited trade and a changing physical landscape as we emerge from what could be an extended lock-down.

Dividends on shares are expected to be lower going forward as companies bolster balance sheets amid a volatile operating environment. Investors with rigid expense budgets should prepare themselves as capital gains may need to be incurred on the back of declining dividend and cash yields in the near-term.

Table 4: Total return of selected global indices at 31 March 2020 

Returns in USD

Qtr %

1 Yr % 2 Yr %* 3 Yr %*

5 Yr %*

MSCI World NR USD

-21.1

-10.4 -3.5 1.9

3.3

EPRA/NAREIT  Property TR USD

-28.4

-23.0 -7.0 -2.4

-0.8

FTSE WGBI USD

2.0

6.2 2.2 4.3

3.0

BofAML USD Libor TR USD

0.3

1.9 2.0 1.8

1.2

US BLS CPI USD **

0.6

2.3 1.9 2.0

2.0

* Returns are annualised / Source: Morningstar Direct / **Inflation lags by 1 month due to data availability

March 2020 was one for the record books in terms of performance as equities and yields fell, credit spreads widened, and economic activity contracted. In response, central banks threw everything at the problem, bar the kitchen sink. Our top 3 takeaways during the Covid-19 dominated period are:

  • Volatility has remained high
  • The USD remained strong despite narrowing rate differentials
  • Gold has proven its worth as a disaster-hedge

 Table 5: Cordatus WW Flex Fund Performance 31/12/2019 – 31/03/2020 

All figures in ZAR

Quarter

Cordatus Worldwide Flexible Fund A1

6.0%

Cordatus Worldwide Flex Fund Benchmark *

2.8%

Average Worldwide Flexible Fund

-5.8%

MSCI World Index NR

0.8%

Source: Morningstar / * SA CPI + 5%

Cash returns globally have been suppressed further as central banks cut rates. SA investors have no reason to hold cash offshore as a result, save for protecting oneself against rampant ZAR depreciation and lingering doubts around global risk assets.

USD denominated emerging market sovereign bonds have seen their yields trade materially higher and depending on your risk profile offer relatively attractive opportunities, once world markets calm down. US investment grade high yield bonds offer a similar opportunity, with a handy Federal Reserve proving a safety net. We have no offshore government bonds within our portfolios, as the risk going forward from these low yields is not matched by the return required to compensate us.

Recent years has seen the USA having substantially higher interest rates than Europe, make owning the USD attractive. However, with the US Federal Reserve cutting rates to close to zero in March, one would expect the USD to falter. Markets seeking USD assets during the panic period resulted in funding and liquidity issues which have kept the USD stronger. Going forward however, a reduced rate differential advantage, overvaluation against all but a couple of very cold countries on a PPP basis (see Big Mac example on the ZAR) and a need for cash in home countries funding lock-down related expenses, we expect the USD to weaken. With the opportunity cost of holding gold as against the USD now negligible, we prefer our current gold holding as it is normally negatively correlated to the USD. The NewGold ETF is our biggest single position within the Cordatus Worldwide Flexible Fund. The GBP hit a 35 year low against the USD during March and we are rotating out of USD cash held within GBP denominated portfolios as a result. Dear Boris, get well soon!

Cutting through all the jargon related to and human implications of “flattening the curve”, “acceptable mortality ratios”, “peak infections” and the politics surrounding ventilators and PPE’s the one thing we do know is that Governments around the world are keen to get their populations back to work as estimates of the impact on economic growth of extended isolation periods are being published by all and sundry, from the safety of their living rooms.

Using the Cordatus Worldwide Flexible Fund to summarise our equity thinking, we highlight a few factors that we see as pressing given a very uncertain future in 2020. In addition to balance sheet strength required to survive an uncertain virus horizon and the resulting impact on earnings, the following thoughts require our undivided attention:

IT stocks have held up relatively well over the quarter and as we go forward our focus is on those stocks with recurring income relating to cloud storage, cyber security and online services (education, gaming, etc) are sought or added to. Healthcare stocks offer similar opportunities going forward in the form of a global populace that will be looking forward to having their constitutional right to being a hypochondriac restored. Materials look interesting in an environment which sees global trade improving, while Financials, other than those with a large wealth management component, remain underweight in an environment of low/negative interest rates. We reduced our exposure to private equity as holding stocks which relied on massive debt financing seemed a bit counter-intuitive.

We definitely do not claim any information advantage in the current environment. We will just be sticking to our knitting, trying to find the most attractively priced assets that will have even more relevance in the future once we “kick the curve”. We feel for our dear President as, armed with multiple scenarios, is going to have to make a call on whether to extend SA’s lock-down after Thursday’s deadline. Making the call as to an acceptable mortality ratio is going to haunt him forever. Our thoughts are with him during this trying time.

Feel free to contact us at any time so we can find a quiet corner and chat.

Regards,  

Your team at Cordatus

 Website:          www.cordatus.co.za

Twitter:            @CordatusC

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DISCLAIMER

Cordatus Capital (Pty) Ltd is an authorised Financial Services Provider [FSP # 21263]. The content of this document and any information provided may be of a general nature and may not be based on any analysis of the investment objectives, financial situation or particular needs of the client (as defined in the Financial Advisory Intermediary Services Act). As a result, there may be limitations as to the appropriateness of any information given. It is therefore recommended that the client first obtain the appropriate legal, tax, investment or other professional advice and formulate an appropriate investment strategy that would suit the risk profile of the client prior to acting upon such information and to consider whether any recommendation is appropriate considering the client’s own objectives and particular needs. Any opinions, statements and any information made, whether written, oral or implied are expressed in good faith. The products discussed in this document, may or may not, be regulated by the FSCA.

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