2020 Budget Asset Manager Survey

Budget Highlights

The 2020 Budget has come at one of the most difficult fiscal periods of our history, when our country is faced with very low economic growth, systemic risks (including to our vulnerable power generation capability) and debt, which is increasing in an unsustainable manner.

Given the constraints and options available, we think the finance minister’s strategy addressed the issues in a manner which was, to a certain extent, both realistic and pro-growth. Our fundamental trajectory, however, is still negative and will require not only good intention but also excellent execution, to not only halt the negative trend but turn it positive. This kind of structural reform will require confronting some of our more intractable political problems including the public wage bill, at a time when the current administration’s political capital is far from strong. In short, while there is a window for cautious optimism, this window could close rapidly.

One of the most important issues that the government is focusing on is the ever-growing debt figure. The aim is to address the debt problem, not by increasing the burden on tax payers, but instead by cutting R160bn of public wage expenditure in aggregate, which is almost 3% of GDP. This implies average consolidated compensation growth of just 3.5% in nominal terms over the next three years. In turn, the impact of wage restraint is partially offset by additions and reallocations of R111 billion. The latter includes R60 billion for Eskom and South African Airways. Overall, the cuts are deep enough to ensure a decline in non-interest spending in real terms over the next three years.

National Treasury acknowledges the immensity of this task, particularly in the first year as this is still under the 2018 wage settlement, but emphasizes that the longer it takes to start the curtailment, the more costly it will become. National Treasury has proposed wage increases limited to inflation, wage freezes for the high-earners, seemingly limited job cuts, and pending legislation to align excessive SOE pay to government employee compensation. The unions have reacted aggressively and the battle lines have been drawn.

If the proposed wage bill cuts are achieved, they will not only reduce the aggregate level of spending on consumption (payments towards wages are termed consumption), but will also help to shift the composition in spending away from consumption and towards fixed investment, which is important for driving growth over the long term.

We think that the Budget lowers the probability of a rating downgrade by Moody’s in March. The rating agency is likely to be prepared to allow government time to begin executing on its plans. However, like many market participants they will understand that ultimately action needs to follow words, and that time for enactment of the proposed reforms is short.

Asset Manager Budget Survey 2020

A survey was conducted by the Sanlam Investments Manager Research Team in order to gain greater insight into asset manager views with regard to the 2020 Budget and how they were positioning themselves post the Budget speech. We also asked them for their opinions regarding government bond yields, the probability of a Moody’s downgrade and their advice to investors.

Fourteen managers responded, of whom two wished to remain anonymous.

Survey questions

Post the Budget:

1. What do you consider to be a fair yield of the SA sovereign ten-year bond?
2. What area of the bond curve do you consider to be most vulnerable to an increase in yield?
3. Do you think that South Africa will be downgraded to below investment grade by Moody’s before the end of 2020? If so, what do you foresee will be the consequences of the downgrade?
4. Do you intend making changes to your strategy or strategies in terms of asset allocation, yield curve positions or other exposures, such as sectors in the case of equities?
5. What advice or opinions do you have for investors or clients?

Summary of responses

• Most managers were of the opinion that the fair value of the SA sovereign 10-year bond yield was in the 8.6-9.0% range.
• The majority of managers also considered longer-dated bonds (in the 12-year and more range) to be the most vulnerable to an increase in yield.
• Despite the positive aspect of the Budget referred to above, most managers were of the opinion that South Africa’s credit rating will nonetheless be downgraded before the end of 2020.
• Eight out of the 14 managers surveyed did not intend making changes to the positions of their portfolios.

Below is a summary of the views of those managers who did not intend to make changes:

• Allan Gray: The Budget speech delivered on the 26th of February has not changed Allan Gray’s view on asset allocation, yield curve positions or exposures. The manager continues to employ a bottom-up investment approach where they focus on identifying instruments (irrespective of asset class) that are trading at a sufficient discount to their estimate of the intrinsic value.

• Truffle: Truffle’s funds are already defensively positioned. Truffle continues to review the fundamentals of each security in the context of estimates of intrinsic value. If there are any meaningful changes to their assumptions, this would result in sector and security specific changes.

• Sesfikile Property: Sesfikile has already allocated a higher proportion of assets to cash to be positioned to take advantage of any mispricing following a downgrade or WGBI exclusion.

• ABSA Equity: ABSA Equity views its current exposure in terms of asset allocation and individual equities as remaining appropriate based on sector/equity specific factors and valuations as well as their current macroeconomic view.

• Matrix: Matrix remains defensive in its asset allocation mix, preferring bonds over equities domestically as the former stand to benefit from low global yields and the potential for rate cuts. Within the equity exposure mix they are overweight select basic materials and mining counters, as well as global defensives that are low-beta to the global discretionary cycle and have rand-hedge properties. They prefer forex exposure via optionality and favour short-end inflation-linked bonds that will benefit from rand weakness and/or rate cuts. The Budget outcome supports their stance on the attractive valuations in fixed income, which is also reflected in their asset allocation view. In Matrix’s fixed income portfolios, they may consider increasing duration, given the potential for fundamental improvements in fiscal strategy.

• Tantalum: With regard to fixed income, Tantalum was positioned at neutral duration levels going into the Budget, and will be patient in looking for opportunities to lift duration above this level. To be significantly overweight bonds as an asset class, they would require some level of comfort that it would be possible for government to achieve future stabilisation of debt/GDP. From an equity perspective, Tantalum’s investment thesis around SA Inc. stocks is based on balancing the real value on offer with some caution regarding the likelihood of raised currency and bond yield volatility, before and after these sovereign ratings reviews. As a result, the equity allocation is lower than it would usually be to both SA banks and some other interest-rate sensitive stocks like retailers.

• Prudential: The potential rating downgrade has been well telegraphed, bond yields have repriced substantially over the last two years, the currency is cheap and equities are at their cheapest levels in a few years. In summary, SA assets have de-rated and are pricing in significant amounts of bad news already.

• Manager A: Little new information was forthcoming to convince this manager of wholesale changes to the current strategy of its investor portfolios. The portfolios remain defensively positioned with relatively high levels of optionality and liquidity, which allow the manager to take advantage of attractively priced long-term opportunities.

Below is a summary of the views of those managers who intended to make changes post the 2020 Budget speech:

• Sentio: Sentio was slightly underweight duration and the ultra-long end of the yield curve going into the Budget, but has subsequently increased exposures at the ultra-long end with an overall duration neutral stance.

• Steyn: Steyn has progressively been increasing its exposure to high quality, domestically-focused South African equities, given the outstanding value attractions.

• ABSA Property: In light of the weakness seen across the property sector in 2020, they have begun to reduce their cash weighting to take advantage of the attractive relative valuations seen in select names across the property sector.

• Manager B: We are being reactionary. The current investment environment is highly tactical and liquidity is important.

Finally, managers shared their opinions and advice for investors:                              

• Allan Gray: Diversification is paramount. A well-diversified portfolio should include offshore investments and diversification within asset classes is also useful. Allan Gray’s global portfolios are maintaining maximum foreign exposure.

• Truffle: Truffle advises firstly to stick to your long-term financial plan. They advise against jumping between strategies, as this inevitably decreases the probability of meeting your long-term return expectations. They urge investors to remain focused on the fundamentals and ignore the market noise. This will give you opportunities to acquire mispriced securities trading at discounts to their intrinsic value.

• Catalyst: Catalyst believes that a diversified portfolio is critical; this includes having an allocation to offshore assets. Investing is long-term but in the current economic climate being overweight cash is not a bad option. The possible Moody’s downgrade could provide a buying opportunity, especially for property, which is interest rate sensitive.

• Sentio: The Budget has provided tax relief for consumers that will hopefully translate into greater growth and investment. It remains to be seen if this confidence lasts amidst load-shedding, but currently Sentio believes that domestic assets will perform well. They also emphasize, however, that global asset allocation is warranted on the back of fears about the coronavirus.

• Steyn: South African domestically focused equities are trading at a two-decade low valuation, and potentially represent a generationally low buying point. They do foresee some risks, but believe that now is the time to be increasing your allocation to South African equities. They saw the Budget as reflecting the reformist character of the current government, and saw this as possibly providing a catalyst for a re-rating of domestic stocks.

• Tantalum: Current market volatility is certainly unsettling, and the path of domestic asset returns is particularly unclear given the unfolding of SA risks at a time when global risks (driven by Covid-19 fears) have become heightened. Given these circumstances, Tantalum believes that the most prudent way to approach portfolio construction at this time is to focus on the basic fundamentals of fair value analysis and portfolio diversification, with a conscious focus on limiting downside in risk scenarios.

• ABSA Property: They believe that valuations within the listed property sector are now attractive in both absolute and relative terms.

• ABSA Equity: : It is very important to use macro-economic information together with the individual company and sector valuations, which are impacted by various factors, e.g. global macroeconomic shifts, currency movements and management strategy, to name a few. At present, ABSA is also closely monitoring the impact of the coronavirus on stocks, specifically as they are seeing increasing concern by company management and downward adjustments to earnings guidance. Further, rising concern exists around the downside risk related to the negative global trade impact from the coronavirus on the already depressed current forecast of local GDP growth.

• Matrix: Matrix thinks offshore equity markets and particularly the US are expensive relative to late cycle growth and earnings prospects. They prefer assets with a higher degree of certainty associated to achieving an appropriate real return. To this extent, their portfolios reflect overweight allocation to local bonds and inflation-linked bonds. Local property exposure is low but is starting to screen as very attractive, as a domestic recovery play from distressed valuations as well as providing significant real yield prospects. This said, a protracted supply chain disruption associated with the coronavirus will in all likelihood be met with further (and potentially aggressive) global central bank monetary response, which would benefit risk assets at such a point in time. In this event, the SA Reserve Bank would in all likelihood follow suit, resulting in high investment risk of being invested in low duration cash proxies.

• PSG: PSG advises investors to maintain their position in domestic-orientated equities.

• Sesfikile Property: Sesfikile believes that there is some re-basing of property company earnings still to be done, but that the majority has come through over the last two years. Off these levels, we are likely to see a marginal acceleration in earnings (marginal in that the economic climate is still providing a headwind for a more attractive correction). With that said, the property sector is screening value. After the Budget announcement, markets will turn their attention to the Moody’s decision on whether to capitulate and downgrade South Africa’s sovereign rating to ‘sub-investment grade’. 2020 will no doubt be another volatile year, with global tensions, the coronavirus and possible wars, be it trade or other. The global growth outlook is still muted and should see bond yields remain low and supportive of property prices.

• Prudential: Prudential does not place a huge emphasis on short-term noise and instead tries to focus on fundamentals and time horizon. Separately, the current global situation is incredibly fluid with considerable uncertainties in respect of the magnitude and duration of any impairment to global growth. Valuation signals are naturally degraded in this environment and care must be taken to ensure proper risk control processes remain in place. Equally, it is extremely likely that an increase in risk aversion is playing some role in recent market declines and over time this tends to be mean reverting, suggesting that the probabilities are high that risk assets produce higher returns in the medium term, subject to any further changes in the facts of the current crisis from here.

• Manager A: The manager urges investors to take a long-term view and be patient. Investors are advised not to make decisions based on short-term noise and volatility but to stick to a long-term investment strategy, which allows investment managers the ability to allocate capital to asset classes free of any asset class constraints