• James Twidale & Oratile Tlhabane

Who wants a broken toy?


The year has been a tough one for investors across all asset classes both local and foreign. Investor sentiment is low and the resolve to remain invested after a disappointing 3-year investment period is being put to the test in a serious way.

The appeal of cash in the South African context is becoming, if not already, an attractive alternative for many investors who are feeling the pinch every time they look at markets or their own investment statement.

Advisors cannot be finding this scenario enjoyable either. Clients feel like negative investment performance is the breaking of the promises originally made or implied when investments were put together. When performance is in the red, relative performance is not even a consideration, nor are the drivers of performance that may be beyond advisors/investment managers control. In fact, it seems, that if performance is negative clients seem to think that something is broken and must be fixed.

Unfortunately, the solution to this “broken toy” is perceived to be that a new investment selection must be made. This is either a switch to far more conservative assets (cash included) or a change of funds to something that resembles the best performing fund in a respective sector. It could also mean the scramble for something familiar like a large brand name fund manager. All-in-all something is expected to be done, action must be taken to get back onto the path that was originally promised otherwise what is an advisor for?

The advisor in this scenario finds themselves in a rather tough situation. If you do nothing you are perceived by your client not to be doing your mandated job. Which may put the client relationship at risk. On the other hand, if you have done your homework and understand investing and the behavioral biases attached to it, you will also know that changing the clients risk profile or trying to switch to a “better” fund is likely the most value destructive thing you can do for that client. Investors and advisors locally and abroad have a dismal record of trying to time the entry and exit out of funds and markets. If you are lucky you also have a fund manager that does their best to explain the merits of their strategy at times like this and gives you the ammunition to have the tough conversations with your client. Even with that support it’s still an uphill battle for advisors.

The conundrum is a tricky one to maneuver as there is no outcome or path here that is smooth and easy. On the one hand, there is the choice that keeps everyone happy but has the biggest negative long-term impact on the client and their investment outcomes. The second, is a more difficult conversation that perhaps ends the relationship but is likely to ensure the client has a higher chance of achieving their goals.

I think it’s also important to realize for most advisors out there the funds they have been selecting that are currently in the red or not achieving their mandated investment objectives, are not in fact broken at all. The market has been through a very strange period over the past 36 months which has not seen risk premiums materialize. Investing is not always a linear march to your investment outcome and it’s at times exactly like these that sticking to investment strategies and mandates is of the utmost importance. Over time, risk premiums will be realized and investors will be rewarded for stomaching the risk that goes hand in hand with investing in assets like equities, listed property and commodities.

To the investors and advisors who understand that their toys are in fact not broken, the rewards will be clear to see when the proverbial dust settles. For those that chose to chop-and-change, I extend a cautionary note; timing the market is difficult, if not impossible, consistently over time. You will continue to sell low and buy high and the value destruction will lead to a far bigger problem in the long run for investors. There will always be something that is broken, so perhaps now is the time to make sure the paradigm shifts, and the advisor is given the trust needed to advise through both the good and bad parts of the investment cycle.

The month of October was a disappointing one for local and international investors. This does however continue the trend that we have experienced for much of 2018. The decline in markets was wide spread, spanning across a multitude of domestic and international market sectors. Local equities shed -5.8% for the month, led (again) by Industrials which fell -8% for the month. The driving factor being the -15% drop in our largest stock on the JSE, Naspers. It continued to lose value from its 31% holding in Chinese internet giant Tencent, which has lost more than $200 billion in its market value this year.

Large and small caps both closed -6.7% and -3.4% lower, respectively. Mid-caps were marginally higher, adding 0.7%. Resources gave back -4%, despite the gold index gaining almost 17% in October with most gold counters showing robust growth from increased demand of the safe-haven asset. Financials ended the month -3.2% softer, while property fared relatively well ending the month -1.7% lower.

Local bond yields rose sharply on the back of a disappointing Medium-Term Budget Speech, with SA bonds closing -1.7% lower in October. Tax revenue was revised down from R27.4bn to R24.7bn due to higher VAT refunds, a constrained economy in a recessionary environment and widening deficits due to currency depreciation. The main highlights of the budget were:

  • Tax rates are expected to remain unchanged with additional items to be VAT zero-rated

  • State-owned enterprises (SOE’s) will be recipients of further bailouts

  • A capping of the state wage bill will be introduced

On a more positive note locally, President Cryril Ramaphosa's investment summit garnered just under $20bn in investment commitments from investors. This was in addition to the $35.5bn in pledges from various countries, with China being a significant portion of this. The oustanding target is just over $50bn, placing us closer to the $100bn target he has set out in his ‘Thuma Mina’ objective.

This places SA in a better footing to uplift the SA economy out of the slump it is currently experiencing and boost economic growth going forward. Also positive was the fact that many South African corporates have committed to deploy capital in SA over the next 3-5 years which is something that has been absent for a few years already, much of which is a direct result of policy uncertainty.

Source: Bloomberg

China is in the middle of an intense trade war with the US, both superpowers are exchanging tariffs on hundreds of billions of dollars’ worth of goods which has spurred on the global risk-off trade. Pressure was further felt due to the second-largest economy expanding 6.5% in the third quarter, below expectations and down from 6.7% in the second quarter. Emerging markets, of which China is its largest component, ended the month -8.7% weaker as a result of volatility in China and a general global risk off environment.

The US market experienced its worst monthly drop in over 7 years (since September 2011). A combination of the following had an impact on the pressures exerted on developed markets, which closed -7.3% down:

  • Lower than expected GDP data and downbeat earnings from the Eurozone

  • Fears of a decoupling of global economic growth

  • Disappointing earnings reports of large cap companies in US (mainly tech focused)

  • Anxiety around the outcome of the US Mid-Term elections

Robust economic growth from the US however, boosted demand of the US Dollar with GDP up 3.5% vs. an expected 3.3%. Furthermore adding 250,000 jobs and keeping unemployment at 3.7%. The positive economic news was not enough to prop up the financial markets and the above elements seemed to carry more weight in terms of what dictated the flow of funds.

The below chart shows strength of the US Dollar over the year and October saw it gain 2.3% as measured by the Bloomberg Dollar Spot Index.

Source: Bloomberg

The price of Gold was boosted as investors seek shelter from falling equities, gold saw a rise of 1.7%. Brent crude oil however experienced a sharp -8.8% decline on the back of concerned of subdued demand due to a slowing global economy. US stockpiles have increased and OPEC, along with non-cartel members have set a meeting in November to discuss a possible cut in production amid slumping prices.

Disclaimer: The opinions and views expressed in this newsletter are those of the authors and do not necessarily represent those of 1st Fusion Asset Management and the Genesis Capital Group. Content stated as fact was fact at the time of writing. The information in this newsletter is not intended to constitute financial advice as contemplated in the Financial Advisory and Intermediary Services Act.

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