Karl Leinberger, Chief Investment Manager for Coronation Fund Managers, comments on Coronation’s house view of the current situation and, from a multi asset perspective, their view on valuations across the major domestic and global asset classes.
The role of active asset allocation
This crisis has very much felt like the financial crisis in that it has strongly demonstrated the importance of active asset allocation. Coronation’s equity funds were, through pure luck, well positioned for Covid and have performed very well through the year. Our multi asset class funds were not well positioned being overweight in equity and property. Looking at performance against benchmark and peers, I think performance has very much been on the fairway and we’ve delivered very close to benchmark performance through this year.
The only reason for that is the value that’s been delivered from active asset allocation. We aggressively cut exposure to equities early in January and February and then materially increased this exposure in late March and early April. We also did a big Rand hedge in our balanced funds on the currency at R18.20. All these actions point to the value of active asset allocation. We definitely aren’t through this crisis. There are many challenges ahead and we expect to make meaningful changes to our asset allocation as we proceed through unprecedented times.
View on major asset classes
Offshore bonds: We’ve been very negative on sovereign developed market bonds for several years given their unprecedented levels of indebtedness. We are concerned there is a risk of inflation in the years ahead as a consequence of unprecedented printing of money and a slow reversal of globalisation. The only global bonds that we hold in our multi asset class funds are credit bonds that we bought in the crisis in March and April. They have rerated quite strongly and we still hold most of them, but could sell if the rerating continues.
Global equities: We were very negative on global equities in 2019 based on valuations. We used the Covid crisis to go from underweight to a meaningful overweight position, currently at just under 28% in our balanced funds. We are reasonably optimistic and sanguine about the economic outlook for most of the world’s developed market nations. They are vulnerable to second waves of infection, but think we’re through the worst of it. We are negative on emerging markets outside of Asia because we think they’re poorly positioned for the pandemic. As a result, Asia is where the bulk of our EM funds’ exposure is at the moment. We do think that the long-term value lies in equities and not in cash or bonds and caution against excessive attempts to try and time the markets.
SA local bonds: We’ve held our bond weighting of about 15% in our balanced funds. We are very concerned about the risk of a debt trap in South Africa. We see several years of double digit budget deficits with government debt to GDP for South Africa getting close to 100% in the next few years. We’re concerned that South Africa will lose its fiscal discipline again. Unless very hard political decisions are made to deliver austerity and to reign in debt levels in the next three years, the opportunity will be lost and we’ll find ourselves on the wrong side of the power of compounding. We are therefore nervous holders of South African government bonds. We’re watching the situation very closely and if we don’t get comfort that hard political decisions will be made, we’ll sell our positions even though they’re yielding double digit levels. We did use the crisis to build a small position in inflation-linked bonds. We haven’t owned ILB’s for about 5-7 years. They’re very unpopular at the moment given the deflationary effects of Covid, but we do think that what they deliver in terms of diversification and risk, which makes them good to have in a balanced fund.
SA equities: We are very negative on the South African economy and think that there will be massive fallout for households and small businesses as a result of the lockdown and we’re concerned about the long-term economic damage that occurred during this period. Our concerns about the long-term outlook for domestic stocks are just too great, so during the crisis we used our clients’ risk budget to rather buy global stocks listed on our market that had been hammered during the crisis, such as Anglo, AVI and Bidcorp. The domestic stocks that we do own are only the highest quality businesses in South Africa. We have a list of South Africa’s 12 best businesses. Three to four years ago we could only afford to own three of those stocks. We currently own nine of them in our portfolio and we’re comfortable that these businesses will retain their earnings power through the crisis.
Currency: As much as we’re negative on the long-term outlook for South Africa and as much as the Rand is the country’s release valve, we do think it was oversold, but that there’s a decent chance that we come close to running a current account surplus this year. In our balanced funds, 5% of our exposure is hedged. We did that at R18.20 to the Dollar and if we get close to R16 to the Dollar, we may take that off, but currently we feel comfortable having hedged a meaningful portion of our offshore exposure.
SA listed property: This sector is right in the eye of the storm in that there have been huge short-term disruptions to rental streams for all of these businesses. Work from home will transform the office environments of the future while Covid has accelerated the adoption of online commerce for retail, so retailers around the world will also need less space. Property companies were highly leveraged coming into the crisis and this has been further aggravated by Covid. There is, however, value there and some good quality assets with good management teams that will come through this crisis. Stocks look very depressed and money will be made, but this is a sector where you really need good stock pickers and disciplined research to fully understand what is going to happen to the earnings base in the next few years.