Market overview

Global equities, as measured by the MSCI ACWI IMI, rose 1.5% in rand terms in the second quarter, bringing year-to-date gains to 6.2%. This was the best first half since the bull market began in 2009. The charge was led by emerging markets (EM), which gained almost 12% in rand terms and represents six straight months of outperforming developed markets (DM). This has only happened four times in the past 20 years. The catalyst seems to be the unwinding of the bullish dollar trade post Trump’s victory in the US presidential elections - partly reflecting a lack of detail on tax reforms and a failure to repeal Obamacare. European Union (EU) assets were buoyed by electoral losses of right wing parties in the Netherlands and France. European banks in particular benefited from the renewed confidence, gaining 20%. This saw the Euro Stoxx gain 18%, outperforming the S&P 500, which gained 9% in dollar terms. Commodity performance has been mixed this year with gold gaining 8% and oil falling 14%. Russia lost 8%, while Brazil lost 9%, reflecting the deteriorating outlook for Energy. Brazil was also impacted by political tension surrounding the possibility of President Temer’s impeachment. UK assets were negatively impacted by the surprise loss of Prime Minister May’s parliamentary majority following a snap election.

Portfolio review

The Fund gained 3.0% in rand terms in the second quarter, extending this year’s outperformance relative to the benchmark to 1.8%. Attribution shows the largest driver of returns was the Fund’s overweight to EM. The Capital Group has done well this year, outperforming by 3.2%. Stock selection in North America has been their biggest driver of relative returns. The best performer however, has been Veritas who are about 6% ahead of the benchmark. The laggard this year has been our value-weighted AB passive account, which underperformed by around 1.5%. While it helped to down-weight the holding to almost half of what it was a couple of years ago, the allocation proved a drag on performance as the reflation trade post the US election unwound. Over a one-year period however, the mandate is still more than 3% ahead. Aberdeen’s performance was -middle of the road- within our composite, outperforming 1.2% in the second quarter and double that for the year-to-date. Overweight positions in Hong Kong and solid stock picking in Singapore helped. We are currently assessing their merger with Standard Life - which was approved in June - and will communicate our views upon conclusion of a series of due diligence reviews. Hosking outperformed by a similar margin. Their overweight to Italian banks was the largest contributor to returns. Arrowstreet outperformed a little less than 1% for the quarter and are ahead by 2.5% year-to-date. Their underweight Energy and overweight Korea allocations contributed positively. Conversely security selection detracted. The final highlight of the quarter was the MSCI decision to include Chinese shares in their indices. It is still however, early days and the inclusion will take place in small tranches over a long period of time but it is the change in direction rather than magnitude that counts. We had a small off benchmark
allocation that benefited from this change and we will continue to monitor events. At a total portfolio level, the largest underweight is to Energy, which accounts for 4% of assets. The largest overweight of our active managers is Industrials, with a cluster of airline-related companies with Safran, Airbus, Rolls Royce and Delta among the favourites.

Portfolio positioning and outlook

The rally in global equities has been backed by a run up in reported profits with valuation changes contributing very little. We still believe the current PE of 21 is expensive but acknowledge this is where the multiple of the MSCI traded at the beginning of 2004 - early stages of the last bull market. Despite the high valuation, equities rose a further 70% before peaking in 2007. The obvious question is whether we may see the same again. We are not convinced - profit margins are not as depressed today as they were back then. And sales growth is still in short supply. By comparison, sales growth globally averaged 13% per annum in the last bull market, whereas today, even with the pick-up in commodity prices over the past 12 months, it is only around 4%. Our biggest concern at the start of the year was a rise of protectionism. Fortunately US President Trump has backed off the anti-trade rhetoric.

Political risk has also receded in the EU with electoral setbacks by Eurosceptic parties. In Germany, the CDU emerged stronger from regional elections, thus enhancing prospects that the coalition it leads will hold onto power after federal elections in September. Going forward, the Italian elections will be at the forefront of investor’s minds as will be concern about North Korea’s nuclear program.