Phakamani Hadebe (now at the helm of Eskom) as its new ...... Africa Limited, Main Tower, Standard Bank Centre, 2 Hertzo
ANGLES & PERSPECTIVES THIRD QUARTER 2018
Contents
1. Introduction – Anet Ahern
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2. Our fixed income process: patience, prudence and conviction – Tyron Green
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3. The opportunity in SA Inc. – Mikhail Motala
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4. South African government bonds: stress-testing our positive view – Lyle Sankar
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5. The PSG Diversified Income Fund: a flexible mandate to preserve capital while maximising income – Tyron Green and Lyle Sankar
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6. Portfolio holdings as at 30 September 2018
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7. Percentage annualised performance to 30 September 2018 (net of fees)
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8. Risk/reward profile
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9. Unit trust summary
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10. Contact information
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11. Digital subscriptions
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Our long-term mindset and focus on the value we’re getting for the price we’re paying often means that we invest in uncrowded parts of the markets. In these areas, negative sentiment is more likely to result in the mispricing of attractive individual opportunities.
Introduction
Anet Ahern
Anet has over 30 years’ experience in investment and business management. After starting her career at Allan Gray in 1986, where she fulfilled various roles in trading and investment management, she worked as a portfolio manager at Syfrets, and later BoE Asset Management, where she was CIO and CEO. She also spent six years at Sanlam, where she was the CEO of Sanlam Multi Manager International. Anet joined PSG Asset Management as CEO in 2013.
We apply our process consistently across all asset classes We assess all securities we consider for investment from the bottom up. Those who know us will be familiar with our 3 M criteria, on which we base these assessments: evidence of good leadership (Management), a sustainable competitive advantage (Moat), and the attractiveness of the security’s price or yield relative to our estimate of fair value (Margin of Safety). This process ties in to what we think of as ‘the PSG Asset Management way’ We believe in long-term thinking. By conducting our own thorough research we aim to determine the true worth and associated risk of a security, independent of prevailing narratives. If we believe that it will unlock value for clients in future, we invest with conviction – even if market sentiment is poor. If we believe that it is overpriced or likely to drop in value, we keep available reserves in cash – even if there is widespread positivity. In recognising our role as stewards of our clients’ capital, our aim is to invest prudently, by never overpaying for a security. In fixed income, we place particular emphasis on avoiding capital losses We appreciate that the average fixed income investor’s risk appetite is fairly conservative. We therefore focus on minimising mistakes, so that our clients don’t lose money. In the first article of this edition, Tyron Green sets out how the PSG Asset Management way plays into our fixed income process and considers our investment in Land Bank bonds as a practical illustration.
However, as Mikhail Motala notes in his article, these ‘worst of times’ politically and economically could be the ‘best of times’ for investors. While many SA Inc. businesses remain strong, valuations are generally low. This presents the opportunity to invest in quality companies at attractive prices. Government bonds also continue to present a compelling investment case Similar to the scepticism towards SA Inc. shares, a fresh wave of emerging market sell-offs and a struggling economy have made investors wary of South African government bonds. In his article, Lyle Sankar highlights the attractiveness of long-term government bond yields and provides insight into how we have stress-tested our positive view. Fund Focus: the PSG Diversified Income Fund The objective of the PSG Diversified Income Fund is to preserve capital while providing an attractive income. To achieve this, it invests in a mix of assets (both local and foreign), including fixed income securities, property, bonds and shares. This mix will be optimised so that the fund is best positioned to achieve its return objective of inflation +1% over the medium term. Given the attractive opportunities we are currently finding across fixed income and equity markets, the fund has been able to lock in attractive real yields for investors, while equity exposures should provide a good growth runway. Thank you for your continued interest and support. We hope you enjoy the read.
We consider long-term market cycles Our long-term mindset and focus on the value we’re getting for the price we’re paying often means that we invest in unpopular parts of the markets. In these areas, negative sentiment is more likely to result in the mispricing of attractive individual opportunities. This is currently the case for shares exposed primarily to South African GDP – the so-called ‘SA Inc.’ shares.
THIRD QUARTER 2018 | 1
Our fixed income process: patience, prudence and conviction
Tyron Green
Tyron joined PSG Asset Management in 2013. He was appointed Fund Manager of the PSG Income Fund in 2017 and Fund Manager of the PSG Diversified Income Fund in 2018. In addition to his fund management responsibilities, he performs credit and fixed income research for the broader team.
We recognise our role as stewards of our clients’ capital When investing in fixed income, we appreciate that the average investor’s risk appetite is fairly conservative. We therefore take a similarly conservative approach. Our emphasis is on minimising mistakes, so our clients don’t lose money. As long-term investors, we wait patiently for value to be unlocked Across the funds we manage, we look for investments with inherent quality that are trading at lower prices or higher yields than our estimates of their intrinsic value – the opportunities the market may be missing. While it may take time to realise mispriced value (and may even come at the cost of short-term performance), we know that patient investors are rewarded. Since the best opportunities tend to present themselves in times of fear and uncertainty, the ability to remain level-headed and to look beyond market noise or hype is essential. We are all at risk of falling prey to behavioural biases. To avoid this, we rely on the consistent application of our process. As illustration, Graph 1 shows the yield of the generic South African 10-year sovereign bond during market crises over the past 15 years. It also reflects the average South African inflation rate over this time, which has been contained at 5.7% since the South African Reserve Bank introduced inflation targeting. While this has resulted in more stable bond yields, the yields on offer during times of crisis have consistently been higher. Investors who were able to evaluate market narratives rationally could have benefitted on several occasions when risks were not as high as generally believed. We believe in the importance of our own thorough research We always do our own homework to understand the risks associated with an investment. In the fixed income space, this means that we perform extensive credit analyses alongside industry risk ratings to fully evaluate any risk of capital loss. While we construct all our portfolios from the bottom up (based on the individual merits of each security), we also factor in long-term yields, inflation rates and interest rates when valuing securities. In addition, we consider the impact of economic and market cycles.
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We act with prudence by only buying with a sufficient margin of safety This is a cornerstone of our investment philosophy and integral to our process: we aim to maximise potential upside and limit potential downside by ensuring a sufficient margin of safety in any investment we make. Without it, we are quite willing to forego an opportunity and will hold cash in our funds until we are comfortable that we can use the cash sensibly. When we do, we act with conviction. For example, until 2016, our funds held mostly short-duration assets, which are less sensitive to interest rate changes. In our view, the yields on most longer-duration assets were too low for the associated risk. However, political uncertainty, triggered by the unexpected shuffling of finance ministers in late 2015, created an opportunity. Based on our research, we increased our exposures to longer-dated bonds when their yields rose to compensate for higher perceived risk, providing the margin of safety we required. This is shown in Graph 2, which reflects the PSG Diversified Income Fund’s investment in duration assets over the past five years. Applying our process consistently helps us to build robust portfolios We believe that a prudent mindset, emphasis on in-depth research, and the discipline to apply the outputs of our research process consistently all help to place the odds in our clients’ favour. The additional checks and balances we have in place act as further risk overlays, and include a team-based approach, formal Investment Committees, an independent Credit Committee, and the buy lists these committees produce.
Graph 1: Local bond yields have been higher in times of crisis 12 Global financial crisis 'Nenegate'
11
Emerging markets crisis
Bond yield (%)
10 9 8
Average yield: 8.2%
7 6
Average CPI: 5.7%
5 2003
2005
2009
2007
2011
10-year generic bond yield
2013
2015
Average headline CPI
2019
2017
Average yield
Sources: PSG Asset Management, I-Net
10
3.0
9
2.5
8
2.0
7
1.5
6
1.0
5
Modified duration
Yield to maturity (%)
Graph 2: The PSG Diversified Income Fund’s exposure to long-duration assets increased in 2016
0.5
4
0.0 JAN '13
JUL '13
JAN '14
JUL '14
JAN '15
JUL '15
SA 10-year bond
JAN '16
JUL '16
JAN '17
JUL '17
JAN '18
JUL '18
Modified duration
Sources: PSG Asset Management, Bloomberg
THIRD QUARTER 2018 | 3
Our process in practice: Land Bank bonds Land Bank made a successful turnaround between 2008 and 2011 In 2008, plagued by governance concerns and under strain from non-performing loans, Land Bank was placed under National Treasury for stabilisation. A year later, with Phakamani Hadebe (now at the helm of Eskom) as its new CEO, Land Bank announced its first profit in five years. By early 2011, the Director General of National Treasury, Lesetja Kganyago, had declared its turnaround a success. In 2015, ‘Nenegate’ triggered a significant sell-off in local bonds Heightened political uncertainty in the wake of ‘Nenegate’ – the surprise replacement of Finance Minister Nhlanhla Nene in December 2015 by former president Jacob Zuma – spurred a significant sell-off in South African bonds. Both government bonds and those issued by state-owned enterprises (SOEs) came under pressure. The sell-off created an opportunity to buy Land Bank bonds at attractive spreads Along with other SOEs, Land Bank credit spreads widened significantly in 2016 (as shown in Graph 3). In other words, Land Bank bonds were offering higher yields to attract investors against a backdrop of heightened caution and poor sentiment towards government in general.
We took advantage of the opportunity to lock in real returns for our investors As we are naturally drawn to unloved parts of the markets (where there is the greatest chance of mispricing), we capitalised on the high real yields that Land Bank bonds were offering. We were satisfied with the bank’s recovery and continuing improvements. We also gained comfort from legal provisions that allowed for early redemption if the bank moved from National Treasury, breached corporate governance policies, or changed the nature of its business. The margin of safety that Land Bank bonds were offering, coupled with a rational assessment of the associated risks, presented a compelling investment case. Land Bank credit spreads have since narrowed Land Bank continues to be well run and plays an important role in the South African economy. The market has come to appreciate this, with credit spreads narrowing and investor appetite for Land Bank securities increasing. Indeed, demand outstripped supply at its last bond auction in September 2018, which was oversubscribed by 1.4 times. While the yields that were previously on offer are no longer available, we still believe there is potential for spreads to narrow further towards intrinsic value.
Graph 3: Land Bank spreads widened significantly in early 2016 350 300
Credit spreads (basis points)
300
285
285
250 190
200 150
225
215
195
153
100 50 0 NOV '13
MAY '14
NOV '14
MAY '15
NOV '15
MAY '16 5-year spreads
Sources: PSG Asset Management, I-Net
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NOV '16
MAY '17
NOV '17
MAY '18
NOV '18
The opportunity in SA Inc.
Mikhail Motala
Mikhail joined PSG Asset Management in 2015 and serves as an Assistant Fund Manager. He conducts research on both local and global companies across various sectors. Before joining PSG, he worked in the assurance division at Ernst & Young. Mikhail is a qualified Chartered Accountant.
and valuations are high) or cold (where market participants are very pessimistic, and valuations are low). As counter-cyclical investors, we exercise caution by building cash in hot markets while aggressively deploying cash in cold markets.
'It was the best of times, it was the worst of times…' Charles Dickens, A Tale of Two Cities
The best investment returns are born in times of fear and uncertainty The views of value investors currently assessing South Africa are likely to echo Charles Dickens’s description of the atmosphere ahead of the French Revolution in the late 1700s. On the one hand, there’s a prevailing negative narrative about the endless and seemingly unsolvable problems facing the country. On the other hand, these ‘worst of times’ politically and economically could be the ‘best of times’ for investors. Exploiting market cycles is key to investment success Markets are inherently cyclical. There are ups and downs, good times and bad. Understanding and exploiting these cycles is a key determinant of investment success. In his book The Most Important Thing, Howard Marks, the esteemed American investor and writer, provides a framework to understand market cycles. He introduces the concept of taking the market’s temperature. The goal is to determine if markets are at either of two extremes: hot (where market participants are very optimistic,
South Africa is currently at the cold end of the market spectrum Signs that point to this include: • Newspaper headlines that consistently highlight the negatives: recession, political turmoil and fears around land expropriation. Any talk of the ‘Cyril Spring’ or ‘Ramaphoria’ is a distant memory. • Business confidence (shown in Graph 1) that is close to 40-year lows seen during the Rubicon speech in 1985, fears of a civil war following Chris Hani’s assassination in 1993, the Asian financial crisis in 1997/1998, and the global financial crisis of 2008/2009. • Recent financial results commentary from JSE-listed companies that reveals just how tough the current economic environment is. Businesses exposed to South African GDP (SA Inc.) are experiencing some of their most testing times.
Graph 1: The SACCI Business Confidence Index is close to 40-year lows 150
Index value (2015 = 100)
140 130 120 110 100 90 80 70 1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
2018
Sources: The South African Chamber of Commerce and Industry (SACCI), I-Net
THIRD QUARTER 2018 | 5
Graph 2: The price-to-book (P/B) ratio of the FTSE/JSE Mid Cap Index is at historic lows 4.0 3.5
P/B ratio
3.0 2.5 2.0 1.5 1.0 0.5 2002
2004
2006
2008
2010
2012
2014
2016
2018
FTSE/JSE Mid Cap Index P/B ratio Source: Bloomberg
Mid-cap shares are trading at historically low valuations Looking at the JSE, the FTSE/JSE Mid Cap Index serves as a good proxy for SA Inc. companies. Many of the constituents of the FTSE/JSE Top 40 Index are global businesses, with only a small proportion of their earnings coming from South Africa. As Graph 2 shows, the valuation of the Mid Cap Index, based on its price-to-book ratio, is at historic lows last seen in 2002.
• In various South African industries (such as infrastructure
Valuations closely follow business confidence, as both are proxies for investor sentiment Depressed valuations signal that the market has very low expectations for future earnings growth. It is therefore not despite of but because of the tough economic environment that local mid-cap shares present attractive opportunities. Many of the fears about South Africa’s economic woes appear to be priced in to these shares. So even if economic headwinds persist for longer than expected, shareholders can still expect to make decent returns. If, however, a ‘normal’ cycle unfolds and some of the headwinds abate, the resultant earnings recovery could be dramatic. In this scenario, shareholder returns could be highly attractive.
• •
It’s not all doom and gloom It’s very difficult to predict if or how an economic recovery may take shape, and market participants should by no means underestimate the challenges the local economy faces. However, we believe there are a few encouraging factors to consider:
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•
•
and energy), there is pent-up demand from the so-called ‘lost decade’ – the economic stagnation experienced over the past 10 years. Growth follows investment. Investment into emerging markets generally is at cyclical lows. Within emerging markets, South Africa has taken a bigger knock than many of our peers. Generally, South African corporate balance sheets are strong. Key local institutions such as National Treasury and the South African Reserve Bank have been thoroughly tested over the past 12 months and have proved their mettle. Despite a recession and an inquiry into state capture, there has been a peaceful and democratic change in the leadership of the ruling party.
Our funds currently feature several SA Inc. opportunities We’ve highlighted two examples below. 1. Hudaco Industries Limited (Hudaco) Hudaco was founded in 1891 by Hubert Davies, as a company that supplied equipment to mines. More than 100 years later – having successfully navigated many ups and downs – the company still bears its founder’s name (Hubert Davies and Company) and still supplies equipment to mines.
Table 1: Hudaco has outperformed the FTSE/JSE Top 40 Index over 20 years Hudaco
FTSE/JSE Top 40 Index
Difference
20-year total shareholder return
25.0%
15.8%
9.2%
Average return on equity
20.7%
15.6%
5.1%
11.4x
17.2x
R86.7 million
R18.8 million
Price-earnings ratio R1 million invested in 1998
R67.9 million
Source: Bloomberg (data from September 1998 to September 2018)
Over the past 20 years (as shown in Table 1), Hudaco’s total shareholder return was 25.0% a year, compared to the FTSE/JSE Top 40 Index (Top 40), which delivered 15.8% a year. This 9.2% annual difference is noteworthy. An investment of R1 million in Hudaco in 1998 would be worth roughly R86.7 million today. The same investment in the Top 40 would be worth R18.8 million. Hudaco’s excess return is partly due to its return on equity (ROE), which has averaged 20.7% (compared to the Top 40’s ROE of 15.6%). Its higher ROE is one indicator that Hudaco is a higher-quality business than the average Top 40 company. Despite this, its shares are notably cheaper, trading at a price-earnings (P/E) ratio of 11.4 times, compared to the Top 40’s P/E ratio of 17.2 times. Given its depressed valuation, we believe there is sufficient upside in Hudaco even without a significant economic recovery. Under a scenario where growth recovers to the average long-term rate, however, the upside could be considerable. Hudaco is a sizeable position in all our local funds. PSG Asset Management owns more than 10% of Hudaco. 2. AECI Limited (AECI) AECI was founded in 1924 and has positioned itself as a market leader in providing explosives and specialty chemicals to the industrial, mining, water and agricultural industries. Its business model is easy to understand: chemical applications are typically a small component of their customers’ production costs, but their precision is mission critical. This gives AECI the proverbial hook. AECI experienced the perfect storm in early 2016, with all key areas in which they operate facing temporary headwinds: a mining commodity crisis, depressed local manufacturing volumes, and a nationwide drought. This was a meaningful stress test for the business and resulted in temporarily depressed earnings. Crucially, AECI entered
the downturn with a strong balance sheet. This allowed the company to use the opportunity to buy back shares and buy complementary quality businesses at reasonable multiples. A business that has both cyclically depressed earnings and a management team that understands and exploits cycles appeals to us. We are therefore of the view that AECI holds the potential for an asymmetrical payoff if economic conditions improve, as earnings will normalise and the share will re-rate. AECI is a sizeable position in all our local funds. PSG Asset Management owns more than 5% of AECI. We believe that SA Inc. exposures will serve our clients well in future We have used our advantage over larger peers to exploit SA Inc. opportunities outside the Top 40. Companies such as Hudaco and AECI form part of a large cluster of mid-cap SA Inc. shares we hold in our portfolios. Others include Super Group, Sun International, Reunert and Raubex. Most of our SA Inc. holdings trade at free cash flow yields of 10% or above – very attractive entry points relative to both history and other opportunities globally. As free cash flow is a measure of the cash available to distribute to shareholders or expand the business, these companies could effectively return well over 15% a year, even if we assume that they only grow by inflation in the absence of any GDP growth. Our funds’ SA Inc. positions are therefore not based on an expected recovery in the South African economy. It must, however, be noted that current levels of free cash flow were generated in a recession, and any growth in the economy would provide considerable upside to prospective returns. While these companies may therefore be undergoing the ‘worst of times’ as businesses, their investors could, in time, be enjoying the best of times.
THIRD QUARTER 2018 | 7
South African government bonds: stress-testing our positive view
Lyle Sankar
Lyle joined PSG Asset Management in 2014 and was appointed Fund Manager of the PSG Money Market Fund and PSG Diversified Income Fund in 2018. He is responsible for credit and fixed income analysis, and serves as fixed income trader for all PSG funds.
South African government bonds are out of favour and providing attractive yields The long end of the South African government bond curve is currently offering compelling real (after-inflation) yields, driven higher by elevated fears about emerging market assets. In fact, 20-year bonds are yielding over 10%. Graph 1 illustrates how often the yield of the 20-year government bond has been at certain levels since the South African Reserve Bank (SARB) introduced inflation targeting in 2003 (a policy move we believe led to significant structural change in local fixed income markets). The gold bar highlights the current yield. The graph shows that over this period, 20-year government bond yields have only been higher 3% of the time. Expected returns on these instruments are favourable CPI has averaged 5.7% since the implementation of inflation targeting. We expect domestic inflation to remain anchored within the SARB’s target band of 3% to 6% – and believe that a move towards 5% is a distinct possibility.
A nominal yield (without factoring in inflation) of 10% therefore implies real yields of 4% to 5%. This is an attractive starting point, given the SARB’s proven ability to contain inflation. Graph 2 shows the three-year total returns achieved from different starting points (using actual historical yields) between 2003 and now for the 20-year government bond. It highlights three key observations: 1. Historically, there has been a positive correlation between yields and subsequent three-year returns: the higher the starting yield, the higher the return. 2. When starting from a yield of 9% and above, investors haven’t lost capital over any subsequent three-year period and have earned inflation-beating returns. 3. At yields of 10% and above (as currently on offer), investors have historically achieved three-year returns in excess of 11%, or inflation plus 5% (assuming 6% inflation). This is indicated in the gold circle in the graph. These returns are similar to those generally delivered by the equity market, explaining why our funds, including higher-target funds such as the PSG Flexible Fund, have been buyers of 20-year government bonds this year.
Graph 1: 20-year government bond yields are high relative to historical yields 8 7
Frequency (%)
6 5 4 3 2 1 0 6.9
7.1
7.3
7.5
7.7
7.9
8.1
8.3
8.5
8.7
8.9
9.1
9.3
9.5
9.7
9.9
Yield (%) 20-year government bond yield Weekly yield distribution: 2003 - September 2018 Sources: PSG Asset Management, Bloomberg
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Current bond yield
10.1 10.3 10.5 10.7 10.9
Graph 2: Historically, high yields have led to favourable returns
3-year total returns (%, annualised)
16 14 12 10 8 6 4 2 0
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
Yield (%) 22 OCT '13
26 JAN '11
01 MAY '08
05 AUG '05
Sources: PSG Asset Management, Bloomberg
What are the risks to our positive return outlook? To test our thesis, we considered the factors that could sustainably push yields higher from their current levels, and identified three key risks: 1. The SARB loses its credibility in inflation targeting and bond yields spike. Bond yields reflect expectations of future inflation. The ability of a country’s central bank to keep inflation in check is therefore key when assessing potential bond returns. Turkey provides a case study of what happens to yields when markets no longer trust a central bank’s ability to curb inflation. In 2015/2016, Turkey experienced foreign outflows due to political unrest, while a weakening currency resulted in inflationary pressure. This was coupled with wage increases of close to 30%. The Central Bank of Turkey caved to political pressure and failed to implement the necessary rate hikes, which caused a spike in bond yields. Is there a risk that this could happen in South Africa? We believe this is highly unlikely. In the first instance, the SARB’s independence is protected by the Constitution and has been thoroughly tested in recent years. In addition, it has demonstrated its credibility by successfully anchoring inflation comfortably within its target band.
2. A credit rating downgrade makes South Africa ‘uninvestable’. The possibility of South Africa being downgraded to sub-investment grade remains a market concern. While this may or may not happen, we believe the impact of a downgrade on asset prices may be less significant than the market expects. South African credit spreads already trade in line with other sub-investment grade countries (such as Turkey and Brazil) and our bond market has seen significant outflows from foreigners. There is therefore a possibility that a downgrade has already largely been priced in. 3. We see a repeat of the blowout in the rand and local bond yields, which we saw during the 1998 Asian crisis. Since the start of inflation targeting, we have witnessed several vigorous tests of our bond market: the 2008 global financial crisis, the subsequent ‘taper tantrum’ and, more recently, fiscal imprudence and allegations of state capture in South Africa. We currently see fears in emerging markets that are similar to 1998. The question then becomes whether our period of analysis (since 2003) ignores the risk that the high yields of the late 1990s will be repeated, which would shift the yield distribution (see Graph 1) further to the right.
THIRD QUARTER 2018 | 9
South African assets and the rand sold off dramatically in the wake of the 1998 Asian financial crisis – the 10-year government bond yield briefly breached 20%. However, while the current distress in emerging markets such as Argentina and Turkey is similar, we don’t believe it will have the same effect. Firstly, the Asian financial crisis occurred before the SARB implemented inflation targeting, and inflation was volatile. At that point, South Africa had only recently been readmitted into global markets and lacked a track record of stability. In addition, our banking system was weaker than it is now – since the global financial crisis, Basel III has had a significantly positive impact on aggregate financial system liquidity and stability. Finally, during the Asian crisis, exchange rate targeting was still one of the SARB’s key policy tools. It tried to protect the falling rand, which exacerbated the currency’s depreciation as speculators took advantage of relatively smaller SARB reserve balances.
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We believe we have locked in an exciting opportunity in government bonds for clients While we accept that market dislocations may still occur, we factor this into our process and investment valuations. We incorporate the probabilities of bear-case scenarios in our intrinsic-yield estimates and only invest when the odds of favourable outcomes outweigh those of negative outcomes. Given our research on government bonds, we believe that the odds are in our clients’ favour. Importantly, we also ensure that our portfolios remain well diversified and are positioned to perform under various possible scenarios. Therefore, while we believe that bond yields are very attractive, our funds don’t carry excessive duration (sensitivity to interest rate movements) and we continue to keep cash on hand as firepower for future opportunities.
Tyron Green
Lyle Sankar
The PSG Diversified Income Fund: a flexible mandate to preserve capital while maximising income
Tyron joined PSG Asset Management in 2013. He was appointed Fund Manager of the PSG Income Fund in 2017 and Fund Manager of the PSG Diversified Income Fund in 2018. In addition to his fund management responsibilities, he performs credit and fixed income research for the broader team. Lyle joined PSG Asset Management in 2014 and was appointed Fund Manager of the PSG Money Market Fund and PSG Diversified Income Fund in 2018. He is responsible for credit and fixed income analysis, and serves as fixed income trader for all PSG funds.
Basic fund information Fund name: PSG Diversified Income Fund Fund size: R1.7 billion ASISA sector: South African – Multi Asset – Income Benchmark: Inflation +1% Managers: Tyron Green and Lyle Sankar
The fund’s dual objective is to preserve capital while providing an attractive income To achieve this, the fund invests in a mix of assets (both local and foreign), including fixed income securities, property, bonds and shares. This mix is optimised so that the fund is best positioned to achieve its return objective of inflation +1% over the medium term. Investments in equities and property are both capped at 10%, with total offshore exposure limited to 30%. The fund therefore sits at the lower end of the risk/reward spectrum. However, investors should be comfortable with a small degree of exposure to market and interest rate fluctuations and should have an investment horizon of two years and longer. Our philosophy is centred on identifying mispriced value Across the funds we manage, we seek to generate strong returns for clients by buying low, investing with patience, and selling high. To find the most attractive opportunities, we look in areas of the markets that offer the best chance of mispricing (generally those characterised by fear, uncertainty or neglect). To improve our chances of success, we apply our 3 M criteria. We use these to evaluate both quality (strength of ‘Management’ and evidence of a competitive advantage that serves as a ‘Moat’) and price (‘Margin of Safety’, or how far a security is trading from its fair value).
Our process assesses both quality and risk Our Fixed Income Investment Committee identifies what we deem to be the most attractive opportunities on the yield curve, given interest rate risk. This will include cash and short-term instruments (such as negotiable certificates of deposit), medium- and longer-dated bonds, and listed property. For each of these assets, we determine what we believe the appropriate yield should be based on fundamental, bottom-up research and considering the macroeconomic environment. We also take into account the outputs from our Credit Committee, who evaluate the quality of (and yields on offer from) all lenders whose credit instruments or bonds we consider for investment. Securities that meet all the Investment Committee’s hurdles are added to our fixed income buy list. Fund managers populate the funds they manage from this list by considering each instrument’s risk/reward prospects relative to the fund’s mandate. We are currently finding good opportunities in fixed income markets Sustained pressure on emerging markets – and resultant market turbulence – have created attractive buying opportunities. In recent months, we have used available cash balances to add to positions in which we’ve built conviction and to buy bonds issued by select state-owned entities. We have also invested in South African inflation-linked bonds – an area of the market we’ve been watching for a while, but which previously offered an insufficient margin of safety. In combination, we’ve been able to lock in attractive real yields for our investors, as shown in Graph 1.
In fixed income, we focus on the return our investors receive relative to the associated risk When we consider lending our clients’ money to governments, banks or corporates, we first assess risk. How likely is it that our investors will get their money back? Next, we evaluate whether they’ll earn an appropriate return (coupon) given the risk profile of the lender and longer-term inflation rates. To ensure that we generate real (inflation-beating) returns at appropriate levels of risk, we only accept higher yields when there is a very small chance of losing money.
THIRD QUARTER 2018 | 11
Graph 1: The PSG Diversified Income Fund currently offers attractive real yields 9.0 8.5 8.0 Yield (%)
Diversified Income Fund 8.52%
Income Fund 8.48%
Stable Fund 8.75%
Balanced Fund 8.81%
7.5 7.0 Call rate 6.25%
6.5 6.0 5.5 0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
Duration Call rate
Fixed income yields and durations
Source: PSG Asset Management as at 28 September 2018
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Average long-term inflation
5.0
Notes
THIRD QUARTER 2018 | 13
Portfolio holdings as at 30 September 2018
PSG Equity Fund
PSG Flexible Fund
PSG Balanced Fund
Top 10 equities
Top 10 equities
Top 10 equities
Old Mutual Ltd Brookfield Asset Management Inc Glencore plc Discovery Holdings Ltd Super Group Ltd AECI Ltd Japan Post Insurance Co Ltd Sun International Ltd Colfax Corp Tongaat-Hulett Ltd
Old Mutual Ltd Brookfield Asset Management Inc Discovery Holdings Ltd Glencore plc Super Group Ltd Japan Post Insurance Co Ltd Colfax Corp AECI Ltd L Brands Inc The Mosaic Co
Brookfield Asset Management Inc Old Mutual Ltd RMB Holdings Ltd AIA Group Ltd Discovery Holdings Ltd L Brands Inc Super Group Ltd AECI Ltd Japan Post Insurance Co Ltd Washington Prime Group Inc
Asset allocation
Asset allocation
Asset allocation
• Domestic equity 66.7%
• Domestic equity 47.0%
• Domestic equity
• Domestic cash
0.5%
• Domestic cash
16.7%
• Domestic cash and NCDs
• Domestic property
1.2%
• Domestic gold
0.7%
• Domestic bonds
24.8% 25.3%
• Foreign equity
29.2%
37.9% 8.6%
• Domestic bonds
6.2%
• Foreign equity
• Foreign cash
0.2%
• Domestic property
0.7%
• Foreign cash
0.5%
• Foreign property
2.2%
• Foreign equity
• Foreign property
2.9%
Total 100%
25.6%
• Foreign cash
0.1%
• Foreign property
3.0%
Total 100%
Total 100%
Performance
Performance
800
1 400
1 400
700
1 200
1 200 1 000 800 600 400
'02
'04
'06
'08
PSG Equity Fund
14 |
600 500 400 300 200
200 0
Rand (thousands)
1 600 Rand (thousands)
Rand (thousands)
Performance
'10
'12
'14
'16
'18
FTSE/JSE All Share TR Index
100
1 000 800 600 400 200
'04
'06
'08
'10
PSG Flexible Fund
'12
'14
'16
Inflation +6%
'18
0
'00
'02
'04
'06
'08
PSG Balanced Fund
'10
'12
'14
'16
Inflation +5%
'18
PSG Stable Fund
PSG Diversified Income Fund
PSG Income Fund
Top 5 equities
Top 5 equities
Top 10 issuer exposures
Brookfield Asset Management Inc Old Mutual Ltd AIA Group Ltd RMB Holdings Ltd L Brands Inc
Brookfield Asset Management Inc Washington Prime Group Inc Old Mutual Ltd AIA Group Ltd AECI Ltd
Top 5 issuer exposures
Top 5 issuer exposures
The Republic of South Africa FirstRand Bank Ltd Standard Bank of SA Ltd Absa Bank Ltd Nedbank Ltd
FirstRand Bank Ltd The Republic of South Africa Absa Bank Ltd Standard Bank of SA Ltd Nedbank Ltd
FirstRand Bank Ltd Absa Bank Ltd Standard Bank of SA Ltd Nedbank Ltd The Republic of South Africa PSG Money Market Fund Land and Agricultural Development Bank of SA Capitec Bank Ltd Eskom Holdings SOC Ltd Bidvest Group Ltd
Asset allocation
Asset allocation
Asset allocation
5.0%
• Domestic bonds 35.6%
• Domestic cash and NCDs 21.0%
• Domestic cash and NCDs 43.0%
• Domestic cash and NCDs 64.4%
• Domestic bonds
40.2%
• Domestic bonds
Total 100%
• Foreign equity
14.3%
• Domestic equity
21.7%
• Domestic equity
46.4%
• Foreign equity
3.5%
• Foreign cash
1.3%
• Foreign cash
1.0%
• Foreign property
1.5%
• Foreign property
1.1%
Total 100%
Total 100%
Performance
Performance
160 140 120 100 80 60
'11
'12
'13
'14
PSG Stable Fund
'15
'16
'17
'18
Inflation +3% over a rolling 3-year period
300
160
250
140
Rand (thousands)
180
Rand (thousands)
Rand (thousands)
200
Performance
200 150 100 50
'06
'08
'10
'12
PSG Diversified Income Fund
'14
'16
'18
Inflation +1%
120 100 80 60
'11
'12
'13
PSG Income Fund
'14
'15
'16
'17
'18
STeFI Composite Index
THIRD QUARTER 2018 | 15
PSG Money Market Fund
PSG Global Equity Sub-Fund
PSG Global Flexible Sub-Fund
Top 10 issuer exposures
Top 10 equities
Top 10 equities
The Republic of South Africa Nedbank Ltd Absa Bank Ltd FirstRand Bank Ltd Standard Bank of SA Ltd Investec Bank Ltd Land and Agricultural Development Bank of SA Capitec Bank Ltd Barloworld Ltd Netcare Ltd
Brookfield Asset Management Inc The Mosaic Co Japan Post Insurance Co Ltd Colfax Corp Liberty Global Inc L Brands Inc AIA Group Ltd Babcock International Group plc Washington Prime Group Inc Simon Property Group Inc
Brookfield Asset Management Inc The Mosaic Co Japan Post Insurance Co Ltd Liberty Global Inc L Brands Inc Colfax Corp Babcock International Group plc Simon Property Group Inc Washington Prime Group Inc AIA Group Ltd
Asset allocation
Regional allocation
Regional allocation
• Linked NCDs/Floating-rate notes 21.4%
• US 39.2%
• US 32.1%
• Step-rate notes
11.9%
• Europe 6.0%
• Europe 4.8%
• NCDs 41.0%
• UK 12.6%
• UK 10.6%
• Treasury Bill 24.0%
• Asia ex Japan
• Asia ex Japan
• Corporate bonds
1.7%
• Japan 9.5%
• Japan 7.7%
Total 100%
• Canada 9.7%
• Canada 8.1%
• Africa 4.6%
• Africa 3.5%
• Other 0.5%
• Other 0.4%
• Cash 11.8%
• Cash 27.8%
Total 100%
Total 100%
Performance
Performance
Performance
250
500 400 300 200 100 0
'00
'02
'04
'06
'08
PSG Money Market Fund
16 |
'10
'12
'14
'16
'18
(ASISA) South African IB Money Market Mean
200 150 100 50
5.0%
180 US dollar (thousands)
US dollar (thousands)
Rand (thousands)
600
6.1%
'10
'11
'12
'13
PSG Global Equity Sub-Fund
'14
'15
'16
'17
'18
MSCI Daily TR Net World USD Index
160 140 120 100 80 60 40
'13
'14
'15
'16
PSG Global Flexible Sub-Fund
'17
'18
US inflation +6%
Percentage annualised performance to 30 September 2018 (net of fees) Local funds 1 Year
3 Years
5 Years
10 Years
Inception
Fund inception date
PSG Equity Fund A
6.50
11.45
9.86
14.48
17.55*
31/12/1997
FTSE/JSE All Share Total Return Index
3.32
6.67
7.99
12.11
13.75
PSG Flexible Fund A
7.63
10.69
10.77
14.39
15.88**
10.95
11.20
11.33
11.33
11.83
PSG Balanced Fund A
7.73
9.86
9.68
12.00
14.05
Inflation +5%
9.95
10.20
10.33
10.33
10.56
PSG Stable Fund A
7.51
8.62
7.99
Inflation +6%
9.53
Inflation +3% over a rolling 3-year period
7.94
8.20
8.33
PSG Diversified Income Fund A
7.51
8.26
7.78
7.91
Inflation +1%
5.94
6.20
6.32
6.32
PSG Income Fund A
7.94
8.23
7.49
STeFI Composite Index
7.27
7.33
6.81
PSG Money Market Fund A
7.32
7.36
6.81
6.75 6.80
02/11/1998 01/06/1999 13/09/2011
8.44 7.91
10/04/2006
7.09 6.87
01/09/2011
6.40 8.48
19/10/1998
7.44
7.49
6.86
PSG Global Equity Feeder Fund A
13.82
15.36
12.84
14.47
MSCI Daily Total Return Net World USD Index (in ZAR)
16.59
14.42
17.00
20.34
PSG Global Flexible Feeder Fund A
10.95
13.05
12.18
14.66
US inflation +6% (in ZAR)
13.93
8.74
15.11
17.05
1 Year
3 Years
5 Years
Inception
Fund inception date
7.57
13.87
5.88
5.91
23/07/2010
South African Interest Bearing Money Market Mean
8.49 03/05/2011 11/04/2013
International funds PSG Global Equity Sub-Fund A MSCI Daily Total Return Net World USD Index (in USD)
10 Years
11.25
13.54
9.28
10.76
PSG Global Flexible Sub-Fund A
5.14
11.97
5.16
5.90
US inflation +6% (in USD)
8.71
7.90
7.52
7.61
02/01/2013
* Fund manager inception date 01/03/2002 ** Current benchmark inception date 01/11/2004 Source: 2018 Morningstar Inc. All rights reserved as at end of September 2018. Annualised performances show longer-term performance rescaled over a 12-month period. Annualised performance is the average return per year over the period. Past performance is not necessarily a guide to future performance.
THIRD QUARTER 2018 | 17
PSG Money Market Fund
PSG Income Fund
PSG Diversified Income Fund
Risk/reward profile
Potential return
18 |
Higher risk requires a longer investment horizon
PSG Stable Fund
PSG Balanced Fund
PSG Flexible Fund PSG Global Flexible Sub-Fund PSG Global Flexible Feeder Fund
PSG Equity Fund PSG Global Equity Sub-Fund PSG Global Equity Feeder Fund
THIRD QUARTER 2018 | 19
PSG Diversified Income Fund
PSG Income Fund
PSG Money Market Fund
Aims to offer investors long-term capital growth without assuming a greater risk, and earn a higher rate of return than that of the South African equity market as presented by the FTSE/ JSE All Share Index (including income)
FTSE/JSE All Share Total Return Index
High
7 years and longer
• want an equity focused portfolio that should produce high real returns above inflation and capital appreciation over the long term • are comfortable with significant stock market fluctuations
Investment objective
Benchmark
Risk rating
Time horizon
The Fund is suitable for investors who:
Bi-annually
As per the platform minimum
Annual management fee: Class A: 1.50%
No
Income distribution
Minimum investment
Fees (excl. VAT)
Compliance with Prudential Investment Guidelines (Regulation 28)
No
Annual management fee: Class A: 1.00% + 7.00% of outperformance of high watermark
As per the platform minimum
Bi-annually
0% - 100%
• have a medium- to long-term investment horizon of five years and longer
• are willing to accept potential capital loss
• aim to build wealth
• want exposure to the equity market, but with managed risk levels
5 years and longer
Moderate - High
Inflation +6%
Aims to achieve superior medium- to long-term capital growth by investing in selected sectors of the equity, gilt and money markets, both locally and abroad
South African - Multi Asset - Flexible
Yes
Annual management fee: Class A: 1.50%
As per the platform minimum
Bi-annually
0% - 75%
• have an investment horizon of five years and longer
• would prefer the fund manager to make the asset allocation decisions
• are willing to accept potential capital loss
• are comfortable with market fluctuation risk
• aim to build wealth with a balanced portfolio that diversifies the risk over the various asset classes
5 years and longer
Moderate - High
Inflation +5%
Aims to achieve longterm capital growth and a reasonable level of income for investors
South African - Multi Asset - High Equity
Yes
Annual management fee: Class A: 1.50%
As per the platform minimum
Bi-annually
0% - 40%
• have a medium-term investment horizon of three years and longer
• have a low risk appetite but require capital growth in real terms
3 years and longer
Moderate
Inflation +3% over a rolling 3-year period
Aims to achieve capital appreciation and generate a return of CPI+3% over a rolling three-year period with low volatility and low correlation to equity markets through all market cycles
South African - Multi Asset - Low Equity
Yes
Annual management fee: Class A: 1.00%
As per the platform minimum
Quarterly
0% - 10%
No
Annual management fee: Class A: 0.65%
As per the platform minimum
Quarterly
0%
• have an investment horizon of one year and longer
• require an income
• want to earn an income, but need to try and beat inflation • have a short- to medium-term investment horizon of two years and longer
• have a low risk appetite
1 year and longer
Low - Moderate
STeFI Composite Index
Aims to maximise income while achieving as much long-term capital appreciation as interest rate cycles allow
South African - Interest Bearing - Short-term
• have a low risk appetite
2 years and longer
Low - Moderate
Inflation +1%
Aims to preserve capital while maximising income returns for investors. The portfolio comprises of a mix of high-yielding securities, property, bonds, preference shares and assets in liquid form (both local and foreign)
South African - Multi Asset - Income
Yes
Annual management fee: Class A: 0.50%
R25 000 lump sum
Monthly
0%
• have a short-term investment horizon
• need an interim investment vehicle or 'parking bay' for surplus money
• seek capital stability, interest income and easy access to their money through a low risk investment
Minimum of 1 day
Low
South African - Interest Bearing - Money Market Mean
Aims to provide capital security, a steady income and easy access to your money
South African - Interest Bearing - Money Market
For full disclosure on all risks, costs and fees, as well as performance fees FAQ, refer to the fund fact sheets on our website: www.psg.co.za/asset-management
80% - 100%
Net equity exposure
• have a long-term investment horizon of seven years and longer
• are willing to accept potential capital loss
South African - Equity - General
Fund category (ASISA classification)
No
Annual management fee: Class A: 0.75%
As per the platform minimum
Annually
No
Annual management fee: Class A: 0.75%
As per the platform minimum
Annually
0% - 100%
• have a long-term investment horizon of five years and longer
• have a long-term investment horizon of seven years and longer
80% - 100%
• are comfortable with international equity market and currency fluctuations
• want exposure to global equities without personally expatriating rands
5 years and longer
Moderate - High
US inflation +6% (in ZAR)
Aims to achieve superior medium- to long-term capital growth through exposure to selected sectors of the global equity, bond and money markets
Global - Multi Asset Flexible
• are comfortable with international equity market and currency fluctuations
• want exposure to global equities without personally expatriating rands
7 years and longer
High
MSCI Daily Total Return Net World USD Index (in ZAR)
Aims to achieve capital growth over the long term with the generation of income not being the main objective of the portfolio
Global - Equity General
PSG Global Flexible Feeder Fund
PSG Global Equity Feeder Fund
PSG Stable Fund
Rand-denominated offshore PSG Balanced Fund
PSG Equity Fund
PSG Flexible Fund
South African portfolios
Unit trust summary
Contact information Local unit trusts 0800 600 168
[email protected] Offshore unit trusts 0800 600 168
[email protected] General enquiries +27 (21) 799 8000
[email protected] Websites www.psg.co.za/asset-management www.psgkglobal.com Client services SA Toll Free 0800 600 168
Cape Town office
Guernsey office
Malta office
Physical address First Floor, PSG House Alphen Park Constantia Main Road Constantia Western Cape 7806
Address 11 New Street St Peter Port Guernsey GY1 2PF
Address Unit G02 Ground floor SmartCity Malta SCM 01 Ricasoli Kalkara SCM 1001
Postal address Private Bag X3 Constantia 7848
Switchboard +44 (1481) 726034
Switchboard +356 (2180) 7586
Switchboard +27 (21) 799 8000
The information and content of this publication is provided by PSG as general information about its products. The information does not constitute any advice and we recommend that you consult with a qualified financial adviser before making investment decisions. For further information on the funds and full disclosure of costs and fees refer to the fund fact sheets on our website. Disclaimer: Collective Investment Schemes in Securities (CIS) are generally medium- to long-term investments. The value of participatory interests (units) or the investment may go down as well as up and past performance is not a guide to future performance. CIS are traded at ruling prices and can engage in borrowing and scrip lending. Fluctuations or movements in the exchange rates may cause the value of underlying international investments to go up or down. Where foreign securities are included in a portfolio, the portfolio is exposed to risks such as potential constraints on liquidity and the repatriation of funds, macroeconomic, political, foreign exchange, tax, settlement and potential limitations on the availability of market information. The portfolios may be capped at any time in order for them to be managed in accordance with their mandate. Excessive withdrawals from the fund may place the fund under liquidity pressure and, in certain circumstances a process of ring-fencing withdrawal instructions may be followed. The fund may borrow up to 10% of the market value to bridge insufficient liquidity. Unit trust prices are calculated on a net asset value (NAV) basis, which is the market value of all assets in the fund, including income accruals less permissible deductions divided by the number of units in issue. Fees and performance: Prices are published daily and available on the website www.psg.co.za/asset-management and in the daily newspapers. A schedule of fees, charges and maximum commissions is available on request from PSG Collective Investments (RF) Limited. Commissions and incentives may be paid and, if so, are included in the overall costs. Forward pricing is used. Different classes of Participatory Interest can apply to these portfolios and are subject to different fees, charges and possibly dividend withholding tax and will thus have differing performances. Performance is calculated for the portfolio and individual investor performance may differ as a result thereof. All performance data for a lump sum, net of fees, include income and assumes reinvestment of income on a NAV-NAV basis. Investment performance data is for illustrative purposes only. Income distributions are net of any applicable taxes. Annualised performance show longer-term performance rescaled over a 12-month period. Actual performance figures are available on request. Where a portfolio derives its income from interest-bearing instruments, the yield is calculated daily based on the historical yield of such instruments. Source of performance: Figures quoted are from Morningstar Inc. Cut-off times: The cut-off time for processing investment transactions is 14h30 daily, with the exception of the PSG Money Market Fund, which is 11h00. The portfolio is valued at 15h00 daily. Additional information: Additional information is available free of charge on the website and may include publications, brochures, application forms and annual reports. Company details: PSG Collective Investments (RF) Limited is registered as a CIS Manager with the Financial Sector Conduct Authority, and a member of the Association of Savings and Investments South Africa (ASISA) through its holding company PSG Konsult Limited. The management of the portfolios is delegated to PSG Asset Management (Pty) Limited, an authorised Financial Services Provider under the Financial Advisory and Intermediary Services Act 2002, FSP no 29524. PSG Asset Management (Pty) Limited and PSG Collective Investments (RF) Limited are subsidiaries of PSG Konsult Limited. Money Market: The PSG Money Market Fund maintains a constant price and is targeted at a constant value. The quoted yield is calculated by annualising the average 7-day yield. A money market portfolio is not a bank deposit account. Excessive withdrawals from the portfolio may place the portfolio under liquidity pressures and in such circumstances a process of ring-fencing of withdrawal instructions and managed payouts over time may be followed. The total return to the investor is made up of interest received and any gain or loss made on any particular instrument. In most cases the return will merely have the effect of increasing or decreasing the daily yield but in the case of abnormal losses it can have the effect of reducing the capital value of the portfolio. Fund of funds: A fund of funds portfolio only invests in portfolios of other CIS, which levy their own charges, which could result in a higher fee structure for fund of funds portfolios. Feeder funds: A feeder fund is a portfolio that, apart from assets in liquid form, invests in a single portfolio of a CIS, which levies its own charges and which could result in a higher fee structure for that feeder fund. Trustee: The Standard Bank of South Africa Limited, Main Tower, Standard Bank Centre, 2 Hertzog Boulevard, Cape Town, 8001. Tel: +27 (21) 401 2443. Email:
[email protected]. Conflict of Interest Disclosure: The funds may from time to time invest in a portfolio managed by a related party. PSG Collective Investments (RF) Limited or the Fund Manager may negotiate a discount in fees charged by the underlying portfolio. All discounts negotiated are re-invested in the fund for the benefit of the investor. Neither PSG Collective Investments (RF) Limited nor PSG Asset Management (Pty) Limited retains any portion of such discount for their own accounts. The Fund Manager may use the brokerage services of a related party, PSG Securities Limited. PSG Collective Investments (RF) Limited does not provide any guarantee either with respect to the capital or the return of the portfolio and can be contacted on 0800 600 168 or on email at
[email protected]. © 2018 PSG Asset Management Holdings (Pty) Limited Date issued: 26 October 2018
20 |
Digital subscriptions Angles & Perspectives is a quarterly publication. If you are not on our regular mailing list and would like to receive an electronic copy going forward, please email us at
[email protected].
ANGLES & PERSPECTIVES
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THIRD QUARTER 2018 | 21
