Old Mutual Investment Group

Invest with Perspective| Q1 2022 Market Update

April 26, 2022 Old Mutual Investment Group
Show Notes Transcript Chapter Markers

Portfolio Manager, Siboniso Nxumalo shares his quarterly perspectives unpacking global and local themes as well as investment performance.

Siboniso Nxumalo  00:00

Hi, my name is Siboniso Nxumalo. I'm a Portfolio Manager at the Old Mutual Investment Group, Macro Solutions. This is the first quarter of 2022's investment review. Our funds over the last three months have delivered a mixed but pleasing performance, with a lot of them in the first and second quartile. We've got the mid- and small capped fund and the property funds in the fourth quartile. But if you look further out over the last 12 months, our funds have actually delivered a fairly pleasing performance on behalf of clients. 


So, I'm going to explain where this comes from, in terms of what's driven this performance. And I'm gonna start with a Howard Marks quote, just to lay the context. This quote: "The riskiest thing in the world, is the belief that there is no risk". By the same token, the safest and most rewarding time to buy, usually comes when everyone is convinced that there is no hope. So, let's talk about South Africa, because it has been the driver of our investment returns. 


To explain this quarter's performance, we must go back to the first quarter or the end of the first quarter of 2020, first of April 2020. And I'll give you R100 to invest in two shares: Naspers, which owns a large stake in the tech company, Tencent in China, versus Standard Bank. Tencent, at that time, was trading at a 32: P/E, while Standard Bank was trading at a 6.7: P/E. 

Again, let's step back and look at Naspers. The world was in lockdown on the first of April 2020. The gaming industry was booming. Tech valuations were very high, and companies in the tech sector, um, like Tencent, were delivering record profits and those profits would have continued. 

Standard Bank, on the other hand, coming back to South Africa, the bad debts were ballooning. Consumers and businesses were under cashflow pressure and required government and bank interventions to actually restructure their bad debts and make sure that people can make payments. Bank dividends were being canceled, and banks were heading into a period of extremely low profitability. However, the valuations of South African banks headed back, reflecting this sour mood, back to the mid 1980s, where we last saw South Africa with sanctions. 

So, South Africa, going into the Covid pandemic, couldn't afford the Covid pandemic. It was marred by corruption, high unemployment rate, anemic growth, and as a country, we were in crisis and in dire need of structural report. On the first of April 2020, the Rand was at R19 and there was a very loud and growing cacophony of commentators saying, take your money offshore, take your money offshore, South Africa is un-investable. 

China, on the other hand - coming back to my Naspers example - China was second largest economy in the world and was one of the fastest growing economies in the world with great control of their economy, and they had issued stimulus in the economy and actually, by then, they were starting to come out and lead the world out of their recovery. 


Let's take a look two years later. So, 31st of March 2022, this particular quarter we're talking about. Remember, I gave you R100 to invest in two companies, Naspers and Standard Bank. The one was the best of times - Naspers - the one was the worst of times - Standard Bank. R100 invested in Naspers, in the first of April 2020, would have equated to R57 today. R100, however, invested in Standard Bank, at the worst of times, would have equated to R178. 

So, what happened? Let's go back to the Howard Marks quote. Let me just refer to it again. "The riskiest thing in the world is the belief that there is no risk." By the same token, the safest and most rewarding time to buy usually comes when everyone's convinced that there is no hope. So, clearly Naspers, everyone presumed there was no risk. South Africa, everyone presumed there was no hope. South Africa got the investment returns and our clients benefited. 

South Africa actually got relatively better. February this year, we had a very positive budget. Moody's even upgraded our outlook. We've got - South Africa is endowed with commodities. And so, high commodity prices are very good for our fiscal balance sheets. And also, the government surprised and said, hey, we're going to increase your offshore allocation from 30 to 45%. That was a positive surprise in terms of the market and lowered corporate tax rates. 


South Africa is getting better, while the world got relatively worse. Russia invaded Ukraine. So, there was war. War is never good for global economies. There's high inflation globally, something that the developed market world hasn't seen in a very long period of time. And there's rising interest rates, which obviously are going to cause issues in terms of slowing down consumption. The price we were paying for South African assets in 2020 didn't factor in improvement. Whereas the valuations for global assets, they assumed that actually the world would stay in that heightened state for a long period of time. And there in lay our investment opportunities to make outsized returns for our clients. 


And part of our work back in 2020, we came up with a few themes because we look at the world through a theme and price perspective. And one of our themes - two of our themes were liquidity tightening and rotation. Liquidity tightening, going into 2020, we'd seen a lot of stimulus go out to the world to save the economies from Covid. And so, therefore, we're seeing that over time, central banks will pull this back. We're seeing very sharp rises in inflation. And thus, we would see rising rates. And now this was going to impact markets, especially global markets. 

We're also seeing rotation, which is value shares, like Standard Bank. would outperform growth shares in such an environment. And so therefore, we were more positioned in the value shares rather than the growth shares. And we realise that both of these key themes will produce different winners and losers from what had been previously, and we positioned our clients' funds accordingly. 


So, coming back to this quarter. After an outstanding year for risk assets in 2021, the first quarter of 2022 reflected a difficult environment for investors. The key drivers for the quarter were rising expectations of the Fed hiking interest rates more aggressively to curb the 40-year high inflation in the US, as well as a significant economic uncertainty coming from the Russian invasion of Ukraine. We saw developed markets equity fall 5% in dollars, recovering somewhat of their losses in March, while emerging markets' equities fell 6.9% in dollars. Within emerging markets, China struggled, falling 14.2% in dollars as a new round of the Omicron cases resulted in renewed lockdown imposed in several major cities in China. 

For South African investors, the story was good though. Local equities were up 6.7%. Divergent performances though from the underlying sectors. Resources were up 19%. Financials were up 16.7% with standout winners, while industrials were down 13.1%, weighed heavily by the Naspers/Prosus  underperformance. In other asset classes, we saw South African bonds up 1.9%, while cash generated 1%. And SA property fell 1.3% for the quarter. The Rand was flat, surprisingly, and ended the quarter at R14.61 to the dollar. 


To position for this environment, our funds have been trimming some of our cyclical exposure, while retaining holdings in our South African financials, like Standard Bank. We've also been adding to defensive shares as the investment cycle matures. These include, Life Healthcare, the hospital group, and Remgro. South African industrials, especially the smaller industrials, have performed well, and we believe that they have more to give. In many cases, evaluations have remained suppressed, and profits have only began to recover. 

So, our faith in South Africa, and that recovery, continues. We are confident that the funds are well positioned for the current environment. The rotation into value shares out of growth shares is well established, and the fund is however starting to increase its position in the more defensive names as the global growth cycle starts slowing. As the cycle matures, we have been selectively buying protection in some of our multi-asset funds. And the team is now starting to rigorously debate the rising possibility of a recession and thus shifting portfolios accordingly. In a world where there's tapering, in a world where interest rates are rising, we have to consider that actually the cycle has matured, prices have risen, we now need to start shifting portfolios to a more defensive tone. 

We are pleased to have delivered what is, I think, a pleasing quarter for clients in various of our funds. And we hope that when I talk to you next time, we would have continued the same. Happy investing to you. Thank you.

What drove performance in Q1 2022?
Going back to Q1 20202 – using Naspers/Tencent and Standard Bank as examples with a R100 investment
Two years later – where is that R100 you invested in Naspers and Standard Bank?
The investment opportunities in South Africa
The key themes we looked at in 2020 – liquidity tightening and rotation
Looking at Q1 2022 in more detail
How did we position funds for this environment?