Balanced Fund quarterly feedback

Saul Miller and Iain Power of Truffle Asset Management, Fund Managers of the Nedgroup Investments Balanced Fund provide an overview of the Fund’s performance for the last quarter and positioning going forward.

To watch a recording of this conversation, go to the Nedgroup Investments channel on Youtube.

Performance
The Nedgroup Investments Balanced Fund has performed in the top quartile over all time periods since inception. In the last year, commodities and rand-hedge shares have added to performance, while detractors have been the domestically exposed shares, even though these make up a relatively small portion of the fund.

Naspers has done well for us. We still have a sizeable holding in Naspers as we think it is relatively cheap and Tencent has not rerated as much as some of the US tech companies that are now looking quite expense - so we are very happy to hold on to Naspers.

BTI did very well through the COVID-19 pandemic – and we have sold out of BTI into the outperformance and added to some of the shares that have been hit by COVID and are now cheaper as a result.

We’ve maintained a sizeable position in the PGM sector and remain positive on that.

The detractors have been quite broad-based across SA industrials and financials and the shares have not really recovered post the economic collapse since COVID-19.

Netcare is a share that we have been buying into weakness as we believe it will recover with time as many elective procedures that have been postponed are rescheduled and volumes increase in hospitals again.

Economic views
There are 3 key themes we are watching:
1. Unprecedented levels of fiscal stimulus across the globe
2. Very accommodative monetary policy that seems to be getting more accommodative – low interest rates and QE
3. Inflation expectations remaining subdued in spite of growth

Debt levels in many countries will be increasing as a result of the fiscal stimulus occurring. Most countries are spending substantially larger amounts now than what they were spending during the financial crisis in 2008/09. As a result of this, the savings rate of individuals will rise and as things improve and as we (hopefully) get a vaccine there will be a lot of money on the side-lines that can be injected into the economies from bank accounts of individual households.

The US is spending by far the most compared to other countries. This in turn puts a lot of pressure on the dollar, which we will elaborate on later.
China has also increased their level of fiscal stimulus. Therefore, because China is such a large consumer of commodities (about 50% of metals demand), this will be very positive for commodities and we have already seen that in commodity prices. This is another reason why we like commodity and resource stocks, apart from being quite cheap, there are macroeconomic tailwinds driving that.

Looking at US monetary policy – bond yields are reaching record lows. This is due to the Fed introducing much more accommodative monetary policy where they are now targeting average inflation. Before, if inflation went above 2%, we would have seen some immediate action. Now however, because they want average inflation to stay below 2%, even if inflation overshoots for a while, we will likely still see a continuation of this very relaxed monetary policy.

Implied or expected US inflation is currently sitting at below 1% so despite all the fiscal stimulus and the low interest rates, there is still very little expectation of inflation and no expectation of an inflation surprise being priced into bond markets.

Importantly, the bond rate is actually less than inflation - so you are getting a negative real return on bonds. Therefore, investors are looking to equity markets for better returns. The growth shares (FAANGS etc.) are much more sensitive to this so it’s not surprising that they are running hard at the moment.

Along with most other market participants we have been very surprised at the swift recovery of markets post-COVID.

We are certainly reaching the end of the 40-year bull run on bonds which has been very positive for equities. This is a risk for equities going forward when forming a portfolio – and we believe one should be particularly cautious about the shares that have benefitted from these low interest rates and we have kept those to a minimum in the portfolio. We don’t think all shares have benefited from low interest rates so there are opportunities to invest despite this very low interest rate environment, but we are cautious.

The dollar is facing headwinds
The PPP of the dollar is far more extended than other countries currently – the dollar is trading at close to 12% above its value when many other currencies are trading on quite significant discounts. On a long-term view this is not positive for the dollar. More importantly, the US-Euro interest rate differential gap has closed which is a significant headwind for the dollar and partially explains some of the decline in the currency. We think this is going to continue which is particularly important for commodities. Generally, a weaker dollar is positive for commodities. So apart from valuations being reasonable, you also have a weaker dollar and Chinese expenditure that has picked up – all of which are positive factors for mining shares at the moment.

South Africa – Green shoots?
We think the SA environment is still highly uncertain but there have been some positive moves in the last month. Firstly, for the first time in a long time we are seeing arrests and people being charged for corruption. While this may not have spilled into the higher levels of government yet, we do believe this is a positive sign and we hope that it will continue into the future. We have seen NERSA approve a plan to tender 12GW for power, a lot of which will go into renewables. This will solve the problem of rolling blackouts in the medium term which is very positive. The ICASA tender is also a very positive move which will raise money for the fiscus.

However, it’s not all positive. Two key negatives are that Treasury is still looking to fund SAA for a bailout which we think is disappointing, and the delay in sign-off for big infrastructure projects. If we want to see growth, we will have to see sign-off on big government projects which we are not seeing yet.
The medium-term budget will be key in providing clarity on these issues and we hope that there is a reasonably positive message that comes out of that.

Valuations in South Africa have come down and are looking a bit cheaper along with a slightly better news flow, so we have upped our exposure to SA shares, although not significantly. We are looking for businesses that have strong balance sheets and can sustain themselves over a prolonged downturn in the economy, as well as companies that are not pricing in overly high levels of optimism since there is uncertainty about how things will pan out in South Africa.

To summarise
- The risk of interest rates increasing offshore is a risk for high-priced equities that have benefitted from this
- We are maintaining quite high levels to commodities and cyclicals especially via the PGM shares
- In terms of SA we think things are improving but the environment is still very uncertain so we are maintaining exposure to offshore companies listed on the JSE
- We have upped our exposure to some high-quality domestic companies with strong balance sheets that aren’t pricing in overly optimistic growth expectations