Counterpoint SCI Dividend Equity Fund - Dec 19 - Fund Manager Comment26 Feb 2020
The All Share Index advanced by 4.60%, which reversed the decline in the previous quarter and provided a welcome return to the positive momentum of the first half of 2019. The advance was broad based and in terms of broad sectors, SA Industrials lagged with a flat performance for the quarter. Mid-Caps surged, with a 12.4% advance, while Small- Caps continued to lag with a 0.7% return. Small-Caps are down by 4.1% for the year. In terms of Equity sectors, the top performers were Platinum +47.0%, Pharmaceuticals +30.9%, Gold +26.1% and Chemicals +19.6%. The worst performers were Fixed Line Telecoms -49.9% , Beverages -15.0% and Household Goods -14.3%.
Emerging Market equities enjoyed a resurgence, as global investors responded positively to a de-escalation in trade tensions. In Q4, SA Equities advanced by more than other EM equities. The quarter was less volatile than the previous quarter but was dominated by increasing positive sentiment towards risk assets in general and equities more specifically. Domestically oriented equities, most notably Small-Caps, have not participated in the recent advance and valuations are very cheap relative to history. The decline in domestic equity valuations now discount very low expectations and represents a multi-decade opportunity for investors to participate in the recovery on a more rational basis. Current valuations are reminiscent of the early 2000’s, when negative sentiment towards domestic small and mid-caps provided a platform for high prospective returns in the ensuing years.
Policymakers and leadership have demonstrated a resolve to address the structural impediments in the fiscus and critical institutions. The process is underway and is taking time. For the moment, Moody’s seem patient and willing to grant additional time for policymakers to set the country on the road to fiscal recovery.
Domestic Equity valuations remain attractive relative to long term growth prospects. The Rand is likely to remain range bound and could even remain strong, as US dollar weakness persists and the US Fed continues the current monetary policy path. SA Inc equities are undoubtedly cheap and discounting very weak prospects. We continue to believe that we are entering a prolonged period that will suit stock-pickers and active managers.
The probability is high that equities, as an asset class, could continue to muddle through. Risk assets are hovering close to all-time highs but remain extremely vulnerable to either a recession or a sudden increase in risk aversion.
For that reason, we continue to advocate caution and conservatism, with adequate diversification across portfolios.
Portfolio overview
The Dividend Equity Fund follows a long-term objective based approach. The fund’s primary objective is for total investment returns to exceed SA Inflation + 6% per annum, over the long run (7yrs and longer). Parallel and contributing objectives are for the fund to provide an income yield (after dividend withholding taxes) greater than the FTSE/JSE All Share Index (ALSI); to grow distributions ahead of SA inflation; and to achieve its objectives at a lower level of risk- than the ALSI.
The fund employs a ‘dividend growth plus yield' strategy and targets total returns. Long term views are taken on investments. The fund seeks to hold lucrative investments for extended periods to capture the benefit of compounding.
The strategy seeks to invest in quality businesses exhibiting the following attributes: . . . . . . .
Sustainable real growth in future expected earnings and dividends
A track record of predictable cash flow and healthy profit and dividend growth
High prospective returns on capital with conservative use of gearing
Robust business model, customer value offering and competitive strengths
Management who display integrity, stewardship and continuous improvement
Forward dividend yield greater than the ALSI Price which offers attractive absolute value, at a conservative margin of safety
Given the emphasis on predictable dividend growth the fund is unlikely to hold a significant weighting in Resource shares due to the highly unpredictable nature of future earnings and dividend growth in these businesses. Additionally, due to its yield objective the fund is unlikely to hold significant positions in low yielding stocks.
The fund is mandated to invest up to 30% of the portfolio in offshore investments plus a maximum of 10% in Africa (excluding South Africa) investments.
A minimum of 80% of the market value of the fund must be invested in equities.
- risk as measured by standard deviation over a 3-year rolling period.
The Fund generated a 0.7% return for the quarter. The fund’s benchmark, the South African General Equity Peer Group average, returned 4.6% for the period.
The fund’s offshore exposure proved to be a significant drag on performance, due the Rand strengthening against the US Dollar by over 9% during the quarter. As a result, offshore assets detracted 1.1% from total fund performance. Domestic assets contributed 1.9% to returns, rising 2.8% over the quarter. Key domestic contributors included Remgro, up 21.8%; Stor-age Property REIT, rising 10.5%; and Spar Group, up 6.1% for the quarter. Detractors included Woolworths, down 11.8%; and the JSE Ltd, which lost 8.8% over the period.
The fund’s offshore exposure stood at 24.8% at quarter end. Offshore securities fell 3.5% in Rands but rose 4.6% in US Dollars over the period. Key positive contributors in the offshore portion (in US$) were Union Pacific, rising 12.2%, TJX, gaining 10% and Investor AB, up 16.3% in US$. The main contributing detractors were Ventas, down 19.9% and McDonald’s, down 7.4% in US$ over the quarter.
The fund has an 11.2% allocation to property stocks (local and offshore) which rose 1.3% during the quarter. To add some further yield to the portfolio, preference shares are held amounting to 3.8% of total assets. The yield on these instruments is on average almost 10%. Additionally, the fund has a 2.5% position in select corporate debt instruments. These instruments are offering yields of over 11%, which we believe to be attractive.
The forecasted weighted average yield of all the securities in the fund is 5.4%.
We expect the fund to grow distributions ahead of SA inflation for the forthcoming 12 months, in line with its objective. Note: all yields are quoted on a gross basis before deducting local and offshore withholding taxes.
Portfolio positioning
Our core style of investing predominantly in attractively valued quality shares we believe delivered a robust return for the quarter. The style places an emphasis on earnings and dividend stability and predictability.
Over a full market cycle, we believe this approach to be best suited to delivering the fund’s stated objective.
Looking forward we continue see value in select South African and Offshore equities, despite the evolving risks. South African based industrial companies look especially attractively valued relative to their low earnings bases. Even a small improvement in economic conditions in South Africa could fuel a significant improvement in earnings, driving market values higher. This prospect needs to be balanced against the low level of business and consumer confidence in the country. There is however a significant amount of negativity already priced into ‘SA Inc.’ equities and we have been cautiously deploying cash into select quality companies. Nonetheless, our current cash position still sits at a conservative 10% (local and offshore combined). A higher cash level provides useful ‘dry powder’ during periods of short-term overreaction to bad news. We do believe there is risk of disappointment and aim to be ready to seize any opportunities. As is our chosen approach we are always highly selective and measured in our deployment of investors’ capital, demanding a significant margin of safety in the purchase price of any investment.