Has the future ever looked so uncertain? Probably not, at least not for a very long time. The fallout arising from the COVID-19 pandemic has, in just a few months, completely upended the way we live our lives, and furthermore, has disrupted many of the assumptions we use to predict what the future might look like. It is now very difficult to know what we will be doing next year, let alone in 3 to 5 years' time.
The resultant anxiety is not only understandable, but also tangible, as evidenced by rising mental health illnesses and stress-related issues around the globe – change is difficult for most people, even more so when it is imposed upon us and unfolds rapidly. Working from home, travelling less, not going to gym and home-cooked meals were all enjoyable for a while, however, 100-odd days into lockdown and it now feels as if we are all desperate to get back to "normal".
This new, rapidly evolving and unstable world understandably poses significant challenges for investment managers. Economic variables are now almost impossible to predict, along with company profits where even company management teams are not able to provide earnings forecasts for the remainder of the year. With the potential for mistakes now undoubtedly high, how do we best go about generating a predictable investment outcome – our primary promise to investors?
The key, in our opinion, is to keep things simple, stick to quality, and focus on what we know.
What we know (with a reasonable degree of certainty)
About the virus
- A vaccine will eventually be developed.
About the economy
- Global economic recovery is likely to be slow, as debts (both consumer and government) must be repaid, and consumer and business confidence restored.
- The first world is set to recover faster than emerging economies, as they have more resources at their disposal to deal with the crisis.
- South Africa was in a vulnerable position heading into this crisis. With unemployment now at 30%, consumer confidence at a 15-year low, and an unfavourable fiscal position (which limits the government's ability to spend to stimulate growth), South Africa faces a particularly long road to recovery.
- The basics of life will carry on. No matter how tough it gets, people will continue to eat, drink, brush their teeth, require healthcare etc.
- Quality companies, those that have the balance sheet strength and management experience required to navigate and survive this crisis, are likely to emerge stronger. They are also likely to take market share from smaller, more vulnerable businesses and in doing so, will become more dominant in their particular industries.
- High-quality, multinational companies offering timeless products and brands have been able to increase their dividends during the COVID-19 crisis.
- In addition, companies of this nature are currently offering very good value as the differential between their current dividend yields and the 10-year US Government Bond yield is the widest it has been in over 30 years as illustrated below:
- In contrast though, even the highest quality South African companies have come under pressure to retain earnings in order to strengthen their balance sheets and ensure cash is readily available to weather the crisis. As a result, dividends have been cut.
About interest rates
- First world bond yields are so low that the probability of an inflation-beating long term outcome is close to zero.
- Due to a 3% reduction in the South African repo rate since the beginning of the year, cash rates in SA are now the lowest they have been in 50 years.
- SA government bonds are offering some of the highest real yields (i.e. the bond yield after deducting inflation) in the world.
Update on Portfolio Positioning
Taking these factors into consideration, we have positioned our portfolios as follows:
Equities – quality companies for resilient growth
- No compromise on quality – we apply a stringent filter process when selecting companies for our portfolios to ensure we only own shares in companies that have strong balance sheets, first class management teams, market leading brands and resilient business models. These are qualities that are often under-appreciated when times are good but become increasingly valued in adverse market conditions.
- Maximum developed market exposure where possible – first world stock exchanges offer investors higher quality companies, with better growth prospects and attractive dividend yields.
- Defensive local market exposure – we prefer South African companies that operate in resilient industries such as food, personal care and healthcare as their dividends are likely to bounce back strongest and soonest.
South African Government Bonds – attractive real yields
- Best value locally – South African Government Bonds are offering real yields in excess of 5%, which are amongst the highest in the world.
- Increased exposure across several portfolios – in the Core and High Income Funds, for example, we increased exposure to 7-year government bonds (R186) by 36% at a weighted average yield of close to 10%, as shown in the graphic.
- Although South African government bonds are not without risk, especially given the strain the current crisis is placing on the government's already stretched balance sheet, they remain one of the safest and most liquid investments available in the domestic market.
- We remain concerned, however, about the trajectory of government debt-to-GDP and expect a continued deterioration in the years ahead despite Tito Mboweni's best efforts to rein in government spending. With this in mind, we have limited our buying to the front end of the yield curve favouring bonds maturing in 6.5 years (R186).
Property – unpredictable dividends
- Minimal exposure – SA listed property is trading at substantial discounts to Net Asset Values (the book value of their property portfolios), however, dividend risk is high as many property companies will need to retain dividends to shore up their balance sheets (avoid breaching covenants).
- Prefer distribution focused REITs internationally – the growth of e-commerce has been accelerated by the COVID-19 crisis to the benefit of warehouses catering for last mile delivery and at the expense of high street shopping malls.
Cash – reduced exposure
- Reduced exposure – with the South African repo rate sitting at 3.5%, there is minimal real return potential from cash.
Marriott Fund and Portfolio Performance
|As at 31 July 2020
|High Income Fund (Class A)
|High Income Fund (Class C)
|Core Income Fund
|Dividend Growth Fund
|Balanced Fund (Class A)
|Balanced Fund (Class C)
|Worldwide Fund (Class A)
|Worldwide Fund (Class C)
|Essential Income Fund
|Property Equity Fund
|Property Income Fund
|Rand-Denominated International Funds|
|Intl. Growth Feeder Fund
|Intl. Real Estate Feeder Fund
|First World Equity Feeder Fund
*Annualised #Assuming R1,000,000 invested Source: ProfileData|
Please note that the Class A funds indicated above have a higher Marriott Annual Management Fee due to the intermediary fee paid on to the financial advisor. The Class C funds have a lower Marriott Annual Management Fee and do not pay an intermediary fee.
|Total Return as at 31 July 2020
|Offshore Share Portfolios|
|Income Growth Portfolio
*Annualised Gross Source: Bloomberg|
A combination of high-quality, first world listed equities for growth (income and capital), and medium-term South African government bonds for yield (income) will enable our portfolios to continue delivering reliable income and decent long term returns. The future may be more uncertain than ever but through keeping it simple, sticking to quality, and focusing on what is known, we are confident that we will continue to deliver on our promise to investors – a more predictable investment outcome.