Economic Market Overview

"Return alone-and especially return over short periods of time-says very little about the quality of investment decisions." - Howard Marks from Oaktree Capital.

The volatility we experienced during the last quarter of 2018 remains fresh in most investor’s minds, yet 2019 has provided committed investors some welcome reprieve from the carnage and even though global assets came under a little bit of pressure from a stronger local currency, local growth assets performed amicably.

Uncertainty around global trade policy combined with continued tensions in the Middle East contributed to some weakness across many emerging markets, putting pressure on global growth asset returns. The negotiations between the US and China around trade tariffs have ebbed and flowed from very positive to extremely negative and although the hubris of President Trump can excite many pundits and journalists, the negotiations have yielded limited, if any, success. On top of these issues, we have seen global growth repeatedly disappoint across many parts of the globe with the IMF and World Bank simultaneously reducing their growth estimates and outlook for the next 3 years.

All of these factors have continued to dampen both consumer and business confidence which spilled over into investor confidence resulting in increased volatility and apprehension around embracing risk. This culminated in a significant market sell off in the month of May 2019 which resulted in significant losses across growth assets. Yet some sanity returned to markets during June which resulted in most global investors ending the quarter almost flat.

Local investors in South Africa had a more upbeat experience and outcome as local growth assets continued to recover from the December 2018 lows. The certainty that came with the completion of our 6... democratic election during May 2019 resulted in some optimism, be it subdued, as the fall out from the previous administration remains enormous. It has come to light that the structural decay associated with State Capture was underestimated and new information continues to lay bare the extent of the problems that government need to address urgently. However we believe the resolve of the new administration under President Ramaphosa is significant and the reward for successful implementation is enormous.

As we stressed during our last communiqué, in spite of risks and uncertainties which might impact growth assets negatively over short-term horizons, we believe the long-term entrenched opportunities remain extremely attractive and integral in ensuring effective portfolio construction and future investment success.

Position going forward

Our key positions across the portfolios remain biased toward growth assets in both the local and global environment although our lower risk and more constrained portfolios do have significant exposure to local fixed income assets. The two largest absolute and peer relative positions remain our allocation to offshore assets and our allocation to local listed property.

Whilst remaining cognisant of market valuations and exogenous risks, we need to retain growth assets in the portfolio to ensure we achieve our longer-term real return objectives. As highlighted above, we have also seen a significant revaluation over the last 3 months as volatility has subsided after the carnage seen in the last quarter of 2018, resulting in many growth assets recovering most if not all of the losses seen in that quarter. This resulted in the valuation of many growth assets moving closer to earnings and market fundamentals, although some disconnect remains which presents further near-term opportunities. We believe premium valuations in certain growth sectors could experience normalisation, yet the general valuation across many sectors present interesting, albeit select, opportunities, especially if the monetary environment remains accommodative.

Asset allocation and diversification therefore remain key to ensuring downside risk management while entrenching long term inflation protection and real returns. Our aim is to provide our investors with diverse exposure across various investment strategies, investment managers and assets while continuing to focus our attention on consistently applying our philosophy and process. The result is a rigorous blend of exposures that should have a high probability of achieving our long-term return objectives (a time horizon of at least 3 years, and longer for the more risk-orientated portfolios) while providing protection against short term swings and negative surprises, and reducing the overall risk our investors face.

We urge investors to remain patient and committed to their chosen investment strategy even though negative surprises are possible. We are continuously looking for ways to increase the certainty of cash flow while remaining cognisant of our longer term capital preservation objectives. Our belief in and commitment to our investment approach remains firm and resolute as we have weathered comparable and even worse challenges over the past 11 years. With the commitment from our clients, we remain confident that our philosophy will again result in positive outcomes and ensure safe passage through turbulent markets.

"The time to buy is when there’s blood in the streets, even if the blood is your own" - Victor Rothschilds, 3rd Baron Rothschild.

Even the most seasoned and optimistic long-term investors felt the anxiety and distress experienced in the last quarter of 2018. As examined and explained in our previous newsletter regarding the last quarter of last year, investors relived some of the most dramatic drops seen over the past 100 years. The drop was eclipsed only by the losses suffered during the Great Depression in the late 1920’s. There were pundits and market commentators, both locally and abroad, pushing the narrative that this was the "beginning of the end" and perhaps the "start of the great unwind". Most of these pundits based their predictions on recent information and volatility, extrapolating the experience of the last quarter of 2018 forward into perpetuity. Although they could have been proven correct "if all else remained equal", the market adjusted to new information and resulted in a marked change in the exact opposite direction that many of these bearish pundits predicted.

The most obvious change that occurred related to the US Fed which has turned decidedly dovish, removing any concerns around interest rates moving up too quickly. This dovish tone encouraged risk taking and resulted in a material recovery across all growth assets.

As we stressed during our last communiqué, short-term volatility will present patient investors with opportunities across a number of different sectors, assets and geographies. In spite of risks and uncertainties which might impact these investments negatively over the next few months, we believe the long-term entrenched growth opportunity justifies increasing or at least maintaining an allocation to growth assets, both locally and abroad.

Position going forward

Our key positions across the portfolios remain biased toward growth assets in both the local and global environment although our lower risk and more constrained portfolios do have significant exposure to local fixed income assets. The two largest absolute and peer relative positions remain our allocation to offshore assets and our allocation to local listed property.

Whilst remaining cognisant with market valuations and exogenous risks, we need to retain growth assets in the portfolio to ensure we achieve our longer-term real return objectives. As highlighted above, we have also seen a significant revaluation over the last 3 months as volatility has subsided after the carnage seen in the last quarter of 2018, resulting in many growth assets recovering most if not all of the losses seen in that quarter. This resulted in the valuation of many growth assets moving closer to earnings and market fundamentals, although some disconnect remains which presents further near-term opportunities. We believe premium valuations in certain growth sectors could experience normalisation, yet the general valuation across many sectors present interesting, albeit select, opportunities, especially if the monetary environment remains accommodative.

Asset allocation and diversification therefore remain key to ensuring downside risk management while entrenching long term inflation protection and real returns. Our aim is to provide our investors with diverse exposure across various investment strategies, investment managers and assets while continuing to focus our attention on consistently applying our philosophy and process. The result is a rigorous blend of exposures that should have a high probability of achieving our long-term return objectives (a time horizon of at least 3 years, and longer for the more risk-orientated portfolios) while providing protection against short term swings and negative surprises, and reducing the overall risk our investors face.

We urge investors to remain patient and committed to their chosen investment strategy even though negative surprises are possible. We are continuously looking for ways to increase the certainty of cash flow while remaining cognisant of our longer term capital preservation objectives.

Our belief in and commitment to our investment approach remains firm and resolute as we have weathered comparable and even worse challenges over the past 11 years. With the commitment from our clients, we remain confident that our philosophy will again result in positive outcomes and ensure safe passage through turbulent markets.

Economic Market Overview

2018 turned out to be a disappointing and difficult year for growth asset investors, both locally and globally. We believe structural drivers and long-term fundamentals should reward growth assets and by default risk-seeking investors over the longer term, yet this was however not what investors experienced over the last 12 months.

Global economic growth appeared strong and coordinated in the first 9 months of 2018 leading into the last quarter. Market sentiment remained positive and risk appetite appeared strong which in turn made most market pundits reasonably optimistic on market prospects going into quarter 4. What transpired tested the resolve of even the boldest risk seeking investors.

While some volatility has been clearly evident across most growth assets over the entire year, the last quarter was particularly negative with the pullback seen in the price of Brent Crude oil, probably being one of the best illustrations of the change in economic conditions and outlook.

The price of oil reached a 4 year high in October 2018 – breaking $86 per barrel on the back of strong demand and supply concerns out of the Middle East. Unfortunately, the demand conditions changed quickly as a growing number of market participants struggled to determine the medium to long term effects of trade tensions between the US and China. Another contributing factor to the significant price drop was the possibility of even greater tightening of global monetary conditions on the back of continued interest rate increases being pushed through by the US Fed. These and other factors resulted in the price dropping to a low of $50 per barrel on 24 December 2018. The price did recover some of the losses ending the year at $54 per barrel or negative move of almost 35%!

Market participants started to doubt the narrative around synchronised global growth while concerns around the possible impact of tighter Global Central Bank monetary policies impacted investor confidence and analyst expectations. This in turn resulted in growth assets losing their allure forcing down medium-term expectations and causing significant pain across most equity markets.

Short-term volatility continues to present patient investors with opportunities across a number of different sectors, assets and geographies yet there are numerous risks and uncertainties which might impact these investments negatively over the next few months.

Portfolio Activity

The Ampersand Sanlam Collective Investments Flexible Property Income Fund lost -5.93% for the quarter against the benchmark (33% cash, 67% SA Listed Property) performance of -2.07%. The underperformance of the fund is due to our South African Listed Property exposure which has been under significant pressure as well as our offshore component.
Position going forward

Our key positions across the portfolios have remained consistent for the majority of the past 12 months.

Over the past 18 to 24 months we continued to increase the effective diversification while reducing the overall risk within all our portfolios, as we were not completely comfortable with the dominant narrative in the broader market. Unfortunately, this coincided with a significant increase in volatility across most assets but specifically growth assets which impacted all of our portfolios.

During certain market cycles these strategies have added significant value and resulted in significant outperformance and protection. Unfortunately, over the past 12 months this has not been the case as our strategy to diversify the portfolios away from local fixed income assets detracted significantly from performance due to the continued decrease in global risk appetite and increased risk aversion.

Mark Twain’s observation of “History does not repeat, but it does rhyme” is an apt synopsis for what we experienced during the third quarter of 2018.

The trade tensions and threats of tariffs and protectionism between the US and its major trading partners have continued to upset the perceived calm and tranquillity across the globe, yet economic activity and growth have remained robust.

This robust economic performance provided support to developed equity markets yet the risk associated with higher tariffs and the rise of protectionist policies put pressure on emerging markets as many developed market investors decided to reduce overall risk exposure. This risk adjustment caused strife across most emerging markets as many EM currencies experienced significant losses with Argentina and Turkey being the most affected. However the events also scarred the local currency and stock market.

On the global front, tensions between the US and the rest of the world continue to dominate the narrative. This culminated in an open spat at the recently held G7 Summit in Canada in June 2018 but continued during many of Trump’s subsequent visits across the globe. This has again been evident in the negotiations around NAFTA where the United States has caused strained relations with both their closest neighbours and historic allies. It does appear that the changing of the guard in Mexico where a more conservative government has taken power has paved the way for a revised trade agreement between Mexico and the US, but the negotiations between the Trump administration and Canada has taken a distinctly different tone and seems likely to drag on.

On the local political front President Ramaphosa has dedicated a lot of energy to reviving the local economy and his strategy is focused on attracting foreign investment. He has already managed to convince various parties across the globe to keep supporting South Africa and we have seen public commitments from numerous countries and governments with the most significant coming from the Kingdom of Saudi Arabia, the UAE and China where the President has managed to secure funding of around $35billion. The bulk of this funding will go towards infrastructure and energy orientated project hence it does entrench a much needed longer term focus within the SA government which under the previous administration was more focused on self-enrichment and cadre politics.

The immediate economic growth and employment environment in South Africa however remains dire. The local economy entered a technical recession as the economy contracted for a second quarter in a row. This brought the annual growth rate to a meagre 0.4% yearon- year while the unemployment rate remained stubbornly high at 27.2%. The growth outlook for the local economy also does not appear very rosy as many sectors continue to struggle and it is likely that economic growth could continue to disappoint for the rest of 2018.

The US has continued to lead the global growth trajectory and the US economy has continued to surprise on the upside when it comes to growth and employment. Economic growth has hit a multi-year high, reaching 4.2% year-on-year as at the end of the second quarter of 2018. This culminated in strong US employment growth and the unemployment rate hitting a 49-year low of 3.7%. Expectations around growth remain positive and this has allowed the US Fed to continue with gradual interest rate increases which is expected to continue over the next 12 to 18 months.

Economic growth in the European Union has continued to recover and it finally appears as if the tide has turned. This is especially evident in some of the peripheral economies where the expected growth rates in some smaller economies (like Romania, Ireland, Poland and Bulgaria) are inching above 4% p.a. while the larger economies like Germany and France are slowly pushing above 2%. The one large risk to the region remains the possible negative impact of Brexit and the uncertainty relating to this. Hopefully the EU and the UK will come up with a workable solution but time is quickly running out as the cut-off date for the UK leaving the EU is 29 March 2019.

Portfolio Activity

The Ampersand Sanlam Collective Investments Flexible Property Income Fund gained 2.49% for the quarter against the benchmark (33% cash, 67% SA Listed Property) performance of -0.05%. Our position in local listed property managed to generate outperformance versus the property index due to active risk management and repositioning. Our position in listed property remains a long term underpin and differentiator within the CPI Fund Range and we remain confident that the allocation will contribute strongly to long term absolute and relative returns.

Position going forward

Our key positions across the portfolios have remained consistent for the majority of the past 12 to 18 months.

We retain a strong allocation to offshore assets and we also continue to hold a significant allocation to SA Listed Property. We will continue to monitor the position closely to effectively manage risks and embrace opportunities when they are presented. We remain concerned with market valuations and risk, however structurally we need to retain growth assets in the portfolio to ensure we achieve our longer term objectives.

Asset allocation and diversification therefore remain key to ensuring downside risk management while continuing to achieve our inflation-based returns. Our aim is to provide our investors with diverse exposure across various investment strategies, investment managers and assets. We feel strongly that the result of this diversification strategy should have a high probability of achieving our long term return objectives, while providing protection against short term swings and overall risk.