The Counterpoint SCI Dividend Equity Fund will change it's name to Merchant West SCI Dividend Equity Fund, effective from 13 March 2023.

Performance Review
The Fund gained 6.4% over the quarter compared to its benchmark, the South African General Equity Peer Group average, which gained 10.6%. The JSE Capped SWIX Index advanced 12.2% over the quarter, with the JSE All Share Index rising 15.2% for the period. The South African market’s performance was driven by strength in the Materials sector (+15%) as well as in Naspers and Prosus (+25% as a group). Financials also aided performance, rising 11.4%. No sectors were a material drag on performance. The Fund’s return over the quarter was driven by its exposure to SA Financials (+7.5%), SA-listed Consumer Staples (+5.9%) and its direct offshore exposure (38% fund weight), which was up 12.4% in rands (+14.5% in USD).

There were no broad absolute detractors from fund returns in the quarter, however being underweight Resources, Naspers and Prosus detracted from relative returns. Major domestic equity contributors included Anglo American, up 21.5%, FirstRand, which rose 7.8% and AB Inbev, which gained 24.2% over the quarter. Detractors included Thungela, down -14%, and Spar, which fell -6.3% over the quarter. The key positive equity contributors in the offshore portion (in US$) were TJX Co’s, rising 28.6%, Deere & Co., up 28.8% and Novo-Nordisk, gaining 35.8% over the period. The only marginal detractor was Roche, down 3.6% in US$ over the quarter. The Fund has a position in select longer-dated South African government bonds, ending the quarter with a 4.6% weight. These bonds returned 4.9% over the period.

Management Actions
Notable actions during the period included selling out of Spar. During the quarter information emerged that brought the integrity and ethics of certain members of management into question. While all the issues in question are not yet fully clear, we decided, after evaluating information in the public domain and released by the company, to fully dispose of our holding in Spar. We also trimmed positions in Shoprite and JSE and added to our holding in Bidvest.

Portfolio Strategy
To slow the pace of rapidly rising consumer prices, central banks throughout the world started raising interest rates at the beginning of 2022. A combination of supply chain bottlenecks, increased geopolitical tensions and an energy crisis in Europe pushed global consumer price inflation to multi-decade highs, forcing central banks to respond. The US Federal Reserve has been very aggressive in its efforts to curb inflation, raising official interest rates by 425 basis points in 2022. Interest rates are expected to rise further globally, although there is growing evidence that consumer inflation has peaked and is expected to moderate to much lower levels by the end of 2023.

There is the prospect of a global recession in 2023, fuelled by high inflation, the resulting sharp rise in interest rates, and various confidence sapping events such as the war in Ukraine and its attendant supply and price effects on energy and other commodities. The UK has already posted negative GDP growth for Q3 2022. China’s economy is likely to buck the global trend and grow faster in 2023 as the country emerges from very strict COVID restrictions, as well as implementing stimulatory government spending measures, coupled with accommodative monetary policy. Despite these actions, high debt levels, a weak property sector and government regulatory moves still pose serious risks to the Chinese growth and investment outlook. Against this global backdrop, during 2022 the MSCI World Index fell 18% in US$ (-12.3% in rands) while the MSCI Emerging Markets Index lost 19% in US$ (-13.9% in rands).

Locally, during the quarter South Africa had to contend with political uncertainty surrounding President Cyril Ramaphosa’s Phala Phala scandal and him potentially vacating office. However, he managed to emerge unscathed and be re-elected ANC leader in December. He also strengthened his power in the party, gaining more support for his reform policies – a positive development. Unfortunately, in addition to increasing inflation, rapidly rising interest rates and muted confidence, South Africa was also beset by greatly increased electricity loadshedding over the quarter as well as the resignation of the Eskom Chief Executive.

Despite the headwinds above, the JSE All Share Index managed to outperform global markets, only falling 2.7% in US$ (+3.6% in rands) during 2022, largely thanks to a strong Resources sector and cheaper starting valuations in general. Additionally, the rand strengthened by 6% versus the US$ over the quarter as global sentiment improved. Looking forward, the potential for a global recession, resultant disappointing earnings growth, high inflation, tightening monetary conditions and the effects of the ongoing Russia-Ukraine war pose the greatest risks to global markets. However, any global recession is forecast to be short and mild, there are signs that inflation is calming, and the global rate hiking cycle seems to be nearing its peak. Notwithstanding, inflation remains elevated and the growth outlook weak.

In South Africa, the outlook looks increasingly challenging due to the step up in power outages and uncertainty as to how and when there will be any improvement in electricity availability. In addition, rising inflation and interest rates are weighing on consumer and business confidence. As previously mentioned, we took action, starting in June 2022, to increase the Fund’s weighting to defensive offshore dividend-paying equities. We still retain a reduced but significant weight in SA Inc. equities (c. 42%) as despite increased risks, these stocks still present attractive absolute and relative value, with much bad news priced in. We are however acutely aware and cautious about the risks attached to loadshedding and are monitoring developments closely.

Fortuitously, the selloff in global equities has provided an expanded menu of opportunities offshore to purchase high quality stocks at reasonable prices. The prospect of a global recession will likely be negative for most metals prices as well as the local economy. However, Chinese government stimulus measures could counteract some weakness in metals prices, although the magnitude is uncertain. Notwithstanding, owning significant weights in both Resource counters and SA Inc. equities strikes us as poor risk management in this environment.

To mitigate risks, we employ a highly selective stock picking process and a deliberate risk balanced approach to managing the Fund. We aim to sensibly diversify across industries and geographies as far as the Fund’s mandate allows. As such, we continue to hold a material position in defensive offshore equities and select rand-hedge stocks, the most important being British America Tobacco. We hold only a small position in Resources counters, preferring to remain defensive in the current environment. We seek to invest in companies possessing strong pricing power, sustainable margins and resilient growth prospects, that also trade at reasonable valuations. We seek to hold such businesses for appreciable periods to capture the full benefit of compounding. We look to invest in companies with predictable cash flows and the ability to pay sustainable and growing dividends well into the future. Our view is that high quality, resilient, dividend-paying equities present a very attractive proposition in the current inflationary and growth-threatened environment. The relative attractiveness of SA dividend-paying companies we believe is highly underappreciated by investors.

We estimate the net 12-month forward distribution yield on the Fund to be over 4% at present – an attractive level in the context of the Fund’s history. Recovering off a low base, 2022 income distributions per unit grew over 30% versus 2021 distributions. Looking longer term, over the last eight years, income distributions per unit have grown at a compound rate of over 6% p.a., compared to an SA Inflation rate of 5% p.a.