CONSIDER THIS SA BANKS: NO CRISIS IN SIGHT - pages 16 and 46 - Prudential Investment Managers
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QUARTER 01 2021
Consistency is the only currency that matters.
CONSIDER THIS
SA BANKS:
NO CRISIS
IN SIGHT pages 16 and 46
RISK TOOLS TO THE FORE
pg 38
A BOUNCE BACK FOR
CORPORATE CREDIT pg 46
PUTTING CONSCIOUS
CONSUMERISM TO USE pg 56
Contents Consider this Q1 2021
10 46
TABLE TALK: A unique set of SA’s corporate credit market
investor opportunities in multi- bounces back
asset funds The local credit market has staged
Portfolio Manager Sandile Malinga a better-than-expected revival after
discusses the recent rebound in returns grinding to a halt and suffering
from multi-asset funds and why further credit downgrades earlier
we’re excited about their prospective in 2020, explains Duncan Schwulst,
returns. Credit Analyst.
16 56
BOOK REVIEW: Conscious
Covid-19 and SA Banks: Recovering
consumerism: Driving business
from the lows
change for the better
South Africa’s commercial banks
Miranda Van Rensburg reviews
have near-record provisions but are
Elevated Economics, which describes
still being priced for a crisis, explains
how consumers are effecting change
Equity Analyst Stefan Swanepoel.
among businesses and their leaders
by increasingly using “purpose” as a
25 criterion in their purchases.
2020: The year the world remained
complex
Have global equity markets acted
irrationally in shrugging off the impact
of the Coronavirus? asks Aadil Omar,
Portfolio Manager and Head of Equity
Research.
31
The Active Return Journey
38
Continues
As a follow-up to his earlier article,
Valdon Theron, Head of Institutional
Business, demonstrates how, using
the most appropriate measures,
Prudential’s equity performance has
remained consistent through the cycle,
despite recent disappointments
Letter from the CEO
Bernard Fick provides a 38
04 perspective on markets
and fund returns and
what we could expect
The Risk Manager’s Toolkit
In this time of heightened risk, Clare
going forward. Lindeque, Head of Quantitative
Analysis, explores some of the ways
risk managers keep investment teams 16
on the straight and narrow.
Consistency is the only currency that matters.
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Consistency
works even
harder when
it’s tax-free.
Our extensive range of tax-free funds gives you
access to a variety of asset classes and sectors,
across both local and offshore markets.
Invest online in under 10 minutes by visiting
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Consistency is the only currency that matters. TM
Prudential Portfolio Managers Unit Trusts Ltd (Registration number: 1999/0524/06) is an approved CISCA management company (#29). The Tax -free savings product are approved in terms of section 12T
(8) of the Income Tax Act, 1962 and is only open to natural persons that are South African residents For further details around the tax free products please visit https://www.prudential.co.za/personal-
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LETTER FROM THE CEO
iStock-1251345765
Letter from the CEO
Benard Fick
CHIEF EXECUTIVE
Dear Prudential client, conditions on the ground was
largely ignored as investors began
In the last quarter of 2020 we to look ahead to better growth
saw that, even as a second wave prospects in 2021 and beyond.
of Covid-19 infections spread
alarmingly, causing tighter At Prudential we did not ignore
lockdowns and many more the real-world impact of the
deaths, global financial markets pandemic, instead urging our
celebrated the rollout of vaccines staff and their families to take
in many of the larger economies by even more precautions and avoid
Prudential Investment Managers ©
broadly pushing equity markets to becoming complacent, especially
record highs -- a stark dichotomy during the holidays. We hope this
of sentiment. The worsening was the case for our clients as
of health and socio-economic well, and that you all managed to
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LETTER FROM THE CEO
enjoy a safe, healthy and happy both the local bourse and SA
year end. bonds to deliver positive returns
for the year, and at levels that
Investment returns surprisingly would not have been expected as
positive for 2020 recently as October. The FTSE/JSE
It proved to be a surprisingly All Share Index (ALSI) managed
good year for many investors to record a 7.0% total return in
based solely on the total returns rand terms over the 12 months,
recorded by many different asset
and the All Bond Index (ALBI)
classes around the world. This
produced 8.7%.
was due largely to November’s
vaccine-related developments, as The rand also staged a reasonable
well as the election of Democrat recovery in the latter months
Joe Biden as US President. Other of 2020 from oversold levels,
factors contributing to the but still ended the year weaker,
strong risk-on sentiment were
losing 4.6% against the US dollar,
the US Congress’ agreement of
9.0% versus the pound sterling
a fourth large stimulus package
and 14.4% against the euro. As
in December, and the UK and
such, local investors would have
EU’s last-minute conclusion of a
Brexit deal. benefitted from their offshore
returns being boosted by rand
We also saw some early evidence depreciation.
of investors beginning to realise
the extraordinary value on offer The table below shows the
in certain sectors of the South decent gains in 2020 across major
African equity market that were asset classes, with the notable
particularly beaten down in the exceptions being global and local
March 2020 market correction. We listed property stocks. Even global
experienced a strong rebound in bonds delivered an unexpectedly
the financial sector, and SA banks robust 9.2% total return in US
in particular, where our client dollars, considering the high prices
portfolios held fairly significant at which they started the year,
positions. More broadly, the as central banks and investors
Prudential Investment Managers ©
improved global sentiment helped continued to buy up supply.
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LETTER FROM THE CEO
TOTAL RETURN TOTAL RETURN
ASSET CLASS
Q4 2020 2020
SA equity – FTSE/JSE All Share Index (in rand) 9.8% 7.0%
SA equity – FTSE/JSE Capped SWIX All Share (in rand) 11.5% 0.6%
SA listed property – FTSE/JSE SAPY (in rand) 23.6% -37.5%
SA bonds – BEASSA All Bond Index (in rand) 6.7% 8.7%
SA inflation-linked bonds – JSE CILI Index (in rand) 5.4% 4.2%
SA cash - STeFI Composite Index (in rand) 11.0% 5.4%
Global equity – MSCI All Country World (Total) (in US$ net) 14.7% 16.3%
Global equity – MSCI World (Developed) (in US$ net) 14.0% 15.9%
Global equity – MSCI Emerging Markets (in US$ net) 19.7% 18.3%
Global bonds – Bloomberg Barclays Global 3.3% 9.2%
Aggregate Bond Index (in US$)
Global property – FTSE EPRA/NAREIT Global Property REIT 13.6% -11.4%
Index (in US$ net)
Prudential fund performance positions and the investment case
The past 18-month period was for each, in significant detail. We
one of the most challenging in further used the market correction
Prudential’s more than 25-year to rotate some positions in order
history. We share our clients’ to exploit the opportunity to
disappointment in our portfolio build positions in a handful of
performance over the period specific high-quality companies,
(which have also weighed on the at generational levels of cheap
medium-term performance, as valuations.
reflected in the table). After all,
Prudential staff’s own retirement It is therefore pleasing to observe
savings are invested alongside the strong recoveries posted by
our clients in these funds. nearly all our funds over the
last three to four months of the
Our investment teams spent year, as highlighted in the fourth
considerable time and effort quarter returns in the table, which
Prudential Investment Managers ©
in 2020 to review all portfolio shows the annualised returns of
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LETTER FROM THE CEO
PRUDENTIAL FUND PERFORMANCE to 31 DECEMBER 2020
3-YEAR 5-YEAR 10-YEAR
Q4 2020 1-YEAR
Prudential Unit Trust Fund RETURN RETURN RETURN
RETURN % RETURN %
P.A.% P.A.% P.A.%
Equity Fund 12.6 9.2 2.3 5.4 9.7
Benchmark 9.6 1.9 0.5 3.1 6.9
Dividend Maximiser Fund 10.0 4.0 1.8 4.2 9.0
Benchmark 9.6 1.9 0.5 3.1 6.9
SA Equity Fund* 12.0 -4.2 -3.1 3.0* 8.8*
Benchmark 11.5 0.6 -1.5 3.1 7.9
Enhanced SA Property Tracker Fund 21.4 -35.6 -21.6 -9.5 3.0
Benchmark 22.2 -34.5 -20.7 -8.4 3.5
Balanced Fund 7.0 2.3 2.5 4.6 9.2
Benchmark 5.9 5.2 3.6 4.4 7.7
Inflation Plus Fund 5.3 -0.7 0.1 2.8 7.9
Benchmark 1.6 8.2 9.0 9.6 10.1
Enhanced Income Fund 2.8 4.2 5.5 6.9 7.3
Benchmark 1.0 5.4 6.6 7.0 6.9
Income Fund 1.2 5.1 7.5 N/A N/A
Benchmark 1.0 5.4 6.6 6.9 N/A
Global Equity Feeder Fund 1.5 15.9 11.7 8.1 15.2
Benchmark 0.6 21.6 16.6 11.0 18.1
Global Balanced Feeder Fund -1.1 10.5 N/A N/A N/A
Benchmark -2.7 18.3 N/A N/A N/A
Global Inflation Plus Feeder Fund -4.0 11.4 9.9 4.1 11.0
Benchmark -12.4 5.2 5.0 0.5 9.3
Global Bond Feeder Fund -7.3 14.2 10.4 3.5 11.6
Benchmark -9.4 14.2 11.1 3/6 11.3
SOURCE: Morningstar
*SA Equity Fund 5- and 10-year returns reflect zero-fee B Class returns.
All other funds are A class returns (returns after all fund management fees and other charges).
Prudential Investment Managers ©
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LETTER FROM THE CEO
our Prudential Unit Trust funds for credit rating was downgraded
different periods up to 10 years. further into junk status and the
While fund performances have budget suffered severe revenue
not fully returned to their long- shortfalls and funding challenges.
term benchmark-beating levels, Given the extra bond supply
we are confident that portfolios required, investors could have
are positioned appropriately reasonably expected a weaker
under the circumstances, and we local bond market for the year,
anticipate much more pleasing but in the last three months,
outcomes over the next three to
five years. both local and global investors
snapped up SA government bonds
What has 2020 taught us? due to their attractive yields in
Amid a global pandemic that has relation to global alternatives.
lasted for a year, and widespread This resulted in unexpectedly
lockdowns that have caused the good gains for bondholders in
South African economy to shrink a year of very bad news for the
by an estimated 8.0% for the bond market, and supported our
year, who would have predicted previous viewpoint that investors
that the SA equity market would had materially priced-in a ratings
still manage to deliver a 7% downgrade well before it actually
return for the year? Against most occurred.
expectations, hindsight showed
us that investors who maintained So 2020 has (once again) reminded
their equity exposure for the us that anyone’s ability to make
duration of the year, probably money from forecasting is limited
came out in better financial health at best, and that it makes sense
than would have been expected. to stay true to your investment
strategy even in the midst of
Just as surprisingly, South African extreme short-term uncertainty
bonds were able to deliver an and volatility. Investors who
impressive 8.7% return for panicked amid the March 2020
investors in 2020. This, in a year correction, and sold out of growth
during which the government’s assets such as equities to park their
Prudential Investment Managers ©
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LETTER FROM THE CEO
funds in “safe” money market the economy and government’s
funds, only managed to lock-in fiscal position present some very
their capital losses and would significant challenges that will
probably not have experienced take a concerted effort from all
the subsequent recovery as equity sides to resolve. At Prudential
markets recovered. we are committed to playing our
part in this effort.
For Prudential’s part, we promise
to remain patient, keep a long- We hope you enjoy this Q1 2021
term outlook and follow our edition of Consider this, and as
consistent investment process always welcome any feedback
to deliver competitive, inflation- you may have.
beating returns for all our clients.
We are hopeful that asset prices Sincerely,
will continue to recover in the
months ahead, as the global
vaccine rollouts progress and start
to contain the pandemic, gradually
improving the physical, mental
and financial health of everyone.
In South Africa, however, there
is additional work to do since
Bernard joined Prudential in 2008 as Head of Institutional Business and was appointed as Chief
Executive Officer in 2010. With more than 27 years of industry experience, Bernard previously
worked at Alexander Forbes in a range of leadership roles, including Managing Director of the
Namibian business as well as Head of the Asset Consulting Division. Bernard holds a Bachelor of
Commerce degree in Maths and Actuarial Science from Stellenbosch University and is a Fellow of
Prudential Investment Managers ©
the Institute and Faculty of Actuaries and the Actuarial Society of SA.
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TA B L E TA L K
TABLE
TALK
Sandile Malinga
PORTFOLIO MANAGER
i KEY TAKE-AWAYS
While multi-asset low-equity unit This high prospective return range
trusts like the Prudential Inflation relative to its history (its objective
Plus Fund have underperformed in is 4% above inflation) is due to
the last three to five years, most the very attractive prevailing
have rebounded since the lows of asset valuations across a range of
late March 2020. asset classes the fund is holding,
which increase the chances for it
Although there has been a wide
to outperform as well as giving it
divergence in returns within the
enhanced downside protection.
category, the Inflation Plus Fund
Prudential Investment Managers ©
has returned over 30% during the Based on this, investors should
period, and we are excited by the consider remaining in the Inflation
Fund’s prospective returns of 6-9% Plus Fund in order to catch up on
p.a. above inflation over the next the underperformance of previous
five years. years.
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TA B L E TA L K
Q
I have invested some of my retirement money
in a multi-asset low-equity fund, but it has
been underperforming its benchmark for over
three years. I see returns have started to pick
up now - should I sell my holdings and move
somewhere else?
A
Over the past five years, Prudential’s Inflation Plus Fund has
investors have certainly been one of the very top-performing
been disappointed with unit trusts in the category with a 33.1%
the low returns delivered return over this period, repeating
by funds in the ASISA Multi-Asset its historic tendency to outperform
Low-Equity category of unit trusts, in periods when higher-risk assets
which have underperformed their perform better than lower-risk assets.
historic averages as well as lower-risk We know there is still much ground
fixed income and cash investments. to be recovered by investors, but
However, over the relatively short we are excited by the fund’s return
potential over the next five years.
period since the worst of the
Investors should be as well. This is
Coronavirus-related market crash in
thanks to a unique set of opportunities
late-March 2020, South African asset
that presented itself in 2020 in the
prices have recovered significantly
wake of the Coronavirus crisis. While
across a range of asset classes, with
we certainly owned a lot of assets –
fund performance reflecting this. In
both equities and bonds – that fell
the Low-Equity category, the average sharply, we were able to sell some
fund has returned a very respectable that didn’t fall as much, rotating into
21.3% from its lows, but there has others that presented much better
been a wide divergence of returns upside potential. This has left the
between the funds, with the lowest Inflation Plus Fund with excellent
delivering only 1.8% and the highest prospective returns and downside
producing 36.3%. Consequently, the protection, thanks to both the very
investor experience has likely varied low valuations (some at generational
from extreme disappointment to lows) at which we have been able to
Prudential Investment Managers ©
relative satisfaction. buy selected assets, and the fact that
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TA B L E TA L K
such a large and diverse proportion it holds large active overweights to SA
of assets have such high prospective bonds and SA equities, and a moderate
returns compared to their history. Both overweight to SA inflation-linked
of these factors increase the probability bonds (ILBs). According to Prudential’s
of fund outperformance into the valuation analysis, although all these
future under various scenarios. The assets have become less cheap in
downside protection is enhanced even
recent months, they are still valued
more by the fund’s carefully considered
at levels well below their historic fair
diversification and Prudential’s risk-
value. For SA bonds, the prospective
conscious portfolio construction
process. five-year real returns are the highest
they have been since 2004, with the
We prefer SA bonds, SA equities 20-year government bond indicating
and SA ILBs a real return of 7.6% p.a. and the
Looking at the fund’s positioning as of 10-year bond 5.9% p.a. as of the end
the end of 2020, as shown in Graph 1, of 2020.
GRAPH 1: Inflation
Graph Plus
1: Absa’s Fund: Active
provisions positions
at all time highsvs
strategic asset allocation
35%
Active Positions
30% 28.6% SA Bonds 7.1%
25.0% 25.3% SA Equity
25% 3.6%
22.5%
SA ILBs 2.8%
20%
18.1%
Foreign Cash 2.5%
15.0%
15%
SA Cash 0.0%
11.8% 12.5% 12.0%
11.0%
10% Foreign Equity (incl. Africa) -0.7%
6.4%
5.3% Foreign Bonds -5.6%
5%
3.0%
1.5% 1.5% SA Listed Property -9.7%
0.5%
0%
SA Foreign SA Listed SA SA Foreign SA Foriegn -12% -8% -4% 0% 4% 8%
Equity Equity Property Bonds ILBs Bonds Cash Cash
Fund Asset Allocation Strategic Asset Allocation
Prudential Investment Managers ©
Source: Prudential Investment Managers
SOURCE: Prudential Investment Managers
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TA B L E TA L K
ILBs are also an attractive holding prefer taking overweight positions in
in the portfolio for their excellent sectors such as banks (Standard Bank
diversification and inflation protection and Absa are among the fund’s top
qualities. Investors worried about a overweights). The fund has its other
potential government default would significant overweight holdings in
do well to hold these as protection large, diversified global companies
against such a scenario, rather than like British American Tobacco and
opting for cash. Our analysis shows Anglo American, and in well-valued
ILBs should deliver a real return of groups like Multichoice, all with good
around 4.1% p.a. as an asset class potential to outperform the market.
compared to their historic average of
2.0% p.a. real. Prudential’s valuations Underweight global bonds
for prospective real returns for each Examining offshore positioning,
asset class are shown in Graph 2. Inflation Plus has a large underweight
to global government bonds due to
As for SA equities, their valuations at the negative yields prevailing broadly
the end of 2020 pointed to a real return across developed markets. Although
of 9.5% p.a. for the asset class over historically global bonds have offered
the next five years, versus their historic an average real return of around
fair value of 6.5% p.a.. While SA listed 1.8% p.a., currently as an asset class
property is at first glance trading even they are set to deliver -0.6% p.a. as
more cheaply at a prospective real Graph 2 highlights. The fund also has
return of 9.5% p.a. compared to its a small underweight holding in global
historic fair value of 6.0%. p.a., we are equities, since global markets are
concerned about the high earnings collectively slightly expensive due to
uncertainty in the sector combined the predominance of the expensive US
with relatively high levels of debt and market. As an asset class our valuations
weak growth prospects. We therefore show the five-year prospective real
have a significant underweight to listed return from global equities at 4.9%
property in the Inflation Plus Fund. p.a., when historically their fair value
There is a higher degree of safety has been 5.5%. On top of this, the
in other equity sectors with equally rand remains undervalued against
Prudential Investment Managers ©
high return potential, such that we the major global currencies, so that
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TA B L E TA L K
any appreciation from current levels 9.0% p.a. It is positioned to outperform
could contribute to losses in rand its history under a wide number of
terms going forward. conditions, including: if the status-
quo continues; if SA equities re-rate;
Prospective real fund returns of if the SA yield curve flattens from its
over 6.0% p.a. current steep shape; or if the listed
Looking at the fund’s overall asset property market rallies. It is likely to
holdings and their current valuations, underperform, however, if the SA
the Inflation Plus Fund is set to deliver yield curve steepens further; if there
a real return of over 6.0% p.a. over is a repeat of the listed property crash
the next five years. This assumes that we experienced in 2020; or if South
nothing else changes and asset prices African and global equity markets
and market ratings stay the same de-rate going forward.
going forward. However, should asset
prices rise to reach their long-term As the first two scenarios are highly
“equilibrium” or fair value levels, the unlikely, we have a higher degree of
fund has a prospective real return of confidence in the upside for future
GRAPH 2: Prospective real returns
Graph 1: Absa’s provisions at all time highs
12%
South Africa The World
10% 9.5% 9.5%
9.0%
8.4%
8%
Real Returns
6.0%
6%
4.9%
4.1% 4.0% 3.8% 4.1%
3.8%
4% 3.5%
1.9%
2%
0%
-0.6% -0.6%-0.4%
-2% Cash ILBs Government Corporate Listed Equity World World
Bonds Bonds Property Bonds Equity
Prudential Investment Managers ©
14 January 2021 30 January 2020 Fair Value
SOURCE: Bloomberg,
Source: Bloomberg, Reuters,Reuters, Prudential
Prudential Investment Investment
Managers 14.01.2021Managers 14.01.2021
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TA B L E TA L K
fund returns than the downside. With Going forward, investors now have
South Africa’s short-dated interest rates the chance to “catch up” on the
at such low levels already and longer- inflation-beating returns the ASISA
dated bond yields high compared Multi-Asset Low Equity category funds
to their history, further significant have struggled to produce over the
yield curve steepening is not likely. past five years or so. These higher
And based on the exceptionally low returns are unlikely to come from cash
valuations for listed property currently, as they did during this period: interest
we wouldn’t expect these assets to rates are so low that, on our valuation
de-rate by the same extent in 2021. basis, prospective real returns from
cash investments are negative over
A return of 6.0% above inflation is the next five years. So now is not the
one that has typically been delivered time to hide in low-risk investments,
by high-risk, equity-only funds in the but instead to hold a portfolio of
South African investment industry. carefully diversified assets that will
So a similar level, or the potential provide the potential for excellent,
for a 9.0% return, from a lower- inflation-beating returns with only
risk, well-diversified fund compliant moderate risk.
with retirement regulations like the
Inflation Plus Fund presents a rare
opportunity for investors.
Sandile joined Prudential in 2013 as a member of the fixed-income team, and later joined the
multi-asset team in 2018. He is currently the joint-Portfolio Manager of the Prudential Money
Market, Income, High Interest, Balanced and Inflation Plus Funds. His role involves providing
analytical and economic support to our multi-asset and fixed-interest investment process. He is
also a member of the Prudential Asset Allocation Committee. With 13 years’ industry experience,
Sandile previously worked for Investec Asset Management as a fixed interest dealer and analyst.
He also served as Portfolio Manager on large institutional fixed interest client mandates with
liability immunization objectives. Sandile holds a BSc in Mathematical Statistics and Actuarial
Prudential Investment Managers ©
Science and is a Student member of the Faculty of Actuaries.
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A N A LY S I S
COVID-19 and SA banks:
iStock-936418814
Recovering from the lows
Stefan Swanepoel
EQUITY ANALYST
i KEY TAKE-AWAYS
SA banks were as well-placed as Although loan impairments have
possible to cope with stress arising risen, client support in the form of
from the impact of the Coronavirus, repayment deferrals, government
with all-time high provisioning and financial support and interest rate
tight lending criteria already in place. cuts helped mitigate the deterioration
in banks’ loan books. Banks have
Lower retail transactional income
not been as hard-hit by the crisis as
was offset to some extent by higher
could have been expected.
revenue from facilitating client risk
Prudential Investment Managers ©
hedging.
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A N A LY S I S COVID-19 & SA BANKS: RECOVERING FROM THE LOWS
S outh African banks have certainly
not been immune to the impacts
of COVID-19. The first half of the year
domestic franchises. In our view, all is
not lost, the businesses remain resilient
and we expect to see a continued
was characterised by uncertainty, recovery in earnings off the depressed
with markets expecting banks to bases.
post significant losses and potentially
needing to raise capital. The second Digital adoption accelerates
half of the year saw these fears Earlier in the year, as concerns over
moderating. The banks have proven how rapidly the virus was spreading
to be resilient, with the conservative set in, many banking customers were
standards of the Basel capital accords forced out of branches and onto
and our own National Credit Act digital channels. While this transition
allowing the banks enough headroom was already in progress, its pace
to deal with the negative impact. was dependent on the willingness
and digital enablement of clients.
While the devastation of the pandemic
Particularly marked accelerations were
continues and the chances of further
noted in Europe among the older
severe lockdowns cannot be overruled,
population, where digital adoption
the banks have built up some of
was historically slow. While this will
the largest provisioning buffers on
not result in overnight cost savings for
record (see Graph 1) thanks to the
the banks, the higher level of online
forward-looking accounting principles
engagement does improve their ability
embedded in IFRS 9. Lower interest
rates, while hurting banks’ net interest to cross-sell products. It is also linked
margins, have boosted the ability of to lower costs; however, the banks still
borrowers that were not impacted sit with physical branch infrastructure
by job losses or COVID-19 disruptions that needs to be serviced. As the
to repay. They have also improved branch leases are renewed, the banks
affordability, and we have seen an can reduce their cost bases either with
uptick in retail asset growth demand. complete closures of certain branches
The banks’ operations in the rest of or a reduction in floor space. These
Africa (excluding South Africa) have benefits will filter in over the next
Prudential Investment Managers ©
proven to be more resilient than the few years.
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A N A LY S I S COVID-19 & SA BANKS: RECOVERING FROM THE LOWS
One may be forgiven for thinking that Into 2021 we would anticipate rising
this gives new (digitally advanced) retail transactional revenues to more
entrants like Tyme or Discovery Bank a than compensate for slowing trading
substantial advantage, but that would volumes as hedging drops from peak
discount the huge strides already made levels.
by the big incumbents. Most of the
existing banks’ online branches are Impairments will take time to
already by far their largest contributors work through
of new business. With the cost of As lockdowns were introduced and
the existing physical infrastructure countries around the world were
already in the base, there is substantial bracing for the impact, not only on
opportunity for savings for them into lives but also on their economies,
the future. the banks were forced to deal with
the uncertain consequences of a new
Trading volumes remained robust accounting standard - IFRS 9. While
While transactional revenues on the forward-looking models are always
retail side were depressed during the best for addressing uncertainty, they
early period of the lockdown, these can have their drawbacks in a global
have started to show signs of recovery. downturn where very few sectors are
Large-ticket items relating to travel left untouched. Given the economic
have been notably absent and may woes in South Africa pre-COVID, the
take longer to recover, but the banks South African banks were bracing
have recorded consistent growth since for rating agency downgrades and
the trough in April 2020. All was not potential domestic stress. As a result,
lost as banks also made more money their credit-granting criteria was already
in parts of their trading businesses quite tight heading into the crisis.
amid the heightened uncertainty. Provisions-to-advances ratios were at
As investors and corporates hedged some of the highest levels on record
out risk, banks as market-makers prior to COVID. Banks were as well-
capitalised on the underlying activity. placed as possible for any impending
This boosted earnings into the mid- stress. Over the interim reporting
year June 2020 results reporting, and period mid-year, the banks continued
Prudential Investment Managers ©
will contribute to the full year as well. to increase all-time high provisioning
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A N A LY S I S COVID-19 & SA BANKS: RECOVERING FROM THE LOWS
and tighten their lending criteria even government support, as this support
further, but the approximate 300bps is wound down, non-performing loan
(3.0%) reduction in interest rates has (NPL) levels may increase. Pleasingly, as
improved affordability. the economy reopens, the percentage
of assistance provided by banks
Retail clients working in impacted
continues to reduce dramatically from
sectors were aided initially by blanket
the highs of April 2020. While some
deferrals on their loan repayments or,
in the case of FirstRand, by a personal clients are still being supported and
loan. The assistance was subsequently some risk remains, many loans are
moderated as industries reopened and protected by underlying collateral
the lockdown eased. Most banks now such as vehicles or homes. The banks
require at least partial payments of continue to operate in a pragmatic
instalments. While some clients are manner and will offer support where
still receiving payments in the form of needed in future lockdowns.
Graph 1: Absa’s provisions at all time highs
Graph 1: Absa’s provisions at all time highs
50 000 4,5%
45 000 4,0%
40 000 3,5%
35 000
3,0%
30 000
2,5%
25 000
2,0%
20 000
1,5%
15 000
10 000 1,0%
5 000 0,5%
0 0%
2007 2009 2009 2011 2013 2017 2019
Specific provision General provision Provisions to advances
Prudential Investment Managers ©
Source: Company data, Prudential Investment Managers
SOURCE: Company data, Prudential Investment Managers
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A N A LY S I S COVID-19 & SA BANKS: RECOVERING FROM THE LOWS
The number of corporates in distress consumer affordability. Given the
has also decreased; banks continue restrictions imposed by the National
to track high-risk sectors such as Credit Act, these lower interest rates
aviation, hospitality & tourism-related have helped consumers to qualify for
industries, commercial property finance higher loan amounts, previously out
and construction. Some companies in of reach. Despite banks being cautious
these troubled sectors have recently about lending too aggressively in
had rights issues, passing the risk onto this environment and raising their
shareholders and in turn reducing their credit granting criteria, the substantial
bank debt exposures. We anticipate reduction in the repo rate has allowed
more of this to come in due course. banks to lower their lending rates
but still see an increase in lending
Going forward, the banks will continue volumes. The high activity levels will
to increase their collection capacity in unlock liquidity from the housing
order to support the orderly repayment market and continue to boost top-line
or work-out of loans. Thankfully the revenue for the banks. Historically,
banks have realised that it is in no some of the banks’ most profitable
one’s interest to merely evict non- business was typically written during
paying customers from their homes the worst economic periods, as banks
and repossess their cars. They have remain acutely focused on credit risk
learned many lessons from the 2008 and margins, and this should hold true
Global Financial Crisis, including trying going forward as well. The benefit of
to assist consumers as best possible the lower interest rates has also aided
with selling their various assets, rather those who have not been financially
than out right repossession. Similarly, impacted by the pandemic. The banks
on the corporate side they can earn have seen consistently better payment
fees from their clients’ capital raises trends in the non-impacted sectors.
or planned work-outs.
Africa regions performing better
Consumer affordability aided by than South Africa
interest rate cuts In the rest of Africa, the impact of the
The SA Reserve Bank’s interest rate cuts pandemic on economic growth and
Prudential Investment Managers ©
totaling some 300bps have boosted banking sectors in various countries
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A N A LY S I S COVID-19 & SA BANKS: RECOVERING FROM THE LOWS
has been more muted. Many of the course. Both Absa and Standard Bank
banks posted either limited declines continue to have standout franchises
-- or in several instances even profit in the rest of Africa.
growth – in their African operations
during the period, with low levels Capital remains robust as regulators
of penetration and more resilient consider a return to dividends
economies supporting the bottom In what is a positive development
line. While the Africa regions are globally, regulators are retracting the
not immune to impairment risk, blanket bans for banks on the return
transactional activities and deposit-ed of capital (or dividend payments)
franchises still make up the bulk of the imposed at the start of the pandemic.
underlying businesses; earnings from While initially concerned about the
lending activities are less important. uncertain impact from COVID, most
However, it is notable that the best- of the banks have proven to be much
performing franchises still have as more resilient post the Global Financial
diversified a portfolio as possible. Crisis. In our view, the signal this
is sending is more important than
In our fund positioning we favour the actual payment of a dividend;
those banks with strong franchises regulators would not allow banks to
built up in the rest of Africa. These return capital to shareholders if there
are extremely hard to replicate given were material concerns over future
the unique operating environment losses. If a bank rather elects to retain
and political risks embedded in the its capital, it still aides in increasing
various geographies. With the growth the book value of the bank, and the
outlook in the rest of Africa better than capital could be returned at a future
the domestic outlook, we think this date.
will prove supportive for continued
earnings diversification and higher In Graph 2, we can see how Standard
profitability for banks. We have Bank’s total capital adequacy ratio
seen the rest of Africa make up an (CAR) and its Tier 1 capital ratio have
increasingly greater share of group fallen only slightly from the beginning
profitability, and the region could of 2019 through June 2020, remaining
Prudential Investment Managers ©
make up the bulk of bank profits in due at robust levels on par with, or higher
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A N A LY S I S COVID-19 & SA BANKS: RECOVERING FROM THE LOWS
Graph 2:
Graph 2: Standard
Standard Bank's
Bank’s robust
robust capital
capital level
level
could support a dividend
dividend
18%
16%
14%
12%
10%
8%
6%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 H1 20
Total Capital Adequacy Ratio Tier 1 Capital Ratio
Source: Company data, Prudential Investment Managers
SOURCE: Company data, Prudential Investment Managers
than, those it maintained in 2018. As payment of dividends; however, they
the potential impairment risks abate, have reminded the market that it is
this would suggest that from a financial just a guidance note, and the decision
health perspective, it could afford to ultimately sits with each company’s
pay a dividend without endangering board. In our view, these trends all
its financial strength. point to the fact that the worst has
passed and the risk of any potential
Based on the extent to which the capital raises has been vastly reduced.
banks are trading at discounts to their
book values, we think that dividend A strong indicator of this was the
buybacks would be a preferred way recent upgrade of South Africa’s largest
to return capital in due course. The five banks’ National Long-Term credit
South African regulators have not ratings to ‘AA+’ from ‘AA’ by Fitch,
removed the guidance note issued which it said reflected an improvement
Prudential Investment Managers ©
earlier this year discouraging the in their creditworthiness relative to
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A N A LY S I S COVID-19 & SA BANKS: RECOVERING FROM THE LOWS
the best credits in the country. banks’ financial health is now lower
and signs are pointing towards a better
Banks still offer value credit experience than what is being
Throughout the Coronavirus crisis, provided for presently. This contrasts
South African banks have remained to equity valuations; for example,
well capitalised, and all signs in the final Absa trades at a discount to its book
weeks of the year have indicated that value as the market is expecting high
impairments have peaked. Importantly, levels of losses to continue for the
bank profitability has been robust foreseeable future.
enough to absorb the high levels of
provisioning. None of the big banks Graph 3 shows how Absa has been
posted losses over the period, and net trading at a price-to-book-value ratio
asset value has been preserved. While of less than 1.0 since the market sell-
we are not entirely out of the woods, off in March, and has yet to recover
the risk of a further deterioration in much ground. We would anticipate
Graph 3: Absa’s P/B vs ROE
Graph 3: Absa's P/B vs ROE
3,5 30,0%
3,0 25,0%
2,5
20,0%
2,0
15,0%
1,5
10,0%
1,0
0,5 5,0%
0,0 0,0%
Mar-87 Mar-91 Mar-95 Mar-99 Mar-03 Mar-07 Mar-11 Mar-15 Mar-19
P/B ROE (RHS)
Prudential Investment Managers ©
Source: IRESS, Company data, Prudential Investment Managers
SOURCE: IRESS, Company data, Prudential Investment Managers
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A N A LY S I S COVID-19 & SA BANKS: RECOVERING FROM THE LOWS
that as banks’ cost of credit reduces, above their cost of equity. We think
the return on equity (ROE) would the banks are cheap compared to
recover in due course to pre-COVID their longer-term valuations, and we
levels. We therefore do not believe it is expect them to deliver returns above
justified that Absa trades at a discount the broader equity market and greater
to its book value. As a result, we think than their own historic average over
the total returns are attractive, as time. As such, we are overweight the
substantial levels of earnings growth sector and more specifically, shares like
over the next few years (in excess of Absa, Standard Bank and Investec, in
40%) could be further boosted by our best investment view portfolios
improvements in the ratings. and many of our unit trusts that hold
equity. Our preference for these banks
We think this presents an opportunity. over the other banks is informed
While financial activity levels continue by the relative value of the shares.
to grow off a depressed base and While we rate FirstRand more highly
there are opportunities for future cost in terms of quality, it is substantially
savings, banks’ ROE may take some more expensive than other banks in
time to recover, but should trend to the sector.
With 15 years’ experience in financial services, Stefan joined Prudential in 2019 as an Equity
Analyst focusing on Banking as well as select Property, Speciality Finance and Insurance companies.
Stefan was one of the top three rated analysts covering Banks and Specialist Financial Services
companies on the sell-side. Prior to that Stefan was on the buy-side focusing on Financial Services
companies. He completed his articles at PwC in the FS Banking division and is a qualified Chartered
Prudential Investment Managers ©
Accountant. His qualifications include B.Com Accounting (cum laude) and B.Com Accounting Hons.
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A N A LY S I S
2020: The year the world
iStock-933417870
remained complex
Aadil Omar
PORTFOLIO MANAGER AND HEAD OF EQUITY RESEARCH
i KEY TAKE-AWAYS
Despite the seriousness of the global of influences and actors that comprise
pandemic, global equities (as proxied them.
by the US S&P 500 Index) seemingly The more accepting we are of market
shrugged this threat off by trading complexity, the better able we are
below their 12-month levels for only to identify and optimise for those
43 days. elements that are in our influence.
Many people thought this comprised
Prudential Investment Managers ©
irrational behaviour, but it actually
reflected the complexity of global
equity markets and the vast number
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A N A LY S I S 2020: THE YEAR THE WORLD REMAINED COMPLEX
D o you remember your holiday
season at the end of 2019? To many
readers it will likely be recalled as a less
and financial hardship, loneliness
and emotional tumult, brought on
by this microscopic virus, you would
troubling time. You probably walked be forgiven for feeling somewhat less
into the festive cheer reminiscing optimistic about the future. A touch
about the monumental shifts that of pessimism would not have been
occurred during the past two decades without cause.
since the humdrum of the Y2K bug,
If this narrative made you somewhat
but nevertheless looking forward to
uneasy, I sympathise – writing it
the third. Promising possibilities lay
was equally unsettling. Despite the
ahead.
uneasiness, there is something surreal
Now imagine you knew all the mayhem about the drama that is Covid-19 and
that would descend over the world in its off-shoots. It is one of the few
this, the 20th year since the turn of the narratives universally understood
millennium. Imagine you knew that and relatable to just about everybody
reading this. Covid-19 is probably
a respiratory virus would cast a long
the first disease (in living memory)
shadow over the world, rising – as the
the world has suffered collectively in
sun does – in the east before sweeping
time. It is also likely the first time the
westward over the globe. And then
phrase “we’re all in this together” has
it made itself at home the world
proved true on some level. Equally,
over. In addition to the healthcare
Covid-19 was also the first time our
crisis, imagine you had the insightful
species confronted a complex problem
knowledge that the year 2020 would
in real time.
also be host to one of the deepest
global economic recessions in living Financial markets shrugged off
memory plunging millions of people the threat
into unemployment and reducing The US bull market before Covid-19
once-towering companies to pale was often scoffed at – I recall a
shadows of their former selves. Given commentator referring to it as “the
all the pain and suffering, distress most hated bull market of all time”.
Prudential Investment Managers ©
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A N A LY S I S 2020: THE YEAR THE WORLD REMAINED COMPLEX
Many investors sounded alarm bells pundits shouting in disbelief at the
as they watched the market continue market’s irrationality still grows louder.
to rise into the news of Covid-19 all
the way to the end of February 2020. Graph 1 tracks the daily change in price
Although the sell-off was probably of the S&P 500 relative to its price level
accompanied by a fair amount of a year ago. Over the calendar year
panic, when it finally cracked many 2020, the Index traded below its level
investors sighed a breath of relief - from a year ago for only 43 days (or
the markets were finally behaving in 16% of the time). This in a year when
a way that was sensible and congruent most people would probably agree
to the way we were feeling, as locked with the narrative that the world is
down citizens of the world. Market somewhat different and perhaps a
rationality prevailed. little scary.
For the S&P 500, the correction lasted When something is widely relatable
all of 43 trading days (see Graph 1 it seems only obvious
below). Perhaps the price action was When a phenomenon is as widely
rational, but the cries of many market relatable as our experience of Covid-19
Graph 1: S&P
Graph 500 price
1: S&P500 change
price change y-o-y
y-o-y
40% 4000
30% 3500
3000
20%
2500
10% 2000
0% 1500
1000
-10%
500
-20% 0
Jan-20
Jan-20
Jan-20
Feb-20
Feb-20
Mar-20
Mar-20
Apr-20
Apr-20
May-20
May-20
Jun-20
Jun-20
Jul-20
Jul-20
Jul-20
Aug-20
Aug-20
Sep-20
Sep-20
Oct-20
Oct-20
Nov-20
Nov-20
Dec-20
Dec-20
Dec-20
Change in price level of S&P500 Index (y-o-y) S&P500 Index [RHS] S&P500 Index 1 year earlier [RHS]
Prudential Investment Managers ©
SOURCE:
Source: IRESS IRESS Data
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A N A LY S I S 2020: THE YEAR THE WORLD REMAINED COMPLEX
has been it has the potential of “Prices are not driven solely by real-
framing our world view completely. world events, news, and people. When
We then expect all other phenomena investors, speculators, industrialists,
we encounter to comply with this and bankers come together in a real
view, to live within this frame. The marketplace, a special, new kind
idea that financial markets shrug off of dynamic emerges—greater than,
the plainly obvious, albeit negative, and different from, the sum of the
reality we observe seems preposterous. parts. To use the economists’ terms: In
It is not in the frame. We can only substantial part, prices are determined
but conclude that the market and by endogenous effects peculiar to
some market participants must be the inner workings of the markets
irrational and behaving in a way that themselves, rather than solely by the
is counter to reality. This may well be exogenous action of outside events.”1
so. But consider the alternative: these
The market exists at the intersection
comments might hint more at an
of a vast number of participants,
underappreciation of the complexity each with their own evaluations,
of market mechanisms than they say motivations and specific needs. The
about the rationality of the market. emergent complexity makes for routine
surprises and inexplicable gyrations.
When we observe real-world
While many times a credibly sounding
phenomena and attempt to translate
and easily understood rationale is
them into market prices in a direct
identified after the fact (ex-post), our
real-time (or linear) fashion, we fail
ability to precisely identify causes and
to appreciate the emergent properties
effects ahead of the moment (ex-ante)
of a complex system. Or as the erudite
remains elusive.
mathematician and father of fractal
geometry, Benoit Mandelbrot, Complex means non-compliant to
explains, we should recognise there expectation
are indeed endogenous features within Brenda Zimmerman of York University
the market: and Sholom Glouberman of the
Prudential Investment Managers ©
1
Mandelbrot, Benoit B.The (Mis)Behaviour of Markets (p. 21). Profile. Kindle Edition.
Consider this QUARTER 01 2021 Page
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A N A LY S I S 2020: THE YEAR THE WORLD REMAINED COMPLEX
University of Toronto, professors who Firstly, while complex problems at not
study the science of complexity, have linear, they often embed trade-offs.
proposed a distinction among three Trade-offs invariably mean conceding
different kinds of problems in the something for something else. In the
world: the simple, the complicated, money management business, the
and the complex. Simple problems have trade-offs are well known and run
neatly consistent logical processes, like along the lines of potential return
baking cake from a mix. Following against the risk of loss. What makes
the recipe brings a high likelihood it complex is that outcomes cannot
of success. Complicated problems be known ahead of time.
require a multitude of people, props
and specialised expertise to solve – Next, a key part to dealing with
like sending a rocket to the moon. complexity is deciding what is important
Timing and coordination become and what isn’t – it makes the task of
vital to success. Complex problems are weighing up trade-offs more concrete.
often unique, and while experience Often solutions to complex problems
may provide expertise, it does not benefit from constraints – what are
guarantee success. An example of a the non-negotiables, for instance.
complex problem is raising a child. A
Finally, accept what is likely in your
key feature of complex problems is
frame of understanding and what is
that their outcomes remain uncertain
not. Like the unrequited expectations
(probabilistic at best).
of many market pundits during the
Money management probably lies on pandemic, the market never quite
the spectrum between a complicated complies with our expectations – at
and a complex problem. While there least not over a short time horizon.
is no handy step-by-step guide for The more accepting we are of the
confronting complexity, it may be complexity of the market, the better
helpful keeping the following general able to identify and optimise for those
ideas in mind: elements that are in our influence.
Prudential Investment Managers ©
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A N A LY S I S 2020: THE YEAR THE WORLD REMAINED COMPLEX
Graph 2: S&P 500
Graph 1: S&P500
80% 4000
70%
3500
60%
50% 3000
40% 2500
30%
2000
20%
10% 1500
0%
1000
-10%
-20% 500
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Jul-17
Jan-18
Jul-18
Jan-19
Jul-19
Jan-20
Jul-20
Change in price level of S&P500 Index (y-o-y) S&P500 Index [RHS] S&P500 Index 1 year earlier [RHS]
Source: IRESS
SOURCE: IRESS Data
If we are to learn anything from 2020, Index traded below its level from a
we should learn that the world is still year earlier for 295 days (or 10% of
complex. the time). The events of 2020 did little
to alter the trajectory of this market,
Afterword but it has been a more tumultuous
For readers interested in a longer-term year than we’ve become used to.
view of the S&P 500’s annual price
change, Graph 2 illustrates the time
series over the past decade. In the last
10 years (or 2,870 trading days), the
With 14 years’ investment experience, Aadil joined Prudential in July 2013 as an Equity Analyst.
In August 2018 he joined a global equity hedge fund in London, before returning to Prudential
in January 2020 as Head of Equity Research. He is also joint-Portfolio Manager of our House View
Equity portfolios. He holds a BCom degree (Hons, cum laude) from the University of Pretoria and a
Prudential Investment Managers ©
Masters in Finance degree from INSEAD. He is also a CFA charterholder.
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A N A LY S I S
The active return
iStock-469535168
journey continues
Valdon Theron
HEAD OF INSTITUTIONAL BUSINESS
i KEY TAKE-AWAYS
When analysing a fund’s return Although Prudential’s more recent
performance, it’s important to use relative equity performance has
rolling periods of return, rather than been disappointing, a look at rolling
a simple “point-in- time” return periods over three years and longer
period, such as five or 10 years, as shows the Prudential Core Equity
the latter is an arbitrary period that Composite has continued to beat its
says little about the consistency of a benchmark consistently.
fund’s behaviour through different
Prudential Investment Managers ©
market cycles.
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A N A LY S I S THE ACTIVE RETURN JOURNEY CONTINUES
I n a previous article, The active return
journey (Consider this Q1 2019), we
proposed that investors should analyse
for example five years and longer,
by compounding more gains than
losses against the benchmark over
a fund’s returns relative to benchmark the shorter term.
(active returns) on a rolling basis. We
The last 18-24 months has undoubtedly
argued that this provides investors
been a disappointing period of
with a far more complete picture than
relative performance for investors in
the most popular method of looking
Prudential’s equity portfolios. This on
at a fund’s active returns, whether it
top of below-average equity market
be over 1 year or 10 years, at a single
returns, or beta, which is outside of
point-in-time. Analysing active returns
our control in a fully invested equity
in a monthly sequence provides more
portfolio.
data points and allows investors to
see how a fund has “behaved” over Graph 1 shows rolling 12-month active
various investment cycles. When, and returns (vertical grey bars) for the
how, was outperformance delivered? Prudential Core Equity Composite
To what degree of consistency, i.e. the since its inception in 2004. This is an
frequency by which it has beaten its aggregation of all the institutional
benchmark over various rolling return portfolios we manage using our
periods? specialist Core (Houseview) equity
process. After a particularly strong
A key take-away from the previous
period of outperformance over 2017
article, where we analysed the
and 2018, 12- month rolling active
performance of the Prudential Core
returns have largely been negative
Equity Composite up until 31 December
in the ensuing period.
2018, was that over shorter time periods,
such as rolling 12-month and even Despite the recent downturn in
36-month periods, underperformance active returns, the since-inception
can and does happen. However, outperformance of 1.3% per annum
Prudential has been able to consistently remains very attractive. This means
Prudential Investment Managers ©
beat its benchmark over longer periods, that over the 16-year tenor of the
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A N A LY S I S THE ACTIVE RETURN JOURNEY CONTINUES
Prudential Core Equity Composite, a following lines can prove particularly
R100 million investment would have useful to our clients after a period
grown to R989 million (gross of fees), of underperformance against the
compared to R825 million for a similar benchmark:
investment in the benchmark.
What has caused the
While underperformance in the short underperformance?
term is not unusual, we do assess Was the underperformance
ourselves on a continuous basis. A caused by any change to
superior long-term track record is investment philosophy or process?
ultimately achieved by the “wins” Has the underperformance
outweighing the inevitable “losses” affected the long-term
against the benchmark over shorter performance track record or
time periods. An assessment along the consistency profile?
Graph 1: Prudential Core Equity Composite
Graph 1: Prudential
Performance Core Equity
as at 31 December 2020
Performance as at 31 December 2020
16%
R989.2m
14% 15.1%
12%
10% R825.4m
13.8%
8%
6%
4%
2%
0%
-2%
0%
-2%
-4%
-6%
Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug
04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
12 month rolling Alpha Core Equity Composite Benchmark
Source: Statpro & Prudential Investment Managers
*Market value weighted blend based on the underlying fund benchmarks within the composite, it consists of the FTSE/JSE Shareholder Weighted Index and FTSE/JSE Capped Shareholder Weighted Index.
Prudential Investment Managers ©
SOURCES: Statpro, Prudential Investment Managers
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