Opportunity Fund quarterly feedback

Omri Thomas of Abax Investments, Fund Manager of the Nedgroup Investments Opportunity Fund provides 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.

Looking back six months ago very few of us would have guessed that the markets would hit a six-month high.

Fund returns
While we had a very tough start to the year particularly due to the effect of Sasol earlier this year, it’s very pleasing to see the returns come back over the last six months. There is still a way to go however as 1-year and 3-year numbers are still way below where we want them to be. To put it into perspective, the performance wasn’t achieved by just adding risk. Our equity rating was relatively conservative so a lot of those hybrid/asymmetric return instruments that we have been talking about have delivered.

Performance drivers
Winners
Testament to the contribution of the hybrid instruments, over 3 months the Royal Bafokeng convertible bond was one of the top contributors to performance (2.63%) and over 12 months, the Impala convertible bond (0.84%) was also one of the top contributors to performance.

The Abax Global Equity fund is the vehicle for some of our offshore equity exposure and has done particularly well over the last 5 years, with last year being one of the strongest years. This position has contributed handsomely to returns over the last 12 months (2.45%).

One of our long-term favourites – Naspers, was once again a top 5 contributor to positive performance over 3 months (0.57%) and 12 months (1.83%).

Further to that, our offshore exposure in general added another 1% performance over 12 months.

Losers
On the losing side, the negative performance of Sasol has been felt a lot less over the last quarter as Sasol recovered. Some trading of Sasol over the period also helped to dilute the negative effect of the share in the portfolio.
Over the last 5 years, 2 of our biggest detractors have been banks – but we do not believe we should give up on banks and go into more detail on this point later.
A small company in the top 5 detractors over 1 year – Ethos Capital, was unfortunately affected by the timing of the COVID-19 pandemic. Ethos bought into the Brait Private Equity portfolio just before COVID-19 it and the biggest holding in that portfolio is the Virgin Active Group of gyms - so what initially looked like a fantastic view with a great price turned sour very quickly due to the effect of the pandemic on the Virgin group. We still back the management at Ethos who have already done good things to restructure the portfolio. Long-term we believe there is still a lot of value to be unlocked there.

Fair Values
Currently, we see almost all South African asset classes in the cheap bucket - including SA/EM Equities, SA Bonds, SA Property, Hybrids and SA Cash.

Developed market equities we see as fair, along with commodities.

Meanwhile, we see US Equity as expensive along with with any developed market credit-related instrument – from bonds to credit or cash. Obviously, we are not immune to what happens in the US so one of the biggest risks is what happens in the US elections and we expect this to result in market volatility.

Asset Allocation
Changes since June have reduced our equity exposure, so the portfolio is a bit more defensively positioned.

We have increased our bond exposure, mostly to inflation-linked bonds, although with low duration – especially locally - as we continue to be concerned about the fiscal position of South Africa. 

Our position in SA Property decreased over the quarter mostly due to the market continuing to punish SA Property. There are still pockets of opportunity in SA Property so that is an area where we have had some activity.

Convertibles & Prefs is down slightly having completely sold out of our Impala convertible bond as that bond really became Impala Equity. However, the Royal Bafokeng convertible bond is now through the strike price and we think one of the most attractive assets in the platinum space. However, we have sold out of our Royal Bafokeng equity.

The sell down in equity was mostly kept in cash which gives us some fire-power should opportunities emerge. It also gives the portfolio a slightly more defensive slant.

Offshore bonds are, as already mentioned, mostly in inflation-linked bonds. We don’t hold any developed market bonds apart from a very small holding in 2-year US Treasury bonds.

Top 10 Equities in the portfolio
We remain quite widely diversified but where Naspers used to be our top position, the structures we had in place to protect us from a big sell off saw us selling some Naspers in September. We are still positive on Naspers and await opportunity to increase this holding again when the timing is right.
The banks feature heavily in the top 10 equities with four out of the 10 holdings being banks at end September – ABSA, Standard Bank, First Rand and Capitec bank which we acquired via the unbundling of PSG. Subsequent to the September month-end, we have sold all our Capitec and switched back into PSG.

In terms of offshore exposure, a portion of our offshore exposure is through Euro Stoxx Notes (4.1%), which is still offering a very attractive risk/return profile. Other offshore exposure is obtained via the Abax Global Equity Fund which we have sold off slightly so that it is now sitting at just under 6% (5.7%) of the Fund.

Currency exposure is currently at 33% mostly due to rand weakness over this period so we will need to bring some of this currency back at some point, but we are still concerned about the fiscal position of SA and the latest postponement of the budget is also not a positive sign. Therefore, we will wait for more opportune times to bring back some of our currency.

Banks – why we see opportunity here
Looking at Banks vs the All share – we are back to the 2007/08 crisis levels with banks. The banks index has more than halved from the peak in 2018. With all the banks trading at discounts to book, we argue that the book value is fairly conservative and that banks have used the COVID crisis to clean their debts. We think there is a good chance that we will see special dividends coming from banks as they are allowed to start paying dividends again. When this will occur is uncertain but will likely take a cue from the global banks.

We expect earnings growth of anything between 15-20% from the banking index over the next four years. Therefore, even with our poor prognosis of the South African economic outlook, we think this is more than priced in the valuations of banks and we see this as an opportunity.

Therefore, in summary:
• While global markets look expensive, we still think South Africa offers selective value
• We are at maximum FX exposure and we will look to bring that back if the rand weakens
• We remain cautious on the domestic economic outlook
• We are comfortable that our portfolio offers a good mix of growth and yielding assets providing an attractive risk/return profile.