Corospondent The Personal Investments Quarterly - Coronation

Corospondent The Personal Investments Quarterly - Coronation
                    The Personal Investments Quarterly

                                                         TRUST IS EARNED™   1
Corospondent The Personal Investments Quarterly - Coronation

                                                                                                      C O R O NAT I O N F U N D U P DAT E S
              03                                        17                                                  AND PERFORMANCE
   Notes from my inbox                        Investment analysis
                                               A revival in the life                                    27                                    37
              05                                insurance sector                                  Market review                       Strategic Income
      The biggest risk is                               20                                              29                                   40
        taking none                             Bond outlook                                    Key performance                    Global Equity Select
                                            Deteriorating local fiscal                             indicators                       Global Managed
              07                              dynamics remain a                                                                    Global Capital Plus
    Economic comment
      Global outlook                                                                              Balanced Plus                               43
                                                        24                                           Equity                          Optimum Growth
              11                              Investment analysis                                                                    Global Emerging
   Economic comment
                                             US home improvement
                                                                                                        32                               Markets
   South African outlook                                                                          Capital Plus
                                                                                              Balanced Defensive                             48
                                                                                                                                    Flagship fund range
                                                                                                   Market Plus                                52
                                                                                                    Top 20                        Long-term investment
                                                                                                                                      track record

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thereof, there may be limitations as to the appropriateness of any information given. It is therefore recommended that the reader first obtain the appropriate legal,
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information. Neither Coronation Fund Managers Limited, Coronation Management Company (RF) (Pty) Ltd nor any other subsidiary of Coronation Fund Managers
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The value of units may go down as well as up, and is therefore not guaranteed. Past performance is not necessarily an indication of future performance. Unit trusts
are allowed to engage in scrip lending and borrowing. Performance is calculated by Coronation for a lump sum investment with income distributions reinvested.
All underlying price and distribution data is sourced from Morningstar. Performance figures are quoted after the deduction of all costs (including manager fees and
trading costs) incurred within the fund. Note that individual investor performance may differ as a result of the actual investment date, the date of reinvestment of
distributions and dividend withholding tax, where applicable. Annualised performance figures represent the geometric average return earned by the fund over the
given time period. Where foreign securities are included in a fund it may be exposed to macroeconomic, settlement, political, tax, reporting or illiquidity risk factors
that may be different to similar investments in the South African markets. Fluctuations or movements in exchange rates may cause the value of underlying investments
to go up or down. The Coronation Money Market fund is not a bank deposit account. The fund has a constant price, and the total return is made up of interest received
and any gain or loss made on any particular instrument, in most cases the return will merely have the effect of increasing or decreasing the daily yield, but in the case
of abnormal losses it can have the effect of reducing the capital value of the portfolio. Excessive withdrawals could place the fund under liquidity pressures, in such
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Limited is a licenced insurer under the Insurance Act, No.18 of 2017.
Corospondent The Personal Investments Quarterly - Coronation
Notes from my inbox
                       “Uncertainty is the only certainty there is. Knowing how to live with insecurity is
                       the only security.” – Mathematician John Allen Paulos

                       By P I E T E R K O E K E M O E R

  Pieter is Head of    HUMAN BEINGS ABHOR uncertainty. In a recent          dopamine-rich part of the mid-brain and as a result
Personal Investments
                       study, subjects played a computer game where         is often referred to as the brain’s reward centre. While
                       they received an electric shock if they overturned   dopamine is proven to cause pleasurable sensations,
                       a rock with a snake underneath. The researchers      it is also a precursor to adrenaline, which in turn
                       varied the probability of encountering the           exists to provide us temporarily with more clarity
                       unpleasant outcome when overturning a specific       and energy to deal with life-or-death situations.
                       rock over time, making it alternately easier or      The striatum effectively anticipates good and bad
                       harder to predict where the snakes are. They found   outcomes and creates most stress if the outcome is
                       that stress levels peaked when the sequence was      highly uncertain, when a quick response is most likely
                       random and the player just did not know what         to make a difference to the likelihood of survival.
                       was coming next, which they equated to irreduc-
                       ible uncertainty. Study participants were much       Unfortunately, this system becomes unhelpful if it
                       more agitated when they did not know what was        is constantly triggered by stressors that are not life
                       coming than when the level of shocks incurred was    threatening and it can certainly impede successful
                       higher, but more predictable.                        investment decision-making. As portfolio manager
                                                                            Neville Chester points out on page 5, the response
                       This outcome has a lot to do with how we are         of many investors to the Covid-19 market shock in
                       wired. The striatum, an ancient part of the brain,   February and March last year was to de-risk their
                       combines two core functions. It is responsible       investment portfolios and move to cash. Given the
                       for taking action, as it controls movement and       strength of the subsequent market recovery, this was
                       other aspects of cognition. It is also linked to a   not a useful reaction.

                                                                                                       TRUST IS EARNED™           3
Corospondent The Personal Investments Quarterly - Coronation
The magnitude of market movements over 2020 is            more conventional administration in the US means
illustrated by the performance of Top 20, our concen-     more global alignment in fighting climate change
trated equity fund. By mid-March, when the scale of       and a move away from the trade war rhetoric of
the pandemic became clear and a few days before           the Trump era. The work-from-anywhere lessons we
the first hard lockdown was announced, the value          learnt last year widen the gap between businesses
of the fund declined by a third (measured from the        that successfully embrace technology and those
start of 2020). Since then, its unit price increased      that do not. All these trends create an environment
by 68%, for a total return at the time of writing         in which good stock-picking and portfolio construc-
of 13.2% over the last 12 months. An investor who         tion can add significant value.
divested in late March would have missed the subse-
quent recovery, and given the very low (albeit more       There may even be better news on the vaccine front
certain) cash returns, would still be nursing a loss of   soon. While we currently only have vaccine supply
around 30%.                                               for a fraction of the population, this situation may
                                                          change more quickly than generally expected.
Craving certainty is a fool’s errand when you are         Most developed countries placed multiple advance
dealing with the future, which is by definition           orders for enough doses to cover two to four times
uncertain. Academic literature defines the excess         their population. Some of this excess will even-
return expected from equity markets as a risk             tually become available to the stragglers, espe-
premium, basically a reward for embracing and             cially as more vaccine candidates are proven to
managing uncertainty.                                     work. In addition, if the Johnson & Johnson vaccine
                                                          proves to be efficacious, this may also help to accel-
A NEW YEAR, NEW RISKS AND OPPORTUNITIES                   erate domestic supply. Aspen has the contract and
At the start of 2021, there is, as always, much uncer-    capacity to annually manufacture 300 million doses
tainty to stress about. The state of the local economy    of this vaccine in Port Elizabeth. It is possible to
is still precarious, and government as yet has no         imagine that some of this may become available
clear path to fiscal sustainability. The pandemic         locally later this year.
caused inequality to widen further, with job losses
falling more severely on low-paid, often young            ALSO IN THIS EDITION
and female, employees in industries such as hospi-        Marie Antelme provides a comprehensive review
tality and tourism. Higher taxes on asset owners          of the global and economic data and shares our
and companies will be one likely result. Supported        macro outlook for 2021. Nicholas Stein provides
by unprecedented levels of fiscal and monetary            some colour on how undemanding valuations
support, many equity markets around the world are         have become in the local equity market and
trading at record highs. At some point the income         sets out the investment case for life insurers and,
support programmes and central bank balance               specifically, Momentum Metropolitan Holdings.
sheet expansion will stop, with unclear conse-            Home improvement retailers were one of the bene-
quences for markets. Pundits, especially in the US,       ficiaries of people spending more time at home.
are debating whether we are in bubble territory or        Danie Pretorius sets out the investment case
not. Over time, inflation may make an unwelcome           for Home Depot and Lowe’s Companies, the US
return. Locally, vaccine procurement and roll-out         market leaders in this sector. We also include Nishan
have not been handled well initially, rendering           Maharaj’s regular bond market update, as well as
South Africa one of the worst-supplied countries in       detailed fund commentaries from our portfolio
the world, which will delay the exit from pandemic-       management team.
related social and economic constraints.
                                                          After two consecutive years where investors were
Yet, there are also reasons to be positive. The local     rewarded for taking risk, we hope that it becomes a
economic problems are well known and reflected in         little easier for our clients to deal with the inevitable
asset valuations. South African government bonds          uncertainty that comes with long-term investing.
pay the highest real yield available in the world’s       We remain focused on the task of managing uncer-
investable bond markets. Local equity valuations          tainty on your behalf, by making sensible security
are very undemanding on an already severely               selection and asset allocation decisions in our
depressed earnings base. A small change in investor       portfolios. As always, I invite you to contact us via
confidence can lead to significant gains from current if any aspect of our
levels. Over the longer term, investors can protect       delivery to you is unsatisfactory.
themselves against pockets of overvaluation and
inflation by investing in sensibly diversified port-      Take care.
folios built from the bottom up, based on the indi-
vidual investment cases from assets sourced from
around the globe. While inequality has increased, a

Corospondent The Personal Investments Quarterly - Coronation

       The biggest risk is
       taking none
       Are long-term investors positioned for the future?

       By N E V I L L E C H E S T E R

              THE                         SARB’s Covid-19                 Money market                Current equity                Risk assets are
                                        policy response has              and income funds           valuations trump             better positioned to
             QUICK                     shifted the outlook for             have lost their       history in a low-interest        achieve long-term
             TAKE                            asset classes                     shine                   environment                     growth

                                       CASH, AS THE OLD saying goes, is king. And in a            could have achieved a return ahead of the official
                                       local equity market where we have had a paucity            inflation rate.
                                       of returns, cash and cash-plus funds have certainly
                                       been reigning, both in terms of returns and inflows.       The various cash-plus and income funds could then
                                       South Africa, one of the last few countries that has       use some duration and opportune credit selection
                                       a truly independent central bank, has maintained,          to add an additional 0.5% to 1.0% over and above
    Neville is a senior                up until now, positive real interest rates. The South      this. For the five years up until the end of 2020, the
  portfolio manager with
  24 years of investment
                                       African Reserve Bank (SARB) believed that, due to          average money market fund returned 7.1%, the
        experience.                    South Africa’s loose fiscal policy, it needed to offset    average cash-plus fund 8.0% and tactical income
                                       this by running a very tight monetary policy. This         funds 7.5%. This compares to an average domestic
                                       has meant that, on a pre-tax basis, cash investors         equity fund return of 3.2% over the equivalent period
                                                                                                  and 4.4% for the average high-equity balanced fund.
Figure 1
CUMULATIVE FLOWS OF FIXED INCOME AND MULTI-ASSET FUNDS                                            Given the lower risk profile and lower volatility of
       R billion                                                                                  returns, it is no wonder that money market and
                                                                                                  income funds have attracted the lion’s share of flows.
250                                                                                               For the past five years, R252 billion has flowed into
200                                                                                               these funds, while equity funds and multi-asset funds
150                                                                                               with exposure to growth assets have experienced
100                                                                                               outflows of R150 billion (see Figure 1). What has been
 50                                                                                               surprising, however, is how this trend has continued
   0                                                                                              in 2020, even though the forward-looking opportu-
 -50                                                                                              nities are now very different.

                                                                                                  LOWER EXPECTED RETURNS
                                                                                                  A money market fund return profile is very different
   2016                   2017                  2018              2019        2020                from that of an equity fund. Where the return for
          Fixed income funds       Multi-asset and equity funds                                   equities can never be guaranteed and upside in
Sources: Morningstar, Coronation                                                                  any given year is effectively unlimited, in a money

                                                                                                                             TRUST IS EARNED™           5
Corospondent The Personal Investments Quarterly - Coronation
market fund you have a very good idea of what                      term money at a cheaper rate than the South
                                                  you are going to earn over the next 12 months.                     African government is able to, meaning the funds
                                                  On the day you invest you can easily obtain the                    can actually earn a negative spread over the
                                                  12-month yield, and, barring any surprise interest                 risk-free rate for lending to a quality company.
                                                  rate moves, that is exactly what you’ll earn. Further,
                                                  as policy rates are adjusted by only 0.25%-0.5%                    WHERE TO FROM HERE?
                                                  at a time, potential interest rate moves are also                  This leads to the debate as to what the alternatives
                                                  unlikely to result in a significantly different return.            for investors are. In 2020, despite the immense
                                                  And, given the low duration in money market and                    impact of the lockdown on the economy, South
                                                  income funds, a decline in rates triggers little to                African equities managed to return 7.0% for the
                                                  no capital gains.                                                  year and proved once again how difficult it is to
                                                                                                                     time equity markets based on macroeconomic
                                                  Today, given the poor state of the local economy,                  factors. And, this was despite the fact that many
                                                  the potential return from money market funds and                   South African companies saw their share prices
                                                  income funds is significantly different from those                 declining significantly (the more South African-
                                                  achieved historically. In 2020, the SARB aggres-                   biased FTSE/JSE Capped Shareholder Weighted
                                                  sively cut interest rates to their lowest levels in 50             All Share Index was up only 0.6%).
                                                  years. And with rolling lockdowns continuing to
                                                  weigh on the economy, rates are unlikely to increase               Over the next several years, given the very cheap
                                                  in the short term. The SARB has felt comfortable                   relative levels of the market, we expect equity
                                                  cutting rates given that official inflation is solidly             markets to continue to deliver solid returns. While
                                                  positioned in the Bank’s target range of 3%-6% and                 there is never guaranteed certainty in equity
                                                  they have more confidence in the fiscal prudence                   market returns, the balance of probabilities is
                                                  of the current government (see Figure 2).                          firmly in favour of equities being able to beat the
                                                                                                                     return that a money market fund is going to be
                                                  This has all been good news for borrowers, but, of                 able to achieve in the foreseeable future.
                                                  course, very bad news for savers. With the Johannes-
                                                  burg Interbank Average Rate offering a yield of                    Similarly, a multi-asset fund that can allocate
                                                  3.6% at the moment, the average money market                       between equities, longer dated bonds, property
                                                  fund is going to struggle to offer investors a mean-               and alternative assets, all of which offer meaning-
                                                  ingful return. This yield is at or below official                  ful return prospects, stands a far better chance of
                                                  inflation (which tends to be below actual inflation),              delivering a much more meaningful return than a
                                                  meaning that real returns will also be far worse than              money market fund.
                                                  they have been over the past five years.
                                                                                                                     In behavioural finance, it is a well-known fact that
                                                  A further challenge to income funds being able                     investors tend to allocate money to funds that
                                                  to return a yield ahead of this rate is the fact that              have performed well, and away from those that
                                                  credit spreads for good quality corporates have                    have underperformed, even though there are very
                                                  tightened significantly over the past few years. In                strong rational reasons for why they should be
                                                  fact, today a good quality corporate can borrow                    doing the exact opposite. Today there is a clear
                                                                                                                     inflection point, and we know, with a high degree
Figure 2
                                                                                                                     of certainty, that the potential returns from money
                                                                                                                     market and income funds will be significantly
          %                                                                                                          lower than those achieved for the last decade.

  12                                                                                                                 At the same time, over the same period, equity
                                                                                                                     markets have derated to the point where the divi-
                                                                                                                     dend yields alone of most domestic equities are in
                                                                                                                     excess of money market rates, and there is potential
    6                                                                                                                for capital appreciation over and above that.
                                                                                                                     For any investor with a long-term investment
                                                                                                                     horizon, allocating funds to the safety of cash
    0                                                                                                                is likely to be locking in significant underperfor-
    -2                                                                                                               mance relative to equity and multi-asset alter-
                                                                                                                     natives. The implications of taxation, with capi-
                                         Jan 06

                                                  Jan 08

                                                            Jan 10

                                                                     Jan 12

                                                                                 Jan 14

                                                                                          Jan 16

                                                                                                   Jan 18

                                                                                                            Jan 20
         Jan 00

                      Jan 02

                                Jan 04

                                                                                                                     tal gains and dividends taxed at a lower effective
                  Real repo rate, %        Repo, %         CPI, % year on year                                       rate than interest income, will only further increase
Sources: Statistics South Africa, South African Reserve Bank                                                         this differential. +

6                    COROSPONDENT
Corospondent The Personal Investments Quarterly - Coronation

Global outlook
Post-pandemic recovery in the balance of vaccines and
a return of confidence

By M A R I E A N T E L M E

      THE                 Good prospects of            Vaccines and                Fiscal and monetary policy        Emerging markets
                         an H2-21 recovery in         confidence will                 interventions should           with pre-pandemic
     QUICK              global markets despite         determine the               support economic activity        debt burdens will lag
     TAKE                 second lockdowns           degree of recovery              and restore confidence              in recovery

                             Covid-19 (and the subsequent lockdowns) is the           coming to an end, the economic impact may be
                             most severe exogenous shock to the global economy        exaggerated until further support is felt. Despite
                             in modern history. More akin to a natural disaster       this, the prospects for recovery in H2-21 are still
                             or war than a financial crisis, the supply shock         good. Not only is there positive news of a widening
                             the pandemic imposed on the global economy               availability of prioritised vaccines, but the nature
                             stunned a healthy system into the deepest recession      of the crisis, which has seen little financial sector
      Marie is an            in 70 years. Containment policies, which neces-          damage and relatively targeted income and
   economist with            sarily restricted mobility, were largely to blame        employment protection, bodes well for a growth
20 years’ experience
in financial markets.
                             for the massive loss of output in the first half of      recovery in the year ahead. That said, the strength
                             2020 (H1-20). But unprecedented, broad-based             of the recovery will depend on how the balance of
                             and aggressive policy responses across the globe         forces evolves.
                             were able to cushion the impact of the pandemic
                             on incomes, financial systems and governments’           Most analysts expect the global economy to see
                             ability to intervene, assisting in a sharp recovery      2021 growth off a shattered base. However, there is
                             in the second half of 2020 (H2-20). Given these          quite a range of opinion as to how strong and fast
                             events, the global economy managed to achieve            the recovery to pre-pandemic GDP levels, and the
                             a remarkable, if uneven, recovery during late-2020.      trajectory, will be. Two key factors will determine
                                                                                      the strength of the recovery – first, the speed with
                             The pandemic’s second wave has prompted                  which effective vaccines are deployed, and second,
                             renewed lockdowns in Europe, Japan, the UK and           the degree to which the impact of breaking the link
                             the US, as well as in many emerging markets, and         between containment and mobility sees a return
                             will stall some of this recovery momentum into the       of confidence to economies that were in relatively
                             new year. With many earlier relief programmes            good shape before the crisis hit.

                                                                                                                TRUST IS EARNED™            7
Corospondent The Personal Investments Quarterly - Coronation
1) The prospects of a widely available vaccine                   with commitment by producers to help, there
                                         in 2021 have improved, and many countries                        should be incremental and accelerating rollout
                                         are already implementing administration                          globally this year.
                                         programmes. While there is still some friction
                                         between the speed with which vaccines can be                     2) The size and nature of policy response to the
                                         produced and how widely and quickly they are                     pandemic in 2020 were remarkable, and facil-
                                         accepted and can be administered, it seems                       itated a sharp recovery in H2-2020. Income-
                                         sensible that vaccines that offer protection at                  targeted policies of a scale not seen before
                                         low risk will be popular. The availability of such               accounted for the bulk of fiscal interventions,
                                         vaccines in emerging markets will probably                       which the IMF estimates added nearly four
                                         take longer than in advanced economies, but                      percentage points (ppts) to global growth
                                                                                                          in 2020. This may become less supportive as
                                                                                                          some emergency programmes roll off, and in
                                                                                                          economies – largely emerging markets – where
Figure 1                                                                                                  fiscal space is more constrained.
                                                                                                          However, there is clear debate globally about
                                                                                                          the need to avoid a ‘fiscal cliff’ prompted by
                                                                                                          the premature withdrawal of policy support.
                                                                                                          The recently approved US expenditure
130                                                                                                       package is indicative of a change in thinking.
                                                                                                          The early withdrawal of fiscal support after
120                                                                                                       the 2008/2009 Global Financial Crisis (GFC)
                                                                                                          undoubtedly slowed the economic recovery.
                                                                                                          Governments are less likely to enforce the
                                                                                                          same degree of consolidation in 2021, although
                                                                                                          capacity to sustain expansions varies greatly
100                                                                                                       by country, again, with visible constraints in
                                                                                                          emerging markets.
    2019           2020          2021         2022          2023          2024         2025        2025
                                                                                                          CENTRAL BANK POLICY AND ACTION ARE
                                                                                                          KEY DRIVERS TO RESTORE CONFIDENCE
           World          Developed markets      Emerging markets           Asia        Emerging Europe
                                                                                                          Fiscal support is being underwritten by mone-
           Latin America        Middle East      Sub-Saharan Africa                 Neutral
                                                                                                          tary policies. Central banks in most developed
Source: IMF                                                                                               economies cut policy rates and deployed their
                                                                                                          balance sheets in stunning size to support fiscal
                                                                                                          sustainability during 2020. Utilising uncon-
                                                                                                          ventional policies initiated in the wake of the
Figure 2                                                                                                  financial crisis, developed market central banks
GLOBAL FISCAL POLICY TRACKER (GOVERNMENT DEBT TO GDP)                                                     were able to ensure ongoing market liquidity to
                                                                                                          fund fiscal policies and ensure overall borrowing
                                                                                                          costs remain exceptionally low. Some emerging
                                                                                                          market central banks followed, employing quan-
                                                                                                          titative easing strategies and credit policies
                                                                                                          to limit the impact of lockdowns on financial
                                                                                                          markets and the spillovers to the real economy.

                                                                                                          Available data suggest the combined quantita-
                                                                                                          tive easing and credit policies of the G4 (Brazil,
                                                                                                          India, Germany and Japan) central banks
                                                                                                          added $8 trillion to their balance sheets in 2020,
                                                                                                          boosting the size of these by 20ppts – compared
                                                                                                          to 7ppts in the aftermath of the GFC. As the
                                                                                                          recovery stalled in late 2020, the large central
    2019            2020            2021             2022            2023            2024          2025   banks have committed to ongoing monetary
                                                                                                          accommodation, which should provide support
           Developed markets            Emerging markets           Asia          Emerging Europe
                                                                                                          for fiscal policies in developed economies, as
           Latin America         Middle East         Sub-Saharan Africa
                                                                                                          well as emerging markets, as investors seek yield
Source: UBS/IMF                                                                                           in a low-yield world.

8           COROSPONDENT
Corospondent The Personal Investments Quarterly - Coronation
Figure 3
                                                                                                   general sentiment. All the factors discussed
                                                                                                   above provide the basis for a growth recovery
      %                                                                                            of some strength in 2021. But, critical to the
 70                                                                                          140   economic recovery prospects for this year will
                                                                                                   be the degree to which these interventions
 60                                                                                          120
                                                                                                   combine to restore consumer and business
 50                                                                                          100   confidence. For the recovery to be complete –
                                                                                                   for global GDP to return to pre-pandemic levels
 40                                                                                          80    – employment and investment need to recover
                                                                                                   to the same degree.
 30                                                                                          60

                                                                                                   LINGERING EFFECTS
 20                                                                                          40
                                                                                                   One area where recovery will undoubtedly lag
 10                                                                                          20    is the services sector, notably travel and tourism,
                                                                                                   but also parts of retail and business services.
  0                                                                                       0
                                                                                                   With inter-regional mobility constrained in most
  Mar 06        Mar 08    Mar 10     Mar 12      Mar 14     Mar 16       Mar 18     Mar 20
                                                                                                   parts of the world until a vaccine is widely and
          European Central Bank      US Federal Reserve Board        Bank of Japan (RHS)           compellingly implemented, a full employment
Source: Haver                                                                                      recovery in these critical sectors is unlikely. Cross-
                                                                                                   border restrictions are also likely to continue
                                                                                                   even as vaccines are rolled out.
Figure 4
US BUSINESS AND CONSUMER CONFIDENCE                                                                The labour market may be ‘scarred’ for some
      %                                                                                            time. A slow recovery will undermine the pace
160                                                                                          110   of employment growth, and long periods of
                                                                                                   under-employment tend to be reinforcing. That
                                                                                           105     said, the impact on incomes and domestic
                                                                                                   demand is less negative. Data from the US and
                                                                                                   Europe (and South Africa) suggest that a large
100                                                                                                proportion of job losses have been in lower-
                                                                                                   income occupations (mostly in the services
 80                                                                                          95    sectors). Fewer high-income jobs have been lost
                                                                                                   (unlike during the GFC) and ongoing income
                                                                                           90      support for these households should cushion the
 40                                                                                                economic impact of employment loss for some
                                                                                                   time. Importantly, savings rates have surged,
 20                                                                                                presenting a large potential source of demand
  Mar 10        Sep 11    Mar 13     Sep 14      Mar 16     Sep 17       Mar 19     Sep 20
                                                                                                   on recovery.
          US Conference Board CCI     US Small Business Optimism Index (RHS)

Source: Haver
                                                                                                   DEBT WEIGHS ON EMERGING MARKETS
                                                                                                   It isn’t clear cut how emerging markets will fare
                                                                                                   in the year ahead, as large imbalances have
                                    EASING OF GEOPOLITICAL TENSIONS                                been exposed and have worsened during the
                                    Geopolitical uncertainty should also diminish                  crisis, with striking intra-country variance.
                                    in the year ahead, creating a more construc-                   There are good prospects for growth to recover,
                                    tive political narrative. The transition to a new,             even if at a lag, as vaccines become effective.
                                    more conciliatory and cooperative US admini-                   Global tailwinds will also provide an important
                                    stration should ease the tension brought on                    boost to emerging markets. However, fiscal
                                    by the uncertainty of the past four years, help                fault lines may become more fragile in the
                                    reduce aggravated trade risks and see tradi-                   year ahead. Many emerging markets entered
                                    tional allegiances strengthened, rather than                   the crisis with persistent deficits, already-
                                    weakened. The conclusion of a Brexit deal                      large stocks of debt and limited fiscal head-
                                    eliminates the risk of a ‘hard’ no-deal, even                  room to support an economic recovery. Neces-
                                    if the economic cost to the UK of full with-                   sary fiscal provision and revenue losses have
                                    drawal is likely to linger. Overall, however,                  pushed these economies into uncertain fiscal
                                    this should be positive for global trade and                   positions, with doubtful sustainability.

                                                                                                                              TRUST IS EARNED™              9
Corospondent The Personal Investments Quarterly - Coronation
Figure 5                                                                                                           However, some emerging markets will have to
                                                                                                                   consolidate last year’s fiscal largesse, and this
                                                                                                                   may be an offsetting drag on growth, possibly
                                                                                                                   reinforcing areas of fiscal and political instability.

 90                                                                                                                RECOVERY MARKERS
                                                                                                                   Consensus seems to lie in a cautious recovery
                                                                                                                   outlook, with an incomplete recovery as the base-
 70                                                                                                                line for 2021. On balance, we are more positive
                                                                                                                   about the prospects for a close-to-full global
                                                                                                                   recovery in 2021, notwithstanding the plethora
 50                                                                                                                of tightening lockdowns currently under way.
                                                                                                                   Ultimately, what will drive ‘completion’ is a suffi-
                                                                                                                   cient recovery in business and consumer confidence
 20                                                                                                                based largely on credible fiscal and monetary
                                                                                                                   policy support to propel new investment and












                                                                                                           2022e   re-employment. Here we see advanced economies,
             South Africa      India          Brazil            Mexico           Emerging markets Asia             and China, as being best able to capitalise on the
             Emerging markets Europe, the Middle East and Africa                  Emerging markets ex China        current levels of policy support, for longer.
Source: UBS
                                                                                                                   INFLATION SURPRISES ARE NOT FAR-FETCHED
                                                       While the G20 has recognised the dire                       It is also worth highlighting that, while there is
                                                       position of many emerging markets and                       clearly some debate about the strength of a global
                                                       implemented the Debt Service Suspension                     recovery this year, there is less debate about the
                                                       Initiative (DSSI) for 73 qualifying countries               risk of higher inflation. If GDP fails to recover to
                                                       (the DSSI does not cover middle-income                      pre-pandemic levels, the implied global output
                                                       countries like South Africa), appeals to                    gap should persist, and demand pressure is likely
                                                       private creditors to do the same have been                  to remain low. This scenario certainly currently
                                                       unsuccessful.                                               underpins the monetary policy positioning and
                                                                                                                   communication of most global central banks.
                                                       The Institute for International Finance
                                                       estimates that nearly $7 trillion in emerging               However, a stronger recovery built on massive
                                                       market debt will fall due in 2021 – three times             policy support, especially for incomes, and with
                                                       the amount owed in 2020. While low interest                 a foundation of relatively healthy household
                                                       rates globally have been a considerable                     balance sheets, supported by a robust financial
                                                       support for emerging market government                      system and healthy credit pathways amidst strong
                                                       yields and will certainly continue to contribute            growth in transaction money, could certainly see
                                                       to easier financing conditions, this may not be             inflation pick up ahead of current expectations.
                                                       enough in 2021.
                                                                                                                   A number of additional drivers are also possible,
                                                       Several factors will determine these countries’             including shifting supply chains in the wake of
                                                       fiscal prospects. These include the strength of             the pandemic and retreating globalisation, a less
                                                       pandemic management, the starting fiscal                    constrained regulatory environment, the active
                                                       position, the pace of recovery – supported by               promotion of credit extension, and central banks
                                                       domestic growth strategies and policy imple-                explicitly targeting higher inflation.
                                                       mentation – and each country’s ability to
                                                       leverage global demand. The US reflationary                 The unexpected can happen. Markets and analysts
                                                       policy stance should boost emerging market                  are less focused on this risk than on a weaker
                                                       exports, and the ongoing recovery in China                  global recovery, despite its greater potential to
                                                       should be positive for commodity producers.                 disrupt financial and asset markets. +

10             COROSPONDENT

South African outlook
Good intentions and a renewed commitment to growth are not
enough to make government's financial position sustainable

By M A R I E A N T E L M E

      THE                    Procuring and                SA's fiscal position        Increased confidence is the          Global growth and
                        distributing a Covid-19           was already critical        elixir for boosting growth;        China recovery should
     QUICK                vaccine are crucial;              going into the             government policy action            provide a welcome
     TAKE                supply deficit weighs                 pandemic                    is a key factor too            tailwind; debt a drag

                             THE MOST IMMEDIATE challenge facing South                 that many vaccines currently under development
                             Africa is to effectively manage the Covid-19 pan-         may prove effective and become regulated in the
                             demic crisis. The country’s path to recovery will be      coming months.
                             dictated by its ability to vaccinate enough people
                             to restore mobility and open sectors that are             Expert opinion is that we will land enough vaccines
                             currently restricted. News on this front is sobering.     to cover about 10% of the population by the end
      Marie is an            South Africa has not been able to procure a large         of the year, starting in April in variable lots. This
   economist with            enough vaccine pipeline to adequately inoculate           implies that the population will still face addi-
20 years’ experience
                             most of the population. Under the COVAX initia-           tional waves of infection throughout the year, with
in financial markets.
                             tive, we have a commitment to receive enough              the next likely to hit during the vulnerable winter
                             vaccine to cover 20% of the population as supply          months. Even though the ANC’s National Executive
                             becomes available.                                        Committee has mercifully ruled out another hard
                                                                                       lockdown, this still exposes the economy to varying
                             In addition to this, government has managed               and ongoing degrees of restriction, with a poten-
                             to expedite an additional 1.5 million doses of            tially devastating impact on the vulnerable
                             the Oxford University-AstraZeneca vaccine for             services sector and the fiscus.
                             frontline workers, which is due in January and
                             February. Beyond this, the outlook is uncertain.          The failure to have adequate pipeline supply
                             Gross global supply has been allocated, and South         and a credible rollout strategy in place poses a
                             Africa cannot procure additional doses through            serious and prolonged risk to the economy. Some
                             bilateral agreements with producers unless it is at       hope comes from the mobilisation of considerable
                             the expense of another country. Expanding supply          private sector resources to administer vaccines, but
                             is difficult and will take time, although it is likely    supply remains a constraint. While encouraging

                                                                                                                    TRUST IS EARNED™      11
areas of economic resilience emerged at the end          Companies and households have had limited
                                            of 2020, and global tailwinds are potential sources      ability to invest and spend in a weak economy.
                                            of upside support for growth, domestic health and        Both economic and political constraints have
                                            containment risks are firmly to the downside.            also compromised their willingness to do so. Weak
                                                                                                     economic policy delivery (‘over promise’ fatigue)
                                            A PRÉCIS OF THE YEAR IN REAR VIEW                        and uncertainty related to critical aspects of the
                                            The Covid-19 crisis came at a bad time for South         economy’s regulatory framework combined to
                                            Africa. Growth in 2019 was just 0.1%, and in the         render very weak investment activity and associ-
                                            first quarter of 2020 (Q1-20), the economy was           ated low productivity.
                                            already in recession, deeply constrained by inade-
                                            quate electricity supply, as well as a range of opera-   When the pandemic hit and government imple-
                                            tional and organisational challenges at Eskom.           mented an early and hard lockdown, compliance
                                                                                                     was good, and there was a general support for the
                                            The unemployment rate was 29.1%, and the                 initiative. The central bank acted swiftly, cutting
                                            employment rate had fallen in annual terms               the repo rate cumulatively by 300 basis points
                                            in the second half of 2019 (H2-19). Per capita           (bps), reducing borrowing costs to the lowest level
                                            real GDP had declined every year since 2015              since the 1960s and, after some stalling, intervened
                                            and was -1.3% lower in 2019 than in 2018.                to ensure financial stability and the smooth func-
                                            Combined, these factors have undermined busi-            tioning of the money and rates markets, with regu-
                                            ness and consumer confidence.                            latory support for the banks.

Figure 1                                                                                             The National Treasury, already constrained by
REAL PER CAPITA GDP, % Y/Y                                                                           a weak fiscal position, tabled an Amendment
       %, y/y                                                                                        Budget in June. The total relief package was billed
   5                                                                                                 at R500 billion, but R130 billion was repriori-
                                                                                                     tised from the Budget. Adding this to an antici-
                                                                                                     pated loss in revenue implied a deficit of -14.6%
   3                                                                                                 of GDP, with debt likely to step up 18.3 percentage
   2                                                                                                 points (ppts) of GDP, from 63.5% to 81.8%, and
                                                                                                     expected to rise further over the medium term.

   0                                                                                                 Playing in the background of the economic crisis,
                                                                                                     the ebb and flow of factional politics continued
                                                                                                     in 2020. There were notable successes at the rein-
                                                                                                     forced National Prosecuting Agency, but this was
  -3                                                                                                 tempered by the ruling party’s failure to credibly
   2000             2003             2006            2009            2012          2015       2018   address corruption and restore confidence.
          Real per capita GDP, % y/y          Average                                                Ongoing delays in the implementation of economic
Source: South African Reserve Bank                                                                   strategies, such as the release of spectrum,
                                                                                                     remained sources of frustration and criticism.
Figure 2
                                                                                                     Attempts to address both the capacity of the
                                                                                                     State and to get things done, nonetheless, had
110                                                                                                  some successes as the economic crisis helped focus
                                                                                                     political attention on reviving the economy and
                                                                                                     the government’s financial position. Despite this,
100                                                                                                  ongoing fiscal support for insolvent State-owned
                                                                                                     enterprises (SOEs) remained a critical and conten-
                                                                                                     tious drain on limited resources.

                                                                                                     The lockdown in Q2-20 saw GDP collapse by
                                                                                                     51.7% quarter on quarter (q/q) seasonally adjusted
                                                                                                     and annualised (-17.5% year on year [y/y]), with
                                                                                                     2.2 million associated job losses. This was the big-
 70                                                                                                  gest loss of output in South Africa’s recorded GDP
  Mar 15          Dec 15      Sep 16        Jun 17      Mar 18         Dec 18      Sep 19   Jun 20   history. But the Q3-20 recovery in activity was much
          Total        Private consumption expenditure                                               better than expected, with GDP rebounding 66.1%
          Government consumption expenditure                Gross fixed capital formation            q/q, seasonally adjusted average, and accompa-
Source: Statistics South Africa                                                                      nied by a partial recovery in employment.

12              COROSPONDENT
A closer look at the real economy showed some           2021: A MIXED BAG OF OPPORTUNITY AND
                                           recovery in incomes and stronger household              RISK, THREATENED BY THE FAMILIAR PATH
                                           balance sheets, as well as corporate profits.           OF POLICY COMPROMISE
                                           Household real net disposable income recovered          Against this weak but improving economic
                                           from a fall of 15.7% y/y to -3.9% y/y. The household    backdrop, the outlook for 2021 hangs in the
                                           debt burden reduced to 75.7% of disposable              balance between domestic economic resilience
                                           income, from a spike to 86.5% in Q2-20 and an           underpinning domestic demand and a combina-
                                           average level of 73% in 2019. Importantly, debt         tion of the impact of the second wave and
                                           servicing costs benefited from materially lower         the risk posed by existing areas of weakness,
                                           interest rates and, at 7.5% of disposable income, is    including weak policy implementation, electri-
                                           at a multi-decade low. Credit availability remains      city constraints, poor public sector capacity and a
                                           good, but is constrained by the limited appetite for    fragile fiscal foundation. Global recovery factors
                                           additional debt. Household savings rose, with both      also count, with the possibility that these may
                                           the inability to spend and rising precaution contrib-   provide a significant tailwind to the South African
                                           uting to the increase. Given the improvement            economy. Government’s growth strategy and
                                           in key household metrics, with growth momen-            commitment to fiscal sustainability – with critical
                                           tum into Q4-20, we forecast a collapse in real GDP      focus on actual implementation – will dictate the
                                           in 2020 of -7.2%.                                       shape of the economic outcome.

                                                                                                   WEAK VACCINE STRATEGY
Figure 3                                                                                           The most immediate obstacle to recovery is a
HOUSEHOLD DEBT AND COST OF SERVICE                                                                 currently weak vaccine strategy. Some news of
                                                                                                   additional vaccine procurement is positive but
 90                                                                                          15    inadequate. Importantly, government is not
                                                                                                   expected to implement another economically
 85                                                                                                damaging hard lockdown, but a combination of
                                                                                                   partial restrictions, ongoing uncertainty and slow
 80                                                                                          12    vaccine progress will continue to weigh heavily on
                                                                                             11    the services sector, particularly tourism and recre-
                                                                                                   ation, with a likely increase in long-term scarring.
                                                                                                   Foreign tourism will also not recover until South
 70                                                                                          9
                                                                                                   Africa is deemed a safe destination with respect
                                                                                                   to Covid-19.

 60                                                                                          6
                                                                                                   OUTLOOK FOR GROWTH RECOVERY
  Mar 07          Mar 09        Mar 11          Mar 13       Mar 15       Mar 17   Mar 19          Looking at the drivers of expenditure-side GDP
           Debt to disposable income (LHS)         Debt service costs (RHS)                        growth, a recovery in consumption expendi-
Sources: Statistics South Africa, Coronation
                                                                                                   ture has mixed potential. Private consumption
                                                                                                   expenditure (PCE) accounts for about 60% of
                                                                                                   GDP and, in Q3-20, contributed 43.8ppts to the
Figure 4                                                                                           surging recovery. PCE is driven by a combination
PUBLIC AND PRIVATE EMPLOYMENT                                                                      of employment growth, real income growth, and
       million                                                                                     the availability of credit and consumer confi-
7.60                                                                                        2.85   dence – people’s ability and willingness to spend.
                                                                                                   After the sharp fall in employment, there has been
7.20                                                                                               only a partial recovery, and formal employment
                                                                                            2.70   is still 6.3% below the pre-crisis level. Although
7.00                                                                                        2.65   marginal, President Ramaphosa’s Employment
                                                                                            2.60   Stimulus Programme update in November
                                                                                                   detailed good progress on this front too.
                                                                                                   Incomes remain constrained but also experien-
                                                                                            2.45   ced a strong recovery in the third quarter as mobi-
6.20                                                                                        2.40   lity constraints eased. Net disposable income
   Mar 15            Mar 16            Mar 17            Mar 18        Mar 19      Mar 20          is down -3.2% year to date in nominal terms –
           Formal, private non-agricultural employment                                             after a 13.6% y/y collapse in Q2-20 – while total
           Community employment (RHS, QES)                                                         compensation is down 1.6%, including the Q3-20
Source: Statistics South Africa Quarterly Employment Survey data                                   recovery, after falling 7.2% in Q2-20.

                                                                                                                            TRUST IS EARNED™          13
In real terms, these are down -6.3% and -4.8%,          Figure 5
respectively, year to date, but with solid positive     HOUSEHOLD SAVINGS, % DISPOSABLE INCOME
momentum. For households that derive a signifi-                %
cant proportion of their income/wealth from              1.0
financial assets, the loss of dividend income has
hurt, but the positive financial market perfor-
mance should provide a fillip.                             0

Savings balances (which represent residual cash)
have surged. Measured as a proportion of disposa-
ble income, savings were 0.7%, the highest since        -1.5
early 2005. This is likely a reflection of a combina-
tion of an inability to spend and greater precau-
tions taken. But it also creates the potential for a    -2.5

recovery in spending, while low interest rates and      -3.0
reasonably healthy balance sheets provide the            Mar 05         Mar 07       Mar 09           Mar 11        Mar 13    Mar 15   Mar 17   Mar 19

opportunity for stronger credit growth as incomes       Source: South African Reserve Bank
and confidence improve.

We forecast a modest increase in disposable
                                                        Figure 6
income as employment in hard-hit sectors, such as
                                                        REAL ANNUAL GROWTH BY COMPONENT, YEAR TO DATE
manufacturing, construction and parts of business
services, improves. We see little prospect yet for                                        %

increased employment in the trade sectors, and                              Net trade                                                                    92.0

this remains a drag. With a forecast of real income     Government consumption
growth of 1%, and a small contribution from                         expenditure

increased credit utilisation, ongoing low interest             Personal consumption
rates and some improvement in confidence, we
forecast real growth in private consumption of                                   Total                -7.9

2.7% in 2021, and 2.5% in 2022.                                    Gross fixed capital        -17.6
                                                                                     -40          -20          0         20      40     60      80        100
There is a more positive tilt to the outlook for
gross fixed capital formation; but, again, pan-         Source: Statistics South Africa

demic, regulatory and capacity constraints per-
sist. Private sector investment may get a fillip
from the expansion of renewables within the new         We expect the economy to grow 3.1% in 2021,
energy framework, and investment in machinery           with uncertain lockdown restrictions a considera-
and equipment could be supported by ongoing             ble downside risk, while income recovery and
adjustments to working from home. However, with         net trade should provide a meaningful fillip.
profitability under pressure and poor prospects for     This is a below-consensus forecast. Our forecasts
State-funded investment, we expect gross fixed          assume that capital expenditure will remain a
capital formation to remain weak and detract            drag on growth in the year ahead, although a
from growth momentum in the year ahead.                 more meaningful implementation of energy-
Visible progress in reducing the constraint the         related investment could see this number improve.
State places on the economy by engaging more            Massive inventory drawdowns were a significant
with the private sector has the potential to boost      detractor from growth in 2020; a more modest
confidence – the magic ingredient for growth.           drawdown in 2021 will add positively to growth
                                                        momentum. We do not assume – given power
Net trade was a considerable tailwind for growth        constraints – any meaningful inventory accumu-
in Q3-20, contributing an annualised 38.3ppts           lation over the forecast period.
to the recovery. Both mining and manufacturing
export volumes recovered strongly from the hard         Importantly, this recovery profile does not see GDP
stop of Q2-20, and agricultural exports contributed     levels return to pre-pandemic levels until 2023.
further. While terms of trade remain elevated and       This weak recovery implies that the output gap
domestic demand – notably investment – remains          will remain negative, with little demand-related
depressed, the recovery in global growth and            inflation pressure expected to emerge. Overall
trade volumes should provide a welcome tailwind         headline CPI is forecast to remain below the central
to growth into 2021. There is also further potential    point of the South African Reserve Bank’s (SARB)
uplift for export value from a recovering China.        target range in 2021 and 2022, before rising above

it in 2023. We expect monetary policy to remain                                  and improving the outlook, but South Africa’s fiscal
                                             accommodative and see room for the SARB to                                       weaknesses extend beyond this. There are three
                                             cut the repo rate again to 3.25% in early 2021, as                               interrelated challenges:
                                             growth falters once more. At current levels, policy
                                             rates are at levels not seen since the late 1960s.                               1. Weak and disappointing revenue growth, partly
                                                                                                                                 owing to weak nominal GDP growth and partly
                                             FINANCIAL DEFICIT A HEAVY DRAG                                                      due to the collapse of the tax collection infra-
                                             Government finances were the biggest casualty of                                    structure. Over-estimating revenues upon which
                                             last year’s crisis and remained a significant source                                multi-year expenditure is allocated has led to a
                                             of domestic economic fragility. Of course, better                                   decade of persistently large deficits.
                                             growth would go a long way to boosting revenues
                                                                                                                              2. The composition and size of expenditure,
                                                                                                                                 notably the public-sector wage bill, and there-
Figure 7                                                                                                                         fore the rising debt service burden, must change.
GDP FORECASTS, CONTRIBUTIONS BY COMPONENT SERIES                                                                                 Decisions related to the size of government
                                                                                                                                 were taken as long ago as 2007/2008 when
       %                                                                                                                         public-sector salary structures were expanded
  6                                                                                                                              to protect and attract scarce skills in health and
                                                                                                                                 education. Several generous multi-year agree-
                                2.8                                                      3.1
                                                                                               2.5     2.4     2.1
                                                                                                                                 ments, coupled with aggressive State employ-
                   2.9                 1.7                                                                            2.0
  2                      2.5                   1.3
                                                            1.1   0.7                                                            ment growth saw the consolidated public-sector
                                                     0.6                  0.1
                                                                                                                                 wage bill expand from 33% of expenditure to
                                                                                                                                 36%. While efforts have been made to limit
  -2                                                                                                                             its expansion through headcount limitation,
                                                                                                                                 this has had little effect, as wage growth has
                                                                                                                                 outpaced both inflation and GDP growth.
                                                                                                                              3. Ongoing decisions to bail out SOEs have
 -8                                                                              -7.2
                                                                                                                                 undermined much of the fiscal discipline
                                                                                                                                 imposed elsewhere over the past five years.
           2010                2013                  2016                2019                  2022f                  2025f      Since 2008/2009, Eskom, SAA, the SABC and
                                                                                                                                 the Land Bank combined have cost taxpayers
           Private consumption                 Government expenditure                   Fixed investment
                                                                                                                                 R229 billion. This is no longer affordable.
           Net exports           Stocks              GDP

Sources: Statistics South Africa, Coronation
                                                                                                                              These fiscal vulnerabilities are well known. Conse-
                                                                                                                              cutive budgets, and finance ministers, have attemp-
                                                                                                                              ted to right-size the large expenditure commit-
Figure 8                                                                                                                      ments – especially the wage bill – but successive
HEADLINE CPI AND REPO RATE (INCLUDING FORECAST)                                                                               crises, mostly related to SOEs, amidst very weak
                                                                                                                              growth, have systematically worsened an already
                                                                                                                              weak position.

                                                                                                                              The December ruling in favour of the National
                                                                                                                              Treasury in its dispute with public sector unions
  8                                                                                                                           over the suspension of the final year of its wage
                                                                                                                              agreement in 2019/2020 will go a long way to
  6                                                                                                                           improve the starting position for right-sizing wages
                                                                                                                              within expenditure. Assuming the full R38 billion is
  4                                                                                                                           saved, the consolidated public-sector compensa-
                                                                                                                              tion budget should return to 33% of expenditure
                                                                                                                              in 2020/2021. While this is clearly a ‘win’ for the
                                                                                                                              National Treasury, much still hinges on the forth-
                                                                                                                              coming wage agreement and the wider govern-
 -2                                                                                                                           ment backing of a painful consolidation plan.
 Jan 09             Jan 11            Jan 13          Jan 15            Jan 17           Jan 19              Jan 21

           Real repo, one-year forward                CPI, % year on year               Repo
                                                                                                                              Even with some consolidation in our numbers, fiscal
           Lower             Upper             Core, % year on year
                                                                                                                              metrics remain very weak. With a modest improve-
                                                                                                                              ment in GDP growth, a slightly more robust rate of
Sources: Statistics South Africa, Coronation
                                                                                                                              GDP inflation (boosted by terms of trade), gains in

                                                                                                                                                       TRUST IS EARNED™         15
revenue somewhat ahead of initial expectations,                                        position required to stabilise debt dynamics –
                                                      and relatively contained expenditure, the main                                         seems economically and politically unlikely. South
                                                      budget deficit is still set to be -14.3% of GDP in the                                 Africa also does not enjoy the happy balance of
                                                      current fiscal year. Excluding interest costs, this is                                 nominal growth rates that exceed the average
                                                      still a primary deficit of -9.6% of GDP.                                               nominal cost of servicing government debt. In the
                                                                                                                                             absence of both, debt will continue to accumulate.
                                                      A recovery in revenues and improved GDP growth
                                                      should see this narrow to -10.2% and -5% of GDP,                                       DEBT MANAGEMENT CRITICAL
                                                      respectively, in the coming year, assuming the                                         Rising debt is economically costly; it lowers invest-
                                                      new wage agreement limits annual increases to                                          ment and productivity, and undermines growth
                                                      below inflation (we assume 3% nominal). But this                                       through time. It also implies that as debt is accu-
                                                      deficit is large, and the fiscal adjustment required                                   mulated, government is forced to issue more,
                                                      to push the deficit to a balance – or the surplus                                      not only to fund expenditure but also to pay off
                                                                                                                                             maturing debt in an endless cycle.

Figure 9                                                                                                                                     This reinforces the dynamics that compound the
RELATIVE EXPENDITURE GROWTH BY COMPONENT, INDEX                                                                                              problem and may accelerate a crisis. Ultimately,
                                                                                                                                             this will become unsustainable. The IMF defines
1 500
                                                                                                                                             debt as sustainable when a government can
                                                                                                                                             meet all current and future payment obligations
                                                                                                                                             without exceptional financial assistance or going
1 250                                                                                                                                        into default.

1 000                                                                                                                                        History tells us that sovereigns are poor at mitiga-
                                                                                                                                             ting the risk of looming debt crises, and financial
                                                                                                                                             markets, in a world of extremely low global rates,
                                                                                                                                             may not impose adequate discipline early enough.

                                                                                                                                             Our own economic history is littered with many
                                                                                                                                             sensible plans and good intentions, but, at best,
                                                                                                                                             extremely weak public policy execution. Even with
                                                                                                                                             the best intentions and a renewed commitment
          2013/14           2014/15              2015/16                2016/17       2017/18        2018/19          2019/20
                                                                                                                                             to a sensible growth strategy, the road to fiscal
            Main budget expenditure, ex-debt, wages and SOEs                                                                                 sustainability for South Africa is likely to remain
            Compensation                       Debt                SOEs                                                                      very challenging.+
Source: National Treasury

Figure 10
  6                                                                                                                                    100

  4                                                           3.4 3.4
                      2.8         2.93.0 2.7               2.7
  2             1.8                                  1.8                                                                               80
                                                                                               -0.5                             -0.5
                                                                                           -1.0 -1.0 -1.0                    -1.1
 -2                                                                                    -1.3
                                                                                   -1.6                 -5.0                           50
 -4                                                                       -3.3 -2.6
                                                                                                                  -4.1                 40
 -8                                                                                                                                    20
-10                                                                                                        -9.6                         10

-12                                                                                                                                     0
 1994            1999                     2004                      2009                2014             2019                 2024f

          Primary balance, % GDP                              Gross debt, % GDP (RHS)

Sources: South African Reserve Bank, National Treasury, Coronation

16          COROSPONDENT

A revival in the life
insurance sector
Growth potential at MMH undervalued

By N I C H O L A S S T E I N

     THE                      Pandemic-induced            With drag factors          MMH’s current discount             New management
                           headwinds to still-cheap      accounted for, a 2021         to embedded value                and a re-energised
    QUICK                  life companies are short      earnings recovery is        does not reflect positive        distribution channel
    TAKE                            term                  likely to be robust           future prospects             bolster growth potential

                               CORONATION OWNS STAKES in both Sanlam                   in-force books of business that generate on-
                               and Momentum Metropolitan Holdings (MMH)                going fees, often based on asset levels (which
                               on behalf of clients. Sanlam has long been a share      are driven by stock market levels). This makes
                               we wanted to own, but its persistent premium to         them a bit more defensive.
                               embedded value (a measure of a life company’s         • Tied to this, we believe the JSE offers compel-
                               intrinsic value) left little margin of safety. The      ling value at the moment. A strong stock market
Nicholas Stein is an           Covid-19-induced selloff in March hit high-quality      lifts the asset levels on which fees are earned.
equity analyst with
11 years’ investment
                               and low-quality businesses indiscriminately and       • Above-average returns on equity through the
    experience.                provided us with a good entry point to acquire          cycle.
                               shares in Sanlam below its embedded value. We         • Very strong capital positions designed to with-
                               suspect, however, that readers will find our Sanlam     stand 1-in-200-year stress tests. Companies that
                               purchase uncontroversial and may be more inter-         are inadequately capitalised are often forced
                               ested in the thought process behind our MMH             into sub-optimal decisions at wrong points in
                               stake.                                                  the cycle.

                               LIFE COMPANY ATTRIBUTES                               And yet, while the share prices of many domestic
                               Life companies may be considered mature and           shares have recovered meaningfully from their
                               boring, but they have attributes that contribute      March lows, most life insurers are not trading far
                               to their desirability:                                off them (see Figure 1 overleaf). We suspect there
                                                                                     are two main reasons for this:
                               • Extensive distribution networks of advisers that
                                 are complex to manage and costly to replicate.      • Life companies’ earnings (and to some extent
                               • A number of companies faced existential               embedded values) were hit very hard this year.
                                 threats from Covid-19, for example, restau-         • A dividend mainstay as life companies ceased
                                 rants and landlords. Life companies have large        dividend payments.

                                                                                                                 TRUST IS EARNED™      17
Yet these reasons are short term. When the life                                    knock to embedded value and a R1 billion knock
                                                       insurance companies reported their June results                                    to reported earnings. However, by taking the pain
                                                       this year, markets had not fully recovered. Credit                                 upfront, life companies should see 2021 earnings
                                                       spreads also widened materially. Both factors                                      rebound quicker than the typical company.
                                                       impact earnings meaningfully (negatively to June),
                                                       but have already started reversing. Perhaps more                                   We would also expect most companies in this
                                                       importantly, life companies ‘front-end loaded’                                     sector to resume dividend payments when they
                                                       the earnings pain caused by Covid-19 by raising                                    report in February and March 2021.
                                                       provisions for the expected financial impact and
                                                       expensing them through their income statements.                                    MMH
                                                       For example, MMH assumed its share of 40 000                                       MMH trades at a record 40% discount to embed-
                                                       Covid-19-related deaths and expensed this. The                                     ded value (Figure 2). We find this surprising for
                                                       company also assumed that 50% of policyholders                                     three reasons:
                                                       requesting premium holidays would lapse, and
                                                       up to 10% of all other policyholders, too. MMH                                     • The Covid-19 provision has resulted in a more
                                                       also expensed this. This resulted in a R1.3 billion                                  conservatively stated embedded value.
                                                                                                                                          • Over the last few years, management has
Figure 1
                                                                                                                                            made the life and non-life valuations within
LIFE INSURANCE INDEX VERSUS BROADER MARKET INDEX FROM                                                                                       the embedded value more conservative (effec-
COVID-19 ONSET TO PRESENT                                                                                                                   tively using a lower price earnings/discounted
       %                                                                                                                                    cash flow to value their own business).
110                                                                                                                                       • The new management team under Hillie Meyer,
                                                                                                                                            Jeanette Marais and Risto Ketola has done a
100                                                                                                                                         good job in turning around the operating perfor-
                                                                                                                                            mance of the group.

                                                                                                                                          As such, the 40% discount to embedded value is
                                                                                                                                          even starker than it first appears, given that the
                                                                                                                                          embedded value is far more credible and conser-
                                                                                                                                          vative than it was previously, and the company’s
 60                                                                                                                                       business prospects are brighter.

 50                                                                                                                                       NEW BROOM UNDERESTIMATED
                                                                                                                                          The last point on the new management team
      Dec 19

                  Jan 20

                            Feb 20

                                     Mar 20

                                              Apr 20

                                                          May 19

                                                                   Jun 19

                                                                              Jul 19

                                                                                       Aug 19

                                                                                                 Sep 19

                                                                                                          Oct 20

                                                                                                                   Nov 20

                                                                                                                            Dec 20

                                                                                                                                          and the operational turnaround warrants further
               JSE Life Insurance Index                FTSE/JSE Capped SWIX All Share Index                                               discussion. New management has been in place
Source: IRES                                                                                                                              since early 2018. In our view, the market is not
                                                                                                                                          recognising the turnaround currently under
                                                                                                                                          way and is adopting a wait-and-see approach.
Figure 2                                                                                                                                  Turnarounds often take time to fully manifest in
LIFE COMPANIES’ PRICE TO EMBEDDED VALUE HISTORY                                                                                           reported numbers, but we believe there are some
       %                                                                                                                                  very encouraging signs that the market isn’t
100                                                                                                                                       attaching sufficient weight to.
                                                                                                                                          Some divisions within MMH, such as Employee Bene-
 60                                                                                                                                       fits and Guardrisk, have historically performed
 40                                                                                                                                       well versus their peers. However, there are also
                                                                                                                                          signs that previously lagging divisions are turning
 20                                                                                                                                  12
                                                                                                                                          around. A driving force behind these improve-
                                                                                                                                          ments is the reintroduction of divisional profit
                                                                                                                                          and loss statements, which has boosted divisional
                                                                                                                                          management accountability.
-40                                                                                                                              -41
                                                                                                                                          • Both Metropolitan and Momentum have been
   2004                     2007                   2010                     2013                2016               2019                     growing their tied agency forces ahead of
               Old Mutual            Liberty Holdings                 Sanlam                                                                the broader market, suggesting life insurance
               Discovery*            Momentum Metropolitan Holdings                                                                         agents are starting to view them as attractive
*Embedded value excludes emerging and startup entities
                                                                                                                                            places to work. Improved product offerings and
Sources: Company data, Bloomberg, Avior Capital Markets                                                                                     service levels to agents support this.

18               COROSPONDENT
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