November 2017 marked the 10th year of Discovery Invest creating exceptional value for clients through our unique shared-value model. For the 10 years to end November, our flagship unit trust fund, the Discovery Balanced Fund returned a net 10.4% per annum and was ranked top in its category across three, five, seven and 10-year periods.
The Moderate Balanced Fund, which has a shorter track record, also delivered solid returns to investors adding a net 10.7% per annum over five years. This fund was ranked top quartile over both three and five years. We talked to Discovery Balanced Funds portfolio manager, Chris Freund of Investec Asset Management, about the year that was and the year that is to come.
2017 in retrospect
2017 was a decent year in terms of performance of the Discovery Balanced Fund range. In the second quartile, we missed a first quartile ranking by a very small margin. The Fund’s more balanced exposure to different macroeconomic risks provided support to delivering fairly consistent returns despite significant inflection points, sector rotations, currency fluctuations and increased political uncertainty - all market conditions which typically don't suite a more 'trending' investment style such as earnings revisions. The increased allocation to domestic bonds during the last quarter of 2017 added to returns from an asset allocation perspective.
The Fund remains 1st quartile over three and five years, outperforming the peer group by a significant margin. While a stronger rand impacted any offshore allocation, our active positions in our offshore exposure benefitted returns. Some of our key positions included a high allocation to global equities, with basically no bonds throughout the year and within equities we had a clear regional preference for European and Japanese equities where earnings expectations continue to improve and valuations remain attractive.
Towards the end of the year and December in particular, relative returns were negatively impacted mainly as a result of domestic stock selection. Gains from our exposure to retailers (Mr Price and Foschini) and banks (Standard Bank and FirstRand) were not enough to offset the negative performance from holdings in Steinhoff, STAR and Rand hedge counters such as Anheuser-Busch and Naspers.
Here is a short video from Chris Freund on his view
Source: Investec Asset Management
The South African equity market star performers
Despite a rough economic downturn and political uncertainty in 2017, the South African equity market turned in a good performance for the year. There were a few key stocks that contributed to the FTSE/JSE All Share Index ending 2017 21% higher than when the year started.
This share showed strong gains (up 72%) and due to its market-weight, it contributed 10 of the ALSI's 21 percentage point gains in 2017. We had a substantial holding in the Discovery Balanced Fund (roughly 14% of SA equities). Our positive view on the share is driven by the strong positive earnings revisions on Tencent which we believe will continue to positively contribute to Naspers' share price gains going forward. We therefore maintain a decent allocation to the company. While valuations might look excessive on valuation methodologies such as P/E; on a sum-of-the-parts valuation methodology, the company continues to look attractive considering the significant discount ascribed to the 'rump' (non-Tencent) assets.
Kumba Iron Ore
In 2017, this was the best performing stock on the ALSI, up 159%. However, this is a fairly small company (only 0.2% weight in SWIX) and its contribution to the overall market was only 22bps. We did not hold the share. While the strong gains in iron ore prices drove the share higher, the bulk of the gains came from a re-rating. There was a much higher increase in price compared to the increase in earnings. This re-rating was in part driven by the fact that Kumba Iron Ore produces a higher quality of iron ore where we have seen a sharper increase in global demand and prices. That said, we believe the company’s valuation is high, especially when compared to other iron ore producers, such as Exxaro.
Despite being a fairly small company, Exxaro has been our preferred iron ore producer and we had an average exposure of around 0.7% of SA Equities (market weight of 0.3%) in the company. This positively contributed to returns, but not by a significant margin. The share was driven by strong gains from iron ore prices. Looking forward, we are less optimistic on iron ore prices considering the sharp gains we have already seen over the last two years and prefer exposure to more diversified miners such as Anglo American and Glencore where valuations are considered more attractive against rising earnings expectations.
Clicks has been one of the strongest performers in the domestic retail space in 2017, gaining just over 60%. We have not held the share during the year as the valuation was not attractive and the earnings revisions profile did not meet our investment criteria. Our preferred holdings in the retail space were Foschini and Mr. Price - where valuations were more supportive and earnings expectations were coming off a low base. We increased our allocation to both these stocks during the last quarter of 2017. Both these holdings contributed positively to returns in 2017. Looking forward, we do not have any exposure to Clicks and continue to prefer exposure to the retail sector in mainly Mr. Price where the earnings outlook is strong due to significant operational improvements management has undertaken over the last 18 months.
Anglo American gained a healthy 35% in 2017, but all gains basically came in the second half of the year. We have gradually increased our exposure to the share during the course of 2017. Due to the strong gains from the company's underlying mix of commodities, we remain very confident that the share could continue to receive strong upward revisions in earnings expectations. This, coupled with very attractive valuations, underpin our positive outlook on the company. Anglo American is therefore one of our preferred resources holdings at present.
After a number of years of disappointing share price performance, Richemont gained almost 26% in 2017. We were not significant holders of the share in 2016, but in January 2017, we believed that the market was too pessimistic on the earnings growth potential for the share and believed that growth expectations will be revised significantly higher. We actively added to our Richemont position in January 2017. This has been one of the key contributors to returns for the year. That said, we locked-in some profits during the last quarter of 2017 by reducing our position in Richemont in favour of domestic retailers such as Mr. Price and Foschini. This was because the share traded somewhat expensive. Over recent months, Richemont's share price pulled back. Recent sales updates from the company have been, in our view, positive and speak to more sustainability in recent improving sales (and earnings) trends. We have therefore added back some exposure to Richemont over recent days.
The Steinhoff and Capitec questions
Having looked at the top five stocks of 2017, a round-up of the year would be incomplete without a mention of Steinhoff - which took a drastic price drop following the resignation of the chief executive in early December on the back of rumours of accounting irregularities. At present it is impossible to make any definitive decision on Steinhoff considering that no information has been released in terms of the accounting irregularities. We therefore maintain the holding in Steinhoff. As a business, Investec Asset Management continues to actively engage from a governance and legal perspective on behalf of our clients. Investigations are ongoing, but disclosure of accounting irregularities has not been released as yet.
At the end of January, Viceroy Research issued a report on Capitec, which sent the bank's shares tumbling by 20% in just one day. However, at the time of writing this report, there were no confirmations that the Viceroy report was accurate. Our exposure to Capitec within the Balanced Funds portfolio is extremely minimal:
- Discovery Moderate Balanced Fund - 0.07%
- Discovery Cautious Balanced Fund - 0.15%
We will continue to monitor the situation and make adjustments to our portfolio if we deem it necessary.
The outlook for 2018
Looking forward, we believe that while equity markets and global growth are robust, it is too early to get defensive. We see equity markets moving back to the "traditional battle" of rising earnings versus tighter monetary policy, particularly in global markets. Locally, South African political leadership changes will likely take longer to resolve than some may expect so some caution is warranted. In the short-term, key upcoming events include the State of the Nation speech, the 2018 National Treasury budget and a potential downgrade from ratings agency, Moody’s. This means it is difficult to make any major "macro call" at this point.
We therefore maintain a more neutral positioning in terms of macro exposures from a sector perspective, rather taking stock specific risk. Within the Balanced Fund, some of our key positions include:
- Resources (strong upwards earnings revisions): preferred holdings include Anglo American, Glencore and Sasol
- Other global cyclicals (earnings expectations continue to benefit from strong global growth): Naspers (Tencent), Richemont, Mondi, Barloworld (more 50/50 in terms of geographical exposure)
- SA Inc,: exposure through selective banks and specific retailers such as Foschini and, more specifically, Mr Price. We are very optimistic on the outlook for Standard Bank.
We remain constructive on the outlook for global growth and are pleased with the improvement in sentiment towards the outlook for the domestic political and economic environment. We therefore maintain a reasonable allocation to both domestic and offshore equities and prefer domestic bonds relative to cash.
Potential risks in 2018
Some of the key risks, in our view, would be:
- Rising interest rates and the withdrawal of liquidity: This could start to negatively impact global equities. We are therefore closely watching interest rate expectations and market sentiment towards rising interest expectations.
- Turn in global sentiment: At present, growth conditions are strong which is providing a strong underpin to equity earnings expectations. Any sign that economies are overheating could have a negative impact on equity expectations. We are therefore closely watching any sign of economic capacity constraints and rising inflation expectations.
- Political (intra-party) transformation: On the domestic front, developments around this will be key. Risks remain in terms of our government's fiscal positioning as well as the looming Moody’s credit rating announcement.
The views expressed in this article are those of the author and may not necessarily represent those of Discovery Invest. Nothing contained herein should be construed as financial advice and is meant for information purposes only. Please contact your financial adviser for any advice related matters.
What to know before investing in collective investment schemes (unit trusts)
Before you invest in a collective investment scheme, there is important information you should know. This includes how we calculate the value of your investment, what affects the value of your investment, and investment charges you may have to pay. This notice sets out the information in detail. Speak to your financial adviser if you have any questions about this information or about your investment.
1.1 What the investment is
This Fund is a Collective Investment Scheme (also known as a unit trust fund) regulated by the Collective Investment Schemes Control Act, 45 of 2002 (CISCA). Collective investment schemes in securities are generally medium- to long-term investments (around three to five years).
1.2 WHO MANAGES THE INVESTMENT
Discovery Life Collective Investments (Pty) Ltd, branded as Discovery Invest, is the manager of the Fund. Discovery Invest is a member of the Association of Savings and Investment South Africa (ASISA).
1.3 YOU DECIDE ABOUT THE SUITABILITY OF THIS INVESTMENT FOR YOUR NEEDS
By investing in this Fund, you confirm that:
- We did not provide you with any financial and investment advice about this investment
- You have taken particular care to consider whether this investment is suitable for your own needs, personal investment objectives and financial situation.
1.4 YOU UNDERSTAND THAT YOUR INVESTMENT MAY GO UP OR DOWN
- The value of units (known as participatory interests) may go down as well as up.
- Past performance is not necessarily an indication of future performance.
- Exchange rates may fluctuate, causing the value of investments with international exposure to go up or down.
- The capital value and investment returns of your portfolio may go up or down. We do not provide any guarantees about the capital or the returns of a portfolio.
1.5 HOW WE CALCULATE THE UNIT PRICES AND VALUE THE PORTFOLIOS
- We calculate unit trust prices on a net-asset value basis. (The net asset value is defined as the total market value of all assets in the unit portfolio, including any income accrued and less any allowable deductions from the portfolio, divided by the number of units in issue.)
- The securities in collective investment schemes are traded at ruling prices using forward pricing. (Forward pricing means pricing all buy and sell orders of units according to the next net-asset value).
- We value all portfolios every business day at 16:00, except on the last business day of the month when we value the portfolios at 17:00.
- For the money market portfolio, the price of each unit is aimed at a constant value. This means that all returns are provided in the form of a distribution and that a change in the capital value will be an exception and only due to abnormal losses.
- Buy and sell orders will receive the same price for that day if we receive them before 11:00 for the money market portfolio and before 14:00for the other portfolios.
- We publish fund prices every business day, with a three-day lag, on www.discovery.co.za
1.6 ABOUT MANAGING THE PORTFOLIO
- The portfolio manager may borrow up to 10% of the portfolio's market value from any appropriate financial institution in order to bridge insufficient liquidity.
- The portfolio manager can borrow and lend scrip.
- We value all portfolios every business day at 16:00, except on the last business day of the month when we value the portfolios at 17:00.
- The portfolio may be closed in order to be managed according to the mandate (if applicable).
1.7 FEES AND CHARGES FOR THIS INVESTMENT
There are fees and other charges for this investment.
The fees and charges that apply to this investment are included in the net asset value of the units and you do not have to pay any extra amounts. These fees and charges may include:
- The initial fund management fee
- Incentives (if applicable)Incentives (if applicable)
- Brokerage fees
- Market securities tax
- Auditor fees
- Bank charges
- Trustee fees
- Custodian fees
You can ask us for a schedule of fees, charges and maximum commissions.
1.8 THE TOTAL EXPENSE RATIO
- Total expense ratio means a measure of a portfolio's assets that have been expended as payment for services rendered in the management of the portfolio or collective investment scheme, expressed as a percentage of the average daily value of the portfolio or collective investment scheme calculated over a period of a financial year by the manager of the portfolio or collective investment scheme.
- A percentage of the net asset value of the portfolio is for fees and other charges relating to managing the portfolio. The percentage is referred to as the total expense ratio (TER).
- A higher TER does not necessarily imply poor return, nor does a low TER imply good return.
- The current TER is not an indication of any future TERs. If fees go up, the TER is also expected to increase.
- During any phase-in period, the TERs do not include information gathered over a full year.
1.9 TRANSACTION COST
- Investors and advisers can use transaction cost (TC) as a measure to work out the costs they will incur in buying and selling the underlying assets of a portfolio.
- The transaction cost is expressed as a percentage of the daily net asset value of the portfolio calculated over three years on an annualised basis. (This means the amount of interest an investment earns each year on average over three years, expressed as a percentage.)
- Transaction cost is a necessary costs in administering the Fund. It affects the Fund’s returns. It should not be considered in isolation as returns may also be affected by many other factors over time, including:
- Market returns
- The type of fund
- The investment decisions of the investment manager
- The TER.
- Where a fund is less than one year old, the TER and transaction cost cannot be calculated accurately. This is because:
- The life span of the fund is short
- Calculations are based on actual data where possible and best estimates where actual data is not available.
- The TER and the TC shown on the fund sheet are the latest available figures.
Discovery Life Investment Services (Pty) Ltd branded as Discovery Invest is an authorised financial services provider. Registration number 2007/00596/07.