Against the backdrop of another tumultuous quarter, the fund delivered a return of 1%. We have delivered returns ahead of our benchmark of Consumer Price Inflation (CPI) + 4% on a year-to-date basis and over the very long-term horizon of 15 years plus. Over periods shorter than this, the benchmark has been a tougher hurdle to beat.

This quarter, we have seen the continuation of a very volatile and unpredictable global environment. The escalation of the US-China trade war and the unfolding Brexit soap opera has been further compounded by rising tensions in the Middle East and ongoing protests in Hong Kong. While these events have played out, the outlook for global growth continues to slow. Policymakers are trying to support the global economy, with more central banks around the world cutting interest rates, led by the US Federal Reserve Board (the Fed) and the European Central Bank (ECB). As a consequence, sovereign debt yields are trading at zero to negative real rates and we have even seen some corporates issue bonds with a zero coupon. This is an unusual state of affairs, and, as such, we think the global bond space is not attractive from a risk-return perspective.

Investors are doubtful that monetary easing can prevent a further economic slowdown, especially given that trade-related uncertainty is dragging down investment and exports. These doubts are reflected in global equity markets, with their strong performance at the start of the year petering out in the third quarter. Emerging markets (EMs) also continued to underperform developed markets. South Africa’s economic outlook continues to be muted, despite many self-help options. The lack of political will to implement urgently needed reform at state-owned enterprises (Eskom in particular) has been disappointing. It is difficult to see how business and consumer confidence will return with continued inactivity on this front. Our base case is that the South African economy will continue to show lacklustre growth until these structural issues are addressed.

Given this context, the fund’s positioning is weighted towards local fixed income assets which make up 33% of the portfolio. The yield on these assets, at just over 9%, comfortably meets the fund’s required hurdle rate of CPI + 4%. This exposure has been a positive contributor to the fund’s performance for the quarter. Other local asset class weightings include South African equity, at 30%, and South African property, at 6%. Both of these asset classes produced negative returns in the quarter. While our equity and property selection has been good, it has still not contributed to the fund’s performance.

During the quarter, we took the opportunity to increase our local equity exposure marginally by adding selectively to some domestic equity counters where valuations have become too cheap to ignore. An example of this would be Dischem. We think Dischem is well positioned to show organic growth as well as take market share from independent pharmacies. Concerns over the lack of earnings growth in the short term (due to their heavy investment in their distribution business), has meant that multiples have come back to palatable levels. The combination of robust earnings growth and a strong balance sheet means that this share presents attractive longterm upside. Dischem is one of the few shares that can show growth in a stagnant South African economy.

We remain very choosy in our domestic equity holdings and our local allocation is thus weighted towards rand hedge shares. The South African property counters face an even more strained outlook, and we have thus not added to our positions here, despite the de-rating in the sector and seemingly appealing yields.

Given the attractiveness of the returns we see in the South African fixed-income space, we have largely maintained our offshore exposure at 26% of the fund. This has been a positive contributor to the fund’s performance this year and we have trimmed some of our holdings on the back of strong returns generated.

We think the fund is correctly positioned to navigate this uncertain environment. As we have already seen this year, it is not easy to predict the most accurate political or economic outcome, but with the balanced mix of risk assets and yielding assets, our fund can deliver the required return.

The first three months of 2019 saw a broad rebound in almost every asset class after a very difficult final quarter in 2018. The S&P 500 posted its strongest first quarter since 1998, gaining 13.7% year to date. Meanwhile, 10-year US Treasuries gained 2.9%, German Bund yields fell below zero and credit spreads saw broad tightening. The repricing in global bond markets was largely driven by a change in expectation for further interest rate hikes in the US to potential rate cuts over the next twelve months. The positive performance also fed through into the South African asset classes. During the quarter, the FTSE/JSE Shareholder Weighted All Share Index (SWIX) returned 3.9%, bonds returned 3.8%, and domestic property continued to lag at 1.3%. Against this backdrop, the fund had a decent quarter delivering a return of 5.8%.

The generally strong asset class performances reflect higher investor risk appetite but do not necessarily come with more positivity on the longer-term growth outlook. Growth in both developed and emerging markets is still expected to slow and many key issues remain unresolved. The US and China have yet to come to a trade agreement that is satisfactory to both parties. The Brexit process continues to drag on, with no clear plan. Large emerging markets, such as Brazil and Turkey, have come out of crisis mode but still seem to hit pockets of turbulence.

In line with this, South Africa’s growth outlook continues to be muted. Rising commodity prices and increased political stability should have led to a more positive picture. However, Eskom’s financial and operational issues have quashed any optimistic momentum. While increased government support has temporarily settled Eskom’s financial issues, solving their operational issues will present more of a challenge. We expect that load shedding will be more frequent going forward and will have a negative impact on the current productivity and profitability of South African corporates. Businesses will also delay or scrap new investments and this will negatively impact future growth.

Despite this more cautious outlook, the fund still has a 75% position in domestic assets. Within this, the largest local allocation is to fixed-income assets and cash (32.6% of fund), with a weighted average yield of 9.5%. This yield handily meets the fund’s mandate of delivering returns of CPI +4%. The risk of a downgrade to our sovereign rating has been delayed, with Moody’s deciding not to change their credit outlook at the end of March. While bonds have reacted positively, we think this is a stay of execution rather than an absolute pardon. The risk of a downgrade may still re-emerge in the coming months, but for now the real yields on our portfolio of fixedincome assets remain attractive, given a benign inflation outlook.

We have kept our South African equity exposure fairly constant at 31.6% of the portfolio, with a high weighting to rand-hedge shares. Some of our large equity positions, such as British American Tobacco and MTN posted robust recoveries after delivering good financial results. Resource counters in particular have had a big rerating, and we took the opportunity of share price strength to sell out of our Anglo American Platinum position. We have also taken up select small exposures to domestically-focused defensive businesses. While we are cautious about our South African growth outlook, our investment discipline is to focus on valuations. If an attractive opportunity presents itself at the right price, we will act accordingly. South African property shares have continued to deliver a lacklustre performance. Landlords have now finalised an agreement to support Edcon, either via rental reduction or with a recapitalisation. These actions will result in muted distribution growth going forward. While yields are looking reasonable, we have chosen to largely maintain our exposure to domestic property at 7.5%.

At the start of the year our international exposure was relatively low at 22.6%. We bought currency futures to take advantage of attractive exchange rates and exposure now sits at 25%. Our offshore exposure is still mainly allocated to global equities. All the underlying international investments have delivered good alpha in the last quarter, further assisted by the rand weakness.

In summary, the fund has had an encouraging start to the year. Although the fund has been ahead of inflation over all time periods, it has only beaten its benchmark over the longer term time horizons. While the ongoing global uncertainties create much volatility and can result in a range of positive or adverse growth outcomes, our unwavering focus is to build a diversified portfolio that can absorb unanticipated shocks. In this manner, we want to deliver on the fund’s dual mandate of beating inflation by 4% over time and protecting capital over all rolling 18-month periods. Longer-term performance also meets these criteria.