While the global economy continues to expand, there are signs that the pace is decelerating in both developed and emerging economies. However, encouraged by positive PMI’s, confidence is growing that the prevailing solid growth trend can be sustained. Certainly, central banks believe this and several have signaled moves toward policy normalisation. The Fed is raising interest rates and moving towards reducing its balance sheet and, in Europe, Draghi has indicated that policy may be tempered.

In South Africa, the foreign investor view remains deeply negative. There has been no net foreign buying of SA equities in any single month since November 2015. This should not be surprising as, apart from the fragile political situation, the performance of local equities has been dismal: the all share index is at the same level it was in July 2014. No growth in three years! The risks of further downgrades by S&P and Moodys have escalated sharply following the economy’s slide into recession in the first quarter. Vulnerabilities for the country and its currency remain elevated.

The Fund
After an excellent year in 2016 value shares have underperformed this year and, although the fund made up some ground in June, it has lagged the market for the year to date. Having said that, we remain very positive that our portfolio of ‘value’ stocks will produce strong returns over time.

One of the ‘value’ stocks which we favour is Quantum Foods, a share we discussed in our January commentary. There has been recent publicity over confirmed outbreaks of Avian Influenza on four farms in South Africa (none belonging to Quantum). This has necessitated the culling of 400,000 affected birds, leading to a reduction of the layer flock which comprises roughly 24m hens. So, at the margin, this has reduced egg supply and been positive for egg prices. At the same time, and more importantly, the maize price has fallen sharply this year. The combination of higher selling prices and lower feed costs is clearly beneficial for SA’s leading egg producer. As a result, we expect Quantum’s egg division to show a substantial profit in the second half of the current financial year, after incurring losses in the first six months. The animal feeds and farming businesses should produce steady results, while the problematic African operations will take longer to turn around.

The net result is that even after a poor first half, Quantum should show improved earnings for the full year. By our estimates this will place the shares on a modest PE of around 6. The company continues to buy back shares which is not only earnings enhancing but also highly NAV accretive too, with the shares trading at a more than 50% discount to NAV.

As required by legislation, we confirm that the fund has adhered to its policy objective and strategy

Early in the month, inflation surprised to the downside (core inflation at 5.2%) lifting hopes that the SARB might even cut rates before year end. The current account deficit narrowed and looked sustainable due to rising exports into the recovering global economy. The rand, accordingly, continued to firm reaching a closing high of R12.42:$1 on 24 March. On the day of the announcement of the cabinet changes, the rand collapsed to R13.42 (-8% from its 24 March level), banking shares fell 7.5% while resources soared 6.8% from their respective monthly highs and lows. All these trends were extended sharply after month end.
Zuma’s dramatic cabinet shuffle removed his main detractors: the Finance ministers (to gain control of the Treasury) and the Energy minister (to accelerate approval of the unaffordable nuclear option). So blatantly self-serving are these changes that it is quite breath-taking in its audacity. Post month-end two major rating agencies downgraded SA. This is the first cost of Zuma’s action: a weaker rand, higher inflation and rising interest rates. But the worst is yet to come - breaching Gordhan’s expenditure ceiling, persisting with nuclear, deviating from Treasury's procurement rules, etc., etc. Unless Zuma is unseated, the inevitable widening of the deficit will exacerbate the impact of our already junk status, giving rise to even further downgrades, heralding the entry of the IMF as the only source of funds to repay our liabilities, with all its extremely stringent conditions. Too dire a consequence to contemplate.
The Fund
The fund’s current profile is premised on two key views:
the Rand remains vulnerable despite the recent sell off

there are a number of undervalued small cap industrial stocks on the JSE

Almost 50% of the fund is invested in companies which will benefit from a weakening Rand:
18% - international equity investments held offshore via asset swap.

17% - companies listed on the JSE with all or virtually all their operations offshore (Reinet, AB Inbev, Capco, Stenprop)

8% - precious metal miners (Anglogold, Impala Platinum)

5% - large cap companies with substantial offshore businesses (Old Mutual and Sasol).

The other half of the fund is predominantly invested in small cap SA industrial companies. By definition, this positioning implies that we have minimal exposure to some large areas of the market (e.g. banks, insurers, diversified SA industrials and retailers). The major companies in these sectors are widely owned by foreigners and are likely to remain vulnerable to offshore selling as well as the worsening economic environment they face as a result of the disturbing political developments that took place in the last week of March and early April.

As required by legislation, we confirm that the fund has adhered to its policy objective and strategy.

Market Commentary
While global markets (+2.3%) closed the month in positive territory there were major divergences in performance - Europe (+6.2%), the UK (+5.8%) and China (-6.4%). The US (+1.8%) essentially consolidated its post-election gains as investors absorbed the positive aspects of Trump’s massive stimulus proposals but tempered this, more recently, with the many related uncertainties. (What will Congress actually approve? Will his anti-globalisation views have serious negative implications for world growth? Will he over promise and under deliver?)

The outlook for 2017 is subject to much uncertainty, particularly regarding potential actions by the Trump administration. The elevated valuation levels do not provide much support in the event of a disappointing outcome. Fortunately the world economy is showing signs of improvement with GDP growth forecast to rise from 3.0% to 3.6% in 2017. Consensus growth in global earnings is remarkably positive, with analysts projecting a surprisingly strong 12%. Although this is likely to prove too optimistic, the actual outcome will certainly exceed the anaemic growth recorded in 2016.

In South Africa, the fact that we avoided the ratings downgrades is clearly a major positive, but we are not yet out of the woods as growth in 2017 will remain subdued (consensus is 1.1%). The rand has recovered far more strongly than we anticipated. Notwithstanding ongoing political upheavals and near-recessionary conditions, it rebounded by over 11% against the dollar this year - despite the dollar itself gaining almost 4% on a trade-weighted basis.

The Fund
The fund’s 30.9% return in 2016 was very gratifying and reflects a decisive shift away from expensive growth stocks and towards ‘value’ stocks during the year. In addition to broadbased strength in value stocks, our stock selection within this category was generally good and further enhanced performance.

During December we bought more Impala Platinum as the shares continued to trade at levels some 40% below their three month highs. This investment decision reflects our view that current platinum and palladium prices are unusually depressed and should increase materially over the next few years. Besides Impala, other buying activity was largely focussed on adding to existing holdings in small cap industrials - an area of the market where we believe that attractive opportunities still exist. Our purchases in this category included Quantum Foods, Hulamin and CIL.

As required by new legislation, we confirm that the fund has adhered to its policy objective and strategy.