The Flagship IP Flexible Value Fund aims to outperform both the JSE All Share Index and competing funds over the medium to long term.

International
September ’19 brought further excitement (plus an element of apprehension) to an already event-laden 2019. Political tensions continue to dominate the global narrative, reflected in the on-again off-again trade war between China and the US; the increase in the likelihood of a no-deal Brexit; and the continued political protests in Hong Kong, entering their seventh month, which are taking their toll on the city’s economy, with August retail sales registering a -23% fall – the steepest decline on record. As if all of this wasn’t enough, a Democrat-led process to impeach the US president was initiated on September 24.

During the month the Fed further eased already accommodative monetary policy and, at Flagship, we continue to scratch our heads at the end-game to miniscule interest rates (discussed previously in our Q2 Quarterly Telescope). In Europe, Mario Draghi, the erstwhile president of the European Central Bank (ECB), reintroduced QE as his swan song before being replaced as ECB head by Christine Lagarde who, thus far, has publicly supported the current dovish stance. However, the resignation at month-end of ECB hawk Sabine Lautenschlaeger (from the 6 member ECB Board) tells us that continued loose monetary policy is facing internal opposition.

South Africa
In South Africa, relative underperformance of South African assets, when compared to global assets, continued, with the JSE gaining 7% YTD versus 17% for the MSCI ACWI. A deteriorating economic and fiscal situation - accompanied by continued government inaction - were largely to blame. A government white paper on ending private healthcare, as well as rising support for the reintroduction of prescribed assets, has raised already high levels of investor concern. Should asset prescription become policy, local pension funds will be forced to buy certain types of assets (mostly government and SOE bonds) regardless of their investment merit, allowing government to borrow money at meaningfully lower rates.

It is a commonly held view that reintroducing prescribed assets, last seen under the apartheid government in the 1980s, would do great damage to progress that has been made since 1994 in opening up South Africa’s economy. Should the reality of prescription appear on our horizon, you can be certain Flagship’s asset allocation to the South African economy will be tailored accordingly.

While uncertainty around a trade war has been at its most acute, markets continue to test new highs. US markets continue to outperform the markets of most other developed countries, and MSCI world continues to outperform MSCI emerging markets.

In South Africa, the bad news continues to pile-up and the economy remains stuck in its longest downward cycle since 1945. In the face of numerous crises, the SA government’s responses have been hopelessly inadequate, where it seems either incapable or unwilling to take the strong stand that it promised voters it would - a mere month ago.

The Fund

After a positive three years ending December 2018, the first half of 2019 has been extremely disappointing by any standards. The fund has materially underperformed its benchmark as reflected in the chart below.

As the name indicates, this is a ‘value’ fund and the underperformance of ‘value’ vs ‘growth’ in recent years has been widely reported and analysed. Investors have been, and still are, prepared to pay a significant premium for companies with predictable growth. On the other hand we focus on businesses trading at substantial discounts to intrinsic value, and in which we have confidence that the discount will be unlocked over time, thereby allowing for substantial capital growth.

In keeping with the fund’s value mandate, the international equity exposure is largely held via Contrarius Global Equity Fund, a fund with a contrarian style and a superior long term track record, but which has regrettably lagged the MSCI World Index by 33% over the last twelve months. This, coupled with SA investors lack of interest in small cap domestic stocks, has of course had a significant adverse impact on your fund’s performance. In addition, there have unfortunately been a few decisions which we must categorise as ‘own goals’, rather than just ‘being early’, and subsequently watching the shares drift lower for no good fundamental reason.

In the long run, undervalued investments will revert to their fair values, but this process can be agonisingly slow as the cycle of fear and greed and market sentiment plays out. Brait, for example, peaked at over R170 per share in 2016 (a perfect example of greed and overexuberance) - having watched the shares fall by 85% we invested modestly some months ago at R25 and the price is now even lower at R18.50. We have avoided most of the high profile disasters subsequent to the Steinhoff debacle, for example: Tongaat, Omnia, EOH and Intu. Even Aspen and Mediclinic, both former blue chips in the supposedly defensive healthcare sector, have fallen over 70% from their five year highs. Nonetheless, as alluded to earlier, certain mistakes in less high profile names such as Hulamin have hurt.

We thank you for your patience and support and assure you that we are determined to recover the value that has eroded in the first half of 2019.

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