QUARTER 02 2021
Consistency is the only currency that matters. CONSIDER THIS
SA MOTOR VEHICLES: NOT FIRING ON ALL CYLINDERS page 15
WORRIES (OR NOT) OVER RISING US TREASURY YIELDS? pg 10
UNDERSTANDING AND EXPLOITING THE INVESTMENT ODDS pg 27
BOND WEAKNESS DESPITE GOOD-NEWS BUDGET? pg 34 Contents Consider this Q2 2021
34 SA bonds: Complex dynamics but still attractive An improved outlook hasn’t led to Letter from lower yields, writes Gareth Bern. 03 the CEO 39 Certainly possible Aadil Omar delves into the 10 continuum between certainty TABLE TALK and possibility Sandile Malinga addresses investor worries over rising US Treasury yields. 47 Book Review: Curiosity - For 15 success, satisfaction and human The SA motor industry: Blowing a progress gasket in 2020 Clare Lindeque reviews “Curious”, a After the devastation of 2020, how brief and engaging tome examining is Prudential investing in the auto different types of curiosity and why industry? Pindiwe Mbelani sheds some they’re essential ingredients in human light. progress.
27 Two keys to accumulating wealth: Understanding the odds and exploiting them In an uncertain world, you can improve your investment outcomes by knowing when the odds are favourable and being able to take action, writes Ross Biggs, Head of Equity.
Consistency is the only currency that matters. Back to contents page LETTER FROM THE CEO
iStock-472173973 Letter from the CEO
Benard Fick CHIEF EXECUTIVE
t was another positive quarter higher US inflation and interest Ifor risk assets around the globe, rates which led to bond weakness, with investor sentiment supported mainly in the US. by progress in vaccine rollouts across many large countries, South African equities signs of acceleration in economic outperformed most other growth, and promises of more emerging and developed US government spending in the markets, recording strong gains form of a proposed US$2.25 for the quarter. We have been trillion, eight-year infrastructure commenting for a while now spending program by the Biden that SA equity market valuations administration. However, gains were extremely low compared and sentiment were tempered by to history and to other markets. growing market concerns over These valuations and a recovery Prudential Investment Managers ©
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in corporate earnings have driven packages for consumers and strong price action over the businesses. quarter. In South Africa, market sentiment Prospects for global growth was supported by the government continued to improve as central kicking off its vaccination banks kept interest rates campaign on 17 February, helped broadly unchanged at very low, by news that local manufacturing accommodative levels – central of the Johnson & Johnson Covid-19 banks currently appear less vaccine had commenced, with 30 concerned about inflation than million doses earmarked for use in investors – and governments South Africa. However, questions continued to enact fiscal support remained over insufficient supply
Total return Asset class Q1 2021
SA equity – FTSE/JSE All Share Index (Rand) 13.1%
SA equity – FTSE/JSE Capped SWIX All Share (Rand) 12.6%
SA listed property – FTSE/JSE All Property Index (Rand) 8.1%
SA bonds – FTSE/JSE All Bond Index (Rand) -1.7%
SA inflation-linked bonds – JSE CILI Index (Rand) 4.6%
SA cash - STeFI Composite Index (Rand) 0.9%
Global equity – MSCI All Country World (Total) (US$ net) 4.6%
Global equity – MSCI World (Developed) (US$ net) 4.9%
Global equity – MSCI Emerging Markets (US$ net) 2.3%
Global bonds – Bloomberg Barclays Global -4.5% Aggregate Bond Index (US$ net) Global property – FTSE EPRA/NAREIT Global Property 7.0% REIT Index (US$ net)
SOURCE: Prudential, Bloomberg, data to 31 March 2021 Prudential Investment Managers ©
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and the slow pace of the rollout. budget deficits were unlikely to prevent debt from rising. Fitch Also helping the improving said the country still faced “severe sentiment was news that the challenges” to implement fiscal South African economy grew by consolidation. an annualised 6.3% q/q in Q4 2020, beating market expectations The FTSE/JSE All Share Index of a 5% increase, with eight out delivered an impressive 13.1% of 10 industries reporting positive return in rand terms for Q1 growth in the fourth quarter. 2021, benefitting from higher The South African Reserve Bank commodity prices and the stronger lifted its projected total 2021 global and local growth outlooks, GDP growth to 3.8% from 3.5% as well as re-rating. Gains were previously and kept interest rates led by a strong performance from at near-record lows. Local inflation Resources shares at 18.7%, while remained subdued. Industrials delivered 13.0%. More locally-focused sectors were not as Finance Minister Tito Mboweni impressive but still in the black, with unveiled a better-than-expected Property posting an 8.1% return national budget in February, and Financials producing 3.8%. which saw none of the widely Forward earnings yield upgrades speculated personal tax increases, have started to come through in in favour of fiscal consolidation the local market, especially for and reined-in expenditure to Resources companies, and to a support the pandemic-battered lesser extent for Industrials. Even economy. Mboweni proposed a SA bank forward earnings have government wage bill cut to help experienced upgrades, although reduce government debt, and to a smaller degree. to aid in the funding of the free nationwide vaccine programme. The FTSE/JSE All Bond Index (ALBI) Investors, however, remained was in the red for the quarter cautious over the path of recovery with a -1.7% return as foreign outlined by Mboweni, with investor demand spluttered. Moody’s stating that the lower The yield curve continued to Prudential Investment Managers ©
Consider this QUARTER 02 2021 Page 35 Back to contents page LETTER FROM THE CEO
flatten as bonds in the 1-3 year from the likes of Anglo American, maturities sold off more than Implats, Amplats, Sasol and Sappi, longer-dated bonds, a move that to name but a few. The Prudential benefitted our Prudential funds Equity Fund managed to return on a relative basis, as we are an exceptional 62.6% for the 12 holding longer-dated bonds in months to 31 March, ranking it portfolios. SA inflation-linked in the top-quartile in its ASISA bonds posted another strong category for all annual periods performance, delivering 4.6% as out to 10 years. investors sought some inflation protection, and cash (as measured Our preference for longer-dated by the STeFI Composite) produced SA nominal bonds also helped 0.9% for the three-month period. to cushion losses in this asset class for the quarter, as the SA Most Prudential funds yield curve experienced bigger outperform losses in short-dated than longer- After having experienced poor dated tenors. At the same time, returns at the height of the our client portfolios benefited Coronavirus crisis, we were very from our overweight exposure encouraged to see last quarter’s to inflation-linked bonds (ILBs) global and local equity market given these assets’ significant rebounds extend into the new year. outperformance versus nominal Prudential’s client portfolios were bonds (nearly 5 percentage points) well-positioned to benefit from the during the period. This helped the strong local equity performance Prudential Balanced Fund return (given our overweight exposure 36.0% for the 12 months to 31 to SA equities in our best-view March 2021 and the Prudential multi-asset portfolios), adding to Inflation Plus fund to return 23.8% outperformance for the quarter for the same period. and lifting 12-month returns substantially. Equally, our stock The table below shows the selection also contributed to annualised returns of our outperformance in our equity Prudential Unit Trust funds for unit trusts, with contributions periods up to 10 years, ending Prudential Investment Managers ©
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on 31 March 2021. We remain current asset valuations, and we confident that portfolios are anticipate much more pleasing positioned appropriately given outcomes over the next three to
Prudential Fund Performance to 31 March 2021 (Rands)
Q1 2021 1-year 3-year 5-year 10-year Prudential Unit Trust Fund Return Return Return Return Return % % p.a. % p.a. % p.a.% Equity Fund 16.2 62.6 9.5 8.3 11.2 Benchmark 12.2 48.5 5.7 4.6 8.1 Dividend Maximiser Fund 15.1 53.2 8.3 7.0 10.4 Benchmark 12.2 48.5 5.7 4.6 8.1 SA Equity Fund* 16.2 58.9 4.5 5.8 10.2 Benchmark 12.6 54.2 4.3 4.8 9.1 Enhanced SA Property Tracker Fund 6.3 31.3 -14.3 -10.0 3.8 Benchmark 6.4 34.4 -12.9 -9.0 4.4 Balanced Fund 8.5 35.6 6.3 5.8 9.9 Benchmark 7.4 30.7 7.4 5.5 8.4 Inflation Plus Fund 5.6 23.8 3.1 3.5 8.3 Benchmark 2.0 6.3 7.3 7.8 8.5 Enhanced Income Fund 0.0 6.6 5.1 6.2 7.1 Benchmark 0.9 4.6 6.3 6.8 6.9 Income Fund 1.0 5.0 7.1 N/A N/A Benchmark 0.9 4.6 6.3 N/A N/A Global Equity Feeder Fund 11.7 34.5 18.2 11.6 15.7 Benchmark 5.4 27.9 20.6 13.3 18.0 Global Balanced Feeder Fund 3.3 14.1 N/A N/A N/A Benchmark 3.0 13.2 N/A N/A N/A Global Inflation Plus Feeder Fund -0.4 3.3 11.6 4.8 10.4 Benchmark 1.8 -16.3 7.3 1.6 8.9 Global Bond Feeder Fund -5.1 -3.7 9.7 2.7 10.5 Benchmark -8.1 -13.4 10.6 2.7 10.5
SOURCE: Morningstar *SA Equity Fund reflects zero-fee B Class returns. All other funds are A class returns (returns after all fund management fees and other charges). Prudential Investment Managers ©
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five years. The increasingly globalised and competitive nature of the Prudential strengthens ties investment industry has meant with M&G plc that a closer integration with During the quarter we were our large, international parent excited to announce our plans to company will be important for further strengthen our ties with our future success as a business our global parent and founding and as investors of our clients’ shareholder, London-based M&G savings. We (and by extension our Investments (“M&G”), taking clients) will have easier access to advantage of new opportunities the latest technological advances that have arisen from the de- in investment management and merger of M&G plc from Prudential administration, innovative new plc in October 2019. To cement a investment solutions such as in solid base for closer integration, the areas of unlisted credit and M&G is planning to increase its ESG investing, and closer sharing ownership in Prudential from of active investment ideas from the current 49.99% to 50.12%, around the globe, all of which will returning M&G to a position of enhance our investment offering majority shareholder. We are to clients. Equally, we will be able awaiting regulatory approval to further leverage off M&G’s scale for this transaction, which we and global supplier relationships, expect to be completed during and align with their continuously the second quarter of this year. improving global best-practice We also plan to align with M&G’s governance and risk-management global identity in due course. standards for asset managers. Further details can be found on our website https://www.prudential. Most importantly, we expect this co.za/insights/articlesreleases/ to result in better investment prudential-investment-managers- outcomes for our clients. They will south-africa-strengthens-ties- benefit to an even greater extent with-global-parent-mg-plc/. from our closer cooperation with Prudential Investment Managers ©
Consider this QUARTER 02 2021 Page 68 Back to contents page LETTER FROM THE CEO
M&G Investments’ large team of we have experienced during investment experts, global best- the quarter. Based on current practice, and expanded access asset class valuations, we believe to the latest global investment investors will be well rewarded ideas and technology, among for taking measured risk in their many other advantages. portfolios, despite the still- precarious environment in South Looking forward, we are acutely Africa and many other countries. aware that the world, and South Africa, have not escaped the We hope you enjoy this Q2 2021 ravages of the Coronavirus – much edition of Consider this, and as more needs to be done. Despite always welcome any feedback this, we remain optimistic that you may have. the supportive global policies and positive local economic Sincerely, developments of recent months will continue to improve growth prospects and investor sentiment, in turn extend the turnaround
Bernard joined Prudential in 2008 as Head of Institutional Business and was appointed as Chief Executive Officer in 2010. With more than 27 years of industry experience, Bernard previously worked at Alexander Forbes in a range of leadership roles, including Managing Director of the Namibian business as well as Head of the Asset Consulting Division. Bernard holds a Bachelor of Commerce degree in Maths and Actuarial Science from Stellenbosch University and is a Fellow of the Institute and Faculty of Actuaries and the Actuarial Society of SA. Prudential Investment Managers ©
Consider this QUARTER 02 2021 Page 79 Back to contents page TABLE TALK
iStock 1064562764 TABLE TALK
SANDILE MALINGA PORTFOLIO MANAGER
i KEY TAKE-AWAYS
Investors have been selling longer-dated has happened previously as US interest US Treasury bonds amid worries over rates rose. a possible acceleration in inflation due However, Prudential doesn’t believe to the government’s large spending UST yields have risen enough to cause programmes and recovery in economic a sell-off in emerging markets. In the growth. Yields have risen significantly past, it was shorter-dated USTs (out (over 100bps) in the past seven months. to three years) and not the longer- Investors are concerned the higher dated tenors, that saw rising yields yields from safe-haven assets like US which triggered the emerging market Treasuries will cause others to switch sell-off. This has not been the case in out of higher-yielding emerging market recent months. assets into USTs, sparking a sell-off. This Prudential Investment Managers ©
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I have been hearing that we are likely to get a sell- off in emerging market investments soon, because Q US bond yields have risen so far so quickly. What is your view on this?
It’s true that some investors more than 100bps (1.0%) over the are worried that the recent past seven months, as Graph 1 shows, increase in long-dated US with the benchmark 10-year bond at A Treasury (UST) bond yields over 1.6% in late March versus a low could soon have a negative impact of around 0.5% in mid-August 2020. on the demand for emerging market However, at Prudential we believe assets, including SA equities and it will take a larger increase in UST bonds and cause a broader sell-off in yields from current levels to cause a emerging markets (EM). The yields on shift in investor risk appetite and an 10- and 30-year UST’s have jumped EM sell-off.
GraphGraph 1: 1: Long Long UST UST bond bond yields yields risen risen 100bps 100bps since since August August 2020 2020 4
3,5
3
2,5
2
1,5
Yield-To-Maturity (%) Yield-To-Maturity 1
0,5
0
21-Jul-16 21-Jul-17 21-Jul-18 21-Jul-19 21-Jul-20 21-Mar-1621-May-16 21-Sep-1621-Nov-1621-Jan-1721-Mar-1721-May-17 21-Sep-1721-Nov-1721-Jan-1821-Mar-1821-May-18 21-Sep-1821-Nov-1821-Jan-1921-Mar-1921-May-19 21-Sep-1921-Nov-1921-Jan-2021-Mar-2021-May-20 21-Sep-2021-Nov-2021-Jan-21
SOURCE: Bloomberg 2-year 10-year 30-year Source: Bloomberg Prudential Investment Managers ©
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While the move in UST’s has been by the US Federal Reserve (Fed)’s very quick and quite substantial in a steady, exceptionally low interest historical context, we are somewhat rate policy and its bond purchasing more sanguine about it than we would (quantitative easing) programme. The be under “normal” circumstances central bank has been steadfast in due to the exceptionally low yields/ reiterating its continued support for high prices at which USTs (and other low interest rates until US economic sovereign developed market bonds) growth and employment recover. had been trading prior to August, given As such, it has been the 10-year and the prevailing easy monetary policy 30-year bonds where the re-pricing globally. Therefore it’s not surprising has taken place, steepening the yield that a relatively expensive asset has curve notably. With the shorter end experienced a correction. of the yield curve unaffected, we have not seen an impact on investor The previous time rising UST yields preferences and risk appetite: the led to problems for emerging markets “risk-on” sentiment has stayed intact. (and other risk assets) was 2016-2018, when it was the rise in short-dated US At the same time, the equity market has yields that arguably caused maximum been quite comfortable with pricing- damage, as this tightened global in higher growth. This is supported monetary/financial conditions and by upward revisions to global GDP had a profound dampening effect on forecasts and equity earnings as risk appetite and thus risk assets. The confidence in country and regional higher yields offered by such safe- vaccine rollouts improves. According haven assets tempted many investors to the March 2021 interim OECD to switch out of riskier assets. Economic Outlook report, global GDP growth is now projected to be 5.6% Yet one aspect of this recent move this year, an increase of more than 1 that has been very different to the percentage point from its December previous episode has been that two- report. It therefore makes sense that year UST’s have hardly moved: yields assets which typically do well in rising have remained virtually flat, as Graph 1 growth environments, like EM equities, clearly shows. They have been anchored are doing well right now. Prudential Investment Managers ©
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It’s not clear to us exactly what factors • Phase 1: December 2020 to mid- are behind the rising long bond yields February 2021: the increase in 10- in the US, apart from speculation year US bond yields is associated with around accelerating inflation and some an increase in inflation expectations, technical US Treasury microstructure but issues. However, the Fed has indicated • Phase 2: Mid-February 2021 to that it is not concerned by the increase today: the subsequent rise has been and has thus committed to maintaining driven more by higher real yields current policy. In fact, if we look closely than inflation expectations. at the change in US bond yields over the last three months displayed in M&G Investments, our global Graph 2, there are two distinct phases: shareholder, believes that there is
Graph 2: Change in yields over last 3 months Graph 2: Change in yields over last 3 months
70
60
50 Phase 1 40
30
20
10
0
-10
Phase 2 Change in yields since 17 December 2020 (in bps)
17-Dec-20 24-Dec-20 31-Dec-20 07-Jan-21 14-Jan-21 21-Jan-21 28-Jan-21 04-Feb-21 11-Feb-21 18-Feb-21 25-Feb-21 04-Mar-21 11-Mar-21
10-year US Treasury bond yield 2-year US Treasury bond yield 10-year inflation break evens 10-year TIIPS Real Yields
Source: Bloomberg SOURCE: Bloomberg Prudential Investment Managers ©
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a tipping point above which higher 10-year and 30-year UST yields could become problematic for global risk appetite, but that current levels are still far from this point. If we saw another quick 100bp sell-off in 10-year USTs, for example, this could become worrying for EM assets. For now, however, we don’t believe investors need to be concerned about the jump in UST yields. As long as the market is comfortable that real bond yields will remain steady and the Fed continues to buy up the extra bond issuance required to finance the government’s higher spending from the US$1.9 trillion Coronavirus rescue programme, investor risk sentiment should remain supportive of emerging market assets.
Sandile joined Prudential in 2013 as a member of the fixed-income team, and later joined the multi-asset team in 2018. He is currently the joint-Portfolio Manager of the Prudential Money Market, Income, High Interest, Balanced and Inflation Plus Funds. His role involves providing analytical and economic support to our multi-asset and fixed-interest investment process. He is also a member of the Prudential Asset Allocation Committee. With 13 years’ industry experience, Sandile previously worked for Investec Asset Management as a fixed interest dealer and analyst. He also served as Portfolio Manager on large institutional fixed interest client mandates with liability immunization objectives. Sandile holds a BSc in Mathematical Statistics and Actuarial Science and is a Student member of the Faculty of Actuaries. Prudential Investment Managers ©
Consider this QUARTER 02 2021 PagePage 14 5 Back to contents page ANALYSIS
The SA motor industry: iStock-1140988145 Blowing a gasket in 2020
Pindiwe Mbelani EQUITY ANALYST
i KEY TAKE-AWAYS
South Africa’s motor vehicle industry their share prices fell significantly during had already been shrinking ahead of the worst of the crisis. the onset of the Coronavirus, and the Prudential added to its position in Motus, economic lockdowns it prompted in and bought shares in CMH, when the 2020 had a devastating impact on motor companies’ price-to-book valuations vehicle sales, rentals and manufacturing, were extremely attractive, due to their causing even more severe downsizing. improved profitability following cost- The four main listed motor vehicle cutting, much stronger cash generation companies were hard-hit in terms of and prudent cash management. The share profits, job losses, salary cuts, fleet and prices have subsequently rebounded, dealership downsizing and more, and adding vaue to client portfolios. Prudential Investment Managers ©
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ANALYSIS THE SA MOTOR INDUSTRY
he advent of the Coronavirus multiplier effect created by the sector. Tpandemic in South Africa was It is the country’s largest manufacturing the equivalent of a blown gasket industry. However, these numbers have for the local motor vehicle industry, been shrinking in recent years, as Graph rendering it incapable of powering 1 highlights, due to the slowdown in ahead without some serious repairs the economy and associated pressure in an already-weakened environment. on consumer spending: new vehicle The economic lockdowns of 2020 sales amounted to only 536,000 in caused motor vehicle sales to grind to 2019, a 25% decline from their peak of a halt for a time, prompting further nearly 714,000 in 2006. Consequently, downsizing across the major companies, even before the pandemic, the sector and it was only these “repairs”, plus had been downsizing in the form a better-than-expected performance of closing loss-making dealerships; from the pre-owned vehicle business moving away from dealership brand segment in the last two quarters of exclusivity to the consolidation of the year, that supported industry several brands under one dealership; results. Although both new and used reducing real estate space and staff car sales were lower for the year, the complements; and cutting rental cost-cutting and resulting improved fleet sizes to help companies remain profitability left the companies better profitable in a shrinking market. equipped to accelerate out of the crisis, albeit still having to navigate Not only have consumers been cutting tough conditions. back their new car purchases in absolute terms, but they have also been trading An important, but shrinking, sector down from premium, more expensive The local automotive industry, brands like Mercedes and BMW to the comprising vehicle manufacturing, more affordable brands like Toyota, exports and retail sales, contributes VW, Hyundai, Renault, Nissan, Mazda, some 6.4% to South Africa’s GDP, Kia, as well as relative newcomers while accounting for a total of around Suzuki and Haval. Affordable brands 457,000 jobs across manufacturing, have gained good traction in the assembly, retail sales and other local market, having managed to associated roles, thanks to the strong improve their quality significantly Prudential Investment Managers ©
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ANALYSIS THE SA MOTOR INDUSTRY
Graph 1: SA’s new car sales declining even before the pandemic Graph 1: SA’s new car sales declining even before the pandemic
800 000
700 000
600 000
500 000
400 000
300 000
200 000
100 000
0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Forecast 2021 Forecast 2022 Forecast
Source: NAAMSA SOURCE: NAAMSA
over the years, taking market share an incredible 98% drop from 2019 and heightening competition even levels and May down some 68% after further. the reopening. And sales have only recovered partially since then: every Coronavirus takes new sales levels subsequent month’s volumes have back 20 years, devastates rentals been below their 2019 equivalent. Into this depressed environment came For 2020 as a whole, local new vehicle the Coronavirus, with its accompanying sales totalled only 380,000, 29% lower market lockdown, in March 2020. than 2019 and at a level last seen some Vehicle sales and manufacturing were 20 years ago, as illustrated in Graph completely shut down from 27 March 1. Buyers have not been sufficiently to 13 May, when most of the damage tempted despite 50-year low interest was done, with April sales registering rates. Vehicle exports from South Prudential Investment Managers ©
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ANALYSIS THE SA MOTOR INDUSTRY
Africa also fell by nearly 30% for the latter months of 2020, used cars saw year as a result of a plunge in offshore strong purchases due to pent-up demand, hitting jobs and industry consumer demand, as well as new revenues alike. demand from consumers preferring to switch away from unsafe public Exacerbating the conditions has been transport, a trend that was mirrored the virtual standstill in business travel in many other countries. Also in favour and international tourism for most of the used car market was the rand’s of 2020, which has had a devastating sharp depreciation, which made new impact on the car rental businesses of cars more expensive, as well as the the country’s four major listed vehicle decrease in supply from the new retailers: Motus, Bidvest, Barloworld vehicle market due to the disruptions and Combined Motor Holdings (CMH). in manufacturing. All these factors Approximately 13% of new cars sold helped create a floor under pre-owned in the country are sold on to the market prices. rental businesses every year. Leasing operations including those of Europcar At the same time, the surge in demand and Tempest (both owned by Motus), for used cars also supported the Bidvest Car Rental (Bidvest), Avis rental market to some extent. This is (Barloworld) and First Car Rental because when the rental companies (CMH) were dealt a severe blow, and are regularly “de-fleeting”, or reducing rental demand remains subdued to their inventory of used rental cars at the the present day. end of the tourist season, they sell into the used car market. Last year, many Used vehicle market thrives in the industry were concerned that One of the only lights in the industry dumping new supply after the severe in the last year has come from the lockdown conditions where dealerships pre-owned vehicle market, where were not allowed to operate (just demand has risen in recent years due after peak tourist season when the to the trend of consumers moving most de-fleeting occurs – April to away from buying new cars. This was June) would overwhelm demand and only accelerated by the pandemic. cause the used car market to collapse. When sales restrictions eased in the However, this didn’t happen. Instead, Prudential Investment Managers ©
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ANALYSIS THE SA MOTOR INDUSTRY
the rental companies sold their stocks aggregate 300bps (3%) interest rate slowly into the market and were also cuts during the year, lower debt levels met with resilient demand in the and having fewer vehicles to finance. third and fourth quarters of the year. For example, given that Motus has Surprisingly, groups like We Buy Cars debt of R7.6 billion on average, the reported their best August sales ever, 300bp reduction in the interest rate and Barloworld’s used car division saves them around R200 million per similarly experienced an excellent year in interest costs, which is highly August and September. This strong earnings-accretive. demand contributed to maintaining a price floor under the pre-owned Not firing on all cylinders market. Despite these positive developments, none of this rationalisation has proved The automotive retailers managed successful in returning the vehicle to improve their profit margins after rental businesses to profitability. having taken tough downsizing The general consensus is that it takes measures. Because they had larger- a 65%-70% utilisation rate for a than-usual de-fleeting that was company to be profitable, and Motus necessitated by lower rental activity most recently reported a utilisation levels, they had more cash on hand, rate of 59%. The latest financial results using it in turn to pay down their across the motor industry confirm that debt more quickly and improving even though companies are getting their balance sheets. Plus, having closer to profitability in their shrunken aggressively cut the size of their rental formats, much higher total demand fleets there was less depreciation is needed for the rental segment to write off, lower overhead costs to be profitable. This requires the due to fewer branches and staff return of international tourism and (Motus had retrenched 45% of its resumption of business travel, and rental staff, for example) and, also without these key factors, the rental key, improving the utilisation rates market is incapable of firing on all from very low levels for their (fewer) cylinders. existing vehicles. Financing costs for the industry also fell due to the SARB’s If we look at the impact the pandemic Prudential Investment Managers ©
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ANALYSIS THE SA MOTOR INDUSTRY
has had on the individual listed we had already been experiencing. companies in the sector, we see that all Still, demand is improving, helped four companies’ share prices de-rated by exceptionally low interest rates, considerably in the first few months of subdued core inflation and dealer the lockdown, with the 68% drop by incentives, among other measures. Motus the largest, and the 29% decline These factors, combined with good by Barloworld the smallest. Both CMH demand in the used vehicle market and Super Group lost around 50% and the prospect for the local rental of their value. Subsequently all have market to improve as tourism and experienced a gradual re-rating, largely business travel gain ground (propelled due to their higher-than-expected cash by spreading vaccinations), gives us generation and improved profitability. reason for optimism that the sector All the companies acted prudently, is over the worst. While it will not conserving and generating more cash, be a smooth road ahead, at least the paying down debts and cutting costs companies are now appropriately sized severely. and geared to meet the exigencies of the post-Coronavirus world. Geared to meet the post- Following we offer snapshots of Motus Coronavirus world and CMH, and explain why we are Looking ahead to 2021 and beyond, holding these companies’ shares in the National Association of Automobile select client portfolios, including the Manufacturers SA (NAAMSA) expects Prudential Dividend Maximiser Fund. local new vehicle sales to recover only gradually due to depressed Motus: Market leader with strong consumer and business sentiment. cash flows As Graph 1 shows, it is forecasting Motus is a good example of the a 15% increase in new vehicle sales experience of the entire sector during volumes to around 440,000 for this year, the pandemic. It suffered the sector’s gradually building up to potentially largest share price decline, primarily reach 2019’s volumes only from 2023 because it has the largest market share or so. This is slower than most other (at 20.2% as of June 2020) and is very countries’ projected recoveries due dependent on the local vehicle market. to the recessionary environment It unbundled from the Imperial group Prudential Investment Managers ©
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ANALYSIS THE SA MOTOR INDUSTRY
GraphGraph 2: Prudential2: Prudential adds adds MotusMotus asas P/B P/B fallsfalls below below exceptionally exceptionally cheapcheap 0.6X0.6X 1,80
1.60 20,00% 1,40
1,20 15,00% 1.00
0.80 10,00% 0.60
0.40 5,00%
0,20
0 -0,00% Jul-19 Jul-20 Jan-19 Jan-20 Jan-21 Jun-19 Jun-20 Jun-21 Jun-22 Oct-19 Oct-20 Feb-19 Feb-20 Feb-21 Apr-19 Apr-20 Apr-21 Sep-19 Sep-20 Dec-18 Dec-19 Dec-20 Nov-18 Mar-19 Nov-19 Mar-20 Nov-20 Mar-21 Aug-19 Aug-20 May-19 May-20 May-21
ROE Price to Book (RHS) Median P/B (RHS)
Source: Bloomberg; Uses floating-rate bank certificates of deposit spreads as a proxy for credit market pricing trends SOURCE: Company data, Bloomberg
in November 2018, and is squarely free cash flow and balance sheet: it focused on the industry, with a fully had maintained a net debt/equity ratio integrated business model across (gearing) within its longer-term target imports and distribution, retail, rental, range of 50%-75% for several years. financial services, and aftermarket During the April-June 2020 period, at parts and services. It is focused on the height of the lockdown and end entry-level and affordable vehicles of its financial year, Motus reported a rather than the premium segment, and 70% decline in revenue from its rental has exclusive sales agreements with operations (Tempest and Europcar Hyundai, Kia, Renault and Mitsubishi, brands in South Africa), a 40% drop as well as selling popular brands like in its retail sales operations and a Toyota and VW. 50% revenue fall from imports and distribution. Although the company’s Prior to the pandemic, Motus was vehicle retail and rental business highly cash generative, with a strong accounted for some 70% of its revenue Prudential Investment Managers ©
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ANALYSIS THE SA MOTOR INDUSTRY
in the 12 months to June 2020, this by 35% or some 7,000 vehicles, but segment contributed only 14% of its it also closed 19 outlets countrywide total profit – the operating margin was and reduced its rental workforce by only 0.6% for the period. By contrast, 45%. Every source of spending was its financial services business stood it impacted, with both voluntary and in good stead, despite its small (3%) compulsory retrenchments, salary cuts contribution to group revenue, thanks for everyone earning over R250,000 to its annuity revenue streams: it annually, salary freezes for FY2021, the comprised nearly 40% of its operating postponement of all capital spending profit with only a 10% decline in and property rental deferrals, among revenue. In total, Motus reported a other measures. 7.8% decline in total revenue and 41% drop in total profit for its 2020 Motus also opted to conserve its cash, financial year. suspending its dividend payments for both December 2019 and June 2020, The group also has retail sales and but resuming them for December 2020 rental businesses in Australia and the with a 30% payout level versus its UK that provide some diverse income traditional 45%. This was possible due streams. The Australian vehicle market to its strong cash generation during the didn’t experience as large a downturn year, which also allowed it to conduct as South Africa, and has recovered share buybacks at attractive share much more quickly, and although the prices. The group made it through the UK vehicle market was hit hard by worst of the downturn with its existing lockdowns, it is also bouncing back debt covenants intact, plus some R5.8 more quickly than the local market. billion in unused debt facilities, while its gearing stood at 60% at the end of A large part of Motus’ focus during June 2020, only slightly higher than the pandemic was on cutting its costs, the 56% a year earlier. starting in an environment where it had already downscaled due to At Prudential we owned shares in South Africa’s extended economic Motus before the pandemic, buying malaise. Not only did it accelerate when it traded below its longer-term its de-fleeting, cutting its rental fleet valuation, based on the company’s Prudential Investment Managers ©
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ANALYSIS THE SA MOTOR INDUSTRY
strong free cash flow and balance price plunged due to the Coronavirus sheet, plus its leading market position lockdown in March-April 2020, at one and large offering of used vehicles point down some 68% to a low of and small SUVs. Its retail business is around R23.80. Since then, its price/ also squarely focused on the growing book value ratio (P/B) has re-rated, entry-level and affordable vehicle rising to 1.3X and closer to its historical segments, and the management team P/B of 1.5X. The return on equity (ROE) has proved its ability to be flexible is also expected to improve to pre- and scale its operations to match crisis levels. Its share price managed the changing conditions of South to nearly double by the end of 2020, Africa’s automotive market. Going and as of the end of March 2021 had forward it has a selective acquisition gained some 287% from its April strategy to further diversify (already lows, trading at R89.40 compared to with a small presence in Southeast its pre-Coronavirus price of R73.00. Asia and Southern and Eastern Africa) This is an excellent example of how and implement more operational Prudential’s clients have benefited as efficiencies and innovations. a result of our active, valuation-based investment process. We bought more exposure to Motus in our client portfolios when its P/B was extremely low, after its share
CMH: Offering excellent value during the crisis By Kaitlin Byrne, Portfolio Manager
The conditions faced by CMH, and the 80% of its profits). For its latest interim actions it took to navigate the crisis, results to 31 August 2020, the group were very similar to those of Motus, reported a 38% fall in revenue, while with its primary focus equally being operating profits were down 76%, on retail and rental vehicle operations and its operating profit margin was in South Africa (accounting for over squeezed further from the 3.5% it Prudential Investment Managers ©
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GraphGraph 3: Prudential 3: Prudential buys buys CMH CMH as P/Bas P/B falls falls below below attractive attractive 1.0X1.0X P/B
7,00 45,00
40,00 6,00
35,00 5,00 30,00
4,00 25,00
3,00 20,00
15,00 2,00 10,00 1,00 5,00
- - 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Return on equity (%) (RH) Price to book Median PB +1 Std Dev -1 Std Dev SOURCE: Refinitiv Source: Refinitiv
recorded in 2019. This resulted in a Thanks to de-fleeting, its finance costs loss for the six months of R14.3 million were lower and cash resources rose compared to a R90.5 million profit a 13% for the period, and the group year earlier. was able to declare a dividend for the six months to August 2020 (based CMH also underwent extreme cost on its earnings for the year to end cutting and down-sizing as it reported Feb 2020), after skipping its annual total staff numbers were cut by 24% dividend payout for the 12 months over the six months and it instituted to end February 2020 to conserve its a salary sacrifice programme. It was cash resources. also able to negotiate concessions from its landlords like rental holidays Being the smallest company in the and payment deferrals, while merging motor vehicles sector, CMH has franchises to reduce its rental costs. low structural costs relative to its Prudential Investment Managers ©
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competitors and also primarily offers return on equity – even with lower affordable brands like Haval and rental sales and car sales – as a result Suzuki, catering to the more buoyant of its substantial reduction in costs end of the local market. Because of its and interest rate savings. ability to bring in the right brands at the right prices, It has been increasing Consequently, when the company its market share in recent years, but traded at a P/B of 1.0X in March 2020, with a market capitalisation of only far below its longer-term fair value around R2.0 billion it is still relatively of closer to 2.5X P/B, it presented us small compared to Motus’s market with a unique opportunity to buy CMH cap of R17.9 billion. shares. At the same time, it was trading at a very high long-term dividend yield From its Coronavirus low of around of 18%. Since we believed the cash- R9.00 in May 2020, the CMH share generating ability of the business had price reached R15.00 by the end of the not deteriorated permanently and we year and had nearly doubled to R18.00 regarded it as an excellent dividend by the end of March 2021. Still, this generator, we decided to add it to was just off the R18.40 level at which the Prudential Dividend Maximiser it was trading prior to the advent of Fund. Subsequently, the CMH share the pandemic, so the share has not has recovered, adding good value to performed as well as Motus during our clients’ returns, but it is still very the recovery. CMH should return to cheap at a P/B of 1.6X and a long-term a position where it can earn a 24% dividend yield of 10%. Prudential Investment Managers ©
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Pindiwe is an Equity Analyst at Prudential Investment Managers. She joined Prudential in April 2018 and is responsible for analysing stocks within the industrial and financial sectors. She holds an M.Com in Financial Management from the University of Pretoria and is a qualified Associate Chartered Management Accountant, as well as a CFA Level 3 Candidate.
Kaitlin joined Prudential in May 2015 as an Equity Analyst, and has six years of financial industry experience. She is currently the joint Portfolio Manager on the Dividend Maximiser Fund, Select Institutional Funds and the African Equity Funds. Kaitlin is also responsible for research on South African stocks in the Consumer Staples, Industrial and Gaming and Leisure sector, as well as African stocks in the Banking and Telecoms sector. Prior to joining Prudential, Kaitlin completed her articles at Ernst & Young, where she was responsible for auditing companies in the Finance, Gaming and Leisure, Real Estate and Manufacturing sectors. She holds a B.Acc (Stellenbosch), is a Chartered Accountant (CA (SA)), and a Chartered Financial Analyst (CFA Institute). Prudential Investment Managers ©
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Two keys to accumulating
iStock-870507038 wealth: Understanding the odds and exploiting them
Ross Biggs HEAD OF EQUITY
i KEY TAKE-AWAYS
In an uncertain world, you can improve their cheapest during the biggest crises. your investment outcomes by knowing This is when fear is at its highest but yet when the odds are favourable and being it is usually the best time to buy. able to take action. This involves buying Diversifying a portfolio to include several when valuations are cheap on an historic investment ideas and different stocks that basis: at this point, the odds of future can perform well under different future outperformance are higher. scenarios is important in limiting the downside when the future is uncertain. This also involves being able to overcome This lowers portfolio risk and keeps you the fear of uncertainty that prevails when from relying on one forecast outcome.
Prudential Investment Managers © valuations are cheap: they are usually at
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lthough none of us can know Understanding the odds = Athe future, and investing in the understanding valuations stock market may seem like a huge One of the most important factors in gamble, in fact there are ways to constructing our client portfolios is reduce uncertainty and improve the ensuring that we buy assets at cheap odds that your portfolio will produce valuations compared to their history. superior returns. Here we discuss This helps reduce future uncertainties Prudential’s approach and explain and puts the odds of outperformance how understanding the investment in our favour. How does this work? odds, and being capable of exploiting Graph 1 shows the history of the JSE’s them, are two keys to successfully price-to-book value (P/B) since 1980, accumulating wealth over the long and indicates investors’ odds of getting term. a good future return. It highlights
Graph 1: Improving the investing odds Graph 1: Improving the investing odds 4,0 Leveraged buyouts and Commodity mergers fuel the market super cycle 3,5
3,0
2,5
2,0
1,5
Global 1,0 Accounting scandals, Global recession sparked Russian default Financial Crisis Global IT bubble collapse by high interest rates Pandemic 0,5 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source:SOURCE: Bloomberg, Bloomberg, Datastream Datastream & Prudential Investment & Prudential Managers Investment Managers Prudential Investment Managers ©
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that when the South African market March-April 2020, Prudential seized trades: the opportunity to buy high-quality companies at excellent valuations. We • At a low P/B of around 1.0X, it recognize that the most important is very cheap and investors should thing to focus on during crises is the expect outsized future returns (since odds that the market is offering you. the subsequent historic performance It is very often the case in crises that usually improves); you as the buyer are being offered • At an average 2.0X P/B, the market fantastic odds to accept the future looks to be fair value and investors risks, as looming and dire as they should expect a fair future return may be or seem to be. These points (since the subsequent historic in the market are nearly always the performance is around average); best times to buy. and • At a high 3.0X P/B, the market looks Overcoming fear of uncertainty very expensive, so investors should and loss expect a lower return going forward Yet for most investors, including us, (since the subsequent historic it is exceptionally uncomfortable performance usually deteriorates). to buy assets during a crisis, when conditions appear to be at their worst. So without knowing the future, we Many would rather sell to relieve can tilt the odds of outsized returns themselves of the intense discomfort in our favour by buying shares at they feel from owning assets which cheaper valuations. It is also clear are continually falling in price. This from the graph that fantastic buying is because the human instinct to opportunities are very rare, as the avoid losses is stronger than that of South African market has only traded making potential gains, especially in close to a 1.0X P/B valuation five times an environment of such perceived high in the last 40 years. risk. Many investors therefore don’t take the opportunity to buy at these That’s why, when the JSE’s P/B fell points – it is exceedingly difficult to to almost 1.0X during the height go against their emotions. Because of the Coronavirus market crisis in there is so much bad news around, Prudential Investment Managers ©
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the future feels even more uncertain catalyst triggering the move higher; it and negative. is simply a sudden change in collective market sentiment. In the peak of the Coronavirus crisis we heard many reasons from investors So when these rare opportunities do as to why it was not a good time to come around, investors need to be buy. These included: prepared, and understand that making the decision to buy up assets will feel • Wanting to “wait and see” how very uncomfortable since there will circumstances developed; be many things to worry about. There • Waiting for certain identifiable is likely to be more downside to the catalysts to materialise indicating market ahead and high volatility to improving conditions; and weather. But understanding the odds • Thinking they could temporarily and being prepared to take advantage switch into safe-haven assets and of rare crises – as well as the smaller successfully buy back their riskier market mis-pricings that occur more assets when the outlook improved. frequently – are critical in accumulating wealth over the long term. The problem with this reasoning, however, is that by the time the horizon There is an important caveat to this looks less cloudy or the catalysts approach, however, which is not to arrive, everyone else has also seen take risk simply for the sake of it… things improving. Time and again you want to ensure that the odds are history has shown that large rebounds stacked in your favour. Careful analysis usually happen suddenly and very of the factors driving the asset price, quickly, and it is then too late to get our own judgement of the asset’s fair back in the market to capitalise on value and what other assets we are the lowest prices – investors miss out holding are important considerations on the exceptional returns available. in ensuring that a share is not only And perplexingly, in hindsight it is absolutely undervalued, but also often very difficult to identify a clear relatively undervalued. Prudential Investment Managers ©
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Prudential’s track record for delivering construct portfolios, we try to include strong outperformance over time as many different ideas as possible, all is built on our understanding and which have good odds. Not all of these implementation of these factors. ideas will work out, but on balance we hope that we have stacked the Including diverse ideas to embrace odds in the favour of our clients, no diverse scenarios matter what future scenarios play out. Besides using a valuation-based approach when constructing portfolios Of course the most dangerous risks to deal with uncertainty, Prudential also are usually the ones no one has even always considers how a portfolio would thought about, such as last year’s perform under the broadest possible pandemic. Ahead of the market crash range of scenarios, taking account of we were holding quite a few companies different potential outcomes. which had strong balance sheets and diversified income sources. This We try to include many different strength has enabled these companies investment ideas with a variety of to take advantage of the difficult and stocks to add diversification benefits volatile environment. Some companies as well. In this way, the downside are taking away market share from is mitigated and upside potential their weaker competitors who are is enhanced, even when something in distress; some companies have very unexpected happens. We are aggressively cut costs; and others have very cognisant that we, like other taken advantage of their very low investors, do not know what the future share prices to buy back their shares holds. We often hear highly regarded at exceptionally cheap levels. These economists confidently talking about actions taken during the pandemic how interest or exchange rates will go have no doubt improved the future up or down, or how the economy is prospects for these companies. headed horribly down or fantastically up… only for them to be proven totally Very good opportunities still wrong. We think it is very dangerous available to construct portfolios based on a The local market has recovered from particular view of the future. What the March 2020 lows, but we still think happens if you are wrong? When we that it currently offers exceptionally Prudential Investment Managers ©
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GraphGraph 2: 2: Forward Forward dividend dividend yield yield differential differential ofof JSE JSE stocks stocks (ex-property) (ex-property) still still high high 5,5
5,0
4,5
4,0
3,5
3,0 DY spread
2,5
2,0
1,5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Difference 75th - 25th percentile Mean Mean + std dev Mean - std dev SOURCE: Inet Data Source: Prudential Investment Managers
good opportunities and the potential Consequently, currently there are a to outperform due to the extent of lot of opportunities for investors to the valuation disparities in the local construct a well-considered portfolio market. that includes many opportunities that could pay off in future years. This is Graph 2 shows the valuation disparity about taking on the right kinds of between the dividend yield of the 25th risks and taking on risk because the percentile stock (near the top-ranking odds are in your favour. shares) and the 75th percentile stock on the JSE (near the bottom-ranking Today, we sit in a very uncomfortable shares). When there is a very large gap and uncertain position. We are still it means there are many opportunities going through a global pandemic, and in the middle to make good returns in South Africa particularly we have from stock-picking. And we are now other issues like rising unemployment, at levels that we last saw during the debt/GDP levels that keep increasing 2008 Global Financial Crisis and the to fairly alarming levels, and state- early 2000s during the IT bubble. owned enterprises that are struggling. Prudential Investment Managers ©
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So in the South African equity market there is a lot to be very uncertain about. During these times of high uncertainty, often the most certain thing is how good the odds on offer really are. Being able to understand this and take advantage of these odds are two keys to successfully building wealth over time.
Ross has 19 years of dedicated experience in investment management, having joined Prudential in 2001 as an Equity Analyst, progressing to Portfolio Manager and then Head of Equity in February 2020. He is the joint-Portfolio Manager of several Prudential funds, including the Prudential SA Equity and Dividend Maximiser Funds, with the latter having won several Raging Bull and Morningstar Awards for performance. As Head of Equity, Ross is responsible for overseeing the management of Prudential’s Houseview equity portfolios, as well as a portfolio of specialist Select Equity mandates for institutional clients. He is also the lead Portfolio Manager for our African Equity mandates. Prior to joining Prudential, Ross completed his articles with Andersen in 2000, where he focused on external audit, due diligence and investigative work across a range of sectors, both in South Africa and the USA. Ross holds a BBusSc Degree and is a Chartered Accountant and a CFA charterholder. Prudential Investment Managers ©
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A stock pick can give you a lift. Consistency will give you a legacy.
THE PRUDENTIAL EQUITY FUND: Top quartile performance over all annual periods over the last 10 years.*
Speak to your Prudential representative for more information or visit prudential.co.za
Consistency is the only currency that matters.TM
Prudential Investment Managers (SA) (Pty) Ltd is a licensed financial services provider. *The performance of the Prudential Equity Fund ranked in the top quartile of its ASISA category over all annualised periods, from 28 February 2011 to 31 March 2021, according to Morningstar data, as at 31 March.
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South African bonds:
iStock-482832746 Complex dynamics but still attractive
Gareth Bern HEAD OF FIXED INCOME
i KEY TAKE-AWAYS
Although February’s National Budget don’t really know and we can’t expect presented an improving, and better- to have a 100% true “story” for market than-expected, outlook for government moves. borrowing, South African bonds still At Prudential we don’t trade on forecasts lost ground in Q1 when one could have or expected market moves or “stories”, imagined that they would strengthen. we rely on asset valuations to drive However, financial markets don’t trade our investment decisions. Currently in a local environment only, they could SA nominal bonds are still attractive, have also been influenced by the sell-off and even cheaper than they were in in US Treasuries in Q1, by global and local the previous quarter, which is why we inflation concerns, or by contagion from remain overweight in these assets and
Prudential Investment Managers © the Brazilian and Turkish markets. We even added more in certain portfolios.
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hen South African Finance improved outlook. Higher-than- WMinister Tito Mboweni unveiled forecast revenues, buoyed by increased the government’s 2021 Budget on VAT, customs duties and corporate 24 February this year, it is fair to say taxes (particularly from the mining that the commentary following it was sector which has benefitted from far more upbeat than has become elevated commodity prices), together customary over the last number of with better-than-expected collections years. There were good reasons for this across a range of other sectors, helped – compared to the dire expectations reduce the projected budget deficit in presented in the Medium-Term Budget 2020/21, as well as in the medium term. Policy Statement (MTBPS) in October This in turn reduced the government’s 2020 (a mere four months prior), borrowing requirement over the the Budget presented a materially coming three years and lowered the
Graph 1: South Africa gross Debt-to-GDP outlook Graph 1: South2021 Africa Budget gross vs 2020Debt-to-GDP MTBPS outlook 2021 Budget vs 2020 MTBPS 100 94,6 95,3 95,1 94,5 95 92,9 93,3 90,1 90 85,6 85 88,5 88,9 81,8 87,3 88,3 87,4 85,1 86,0 80 81,9 80,3 75
70
Percent of GDP Percent 65 63,3 60 56,6 53,0 55
50 2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24 2024/25 2025/26 2026/27 2027/28 2028/29
Revised 2020 MTBPS
Source: National Treasury SOURCE: National Treasury Prudential Investment Managers ©
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ANALYSIS TWO KEYS TO ACCUMULATING WEALTH
country’s projected peak Debt/GDP explanations are more akin to educated ratio from around 95% to 89% in guesses – no one can credibly claim 2025/26. to know the real answer.
A contrarian move in Q1 2021 One explanation could be to focus What were the immediate implications on the global dynamics which have for the SA bond market? Taken in come to dominate headlines since the isolation one might have thought the budget announcement – the spectre February Budget would have been of higher inflation in the US has now positive for bond yields given the become the focus of the day. This improved fiscal position and reduced involves the notion that accelerating supply versus what had been projected growth will be accompanied by in October. Combined with National significantly higher inflation given Treasury having already pre-funded a the massive fiscal stimulus provided fair amount of its needs, the market by governments (such as the US’s most saw reductions in the supply of nominal recently proposed US$2.25 trillion and inflation linked bonds (ILBs) on infrastructure spending programme) auction at Treasury’s weekly auctions. and concerns as to possible monetary Instead, the SA bond market has policy tightening or even the potential experienced a material sell-off in yields lack thereof. This concern, in turn, since the February budget! Yields has manifested in a significant sell- have moved higher, with the FTSE/ off in US Treasury yields which has JSE All Bond Index (ALBI) returning rippled across global bond markets -1.7% over the first quarter of 2021. and pushed emerging market (EM) What could be the explanation for yields higher. The South African bond this seemingly contrarian behaviour? market sell-off in this narrative is all about the global dynamics. The reality is that markets do not operate in a vacuum: simple “if this, Another explanation could be the then that” explanations are doomed to weakness in bond yields in Brazil and result in failure. While it is appealing Turkey in recent months reverberating to be able to “explain” movements across all emerging markets and in markets, the reality is that the causing EM bond markets to sell- Prudential Investment Managers ©
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ANALYSIS TWO KEYS TO ACCUMULATING WEALTH
off, re-pricing the entire sector wider. simply has to look at the size and Brazil’s economy has been hit by the growth of South Africa’s interest bill uncontrolled spread of the Coronavirus, to get a sense of the challenge. With and the Turkish President has brought a large part of National Treasury’s on a crisis in investor confidence by budget projections being reliant on firing his latest central bank governor successfully negotiating a public sector and top Cabinet members. wage bill that will shrink in real terms, investors and South Africans should Or perhaps the explanation is something be under no illusions as to the fiscal else entirely. challenge.
Compelling returns on offer As our clients will know, we focus on So where does this leave the outlook asset valuations and not forecasts (or for local government bonds? “stories”) when making our investment Notwithstanding the significant and decisions. In this regard, we remain much-improved outlook in the February constructive on SA government bonds. Budget, it is worth reflecting on the The past quarter’s weakness has made fact that South Africa still finds itself in valuations even more attractive. We a precarious financial position. Against believe they currently offer investors a developed country backdrop, a Debt/ a compelling prospective real return. GDP ratio of around 90% would not With 10-year bonds yields around appear problematic (at least not at 9.5% and with a long-term inflation the moment), since the US and many assumption of around 5%, investors other countries have higher metrics. are being offered a very attractive real The key difference is the high cost of return of around 4.5% (and more for interest South Africa has to pay on longer-dated bonds). This compares the debt it raises versus the near-zero very favorably with our internal long- rates at which developed countries term equilibrium real return estimate can borrow. The real cost of debt (the of around 2.5% – making bonds a nominal interest cost less inflation) in compelling investment prospect. This South Africa is significantly above its view is reflected in our overweight real growth rate – something that is bond positioning across our multi- unsustainable in the long term. One asset funds. In fact, during the recent Prudential Investment Managers ©
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ANALYSIS TWO KEYS TO ACCUMULATING WEALTH
market weakness we added to our overweight bond positions in the Prudential Balanced and Inflation Plus Funds, among other multi-asset portfolios.
As with all investments, this return does not come without risk. We have highlighted some of the risks above – the country’s fiscal trajectory, global dynamics and inflation to name but a few. Additionally, investors should not expect these prospective returns to be delivered in a straight line – bond returns, as we have seen over the last year, can be extremely volatile! But for those investors prepared to look through the short-term noise and volatility, we do think there are compelling returns to be made.
Gareth joined Prudential in 2004 as a Credit Analyst and was appointed as Head of Fixed Interest in April 2018. In addition to overseeing Prudential’s Fixed Income team, Gareth is also responsible for jointly managing the Prudential High Yield Bond Fund and overseeing Prudential’s fixed-income institutional mandates. Prior to joining Prudential, Gareth completed articles at Ernst & Young and qualified as a CA (SA) in 2003. After spending part of 2004 working in the asset management division of Ernst & Young’s New York office, he returned to South Africa and joined Prudential. He currently has 15 years’ industry experience. Gareth’s qualifications include: BBus Sc (Finance), UCT; BComm (Hons) Accounting, UCT; CA (SA); CFA. Prudential Investment Managers ©
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iStock-936418814 Certainly possible
Aadil Omar PORTFOLIO MANAGER AND HEAD OF EQUITY RESEARCH
i KEY TAKE-AWAYS
In an uncertain world, there exists the Gauging how predictable some outcome struggle of possibility against certainty. might be, and determining that outcome, Human beings want both, but during depends on the amount of information times of stress we crave certainty above available about it and understanding all else. This desire is hard-wired and the rules of the domain. There are very causes us to reduce the world to over- few areas or domains where we have simplified frameworks within which 100% of the information and a clear understanding of the rules, and many to make decisions. Recognising this where we have little of either. shortcoming gives us the possibility to act with better understanding. We can work to gather information and Prudential Investment Managers ©
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ANALYSIS CERTAINLY POSSIBLE
improve our understanding to help “Anything is possible when you are improve our outcomes. However, we young. Then you get older and the experience diminishing returns to our thing about getting older is that you efforts. Investment managers spend don’t need everything to be possible much time gathering information to anymore, you just need some things improve their investment outcomes, to be certain.” working between the continuum of certainty versus possibility. So what might be the parallels between a story about an immigrant woman in the East London borough of Shoreditch he novel Brick Lane by Monica and matters of investing? It is the Ali (adapted for the big screen T simple observation that from the in 2007) is both an enlightening and most trivial domestic squabbles to controversial fictional story about the prognosis of a pandemic disease, the trials, struggles and realisations there exists the struggle of possibility of a woman mired in the vice grip of against certainty. Human beings crave circumstance. The tale has many lessons both, but during times of stress, we to ponder, and for readers intrigued crave certainty above all else. While by a circumstantial life story wrapped this desire is hard-wired and has in a love story, it’s well worth reading obviously served us well as a species, (or watching). it is liability laden and coerces us into reducing the world to over-simplified Although it now sits in the cobwebs of frameworks. Therein lies the possibility my memory, there was one theme that to act with better understanding. etched a more permanent impression in my mind; that is the dichotomy Determinism often sounds between possibility and certainty. appealing I remember how well the concept “An intellect which at a certain moment was described by Chanu (husband would know all forces that set nature of the protagonist) as he related the in motion, and all positions of all concept to his wife Nazneen during items of which nature is composed, a somewhat heated exchange: if this intellect were also vast enough Prudential Investment Managers ©
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ANALYSIS CERTAINLY POSSIBLE
to submit these data to analysis, it to morality, social justice and the would embrace in a single formula the scientific possibility of determinism1, movements of the greatest bodies of very few domains of human existence the universe and those of the tiniest satisfy the criteria of being perfectly atom; for such an intellect nothing predictable. And the few that do would be uncertain and the future require significant computational just like the past would be present resources to be deterministic. before its eyes.” — Pierre Simon Laplace, A Philosophical Since prediction is fundamentally a Essay on Probabilities type of information-processing activity, we can estimate how predictable “Une intelligence” was what Pierre something might be based on the Laplace called the analytical tool completeness of the information set capable of knowing the future as and how effectively the information well as we know the past. It is also can be processed. More formally, a often referred to as Laplace’s demon, domain could be defined across two which was and still is a noteworthy axes: articulation of (causal) determinism. 1. Knowledge of the rules governing Determinism as a theory postulates that the domain; all events are completely determined 2. Completeness of information by current or previously existing available for processing. causes, i.e. for known inputs, there are known outputs. At first blush it is Diagram 1 depicts the range of an alluring world view: phenomena combinations of these two variables. have a known cause and are thus predictable. Besides having deeper The reader would have noticed that implications for matters relating this intersection of two variables does
1There has recently been proposed a limit on the computational power of the universe, i.e. the ability of Laplace’s demon to process an infinite amount of information. The limit is based on the maximum entropy of the universe, the speed of light, and the minimum amount of time taken to move information across the Planck length, and the figure was shown to be about 10120 bits.[13] Accordingly, anything that requires more than this amount of data cannot be computed in the amount of time that has elapsed so far in the universe. Wikipedia Prudential Investment Managers ©
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ANALYSIS CERTAINLY POSSIBLE
DiagramDiagram 1: Set 1: of Set outcomes of outcomes basedbased on on knowledge knowledge of rulesof rules and and information information availabilityavailability Knowledge of governing rules Complete Incomplete io n S1 Perfect informat f S3 ili ty o S2 pe rfect Im il ab Ava
SOURCE: PrudentialSource: Prudential Investment Investment ManagersManagers
not yield a quadratic workspace as When stop signs are unambiguous would normally be the case for a 2x2 When the rules governing a domain matrix. Rather, the setup follows a are clear, it is likely we’re in a closed system with limited opportunity for hierarchical construct on the logic that, ambiguity – stop signs always mean if the rules governing a domain are stop. Albeit computationally taxing, not known, the completeness of an a good example of a problem that information set cannot be definitively finds itself in a closed environment is ascertained (more on these open- chess. Chess falls into Segment 1 of ended domains later). the matrix (S1) since we have both Prudential Investment Managers ©
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ANALYSIS CERTAINLY POSSIBLE
complete knowledge of the rules – more information is revealed about governing the game and we have the potential hand, allowing players perfect information – there are a finite to better hone their predictions. Good number of chess pieces on a clearly poker players are not distinguished laid out board and they’re in plain by their ability to predict which cards sight. Although the game remains will come next – such superstition is challenging for human beings (owing reserved for economic forecasters. to our limited information-processing Neither is a grasp of the base odds a capabilities), with enough processing reliable skill; even an amateur player power outcomes are predictable. would have familiarised himself with Winning at chess, and other domains the basic probability of each hand. The that embed both perfect information core skill among good poker players and complete knowledge of the is ‘hand reading’: figuring out which governing rules, becomes a matter of cards your opponents might hold out-processing your opponent. These and how it might affect decisions endeavours are almost exclusively throughout the hand. This makes skill based. poker a purely probabilistic endeavour. As more cards are revealed over the The second segment (S2) considers course of play, forecasts of which hand domains wherein we have complete is playing out should become more knowledge of the rules governing precise. Nevertheless, it is generally the activity, but the information not possible to predict exactly which available for processing is incomplete hands your opponents hold until the or imperfect. Poker would be an cards are revealed. example. While the rules are universally known to all players in a poker game, To recap: each individual player has a limited • We can evaluate problems based amount of information (some shared on how well we understand the and some proprietary) with which rules governing a problem and the to make predications. As the game information with which to make unfolds – for example in a round of assessments. Texas Hold’em from the pocket cards to • When the rules are well known the flop, the turn and finally the river (we understand precisely how Prudential Investment Managers ©
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ANALYSIS CERTAINLY POSSIBLE
something works) and we have To have 100% of the answer, you perfect information, problems can need 100% of the information be solved precisely (given sufficient Activities that involve some type of processing power). prediction generally embed a learning curve. It stands to reason that the • In domains where the rules are well greater the effort exerted on the task, known but we have incomplete or the more accurate the predictions. imperfect information, predictions But this relationship is not linear. As should be made probabilistically. Nate Silver details in his book The • In these probabilistic domains, Signal and the Noise, learning curves we cannot predict outcomes with are more likely to follow the Pareto certainty. principle or 80-20 rule, where progress
Diagram 2: Diminishing returns to results as the effort increases Diagram 2: Diminishing returns to results as the effort increases
100%
80%
60% Accurracy 40%
20%
20% 40% 60% 80% 100% Experience
Source: Prudential Investment Managers (inspired by the work of Nate Silver and Richard Koch) SOURCE: Prudential Investment Managers (inspired by the work of Nate Silver and Richard Koch) Prudential Investment Managers ©
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ANALYSIS CERTAINLY POSSIBLE
is very encouraging as you begin, Afterthought: Stop signs are rare but rapidly tails off as efforts (or in the real world experience) increase. They demonstrate Alas, much of the world we experience diminishing returns to effort. is not as clearly bounded or instructive as the stop sign you encounter when This concave relationship between driving to your local grocery store. We effort and accuracy, as depicted in do not live in the deterministic realm Diagram 2, holds in many competitive of chess, nor in a perfectly probabilistic endeavours where prediction is one like that of a midnight poker den. vital, including decisions related to The rules governing the functioning investing. However, the vital point is of the real world are less concrete not the absolute degree of accuracy and are subject to change, often one is able to muster, but the excess without warning. This is squarely accuracy above the level set by the where investment decision-making competition, that will determine a lives. win from a loss. In a game of high stakes poker, all players arrive with a The distinction between dynamic near-perfect knowledge of each hand environments where the rules are and associated probability of victory, subject to change (S3) and stable but winning the game requires much environments with imperfect more nuance than simple knowledge information (S2) might appear to be of pot odds. It requires a reading of an academic one. Granted, in practice the unseen hand of the other players the only concrete tools available – information that is imperfect at to us are those used to confront best. Similarly, successfully beating matters where we have imperfect the level set by the market requires information in a stable environment, outplaying other teams of motivated namely a probabilistic approach (we professionals trying to do the very need to approach S3 environments same thing. Nuance, perspective and as though they are S2 environments). learning when to use exceptions are But in the real world of dynamic essential. randomness where decisions are made Prudential Investment Managers ©
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ANALYSIS CERTAINLY POSSIBLE
with incomplete information and the rules governing outcomes are themselves incomplete, we should incorporate the possibility that things could change in ways we are not familiar with. Failing to do so means we can approach with all the diligence of a World Series of Poker champion, but we may still get tripped up by a lack of imagination when the world changes. Alas, a panacea for alleviating a lack of imagination remains desperately absent.
Confronting uncertainty remains an impossibly challenging task, and despite Chanu’s cries to Nazneen for an enclave of certainty, we must contend more often with the uncertainty that accompanies possibility.
With 14 years’ investment experience, Aadil joined Prudential in July 2013 as an Equity Analyst. In August 2018 he joined a global equity hedge fund in London, before returning to Prudential in January 2020 as Head of Equity Research and joint-Portfolio Manager of the Prudential SA Equity Fund. He holds a BCom degree (Hons, cum laude) from the University of Pretoria and a Masters in Finance degree from INSEAD. He is also a CFA charterholder. Prudential Investment Managers ©
Consider this QUARTER 02 2021 PagePage 47 8 Back to contents page BOOK REVIEW Curiosity: For success, satisfaction and human progress
Clare Lindeque Head of Quantitative Analysis
One of the privileges of my job is to interact with colleagues whose roles bring them into contact with people, industries and entities whose remit is far broader than that of an asset management firm. As a result, these colleagues help me broaden my own horizons. They are our equity and credit analysts, who spend their days delving deeply In Curious: The Desire to Know and into chicken farming in KwaZulu Why Your Future Depends On It, Natal, the dynamics of nickel and Ian Leslie takes a deep dive into a palladium mining in Russia, or the subject that we don’t think about risks and opportunities presented much. He contends that a curious to investors by a struggling state- mindset is essential, for both success owned enterprise. A unifying and satisfaction in life. characteristic of all these colleagues Leslie emphasises the difference is their curiosity, motivating them between what he calls diversive to seek deep understanding of the curiosity – a superficial desire for issues faced by the companies they the next interesting thing – and cover. It also makes them excellent epistemic curiosity, which delves conversation partners. deeper into questions and seeks Prudential Investment Managers ©
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to understand how things work. According to Leslie, a curious mindset This type of curiosity requires active manifests itself in other traits that are cultivation. For someone like me, necessary for a successful life. Focus, who itches until Google delivers endurance, and “grit” – defined by an answer to the questions that psychologist Angela Duckworth as pop into my head, this distinction “passion and perseverance for long- is challenging. Leslie argues that term goals” – will arise naturally epistemic curiosity leads to true in someone who is curious, in the understanding, which requires hard deep epistemic sense. work and the pursuit of insight more Leslie also makes an argument profound than a quick Google search that, to me, sounds surprisingly can throw up. He also contends that, old school. He lays the foundation rather than facilitating our epistemic for his claim by pointing out that curiosity, the ready availability creativity, innovation and invention of facts and information on the do not take place in a vacuum but internet – those quick answers I are rather built on a foundation love so much - actually damage it. of existing knowledge. Great writers are also great readers. A third kind of curiosity, per Leslie, is Beethoven did not compose his empathic curiosity, which manifests symphonies while being entirely itself as an urge to understand the ignorant of music and the work of thoughts and motivations of others other musicians. Nikolai Tesla had – to put ourselves in their shoes. more than a passing knowledge of It is essential for a compassionate electricity, and Louis Pasteur was a life. He does no more than touch working microbiologist. Chess grand on this quality, and it is probably masters have memorised thousands an entire book subject on its own. of sequences of moves. The more It is, however, closely related to the we know about a subject, the more other kinds of curiosity, looking at readily we can identify the gaps other people and asking “why?” where innovation would be possible instead of “what?” and beneficial. As Leslie describes
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innovators, “having mastered the facts supporting any imaginable rules of their domain, they can viewpoint readily found online, concentrate on rewriting them. They I find this line of reasoning hard mix and remix ideas and themes, to counter. Leslie contends that making new analogies and spotting we have romanticised student- unusual patterns, until a creative or curiosity-driven learning, and breakthrough is achieved.” comes down hard in favour of what amounts to a traditional, classical How do we acquire the foundational education. knowledge that powers innovation? Through our own curiosity, certainly, If this brief overview of Leslie’s but not entirely. Particularly for analysis is getting you hot under those at the start of their intellectual the collar, let me recommend that journey – pupils and students – we you read Curious with an open receive this foundation of facts mind! It’s a brief and engagingly under the guidance of parents and written love letter to an enduring teachers, who not only teach us and essential human characteristic how to think and learn, but actually – indeed, one that separates us impart information. This is the part from other animals, and that has of Leslie’s argument that grated made possible all the generations slightly, as I think of my father’s of advancement that have enabled recollections of school in the early me to be communicating with you 1950s, with its intense emphasis on via the words in this book review, memorisation and rote learning. an internet connection, and the But at the same time, in this age screen of your computer, tablet or of Wikipedia and the alternative smartphone.
Clare joined Prudential in 2007 and is the Head of Quantitative Analysis. With 19 years of industry experience, she has worked in a range of roles spanning quantitative analysis, marketing and web development. Clare holds a Master of Science degree in Financial Mathematics from the University of Cape Town, a Financial Risk Manager certification from the Global Association of Risk Professionals and is also a CFA charterholder.
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