The reality of 2022 is in stark contrast to the high expectations for the global economy at the start of the year. The outlook was for a promising recovery in global growth as the world exited pandemic restrictions. Expectations for a more normalised supply chain environment and a recovery in the service sector would help build on the strong post-Covid GDP rebound we saw in 2021. However, these prospects were rapidly reset as we moved into the second quarter of 2022 (Q2-22), driven by a polycrisis marked by the spread of the Omicron variant in China, which triggered lockdowns and disruptions across the country; Russia’s invasion of Ukraine and the ensuing sanctions; the war-induced surge in commodity prices, which impacted inflation expectations; and the resultant faster trajectory for normalising interest rates and policy tightening from central banks.

With the anchor of low, steady interest rates on asset class pricing removed, almost all major asset classes posted substantial losses in Q2- 22. South African (SA) asset classes, although cheap to begin with, fared better than global asset classes, but did not manage to escape the carnage completely. The FTSE/JSE All Share Index delivered -11.7% for the quarter (its worst quarterly return in 20 years) and the All Bond Index delivered -3.7%. These sharp, negative moves in global and domestic asset classes, together with a rising inflation benchmark, has meant that the Fund’s one-year return of -0.3% did not manage to meet its inflation plus 4% target return. However, the Fund has achieved real returns over three, five and 10 years, while it has exceeded target returns over the very long term.

The Fund’s global exposure has been the largest detractor from performance over the year. We have been sitting below the maximum offshore allocation allowed in the portfolio (currently at 27% of Fund) for some time now as we felt that domestic assets were relatively more attractive. Despite this low offshore allocation, the performance of the Coronation Global Opportunities Equity Fund (17% of Fund, delivering -17.7% for the year) and the Coronation Global Emerging Markets Fund (3% of Fund, delivering -35.2% for the year) has contributed negatively to the Fund performance over the last year. This was partly offset by our exposure to the more defensive Coronation Global Capital Plus Fund (4.5% of Fund, delivering +6.7% for the year) and our global equity put protection. With global equity markets now offering better value, we have raised our offshore exposure. We have not tilted too aggressively as we still think SA assets are cheap and offer the highest potential of delivering the targeted inflation plus returns for investors in the Fund.

Domestic assets have contributed positively to the Fund’s performance thanks to good equity and bond selection over the last year. Within SA equity, positive contributions have come from British American Tobacco, Anglo American, FirstRand, RMI and Shoprite. The last three shares in particular highlight the opportunity for quality, domestic businesses to deliver good returns for investors despite a tough domestic macroeconomic outlook. The combination of Naspers and Prosus is the largest equity holding in the Fund and has been the main equity detractor. The de-rating in the underlying investment holdings has been compounded by a widening discount at both the Naspers and Prosus level. Encouragingly, management recently announced an open-ended buyback of Naspers and Prosus shares as they believe that the discount has moved to unacceptable levels. We view this as a positive capital allocation move that will be beneficial for shareholders.

From a fixed income perspective, SA government bonds still trade at historically high yields and are elevated compared to their emerging market counterparts. SA has benefited from a significant terms of trade boost that provides more breathing room for the fiscus. The SARB will be under pressure to normalise rates at a pace similar to that of major global central banks, but the current premium in bond yields remains excessive and yields have a significant risk buffer to absorb higher local inflation and higher US bond yields. Our local bond weighting has remained steady, with our selection providing healthy real yields for the Fund.

The events in the first half of the year have proven that the future is difficult to predict, and we expect that the uncertainty and volatility we have seen so far in 2022 will continue to be a feature for the rest of the year. The vicious de-rating of global equities and bonds are providing us with additional choice and opportunities to diversify at much more attractive valuations than we had a year ago. At the same time, we continue to see good value local investment prospects that can deliver the inflation plus returns the Fund is mandated to provide. With the recent changes in the Regulation 28 rules, the Fund will have the ability to make significantly higher offshore allocations than before (45% vs 35%). These regulatory changes will not be the primary driver of the Fund’s asset allocation decisions. As always, we will have a considered mix of domestic and offshore exposure with the suitable selection of income and growth assets to deliver the Fund’s return objectives at the appropriate level of risk. Based on our return expectations for the various asset classes at our disposal, we continue to believe that the Fund remains well positioned to deliver on the CPI + 4% mandate in the medium term.

The war in Ukraine dominated world events during the first quarter of 2022 (Q1-22). This is first and foremost a human tragedy, and Russia’s actions should be condemned in the strongest possible terms. The invasion was not broadly anticipated by market participants, and its effects have been most evident in increases in commodity prices - particularly energy-related and agricultural commodities given the region’s importance in the supply of these products - as well as a general increase in risk aversion. This comes after a lengthy period of market gains, at a time when developed market equity valuations are elevated and central banks around the world are starting to raise policy rates. It is therefore maybe surprising that global markets declined by only 5.4% in Q1-22 (as measured by the MSCI All Country World Index).

Events in China also played an important role in markets during Q1-22. Regulatory uncertainty, particularly around the technology sector, continues to weigh on sentiment, despite recent attempts to reassure investors. In addition, their government’s determination to enforce a zero-Covid policy has resulted in mass lockdowns in major cities and manufacturing hubs. This, along with tight labour markets in developed economies and supply disruptions resulting from the conflict in Ukraine discussed above, is evident in significant increases in developed market inflation rates. Increasingly, there are concerns that higher levels of inflation will persist for longer and that central banks will tighten more aggressively as a result.

Amidst the global turmoil, South Africa has emerged as something of an emerging market safe haven. The domestic equity market returned 6.7% for the quarter (Capped SWIX) and the bond market 1.9% (ALBI). When one considers that the rand has appreciated by 9.2% over the same period, translating these returns into dollars places SA as one of the best performing markets globally year to date.

While it would be a stretch to say this improved sentiment is a result of any significant action on our part, there have been some encouraging developments. Higher commodity prices continue to benefit our current account and are likely to support improved revenue collection for as long as they persist at these elevated levels. On the face of it, fiscal discipline is sound - pronouncements in the Budget recognise that medium-term expenditure commitments cannot be based on such windfalls that are cyclical in nature and the Constitutional Court has upheld the government’s decision not to pay an unaffordable increase in the public sector wage bill. Inflation looks relatively well controlled and is currently lower than in many developed markets (although the impact of higher fuel and food prices is yet to be properly felt). The spectrum auction process has finally been completed raising R15bn for the fiscus in the process. And the state of disaster has been lifted along with Covid-19 testing requirements for international travelers, which should provide a much-needed boost to the tourism sector. Progress has been recognised by ratings agencies with Moody’s upgrading its outlook from negative to stable, although we remain some way from investment grade status.

In the context of a very uncertain global environment, the Fund delivered a return of -1.3% for Q1-22, dragging the 12-month return down to 8.0%. Over longer time periods (five years and longer), the Fund remains comfortably ahead of inflation, although generally slightly behind the target of CPI+4%. Since inception, the Fund has delivered an annual return of 11.3%, 5.6% above inflation. The biggest contributor to Fund returns over the past 12 months has been the allocation to SA equity, followed by domestic bonds. Foreign assets (predominantly equities) detracted. Within domestic equities, Anglo American, FirstRand, MTN, Nedbank and Shoprite were the biggest contributors to returns, while the fund’s holding in Naspers/Prosus was a significant detractor.

The banks sector has been one of the strongest performing over the past year. In March four of the five domestic banks reported results that exceeded market expectations and highlighted their resilience over the Covid-19 period, with 2021 pre-provision operating profits (a more meaningful metric than headline earnings, which can be somewhat distorted by the extent to which impairment provisions were raised and subsequently released) matching or exceeding 2019 levels. Despite sluggish advances growth given fortunes that are largely tied to a low growth SA economy, these businesses are beneficiaries of (moderately) rising interest rates, have well provided lending books, continue to demonstrate good cost control, and are well (if not over-) capitalised. They continue to trade on relatively inexpensive valuation multiples. If asset growth doesn’t accelerate, excess capital is likely to be returned to shareholders in order to improve returns, underpinning attractive dividend yields. SA banks currently make up 6.3% of fund assets.

During the quarter we were net sellers of domestic equities, in particular resource companies that continued to benefit from increases in commodity prices. Despite this, given the relative strength of our market, allocation to SA equities has increased slightly to 42%. We continue to believe that the domestic equity market offers attractive returns, including global businesses that are listed in SA. We increased exposure to global equities following the sell-off in these markets. While in aggregate developed markets continue to look expensive, we believe the managers underlying the global funds are well positioned to identify attractive return opportunities in a time of increased market volatility. Mindful of the need to protect capital, we retain put protection against a portion of both global and domestic equity exposure.

The upheaval of the past quarter has impacted negatively on the one-year performance of the Fund, but it continues to deliver returns ahead of inflation. As always, this has been achieved through a considered mix of income and growth assets as well as our careful approach to instrument selection. Based on our return expectations for the various asset classes at our disposal, we continue to believe that the Fund remains capable of delivering on the CPI+4% mandate in the medium term.