“Investor report and newsletter for the second quarter of 2021”
Updated: Aug 11, 2021
As we write this report, the distressing news of the riots and extensive damage taking place in our country dominates the headlines. The damage of these riots on the economy is yet to be assessed and finally quantified. Communities have begun in cleaning up the streets of KZN and Gauteng and the provinces are slowly returning to normal operations, though much is yet to be done to rebuild torched and plundered facilities. With the already fragile state of our country experiencing a brutal third wave of Covid-19 infections, the resilience of South Africans is certainly being challenged.
There is some light at the end of the tunnel. The vaccine roll-out had a sluggish start for the over 60s, but once the queues opened up for the over 50s, and the subsequent grouping of those aged between 35 and 49, a ‘rush’ has been more evident. Promising initiatives such as the renewable energy program, allowing for self-generation of power, establishing the independence of national ports to improve efficiency, a rebound in State Owned Enterprises expenditure as well as the positive mining capex cycle announcements are encouraging. The domestic economic recovery may be interrupted by recent developments, with the growth rates being adjusted slightly lower (than the current expectations of 3% shown in the chart below) but is still on track to recover back to 2019 levels over the next few years.
The charts below highlight the strong recovery in global GDP, driving the equity markets, and with local GDP growth also recovering but lagging the global trend.
Source: Morgan Stanley as at 30 June 2021 Source: Statista as at 30 June 2021
The markets over past quarter
Global equity markets continued to perform strongly this quarter, with some major indices reaching new highs and bringing the YTD (year-to-date) return to 12% in USD. This is supported by strong global economic growth with fiscal and monetary stimulus remaining accommodative. A focus on rising inflation re-emerged and is prompting the debate around premature tightening of monetary policy and therefore potentially derailing the equity rally. Recent factors impacting inflation, including base effects with most economies accelerating off the extremely low base of 2020, and prices of products and services that had collapsed or were restricted, are now higher. Combined with rising energy prices, this will result in higher inflation over the next few months. The duration of higher inflation is unsure, but in the absence of sustainable price rises (which needs to be monitored), the base effects should swing back. When economies reach full employment, in a few years’ time, this may result in higher inflationary outcomes.
The local equity market was flat for the quarter. bringing the YTD return to 13%. The resources sector ended down some 5%, as metal prices declined, while the financial sector was up 8% and the property up 12% (as investor confidence improved in line with the economic outlook). Our currency is certainly earning a reputation for being one of the most volatile emerging market currencies this year. In May the standout feature for the month was the strong appreciation of our currency against the USD, up 5.5%. In June, the ZAR weakened against the USD by 4%. For the YTD, the rand is up 2.5% at USD/ZAR 14.30, and still significantly stronger from USD/ZAR 17.00 less than a year ago.
Performance summary charts
The charts below highlight the strong performance of selected markets for the past quarter as well as the phenomenal recovery in markets over the past year.
Source: MSCI, Datastream, Morgan Stanley Research, Bloomberg and Visio as at 30 June 2021
Valuations and opportunities
The global recovery has been stronger and quicker than previously expected. The global equity market has been dominated by the performance of the USA, justifiably with the meteoric rise of the high growth giants like Facebook, Amazon, Apple, etc., The S&P 500 index is now trading above its long-term average ratings. Non-US equity markets have lagged the US for over 12 years and valuations on a relative basis are at historical lows. Is it time to shift away from the USA? Certain stock selection ideas by our team, based on solid fundamental analysis, have been identified and which may result in changes to the geographic allocation in time.
While the South African economic recovery continues to lag that of other comparable countries, we do benefit from the combined effect of a faster global recovery, high commodity prices and easy monetary conditions. Local earnings expectations have remained positive, importantly across a few sectors such as retail, mining and telecoms. Market valuations remain attractive, as shown in the chart below, currently trading at levels only seen three times before over the past 15 years. It is worth noting that the resources sector is the key contributor to the overall market rating, as this sector is trading at record low, forward PE ratios. The financial sector is now at fair levels after a stronger quarter, and industrial shares are just above average with solid and consistent performance from the large global heavyweights like Richemont, British American Tobacco and Naspers. When compared to our emerging market peers, we remain attractively priced, both on an absolute basis as well as in relative terms as shown in the charts below.
Source: Thomson Reuters, IBES, RMB Morgan Stanley as at 30 June 2021
Naspers and Prosus
Naspers and Prosus, two core holdings in the BACCI SNN Equity Fund, have been getting more press than usual with shareholders voicing their unhappiness over a proposed share swap transaction. Prosus is proposing to acquire a significant stake in Naspers shares in exchange for Prosus shares. The offer is to acquire 45.4% of Naspers N (NPN) shares, resulting in a total economic interest of 49.5%, while the Naspers interest in Prosus drops from 73% to 57%. The share ratio will be 2.27 Prosus shares in exchange for 1 NPN share.
The rationale is that the proposal will unlock immediate value by lowering the discount between Naspers and Prosus. In addition, the intention of the deal is to reduce the heavy weighting of Naspers in the JSE indices and boost the free float of Prosus in Amsterdam. The question is will these outcomes enhance shareholder value? Not necessarily, is what we think.
The valuation of both Naspers and Prosus have remained compelling for some time as both shares trade at a significant discount to the value of the holding in Tencent alone. As at the end of June, the 29% stake in Tencent held by Prosus was worth USD 200bn. The NAV of its e-commerce assets, such as Delivery Hero, PayU and iFood, are valued in the order of USD 40bn. The current market capitalization of Prosus is USD153bn, implying a discount of 25% for the Tencent holding alone and effectively no or negative value for the e-commerce businesses. The Naspers shareholding of the Tencent alone, via Prosus, results in a discount in excess of 40%. Is this ‘negative value’ attributed by the market a reflection of the complex control structure and an assessment of management’s track record thus far for their e-commerce investments? Should this be the case then the discount may not necessarily close as a result, of the deal. In addition, shareholders will exchange a lower discount share (Prosus) for a higher discount share (NPN), which is not ideal. The control structure of the group is complex. Unlisted entities control Naspers with A shares that have high voting rights. As expected, shareholders in Prosus have taken the step to enable the share-swap deal, with Naspers voting its 73% stake alongside 53% outside investors giving their approval. This resulted in more than 90% in total so as to approve the transaction. It is interesting to note that 47% of outside shareholders voted against the deal. Now the question is whether 45% of Naspers shareholders, the minimum required, will submit their shares for the swap? It may be challenging, and our current thinking is ‘not in favour’.
BACCI Global Equity Fund
We are thrilled to celebrate the first anniversary of our global equity fund. We launched the BACCI Global Equity Fund on 1 July 2020, a Dublin based UCITS fund. The investment objective of the BACCI Global Equity Fund is to achieve long-term capital growth by investing across global equity markets. The investment philosophy is to invest in dominant, high quality businesses which have a history of developing both growth and real economic value. The chosen benchmark is the MSCI All Country Index (MSCI ACWI).
While our investment philosophy and approach are by no means short-term in nature, the chart below does gives you an indication of how the fund has performed over the year to 30 June 2021, up 39.2% in USD. By way of comparison, we have included the benchmark, MSCI ACWI price index, which is up 36.5% in USD and the peer group, up 35.6% in USD.
A special mention of thanks to the Pendulum Advisors team, Arjan Buikema, James Campbell and Gerard Pacak, the sub-advisors to the BACCI Global Equity Fund. The team assist BACCI Investment Solutions in stock selection and the portfolio construction process.
The latest minimum disclosure document & general investor report for the BACCI Global Equity Fund, as well as the BACCI SNN Equity Fund and the BACCI SNN Protected Equity QI Hedge Fund can be found on our website and are well worth a read.
Our long-term bias in the portfolio allocation of our clients is to equities where relevant. Over time, equities outperform most investable asset classes available and more importantly provide real growth over the long-term. This holds true both locally and globally. During periods of expected recession, this changes and markets can fall and in time, this provides an opportunity to re-invest. In the current stimulatory global growth environment with low prospects of a recession, equities remain our asset class of choice.
Within our equity selection, we focus on the underlying long-term fundamentals of each investment that we make to determine the return outcome, irrespective of the macro conditions. We reaffirm that each component in your portfolio’s construction is working to ensure that the risk and return characteristics of your assets are optimal, irrespective of the market conditions.
We are pleased to note that returns in these extremely volatile times have remained robust, with volatility being kept to a minimum.
Thank you for your interest. We welcome any feedback or questions.
Oliver, Ulf, Vanessa and Warren