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corospondent
The Institutional Quarterly
Turning
points
SUMMER EDITION
JANUARY 2020
IN THIS ISSUE
03 13 25
Kirshni on point Bond outlook Demonetisation:
India’s bolt from the blue
06 17
The investment case for Retirement: making
29
South African equities value judgements 2019 fourth quarter
in review
08 22
Economic comment The investment case
for Distell
7th Floor, MontClare Place, Cnr Campground & Main Roads, Claremont 7708. PO Box 44684, Claremont 7735. Telephone: 021 680 2000 www.coronation.com
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investment or other professional advice and formulate an appropriate investment strategy that would suit the risk profile of the reader prior to acting upon such
information and to consider whether any recommendation is appropriate considering the reader’s own objectives and particular needs. Neither Coronation Fund
Managers Limited nor any subsidiary of Coronation Fund Managers Limited (collectively “Coronation”) is acting, purporting to act and nor is it authorised to act
in any way as an adviser. Any opinions, statements or information contained herein may change and are expressed in good faith. Coronation does not undertake
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that any performance information is provided herein, please note that: Performance is calculated by Coronation for a lump sum investment with distributions, to
the extent applicable, reinvested. Performance figures are quoted gross of management fees after the deduction of certain costs incurred within the particular fund.
Fluctuations or movements in exchange rates may cause the value of any underlying international investment to go down or up. Coronation Fund Managers Limited
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On the cover: To herald the turning of the decade, we take a look at the world from a broad perspective as the impact of geopolitics is being felt in both global
economic policy and the markets. That said, while cognisant of these events and their impact on sectors and regions, we remain committed to our bottom-up,
valuation-driven investment approach.
chasing likes on Instagram nor venting through
the 140-character limit on Twitter. The tech
revolution materially shaped the last 10 years.
While it has mostly acted to improve friction
points in our daily lives, it has, of course, given rise
to other issues.
Sporting highs shaped the beginning and end
of this last decade. 2010 was all about ‘Ke Nako’
(‘it’s time’), and hope and euphoria filled our
streets as we hosted a very successful Football
World Cup. The vibrancy of our national spirit
was shared with the world one vuvuzela at a time.
And let’s not forget last year’s fantastic win by the
Springboks who proudly brought home the Webb
Ellis trophy, reminding us that we are indeed
#StrongerTogether.
But despite these exhilarating moments, the last
decade has also been a truly dark and depressing
one for our country.
A dark decade for South Africa
And I don’t just mean loadshedding! The 2010s
was a troubling decade for local politics, with
systemic corruption epitomised by #ZuptaMustGo
and #PayBackTheMoney – neatly describing
deeply entrenched State Capture and the gross
Kirshni on point
mismanagement of State-owned entities. The
hope and potential that were heralded by being
included in the rising BRICS grouping has faded,
and we currently stare economic ruin firmly in the
Pause and reflect. face. The full costs of rebuilding our economy,
and the repercussions of these years of corruption
on society and investor confidence will have
a material impact on the country for the next
By K I R S H N I T O T A R A M
decade at the very least.
The global environment has gone through
Kirshni is Global HAPPY 2020 AND welcome to the first edition of immense change
Head of Institutional
Business. She joined
Corospondent of the new decade. I know it’s a Globally, we have seen a decade of unprece-
Coronation in 2000. cliché, but it really is scary how quickly time has dented monetary stimulus, resulting in the longest
gone by and, by that measure, how many of us in bull market in US history, and taking global stock
this industry have matured. For me, entering this markets to lofty valuations.
new decade offered a moment’s pause to reflect
on the last 10 years and the experiences that have In 2020, we move into an election year in the
shaped us and left us, hopefully, wiser. US, following the December 2019 election in
the UK. One cannot help but reflect on the
REFLECTING ON THE HIGHS AND LOWS stark contrast between the Obama/Cameron
The start of 2010 was still very much charac- leadership combination and the Trump/Johnson
terised by the aftermath of the Global Financial duo currently occupying office. Both incumbents
Crisis. This hangover continued to mar investor are controversial characters, arguably elected
confidence for the whole of the last decade, through harnessing the power of social media
leaving trust levels in the financial services sector and targeting disenfranchised voters who feel left
at an all-time low. behind in this disrupted world.
There was no Spotify, Uber or Netflix (I really When the G20 gathered in London in 2009, only
can’t remember how I binge-watched those series a small minority of world leaders would have
– DVD box sets, I think!). And of course, neither fitted the right-wing populist mould. Fast forward
TRUST IS EARNED™ 3
the decade and radical-right populist parties granted. Our organisational values have stood
are securing an increasing number of votes and the test of the ups and downs and continue to
parliamentary seats across the globe – a marked endure today.
shift for the first time since WWII.
Our role in uplifting communities through our CSI
One leader who has managed to maintain his initiatives and ensuring that our own business
grip on power throughout is Russia’s Vladimir reflects the demographics of our country are also
Putin, who has led the country since 1999! His deeply important to us.
efforts to reassert his global influence and
return to superpower status have endured, but And it is with great pride that I note that we
his attempts to revitalise Russia’s economy have finished this decade as we did the last, with
languished. very strong returns for our clients’ portfolios,
continuing to show the strength and resilience of
The rise and rise of China our long-term, active investment approach. The
China delivered the most remarkable economic long-term track records across all our strategies
transformation in history over the past decade have delivered meaningful value to our clients,
– transitioning from an emerging market to the with 97%1 of our institutional client assets experi-
second-largest economy in the world. Its large, encing positive outperformance since inception.
successful companies such as Huawei, Tencent
and Alibaba, have shown great innovation, Figure 1 shows the long-term returns produced by
expanding to now operate head-to-head with US Coronation’s flagship Houseview Equity Strategy
giants such as Apple, Alphabet (then Google) and since its inception in September 1993. As you
Amazon. can see, our active investment approach has
resulted in investors earning 16.1% p.a.2 on their
It is because of China’s rise and subsequent investment over this period.
dominance that we expect global geopolitics to
remain tenuous, despite the fragile trade truce
reached with the US in January 2020. Figure 1
CORONATION HOUSEVIEW EQUITY
Climate change and the Greta effect R million
Global concern for the environment grew through 6
5 027 792
the decade. And when the teenage Swedish (16.1% p.a.)
activist Greta Thunberg launched her solo 5
climate protest outside her country’s parliament
4
building in 2019, her defiant action sparked
a global movement that established her as a
3
powerful influencer on climate change and saw 3 134 592
her being nominated for a Nobel Peace Prize. 2
(14.0% p.a.)
The impact she has made in such a short time
through lobbying political leaders and rallying 1
her supporters is extraordinary. Now we need to
see actual policy change that adequately deals 0
Sep 18
with the significant challenges we currently face. Sep 93 Sep 98 Sep 03 Sep 08 Sep 13
Coronation Houseview Equity
A clear illustration of the devastating impact of Benchmark3: JSE Capped Shareholder Weighted Index (Capped SWIX)
climate change must certainly be the Australian Source: Morningstar
bushfires that have ravaged the country since
September 2019. Governments around the world
surely don’t need more of a wake-up call. This is an important consideration, given the
massive and disruptive rise of index investing
Trust is Earned over the decade – most recent indications show
Of course, no reflection is complete without that index investing now accounts for in excess of
looking back at our own organisation over the 50% of assets in the US, compared to less than
past 10 years. Our purpose and passion have 10% in 2010.
remained steadfast – not just in the last decade,
but in the entire 26 years since we opened our 1
as at 31 December 2019, funds with a 10-year + history.
doors. We help millions of people achieve their 2
Gross of fees
long-term financial goals – such as a better 3
FTSE/JSE Capped Shareholder Weighted Index from 01 May 2017.
Previously 50 Low Resources (inception to 31 January 2002) and FTSE/JSE
retirement. It’s a privilege we never take for Shareholder Weighted Index (01 February 2002 to 30 April 2017).
4 COROSPONDENT
Putting our clients first to cross”. The hardships endure for South Africans
During the decade, we showed in tangible ways and the low expected growth forecast for South
how we prioritise the needs of our clients. An Africa in 2020 is woefully inadequate if the country
excellent example is when we closed our South is to solve the triple challenge of unemployment,
African institutional book to new clients in 2012. poverty and inequality successfully.
This was the largest and longest close ever by a
South African asset manager. It was a pre-emptive As we look ahead to 2030 and beyond, we are
move to ensure that we did not take on additional entering a decade – or even two decades – of
client assets and impair our ability to outperform. lower expected investment returns. For the South
We re-opened our strategies to new clients in 2017. African looking ahead across the years to their
own retirement, what should their strategy be to
Going global thrive in this low-return environment?
Another milestone during the last decade was
welcoming our first global clients. Since launching Our nation desperately needs to develop a
our global franchise in 2008, we have established stronger culture of saving. And it will require
world-class track records across our entire range behavioural change at the individual level. The
of global developed, emerging and frontier key for any saver is to start to put money away
markets. All our global strategies, with a track for their future as early as they can. It is simply not
record of more than a decade, have outperformed possible to play catch up later in such a muted
meaningfully since inception. We are pleased with return environment. We will endeavour to educate
the strong performance of our Global Emerging South Africans through our various channels to
Markets and Global Equity strategies over 2019, help them understand the necessity and benefits
which demonstrates the discipline maintained of saving consistently over one’s life.
throughout the tougher performance periods in
prior years. And of course, we are all hoping that the lights
don’t go out permanently.
Supporting black business and enterprise
development Another decade of gratitude
This decade, we made some significant strides Thank you for your ongoing support over the years.
forward in supporting black businesses in our We would not be here without you. I wish you a
industry. Pre-dating black economic empowerment happy and successful year ahead and, in true
legislation in South Africa, we pioneered a number Coronation style, a prosperous and positive next
of corporate initiatives that continue to contribute 10 years.
to transformation and the development of skills in
our industry. While, our country does not seem to be heading
in the desired direction at this point and is a
In 2006, we launched the Coronation Business source of frustration and despondency for us, I
Support Programme, a ground-breaking initiative am reminded of the timeless words of Dr Martin
to grow emerging black stockbrokers. We allocated Luther King Jnr. – “If you can’t fly then run, if you
a minimum of our South African equity brokerage can’t run then walk, if you can’t walk then crawl,
to a group of black-owned stockbrokers annually. but whatever you do, you have to keep moving
Since 2005, we have allocated in excess of forward.”
R300 million in brokerage to programme
participants. For both the industry and the Sound advice for us all as we head into the next
companies themselves, the transformation has been decade.
remarkable.
Good luck out there!
In 2017, we also supported the creation of the
first black-owned and managed administration
business in the industry and the country, Intembeko
Investment Administrators. Now in its second year
of operation, Intembeko continues on its journey
to become a world-class service provider.
MAPPING OUT THE LANDSCAPE FOR THE
FUTURE
In President Ramaphosa’s New Year’s message,
he reflected that South Africa still has “many
mountains to climb and many treacherous rivers
TRUST IS EARNED™ 5
INSIGHTS
The investment
case for
South African
equities
Significant opportunities may underlie a bleak outlook
By N E V I L L E C H E S T E R
Fiscal consolidation Corruption, SOE failure It is in conditions such
THE and meaningful policy and high debt levels have as these that remarkable
QUICK implementation is essential to hamstrung the economy opportunity can arise and
TAKE restore investment confidence and the aftermath is likely to some SA stocks are worth
and a meaningful growth path continue to do so watching
THE OUTLOOK FOR domestic equity in the and an equivalent 8% dividend yield; and in
period ahead is an exceptionally challenging the large banks, where one can invest in a bank
call to make, given the two vast extremes that like Nedbank, which is trading at seven times
will potentially drive market returns and how one earnings and a 7% dividend yield.
should be positioned.
The reason for the very low rating of South
Neville manages On most metrics, the FTSE/JSE All Share Index African companies is obvious to all who live here.
Coronation’s
Aggressive Equity
(ALSI) shows up as extremely cheap compared to The economy is in a dire state and the political
Strategy and has its history. Like all averages, this hides a number environment remains one where, despite all
23 years of investment of desperately cheap shares and some that are the obvious challenges and problems, change
experience.
still looking fully valued. remains marginal at best and the status quo
prevails. Policies to truly step up growth are
Companies that have been able to deliver con- spoken about and alluded to, but we remain
sistent earnings growth despite the challenging stymied in a low-growth environment, made
environment trade at eye-watering valuations. much worse by the failure, both financially and
At the high end of the spectrum, Clicks and operationally, of Eskom.
Capitec are estimated at forward price-to-
earnings (P/E) ratios of 33 times and 22 times, NOT ALL THOSE WHO WANDER ARE LOST
respectively; whereas companies that have Much like Robert Frost’s paths in the forest, we
had a more challenging time are trading on face two divergent roads ahead. Should we fail to
multiples that we haven’t seen in well over deal meaningfully with the economic challenges
a decade. This is reflected in sectors such as we face, the country is doomed to a low-growth
the clothing retailers, where Truworths, for future and all the attendant financial and social
example, is trading at eight times earnings risks that will come with it. In that case, these
6 COROSPONDENT
low single-digit P/E multiples will have proved is not going to recur. To make matters worse, the
to be appropriate, pricing for an environment debts incurred in the last decade need to be
where real earnings will continue to decline in repaid, which means that a much tighter fiscal
perpetuity. policy must be maintained. In plain English, this
means that money will actually be taken out of
However, should we see signs of the country the economy to service and settle the staggering
choosing to take the path ‘less travelled’, one with debt run up by government and State-owned
short-term challenges, but ultimately leading to enterprises.
a better state where fiscal consolidation occurs,
confidence returns and economic growth picks up, The upshot of this is that businesses that seemed
there are unbelievable bargains to be had in the to be able to grow their earnings regardless of
local equity market at the moment. the economic cycle in past times, may not be able
to repeat that performance in the years ahead.
The challenge is being able to assess the And therein lies the challenge: identifying
probability of which route South Africa is likely investments that offer both upside potential and
to follow, how much is actually priced into relative downside protection.
company valuations and which companies
can potentially grow under either scenario. As A COLD COMING WE HAD OF IT
mentioned earlier, investors who are unimpressed Why are we even bothering if the outlook is
by the trajectory of the South African economy, so clouded and the risks are so high? Because
but want to maintain some local exposure, are the opportunities for patient investors, should
prepared to pay incredibly high multiples for we recover off the low levels to which we have
the perceived safety of shares that have shown fallen, are significant. The last time South Africa
consistent earnings growth the past few years; was in a similar situation was back in 2002/2003
and the consensus view is that they will continue. when the outlook for the country was equally
They are priced for this growth, and then some, pessimistic, and the world was still recovering
and should they disappoint, the gap between from the shocks of the Dotcom bubble and the
expectation and reality will be enormous. A stock 9/11 terrorist attacks. The rand had weakened
re-rating from an expected 33 times earnings to significantly, and domestic shares were trading
our assessment of a normal rating for an average on ratings very similar to where they are today.
South African business would result in a 62%
decline in its share price. What followed was a period of very strong
returns for domestic shares, as the situation
The brutal and all-encompassing nature of the normalised and economic growth returned,
derating of the local market has meant that there with the ALSI delivering a total return of 29.5%
THE are companies which we believe are above-average per annum for the next four years. This is by no
OPPORTUNITIES quality businesses, trading today at ratings we means guaranteed to be repeated, but given
FOR PATIENT think are overly pessimistic. These are companies where valuations are currently trading, one has
INVESTORS, that should be able to defend their earnings base to take a serious look at domestic companies as
SHOULD WE in real terms in a low-road scenario and, if we follow potential investments for the next decade.
RECOVER OFF a better path, could deliver real earnings growth
THE LOW LEVELS that is not being priced for. These make excellent A PROFESSIONAL GUIDE MAKES THE
TO WHICH WE investments where the pay-off profile is skewed to JOURNEY
HAVE FALLEN, ARE the upside. Our key strength and the pillar that supports our
SIGNIFICANT.
investments at Coronation is our intense focus
UNCHARTERED TERRITORY on proprietary research. This will, once again,
However, the future is unlikely to look much like the be absolutely crucial in determining which
past decade in South Africa (refer to economist companies will be the future winners and losers,
Marie Antelme’s article on page 8). Years of not in the next 12 months, but over years. All in,
profligate spending by government and rampant the above reinforces the oft-repeated view that
corruption meant that there was a lot of money while investing is simple in theory, it is incredibly
sloshing around in the economy, a situation that difficult in practice. +
TRUST IS EARNED™ 7
ECONOMIC COMMENT
South Africa’s
at risk of
falling into
a debt trap
Let us not waste another crisis
By M A R I E A N T E L M E
A crisis is an SA’s fiscus requires The increased
THE The remedies that
opportunity to turn the most urgent attractiveness of other
were available to SA
QUICK poison into medicine, attention; it’s almost
in the 1990s have all
emerging economies
TAKE and it takes discipline as if we’re back to is not helping the
but dried up
not alchemy square one situation
CRISES FORCE US to re-evaluate, to think differently, reversed due to several interconnected and
and to seek solutions that challenge the status reinforcing causes, namely low nominal growth;
quo. They are circumstances where all paradigms failing confidence and investment; increasingly
are up for debate and there is greater latitude to complicated economic policies; institutional
question leadership and existing norms. decay and State Capture; and, definitely not
least, the prevailing and intensifying crisis at
Marie is an In South Africa, we are not responding to the Eskom. These events have combined to enforce
economist with current crisis. Not limited to Eskom, the economic the reality that South Africa remains one of the
19 years of
experience in and fiscal ramifications of weak growth have world’s most unequal economies with respect
financial markets. become critical. GDP growth has averaged 0.8% to both income and wealth. This is a gap that is
over the past five years (2019 estimate) and is exacerbated by diminishing resources with which
unlikely to come in much above 0.3% in 2019. to address this compound crisis.
This compares to a post-democracy, pre-Global This is not the first time we have been here. Some
Financial Crisis average of 3.6%. Importantly for of the metrics are different, some of the causes
the current fiscal position, nominal GDP growth is and consequences are too, but in 1993/1994,
running at 4.7%, compared to 12% over the same South Africa was struggling out of a three-year
period. recession, exacerbated by a prolonged drought.
FISCAL WOES TOP AGENDA The fiscal position was under strain as a combina-
The biggest economic casualty has been the tion of weak growth and a sharp escalation in
country’s fiscal position that had improved from expenditure saw the deficit balloon to -6.3% of
a very low base in 1993/1994, a condition not GDP, from -1.2% three years earlier. Debt jumped
very different to the one we’re in now, to one of from 30.5% of GDP to 36.9%, heading up, and debt
notable strength in early 2009. This has since service costs climbed steadily to above 5% of GDP.
8 COROSPONDENT
Figure 1 reasonable forecast horizon. The official forecasts
REAL INTEREST COST VERSUS REAL GDP published in the October 2019 Medium-Term
%
Budget Policy Statement (MTBPS) see gross
6 government debt rise from an estimated 60.8%
5
in the current fiscal year to 71.3% in 2022/2023,
in the absence of any remedial interventions. This
4
trajectory is unsustainable.
3
2 The second is a ‘debt trap’ – this happens when real
1
(nominal) interest payments exceed real (nominal)
GDP growth over a sustained period of time.
0
This results in an ‘explosion’ in the government
-1 debt-to-GDP ratio, which can no longer be
-2 prevented because of limited remedial capacity.
-3
Essentially this means that the State cannot
1990 1995 2000 2005 2010 2015 2019/20e effectively raise revenue or cut expenditure in a
Real GDP, % Real interest cost politically practicable manner, and this dynamic
Sources: SARB, Coronation
creates a self-perpetuating and compounding
increase in government debt.
Figure 2 The SARB paper compared the domestic data at
GENERAL GOVERNMENT MAIN BUDGET BALANCE the time to the IMF’s debt sustainability criteria,
% which state that government debt will continue
2 80 to rise if the ratio of the primary balance to GDP
1 is smaller than the ratio of government debt to
70
0
GDP, multiplied by the real cost of debt (interest
60 rate) minus real GDP growth rate. The rationale is
-1
50 that a government cannot indefinitely run deficits
-2
if the real rate of growth is below the real cost of
-3 40
financing its debt.
-4 30
-5
20
The study found that while the government
-6 was able to finance its deficit in a sustainable
-7
10 manner at the time, it raised serious concerns
-8 0 about the risk of the economy falling into a debt
1990 1995 2000 2005 2010 2015 2019/20e trap. Importantly, the risk of interest-cost growth
General government consolidated deficit Debt, % GDP (RHS) relative to GDP (see Figure 1) could be a key driver
Sources: Coronation, National Treasury of debt accumulation. The fiscal assessment can
then be summarised as follows:
1. The large deficit, although partly reflecting
In 1993, the South African Reserve Bank (SARB) cyclical factors, was high relative to potential
published a paper1 titled, “Is South Africa in a GDP, making a recovery harder to realis-
debt trap?” The parallels to today are sobering. tically forecast. In the 1970s, when the deficit
While the paper concluded that it was impossible had ballooned before, potential growth was
to assess categorically that the country was in estimated at nearly 4%. In 1993, this was closer
a debt trap, by most indicative measures, the to 1% to 2% – slightly above the 1.1% that the
economy was close to this critical position. SARB currently estimates for 2020, implying an
increasingly unsustainable position.
BACK TO THE FUTURE 2. The increase in debt stock, albeit from relatively
The details beg further analysis, and comparisons manageable levels, implied a further rise in the
to today’s position are worth highlighting – both interest burden on tax revenue, which would
the risk and the potential for remedy. To start, it persist should growth remain low.
is important to describe two important concepts. 3. Low domestic savings could raise borrowing
First, ‘sustainable debt’ is debt that stabilises costs, crowding out the private sector and
or diminishes relative to output (GDP) over a widening the current account deficit.
4. Concerns about public willingness to fund
increased borrowing, and at what cost, implied
1
E.J. van der Merwe, “Is South Africa in a debt trap?” South African Reserve
Bank Occasional Paper No 6, May 1993 further upside risk to long-term interest rates.
TRUST IS EARNED™ 95. Lastly, the report raised the possibility that, Ongoing government dissaving has, and will
as the debt burden increased, “authorities will continue to, put pressure on the current account,
be unable to prevent the financing of their making the fiscus and currency vulnerable to
budgetary deficits by means of an increase in a sudden stop in funding flows. Lastly, it could
the money supply and monetary base of the be argued that the relative underperformance
economy”. Under such circumstances, the SARB of South African fixed income to that of other
warned, government debt will increasingly emerging markets in a very supportive global
have to be monetised, destroying the ability of environment already reflects the early onset of a
the Central Bank to contain inflation. ‘loss of faith’ in government’s ability to implement
sufficient remedial fiscal and policy action to
POINT OF NO RETURN? avoid a debt trap.
There are clear parallels with South Africa’s
position today. The recent deterioration in the With debt service costs already the fastest
government deficit to an estimated 6% of GDP growing expenditure item over the medium-term
(6.2%: 2019/2020 MTBPSe), ceteris paribus, is expenditure framework, with tax revenue as a
well in excess of potential growth. The expected percentage of GDP at already high levels and
increase in debt stock and the concomitant stagnating growth, there are enough red flags to
debt service burden suggest a return to interest raise grave concerns about South Africa’s ability
payments of close to 5% of GDP. There is some to avoid a debt trap.
upside risk to this estimate should borrowing costs
rise off the currently low (global) base. A LEAF FROM HISTORY
In the early 1990s, and even more visibly from the
early 2000s, a combination of nominal growth
Figure 3 recovery and institutional reform enabled the
SOUTH AFRICA INTEREST PAYMENT, % GDP
government not only to avoid a debt trap, but
also to rehabilitate the fiscal position to one of
%
outright health. Despite the emerging market
6
crises between 1997 and 2000, South Africa
5 managed to capitalise on a steady improvement
in global growth, materially boosted by the
4
growth acceleration in China.
3
The domestic currency crisis in 2001 added
2
momentum to the recovery, because it left South
1
Africa with a severely undervalued currency. The
boost to domestic terms of trade saw export prices
0 rise meaningfully. This prompted a recovery in
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2019/20e
2021/22f
manufacturing production and an improvement
in employment, and provided government with
Source: SARS much-needed revenue windfalls.
Figure 4 During this time, South Africa also enjoyed several
WORLD REAL GDP, % YEAR ON YEAR positive institutional changes, which not only
facilitated an improvement in growth and thus
%
revenue collection, but also in confidence and in
16
policy implementation:
14
12
• The Constitution was gazetted on 18 December
10
1996.
8
• The National Treasury presented the first
6
MTBPS in December 1997, preparing the way
4
for the first multi-year Budget determination
2
in February 1998.
0
-2
• The SARB implemented inflation targeting,
announced in September 1999 and starting
-4
in 2000.
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
• Mr Pravin Gordhan was appointed as
World Advanced economies Emerging markets South Africa China US Commissioner of the South African Revenue
Source: IMF Service in 1999.
10 COROSPONDENTFigure 5 Early data for the fourth quarter of 2019 (Q4-19)
REAL EFFECTIVE EXCHANGE RATE VALUATION suggest tentative signs of stabilising domestic
output, with an annual rate of about 0.4% in
120
reach for the year as a whole.
110
However, the onset of loadshedding in early
100 December, with the unprecedented escalation to
Schedule 6 and the persistence of a diminished
90 energy availability factor, will also compromise
this nascent recovery. A number of mining
80 companies closed early, and there is anecdotal
evidence that small and medium enterprises have
70 battled to sustain business activity as a result.
60
More broadly, domestic sentiment was hit hard
Mar 94 Mar 97 Mar 00 Mar 03 Mar 06 Mar 09 Mar 12 Jan 15 Mar 18
and confidence remains weak. The clear risk is
REER REER average + 1 STDEV - 1 STDEV
that considerably weaker Q4-19 growth will bleed
Sources: SARB, Coronation
into 2020 as power uncertainty persists, dragging
our 2020 outlook to 0.9% (1.1% previously) on the
back of the ongoing inadequate energy availa-
In line with global inflation, spurred by the bility factor.
recovering exchange rate and facilitated by the
new SARB mandate, domestic inflation (and With real GDP growth of less than 1% and real
borrowing costs) fell from 14% in 1993 to -0.7% debt service costs heading for 5%, the interest
in 2004. The now more disciplined fiscal process, burden is set to reach almost 15% of total
improved activity and the associated revenue expenditure. Unless the gap narrows, interest
benefits all helped to reduce the inherited fiscal cost and debt will compound, and the rising debt
deficit and debt stock. burden will increasingly limit expenditure on all
other essential goods and services.
The fiscal deficit narrowed from -6% of GDP in
1994 via -7.0% in March 1997 to a small surplus IS IT TERMINAL?
of 0.3% in June 2002, with a full windfall from The economy is in crisis. There really isn’t the luxury
the weaker rand, high inflation and very high of time. Until government creates policies that
rand-based commodity prices. Some stimulus in welcome innovation, innovation will not come.
2003/2004 saw the deficit widen in the wake of South Africa no longer has relative economic
slower growth in 2002, notably lower revenue, advantages to offset its challenges in attracting
expanded social security and a big allocation to new investment, driving employment and
the contingency reserve out of the fiscus. With the enhancing productivity.
narrowing of the deficit thereafter, government
gross debt fell from 48.8% of GDP in June 1997 There are lots of emerging market alternatives
to a nadir of 26% in 2008/2009. that need skills and foreign savings, and which
create policies to facilitate their participation.
OUT OF RESERVE The progress of countries like India, China,
Returning to the present day, the drivers of growth Pakistan and Bangladesh in the World Bank Ease
that saved South Africa from a debt trap in the of Doing Business measures shows us this. South
1990s have largely been drained. Their replen- Africa’s performance, which has deteriorated by
ishment would require an innovative shift in 52 places, from 32 in 2008 to 84 currently (where
domestic economic policy, or a recovery in global the lower the rank, the better the score), speaks
growth and commodity prices, and preferably for itself.
both. It is possible that the currently elevated terms
of trade and an uptick in global growth in the A country that used to contemplate which policies
second half of 2020 will provide a catalyst for an could be used to best attract investment and
acceleration in domestic growth momentum. But was able to direct revenue to the most econo-
the structure of the economy has also changed, mically vulnerable, is struggling to grow. A fiercely
and mining and manufacturing are consid- developmental economic agenda is at odds with
erably smaller components of gross value added economic innovation and growth. Redistribution
– together now 19% from 29% in 1993/1994, is not growth, but without growth, redistribution
which limits the ability to fully capitalise on this can only be limited. With growth, it could be
improvement. limitless.
TRUST IS EARNED™ 11POWER STATEMENT This powerful commitment flies in the face of
The near-term answer may lie in a bafflingly ongoing uncertainty and criticism that there is
overlooked commitment by the government in no ability or willingness to rethink private power
an opinion piece by President Cyril Ramaphosa generation in South Africa.
that was published in December last year.
‘A new era in energy generation’2 opens with the Stabilising energy availability; providing room
progressive statement that, “In the wake of the for scheduled maintenance; and sending a
hugely damaging power shortages of the last signal, not only that there is a plan to manage
two weeks, government has agreed – in keeping the Eskom crisis (at least to stabilise chaotic load
with the Integrated Resource Plan (IRP) 2019 – to shedding), but also that government is willing to
allow users to generate power for their own use re-evaluate, to think differently, and seek solutions
and to accelerate the purchase of power from that challenge the status quo, despite inertia,
independent producers. In effect, the path has vested interests and factional resistance, would
been cleared for the expansion and diversification be a grand step in the right direction to structural
of energy production on a significant scale”. reform of the economy.
2
Daily Maverick Opinionista, “A new era in energy generation”,
Cyril Ramaphosa, 18 December 2019. www.dailymaverick.co.za/
But words aren’t enough, we need to see these
opinionista/2019-12-18-a-new-era-in-energy-generation/ commitments come to life. +
12 COROSPONDENTBOND OUTLOOK
Valuing South
African debt
“The best time to plant a tree was 20 years ago.
The second best time is now.” – Chinese proverb
By N I S H A N M A H A R A J
Monetary and The administration
THE Local economic woes
fiscal policy, as well must urgently make Our analysis supports
and policy inertia
QUICK continue to weigh on
as global cost of some hard decisions, the inclusion of SA
TAKE capital, drive local such as cutting the bonds in a portfolio
SA bonds
yields public wage bill
THE LAST YEAR of the past decade, 2019, was renewal more than South Africa’s. Despite the rally
the Chinese Year of the [Earth] Pig. Despite the in global equity and bond markets, South African
images that might spring to mind, in Chinese bond and equity markets underperformed their
astrology the pig represents wealth and treasure. global peers. The local economy continued to slow
Considering the amount of turbulence that was due to concerns about deteriorating government
injected into financial markets by geopolitical finances and State-owned enterprises (SOEs),
Nishan is head of Fixed game changers such as Brexit, the US-China trade and specifically Eskom, as bouts of loadshedding
Interest and has war and the Hong Kong protests, the fortunes of continued to intensify. The All Bond Index (ALBI)
17 years of investment
experience. the Earth Pig did shine on global equity markets produced a total return of 10.3% in rands (13.1%
as they closed 2019 up more than 25% in US in US dollars), which was driven by a rally in the
dollars (as measured by the MSCI World and All three- to 12-year area of the curve, as expectations
Country World indices). of further interest rate cuts continued, given the
low growth and contained inflation environment.
Global bond markets were no exception, as most The slow pace of policy change and implemen-
bond markets saw their yields compress over the tation, and the requisite tough decisionmaking,
course of the year, driven by a slowdown in global will continue to weigh on the country into 2020.
growth and a dovish twist by global central That said, the flower that blooms in adversity is
banks. Emerging market bonds provided a total the most rare and beautiful of all, so let’s hope
return of c. 14% in US dollars as the hunt for yield South Africa can learn and heal from its damaged
intensified in a world where $11.2 trillion worth of past, rather than run from it.
debt now trades at a negative yield.
FINDING THE SWEET SPOT
This year is the Chinese Year of the [Metal] Rat, The only way a leopard can change its spots is
which symbolises renewal. For South Africans, this by going from one spot to another. In 2020, the
is both auspicious and apt, as few economies need spotlight will be on South Africa’s policymakers
TRUST IS EARNED™ 13and their ability to change the course of the (Eskom, SAA and Denel). Eskom has been and
local economy and show marked progress in remains the biggest risk to the local economy.
the right direction. As long-term investors, our Turnaround plans have been tabled and key
key objective is to make sure that we price risk personnel have been replaced, but due to the
correctly and that our clients’ portfolios are extent of a decade-plus of maladministration
robustly positioned. We do this by ensuring that and corruption, operational turnaround has
they are well diversified, avoiding the risks that been slow. It is inevitable that financial support
accompany positioning towards a single-market will be ongoing, and government will need to cut
outcome. expenditure in other areas to keep the nation’s
ailing power supplier online.
This implies that a great deal of time is spent
on understanding the fundamental drivers of The February 2020 Budget will be another
asset prices and whether the assets we hold on watershed moment, as investors will again look
behalf of our clients are adequately priced with to policymakers to make the hard, shorter-term
a sufficient margin of safety to buffer against decisions, such as freezing or cutting the government
short-term adverse volatility. For South African wage bill despite union objections. Most ratings
government bonds (SAGBs), this implies under- agencies have given up hope on South Africa and
standing the fundamental direction of the local moved us into subinvestment territory.
economy and ensuring that they are priced to
reflect prevailing and expected conditions. Moody’s is the only agency that has retained
South Africa at investment grade, which keeps
THE ECONOMY OF SOUTH AFRICAN YIELD us in the FTSE World Government Bond Index
There are three key drivers of SAGB yields: (WGBI). However, given the deterioration seen
over the last year, it is very likely that they will
1. Monetary policy expectations downgrade South Africa in 2020, which should
Monetary policy is driven by inflation and the see outflows from the local bond market of
growth outlook. Inflation is expected to average between R70 billion and R120 billion. This seems
close to 4.5% over the next two years, which is like the end of the world, but we should not forget
at the midpoint of the inflation targeting band, that:
while growth is not expected to reach 1.5% until
2021 (South Africa’s growth has averaged sub-1% a) South Africa has a very deep and liquid bond
since 2015), while global growth is expected to market.
average just above 3%. The Monetary Policy b) The local savings industry is very large and
THIS SEEMS LIKE Committee (MPC) has reiterated that it wants sophisticated.
THE END OF THE inflation to maintain the midpoint so that it c) The fundamental deterioration and risks
WORLD, BUT WE can use monetary policy more effectively during around it have been well flagged over the last
SHOULD NOT times of crisis. two to three years, so investor positioning has
FORGET THAT adjusted accordingly.
SOUTH AFRICA South Africa’s economy is struggling to grow, and d) South Africa comprises less than 1% of the
HAS A VERY DEEP
although monetary policy is a blunt tool, it can WGBI, so at current valuations, investors might
AND LIQUID BOND
MARKET. be used to boost confidence and relieve some choose not to exit.
consumer pressure. Currently, real policy rates are
above 2% and, if the repo rate does not move, the While we are likely to see some fiscal effort in the
real policy rate will average 1.7% over the next two budget and some tough stances regarding SOEs,
years. In previous cycles, when growth was this low, keeping the policy trajectory headed in the right
the real policy rate averaged close to zero. This direction, that doesn’t rule out an exit from the
suggests that there is room for the MPC to move WGBI. In the worst case scenario, government
policy rates at least 50 basis points (bps) lower doesn’t manage to paint a better scenario in
over the next year. 2020 and South Africa exits the WGBI, but that
does not mean the end of the world for SAGBs,
2. Fiscal policy expectations given the current risk premium embedded in
In South Africa, fiscal policy has been on a assets (refer to the point below).
slippery slope since the Global Financial Crisis,
as the administration has struggled to narrow 3. Global cost of capital
the fiscal deficit and government debt has Global bonds are trading close to all-time lows
ballooned. The reasons for this are well known, due to the slowdown in global growth, the flight
but in recent years the slowdown in growth has to safe-haven assets because of geopolitical
decreased tax revenue, while expenditure has uncertainty, and the dovish twist seen by global
continued to increase to rescue ailing SOEs central banks in 2019.
14 COROSPONDENTFigure The backdrop for SAGBs is therefore mixed.
SOUTH AFRICAN 10-YEAR VERSUS US 10-YEAR SPREAD Monetary policy should be supportive, fiscal policy
% will remain in the spotlight and the global cost of
8.5 capital, although it should remain supportive in
8.0 the short term, might be unfriendly over the longer
7.5
term.
7.0
However, from a valuation perspective, these
6.5
risks seem to be adequately priced. First, SAGBs’
6.0 spread over the US 10-year (global risk-free) rate
5.5 is quite extended (see Figure 1). This suggests
5.0 enough room for SAGBs to absorb a move higher
4.5
in global bonds. The follow-on question would
surely be: if South Africa continues to deteriorate,
4.0
should the breadth of the spread represent credit-
Jul 18
Jul 19
Jul 09
Jul 10
Jul 11
Jul 12
Jul 13
Jul 14
Jul 15
Jul 16
Jul 17
worthiness? At current levels, however, South
South African 10-year – US 10-year
Africa’s credit spread already trades very wide
relative to both the investment grade (IG) and
Sources: Bloomberg, Coronation
sub-IG indices (Figure 2), suggesting that further
deterioration away from even sub-IG norms is
Figure 2 being priced.
SOUTH AFRICA'S CREDIT SPREAD VERSUS THE IG AND SUB-IG INDICES
THE RIGHT PRICE?
%
175 Despite what might seem like an impressive
return relative to cash in the local context, SAGBs
have underperformed their peers considerably
125
over the last five years due to a fundamental
deterioration in South Africa. In the last five
75
years, SAGB nominal yields have risen by 148bps,
while the implied 10-year real yield has risen by
25 over 200bps. This compares to the emerging
markets average of a 61bps compression in
-25 nominal yields and a relatively small compression
in implied real yields. As such, SAGBs are now the
-75
cheapest in the emerging market universe from
an implied real yield perspective and the second
Dec 15
Jun 16
Dec 16
Jun 17
Dec 17
Jun 18
Dec 18
Jun 19
Dec 19
cheapest from a nominal bond perspective
South Africa versus BB Index South Africa versus BBB Index
(Table 1 on page 16).
Sources: Bloomberg, Coronation
Constructing a fair value for SAGBs using the
global risk-free rate, inflation differentials
(the difference between South African and US
It is inevitable that bond yields will move higher expected 10-year inflation – see Table 2 on page
over the next five to 10 years; however, in the next 16) and a measure of credit-worthiness for South
two to three years, they could also move lower Africa (the South African credit spread) also
before moving higher. Global inflation remains suggests that the South African 10-year bond,
low, with global growth set to remain sluggish. currently trading at 9%, is at inexpensive levels.
Even adjusting current variables for expectations
Central banks around the world have continued around a rise in the global risk-free rate brings
to inject large amounts of liquidity into financial one to a similar conclusion. The confluence of this
markets to keep crises at bay and will continue to evidence suggests that SAGBs are adequately
engineer a soft landing for the global economy. priced for current risks.
This might not be the goldilocks economy of
the early 2000s for emerging markets, but it will FINDING VALUE
definitely be less turbulent than what we have We believe that bonds at the longer end of
seen previously. Until we see a turn in global the curve continue to offer the best value.
inflation, one should not expect a ramp-up in To ascertain which point on the SAGB yield
global policy rates, which means that global curve is the most attractive, we use a total return
bond yields should see only moderate fluctuation. analysis with a three-year horizon period across
TRUST IS EARNED™ 15various bond maturities. Table 3 shows how these Table 1
bonds will perform if: SAGBs NOW THE CHEAPEST IN THE EMERGING MARKET UNIVERSE
Nominal Implied real 5-year change in 5-year change in
1. The yield curve moves parallel up 1%; yield yield nominal yield real yield
2. The yield curve moves parallel down 1%; 11.9 0.4 4.22 (0.42)
Turkey
3. How much each bond can sell off before it
South Africa 9.0 4.0 1.48 2.14
breaks even with the ALBI; and
Indonesia 7.1 3.5 (0.61) 1.81
4. How much each bond can sell off before it
breaks even with the 10-year bond (R2030). Mexico 6.9 3.3 0.96 1.02
Brazil 6.8 3.0 (5.17) (2.42)
The previous analysis, taken together with the India 6.5 2.6 (1.42) (0.13)
fact that the difference between the 30-year and 6.2 2.4 (4.54) (1.42)
Russia
10-year areas of the SAGB yield curve is close to
Average 5.0 1.3 (0.61) (0.21)
the widest it has ever been (1.39% during the
3.3 1.4 (0.56) 1.10
taper tantrum of 2013), suggest that bonds at the Malaysia
longer end of the curve continue to offer the best Chile 3.2 0.3 0.00 0.44
value in our view. China 3.1 0.6 (0.41) (0.43)
Poland 2.1 (0.5) (0.39) (1.52)
PORTFOLIO ALLOCATION
Hungary 2.0 (1.1) (1.57) (2.03)
Inflation-linked bonds (ILBs), once again, under-
Czech Republic 1.5 (0.7) 0.81 0.36
performed nominal bonds in 2019, with a return
of 2.6%. Only shorter-dated inflation-linked Israel 0.8 (0.4) (1.36) (1.39)
bonds provided a positive return, albeit below
Sources: Bloomberg, Coronation
cash. A five-year ILB trades at a real yield of
3.6%. Using expected inflation of 4.5%, if one
holds this bond for the next three years, the Table 2
nominal return would be in excess of 8%, which SAGBs ADEQUATELY PRICED FOR CURRENT RISKS
compares very favourably to equivalent maturity
Current Expected
nominal bonds.
US 10-year 1.92% 2.75%
In addition, with expectations for the real policy South African 10-year expected inflation 5.04% 5.00%
rate to move closer to 1%, it makes the carry-on US 10-year expected inflation 1.78% 2.00%
shorter-dated ILBs even more attractive. At current South Africa’s credit spread 2.94% 2.94%
levels, shorter-dated ILBs therefore do warrant a
Fair value estimate 8.12% 8.69%
position in a bond portfolio.
Sources: Bloomberg, Coronation
The South African economy has been plagued
with low growth, ballooning government finances
Table 3
and a volatile global geopolitical environment.
Low growth and well-contained inflation suggest TOTAL RETURN ANALYSIS (THREE-YEAR HORIZON)
the trajectory for South Africa’s policy rates to be
Total return
lower over the next 12 months. Current Yield curve Yield curve Breakeven Breakeven relative
Bond Maturity yield sells off by 1% rallies by 1% relative to ALBI to 10-year (R2030)
In addition, South African bonds have continued to R186 21 Dec 26 8.25% 9.93% 7.86% (1.41%) (1.16%)
underperform relative to their global and emerging R2030 31 Jan 30 9.02% 11.43% 7.99% (0.42%)
market counterparts, suggesting an increased R2035 28 Feb 35 9.73% 12.85% 8.18% 0.01% 0.13%
risk premium, given South Africa’s precarious
R2040 31 Jan 40 10.03% 13.51% 8.17% 0.11% 0.22%
economic backdrop. At current levels, SAGBs seem
R2044 31 Jan 44 10.10% 13.82% 8.08% 0.13% 0.23%
adequately priced relative to underlying risks,
which suggest a neutral allocation in portfolios. + Sources: Bloomberg, Coronation
16 COROSPONDENTMaking value
judgements
When it comes to your retirement fund, are you receiving good
‘value for money’? How would you even know?
By R A E L B L O O M
Costs are critically Regulation,
Assessing value
THE The retirement important consolidation and
for money is not
industry is about and should be improved transparency
QUICK delivering value for
an exact science –
commensurate with have increased our
TAKE informed judgement
money to its members the scope and quality understanding of both
is required
of service provided value and cost
VALUE FOR MONEY (VFM) is ultimately about A VFM assessment is an important exercise,
deciding whether the benefit (i.e. the value) of particularly for big financial decisions. To do this,
buying something justifies the cost (the money). you need a framework for making a decision that
But we know that making VFM decisions is almost helps you to evaluate the importance of features
never straightforward. If you are buying a new and benefits, and how much you are prepared to
smartphone, do you go for the cheapest option pay for them.
Rael is a product that does the job, or do you pay more for one with
development actuary better features? What features are important to THINGS TO CONSIDER
and has 16 years of
industry experience.
you? Is it size, build, battery life, display, camera, or When it comes to saving for retirement, VFM is
perhaps it is the brand? And once you have an idea deceptively simple – invest in order to maximise
of how features compare, how do you weigh these after-fee outcomes, which include financial and
up to decide which phone is best for you, given your non-financial returns. However, the devil is, as
needs and the price? always, in the detail:
A RELATIVE GAME 1. The players: There is a range of different roles
With any purchase, value is in the eye of the within the retirement industry. These include fund
beholder. Creating a shortlist is usually easy – sponsors, trustees, lawyers, auditors, admini-
discard the items that don’t have the features strators, consultants, investment managers,
you need and the ones that are unaffordable. But regulators and so on. Each of these provide and
once you have that shortlist, you need to make a charge for their respective services, and together
judgement call. We also know that it’s very difficult they form the retirement value chain.
to ever really know if you have maximised value for
money – after all, nobody likes to miss out. Even 2. No crystal ball: When you buy a smartphone,
though VFM is not an exact science, this does not you know what you will get – push X (or ask Siri/
mean that trying to evaluate VFM is pointless. Alexa/Google to do it for you) and Y will happen.
TRUST IS EARNED™ 17However, when it comes to investing, the future is and whether they create the right incentives by
inherently unpredictable, and it is impossible to aligning the long-term interests of retirement
make a decision that will, with absolute certainty, fund members and service providers.
maximise your future after-fee outcomes.
INCREASING TRANSPARENCY
3. Fees are easier to understand: The difficulty Costs disclosure has improved in recent years.
with measuring VFM means that many commen- In the unit trust market, this started with the
tators tend to look to past returns and narrow in introduction of Total Expense Ratios (TERs)
on costs because this is the most predictable and in 2007 and, more recently in 2017, Effective
measurable component of VFM. While we fully Annual Charge (EAC) disclosures. In the insti-
agree that inappropriately high costs can have a tutional retirement industry, the Association
detrimental impact on retirement outcomes, we for Savings and Investment in South Africa’s
feel that the simple focus on fees alone does not (ASISA) Retirement Savings Cost (RSC) Disclosure
provide a meaningful and accurate assessment Standard came into effect in 2019 and is designed
of VFM. to help employers make better cost comparisons
between different umbrella funds. RSC separates
4. Price check? A big challenge in assessing out the cost components, including the costs of
VFM is comparability across offerings given the advice, administration, investment management
different ways in which providers charge for their and ‘other’ costs.
services. The industry has put in place measures
to help improve transparency and comparability This should, in turn, help to separately assess
– more on this below. the VFM of each component. ASISA has also
released a standard for the disclosure of EACs
VFM AND RETIREMENT SAVINGS to members of retirement funds, which will
So how do you assess VFM when it comes to become effective in 2020. The Default Pension
retirement fund matters? First, you need clear Regulations, which became effective in March
objectives or goals against which to measure 2019, require comprehensive disclosure on the
outcomes. What are you trying to achieve, and costs of default investments and should further
how will you assess success? This is not about improve cost transparency, and hence allow for
investment performance alone, but rather about better assessment of value.
requirements across the full value chain. This helps
you to set out your requirements, considering: INVESTMENT MANAGEMENT COSTS
Investment costs are a significant contributor to
• The range and quality of services that you the overall costs of running a retirement fund.
need to assess the options available to you in Investment fees have come down over time, LARGER
the market. helped by increased competition and the consoli- RETIREMENT
• The costs of each component, including how dation of smaller funds into umbrella funds. FUNDS GENERALLY
and why they might change over time. BENEFIT FROM
• Access to the skills and experience to Consultants have also played an important role ECONOMIES
evaluate and understand your options, for in driving competition within the investment OF SCALE AND
example, by employing the services of profes- industry by assisting their clients with selecting STRONGER
BARGAINING
sional trustees and consultants. and monitoring managers and negotiating
POWER.
commercial terms.
There are few topics more emotive than costs.
Costs are after all, a mathematical certainty – for Larger retirement funds generally benefit from
any given return, the lower the cost, the better the economies of scale and stronger bargaining
outcome. Therefore, funds should be aiming for power. According to the Financial Sector Conduct
the lowest possible costs for their clients, right? Authority (FSCA), the number of South African
retirement funds has reduced from 13 000 to
The reality is that it’s a lot more complex than just under 1 500 over the past 10 years. Going
that. First, returns are not a certainty and vary forward, the regulator would like to see further
significantly by approach. While attention to the consolidation to simplify the regulatory regime
appropriateness of costs are critically important, and further improve economies.
a focus on costs at the exclusion of everything else
will lead to unintended consequences. Appropriately structured performance-based
fees have been a prevalent feature of many
When it comes to costs, the questions that we of the larger retirement funds in South Africa
should be trying to answer are whether fees for many years. This has ensured that the fees
are commensurate with the service provided, charged for active management are directly
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