Allan Gray Stable Fund

Local assets performed strongly following the formation of the new government of national unity (GNU) in June, and this performance continued into the third quarter. Year to date, local shares have returned 15.9% – as measured by the FTSE/JSE Capped SWIX, bonds have returned 16.7% and cash has returned 6.1%. Over this period, the Fund delivered a return of 7.8%, ahead of the benchmark’s 7.2% and August’s year-to-date CPI inflation of 2.9%. The Fund’s local share and bond holdings helped boost year-to-date performance, as both asset classes have outperformed cash.

The Fund aims to generate returns ahead of bank deposits and inflation, while maintaining a high degree of capital stability and minimising the risk of loss over any two-year period. Going into the election, the Fund was carefully positioned to achieve these objectives regardless of the outcome. An even higher allocation to risk assets would, of course, have delivered an even higher return, but this is easy to see in hindsight. While the national elections ultimately resulted in a market-friendly outcome, this was far from certain in the run-up to voting day. Even after the initial election results were declared, there was still much uncertainty about the form the ruling coalition would take.

Given the recent rally in South African assets following the announcement of the GNU, the Fund has taken some profits on both local shares and bonds. Short-term prospects for the South African consumer are looking better than a year ago, with the South African Reserve Bank cutting interest rates by 25 basis points (bps) over the quarter. Lower oil prices, probable further rate cuts and proceeds from the two-pot retirement reform will also put more money into the hands of consumers. Moreover, the reprieve in loadshedding has reduced non-productive expenditure which should improve revenue opportunities for local companies. Beyond these temporary tailwinds, however, we remain concerned about South Africa’s growth prospects. Opposing ideologies between and within the GNU’s coalition partners are likely to cause complications down the road and, in the meantime, South Africa still faces serious structural issues. These include the ongoing challenges at Eskom and Transnet, as well as deteriorating local government infrastructure. It is therefore possible that the recent enthusiasm, which has seen South Africa outperform many of its emerging market peers, has gotten ahead of itself. We carefully weigh up these considerations as we review the investment cases for local assets, and despite the broader structural concerns, we continue to find some compelling opportunities.

At yields of 8-9%, the return on local cash is currently attractive in real terms and, as a result, the Fund’s cash balance has remained substantial over the quarter. In our view, cash is a valuable source of optionality, giving us the flexibility to take advantage of opportunities as they arise. The incremental return that can be earned on longer-dated bonds has narrowed considerably, making bonds a less attractive alternative. The Fund takes little credit risk, and its bond exposure is towards the shorter end of the curve.

The rand has strengthened in the months following the election, causing the Fund’s foreign exposure to be a drag on performance. The same can be said for “rand hedge” shares, such as Anheuser-Busch InBev. The Fund maintains a foreign exposure of 31%, with the ability to increase this up to 45%. Currently, most of the Fund’s offshore allocation is invested in low-risk instruments such as cash or cash-like securities and hedged equities. The foreign component of the Fund remains a useful source of protection against negative developments in South Africa or a pullback in local asset prices.

Over the quarter, we added to our existing positions in inflation-linked bonds and Gold Fields, and trimmed our exposure to British American Tobacco, Glencore and long-dated South African government bonds.

Commentary contributed by Tim Acker