Momentum Enhanced Factor Portfolio Range
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Momentum Enhanced Factor Portfolio Range
quarterly commentary to end June 2021
Assessing investment returns in an outcome-based investment context
The Momentum Enhanced Factor Portfolio Range is managed in terms of our outcome-based investing philosophy, where we
design the portfolios to maximise the probability of achieving the inflation-plus return target of each portfolio over the relevant
period, while continuing to meet the portfolios’ risk targets. To achieve this, our portfolio management approach conceptually
starts at an (multi) asset class level, then progresses to the identification of specific investment strategies within each asset class
(if appropriate) and finally ends up in the selection of (potentially more than one) investment mandates awarded to investment
managers that will implement the desired investment strategies.
Given this outcome-based investing framework, when assessing the returns of the Momentum Enhanced Portfolio Range, it is
important to start with looking at the returns from the portfolios against their inflation-related targets. This allows us to answer
the question: did we achieve our target over the most recent relevant period? We then assess these returns relative to this
target in terms of the following:
• The returns provided by the asset classes included in the portfolios
• The returns from the building blocks that provide the asset class exposure for the portfolio against their asset class
(or strategic) benchmark. This in turn is explained by:
o The returns from the investment strategies (or styles) used in the building block (if any)
o The returns from the investment managers that were awarded the mandates used in each of the building blocks
This quarterly review thus starts with the assessment of the investment returns generated by the portfolios against their
targeted investment outcomes over the most recent periods. The next section focuses on the economic environment and the
returns generated by the asset classes (beta) for the most recent quarter, measured against our average real return expectations
for each asset class. We review the returns from the building blocks and the underlying investment managers against their
strategic investment benchmarks.
Economic overview
Developed market (DM) equities returned 7.9% (in US$) in the second quarter of 2021, emerging market (EM) equities 5.1% and
global bonds 1%. DM equities were supported by policy stimulus and increasing economic activity due to faster vaccinations
Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 1 of 10against COVID-19, but many EMs are struggling to cope with new waves of COVID-19, denting the pace of their recoveries. Global growth of 6% is expected this year, moderating to 4.5% in 2022. Global bonds were affected by rising global consumer price inflation (CPI). Strong demand for commodities, coupled with supply backlogs and disruptions, contributed to the ‘All Commodity Price Index’ increasing by 85% from April 2020 to May 2021, which in turn hurled CPI higher via, among others, higher fuel prices. This contributed to increasing nominal bond yields, suggesting earlier tightening of monetary policy. However, the pace of increase in commodity prices and CPI should slow next year as demand growth slows, supply catches up and base effects dissipate. Although the US central bank (Fed) is expected to start talks about tapering their bond purchasing programme later this year, Fed members indicated interest rates may only increase in 2023. Global equities normally still perform well when CPI is above trend and rising, as is currently the case. Equity markets normally experience more sustained pressure when interest rate increases (expected in 2023) draw closer. Although the potential for an equity market drawdown is increasing, global equities should continue to outperform global bonds as the fundamentals for a subsequent quick rebound are still prevalent. Low interest rates do not support exposure to global cash. If South Africa’s adjusted level 4 lockdown is not extended even further, economic growth should surpass 4% in 2021. CPI is expected to have peaked in May 2021 and should trend downward. A global risk-on environment, prospects of a declining fiscal deficit and another current account surplus in 2021 supported the rand to an overvalued position by mid-2021. With CPI projected to average around 4.5% over the next two years, the repo rate is expected to increase twice in 2022, by 25 basis points each time. On a forward P/E basis the South African equity market trades at large discounts to both EMs and DMs and justify a preference within portfolios. SA nominal bond yields remain attractive against their own history, as well as relative to those in DMs and EMs. Listed property fundamentals remain weak, while prospective SA real cash yields are close to zero. Portfolio management Our portfolios had another strong quarter with all factors recording positive returns. The allocation to fixed interest and property were the primary drivers of returns. Global equity and property also contributed to the absolute returns in the quarter. During the quarter, we reduced local equity marginally in favour of local cash. This cash will be re-deployed in the event of market weakness. The portfolios, however, were overweight total equity. Momentum Enhanced Factor Portfolio Range returns The respective inflation objectives of the portfolios have been difficult to attain, given the low return from growth asset classes for the last five years. However, the portfolios managed to outperform their respective benchmarks for most periods. Asset class returns The returns for the asset class benchmarks for the second quarter of 2021 are reported in the first column of the table below. The next column highlights the returns for these asset classes for the previous year. These one-year returns are then converted into real returns by deducting inflation (5.2%) for the year. The final column in the table contains the returns above inflation we expect to get (on average) for these asset classes for a full market cycle. Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 2 of 10
Nominal returns for the Real returns for Expected real return
Asset class Q2 2021 returns
previous 12 months previous 12 months* (p.a.)
Local equity (Capped Swix) 0.6% 27.6% 22.4% 5.8%
Local bonds (Albi) 6.9% 13.7% 8.5% 3.3%
Local property (Sapy) 12.1% 25.2% 20.0% 7.0%
Local ILBs (Ilbi) 3.2% 14.3% 9.1% 2.8%
Local cash (Stefi) 0.9% 4.0% -1.2% 1.3%
Global equity (MSCI ACWI) 3.9% 15.1% 9.9% 6.5%
Global bonds (WGBI) -2.1% -16.2% -21.3% -0.3%
Offshore property 5.8% 9.7% 4.6% 4.0%
US dollar/rand** -3.4% -17.7%
SA CPI* 1.4% 5.2%
*CPI is to end May 2021
**A positive/negative value here reflects the effects of a depreciation/appreciation of the rand against the US dollar on global asset class returns in rand terms. As the rand gets
weaker/stronger, the returns of global investments get better/worse from a local investor’s perspective.
Building block return assessment
As explained above, our outcome-based investment philosophy starts at the asset class level and then goes down to an
investment strategy (if appropriate) and investment mandate level within each asset class. We thus construct building blocks
that reflect our selected investment strategies and managers that were awarded the mandates to implement these to either
improve on the returns of the asset class or manage its risk profile.
Local equity building block
During the second quarter of 2021, more progress in vaccine rollouts worldwide, as well as positive corporate earnings reports
and economic news continued to lift equity returns, particularly in developed markets, even as concerns emerged over high
valuations. The ALSI was roughly flat for the second quarter, returning 0.1%, while the Capped SWIX ALSI returned 0.6%.
The standout index was SAPY with an 11.1% total return. Financials delivered 7.5% and Industrials eked out 0.8%, but the
Resources returned negative 5.0%.
During the quarter, the building block returned 0.3%, which was marginally below the return of the Capped SWIX.
Prudential delivered a return of 2.5% for the first quarter of 2021, outperforming its benchmark by 1.9%. portfolio.
Being overweight MTN was a key contributor to the outperformance in the quarter. Property, banks and clothing retailers are
typically the most interest-rate-sensitive sectors in the South African economy. Prudential was underweight property for many
years, but, in 2020, as a result of significant price declines in the property sector, started to increase the portfolio’s weighting to
this sector and was overweight during the quarter. The portfolio benefited from being overweight to Growthpoint Property in
the last quarter following a strong return from the property sector. Prudential remains optimistic regarding the South African
equity market returns in the medium term due to the prevailing excessive levels of pessimism reflected in share prices
and valuations.
Fairtree returned negative 2,1% for the quarter. The financial sector was a key performance contributor during the period and
the portfolio’s return was contributors were positions in Foschini MTN, Mr Price, Capitec and Bidvest, while positions in Naspers,
Impala, Northam and Anglo American detracted from the return. Fairtree remains constructive that it is in a strong commodity
up-cycle underpinned by continued global growth, supportive infrastructure plans and green-ification targets that will require
Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 3 of 10considerable amounts of industrial metals (favouring copper, nickel and PGMs) and therefore continue to hold be overweight resources. Truffle returned negative 1.1% for the quarter. PGM miners underperformed, as the PGM basket price pulled back from fairly elevated levels and detracted from returns. Being underweights some locally exposed shares, including Nedbank, Foschini, Sanlam and Capitec, detracted from returns. MTN performed well due to better-than-expected results and an increased likelihood of a more rapid reduction in their debt levels. Richemont performed strongly in the quarter, as the global economy continued to open up. However, the investment managed remained underweight due to its high valuation. Truffle increased the exposure to Glencore and Sasol, as these share were trading on compelling valuations, and energy pricing was not as extended as some metals like iron ore. The investment manager reduced the extent of the overweight in PGMs on valuation grounds and due to the PGM basket being overly extended. It also increased the exposure to cheap locally exposed banks and industrials, like Bidvest. These additions were portfolioed by reducing the exposure to several shares that reached fair value, including Growthpoint Properties, Life Healthcare, Anheuser-Busch and Shoprite Holdings and British American Tobacco. Blue Alpha returned 0.3% for the quarter, which was marginally below the benchmark return. Positions in Foschini, Growthpoint, Capitec and Northam contributed to returns, while holdings in Amplats and Prosus detracted from returns. The biggest contributor to returns this quarter was the clothing sector. A specific share performer in the portfolio was Foschini. Being overweight Richemont, which had a great quarter, was a big contributor to returns as well. The portfolio remained underweight banks and gold, as well as Naspers, British American Tobacco and Anheuser Busch, with the preferred rand-hedge industrial shares being Bid Corp and Richemont. Changes in the quarter included adding Pepkor to the portfolio. Foord returned 3.6% for the quarter. The lower resources weighting and zero allocation to precious metals miners were the largest contributors to portfolio’s outperformance as index heavyweights, Implats and Angloplats, corrected after a very strong rally. The portfolio’s investment in mid-cap industrials also contributed to relative returns. The higher-than-benchmark holdings in Invicta, Hudaco, Omnia and Bidvest contributed to outperformance. Investments in the healthcare sector also added value, with core holding Aspen being the largest single contributor to the portfolio’s outperformance. Hospital holdings were mixed, with Life Healthcare outperforming sharply on the US FDA’s approval of Biogen’s Alzheimer drug, while Netcare underperformed and Mediclinic was neutral. The largest sector allocation, consumer services, also contributed, with strong returns from holdings in Foschini, Massmart and Pepkor, while Spurcorp, Spar Group and Italtile detracted. The zero holding in telecoms was the largest detractor from relative returns, as large index weighting company MTN outperformed the market, which was partially offset by top-10 investments Anheuser-Busch InBev and Richemont, which had a strong quarter. The principal investment in the media sector detracted on a relative basis, as largest portfolio holding Naspers/Prosus retraced on the stronger rand, weakness in key underlying investment Tencent and negative sentiment towards the announced share swap. Financials detracted at the margin driven by being underweight outperforming Capitec. The market-neutral allocation to listed property also detracted, with core holding in London listed Capital & Counties underperforming on the stronger rand The Satrix Momentum strategy returned 0.1% and 22.5% for the quarter and year respectively. From an attribution perspective, being overweight Distell Group and Richemont and underweight Anglo American Platinum added value in the quarter. Being overweight African Rainbow Minerals, Sappi and Northam Platinum detracted value from the strategy. At the last rebalance in June, the portfolio was transitioned based on the evaluation of new factor signals and the risk levels in the portfolio. Based on these signals, Life Healthcare, Royal Bafokeng Platinum, Reinet Investments and Standard Bank were added to the portfolio, while positions in Discovery, Pick n Pay, Sappi, SPAR Group and Thungela were deleted from the indices. Noticeable increases in positions were Investec, Telkom and Capitec and decreased positions were African Rainbow Minerals, British American Tobacco and Richemont. Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 4 of 10
The trending smart beta strategy returned negative 1.1% compared to the benchmark return of 0.6%. At quarter end, the portfolio’s equity exposure was 99.4%. It was overweight the resource sector and materially underweight the financial and property sectors. Within the resource sector, the portfolio was overweight platinum and general mining shares and, within the industrial sector, it was overweight retail shares. Within the financial sector, the portfolio was underweight insurance shares. During the quarter, Fortress A, Reinet, Goldfields and Prosus were sold, and Thungela Resources, Investec Plc, Royal Bafokeng Platinum, Foschini and Woolworths were introduced into the portfolio. The value smart beta portfolio returned 4.1%, which was well ahead of the benchmark return. The portfolio was overweight the financial sector, underweight the industrial sector and slightly underweight the resource and property sectors. Within the resource sector, the building block was overweight general mining companies and underweight platinum shares. Within the industrial sector, the building block was underweight retail companies and overweight telecommunication companies. Within the financial sector, the building block was overweight insurance companies. During the quarter, Thungela Resources, Capitec Bank, Imperial Logistics and Telkom were introduced into the building block. The quality strategy portfolio returned 0.5%, marginally underperforming the benchmark. The portfolio was overweight the industrial sector. Within the industrial sector, it was overweight food and beverage as well as retail shares, while it was underweight personal and household goods shares as well as the property and financial sectors. Within the financial sector, the building block was underweight banks, and also the resource sector. Within the resource sector, the building block was underweight gold mining shares. During the quarter, Sanlam was sold, while Exxaro and Thungela Resources were introduced into the portfolio. Local property building block The South African listed property sector continued to post a recovery in the second quarter of the year, following oversold levels witnessed during 2020. The benchmark SAPY delivered a total return of 12.1% during the quarter-ending June 2021. Several REITs reported their financial results during the quarter. Key operational return indicators continued to point to an industry that was still experiencing tenant demand pressure following the outbreak of the pandemic. Occupancy rates were deteriorating, and growth in rentals were still in deflationary state. Within the office sector side, visibility remained unclear, given the mixed messages from corporates (if any) on the adoption of hybrid working environments. In addition, sub-leasing trends appeared to be picking up in some CBD nodes, which will put pressure on asking rentals and occupancy rates. In the meantime, the weakness in the sector can be seen in national office vacancy rates at 14.2%, fast-approaching historic peaks. On the retail side, some tenants have targets to reduce space requirements to improve profitability. That said, some sectors of the asset class, such retail shops located in rural/non-metropolitan areas have bucked the trend, as evidenced by sales levels recovering back to or surpassing pre-pandemic levels, and occupancy rates unchanged. The building block achieved a return of 12.5% for the period, which was above the benchmark return. Meago returned 12.9% for the quarter. Being underweight Fortress A and B, Hyprop as well as overweight Vukile and Investec Property Fund were the largest contributors. Being overweight Storage and Equites as well asd underweight Growthpoint were the largest detractors. Several off-market trades were executed during June 2021 in MAS Real Estate, EPP and Fairvest further contributing to returns in the quarter. The Momentum Listed Property Portfolio returned 13.0%. The fund benefited from being overweight NEPI Rockcastle, Sirius, Equites and Resilient as well as from a new addition, Spear (a Western Cape focused REIT) in the first quarter of the year. Being underweight Growthpoint, Irongate Group and Investec Property Fund detracted from the returns of the portfolio. Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 5 of 10
Catalyst returned 12.2% for the quarter. The portfolio benefitted from being overweight the retail subsector. Being overweight Arrowhead-B, Vukile, Dipula-A and Resilient, which outperformed relative to the benchmark, and being underweight Fortress B, which underperformed the benchmark, were the main contributors. Being overweight Hyprop and Fortress-A, which underperformed the sector, and being underweight Sirius and Investec Property Fund, which outperformed the benchmark, were the main detractors. The Hyprop underperformance could be attributed to the capital raise of R358 million in May, which was placed at a discount to net asset value, while the Sirius outperformance was largely explained by the strong FY21 results reported by the company. Direct property building block The direct property building block returned negative 2.1% for the quarter, mainly due to a capital write down of 1.8% at 30 June 2021. COVID-19’s initial effect, continued lockdowns and general sentiment continues to have an effect on all property segments. As many economists predict the race to vaccinate is of utmost importance to accelerate economic recovery, with South Africa trailing far behind the global average. Continued pressure on rentals due to an oversupply of office space has been a major contributor to the capital write down within the building block. The retail sector, especially within the rural areas, performed well, as demand for retail space continued to strengthen rentals. building block The industrial sector continued to hold its ground well, although the building block’s allocation to industrial is low and could improve through diversifying into more industrial with the continued sale of non-core office and retail assets. The risk-adjusted arrears (bad debts provided for) at 30 June 2021 for the year, based on billings, was 2.78%. Local absolute strategies building block The absolute strategies building block benefited from the continued rally in local asset classes and returned a respectable 2.8% for the quarter. Being overweight equity as well as allocations to inflation-linked bonds and property were the main drivers of returns. The Sentio Absolute Return Fund performed satisfactorily for the quarter, posting a return of 2.8%, during a difficult quarter, which was characterised by a combination of sharp style rotations, low liquidity and uncertainty around the US interest rate outlook. Top contributions in equities came largely from positions in MTN, Richemont, Sanlam, Aspen and Pepkor, while derivative structures around some of the miners, retailers and banks also added. Detractors included positions in Naspers, Angloplats, Impala Sibanye and Northam. In fixed income, the portfolio was overweight (especially at the long end of the curve due to attractive valuations) and benefitted from bull flattening during the period. After the strong ALBI return in May, risk was reduced to be neutral to the benchmark. Prudential had another solid quarter and significantly outperformed the objective. The portfolio returned 3.r9% for the quarter. The largest asset-class contributors to absolute returns for the quarter were the fund’s exposure to SA nominal bonds (by far), followed by SA ILBs and SA listed property. In terms of specific equity exposure, among the strongest equity contributors to absolute returns for the quarter were the fund’s holdings in diverse shares like MTN, Truworths and PPC, as well as financial shares like Investec, Absa, Standard Bank, Old Mutual and Remgro. Naspers was by far the largest equity detractor from absolute returns, while resource holdings like Implats and Amplats also weighed on returns. Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 6 of 10
Laurium recorded a return of 1.4% for the quarter. Laurium is constructive on South Africa and continued to have reasonable exposure to South African-focused companies’ earnings (SA inc.). Within the South African listed market, the investment manager saw attractive opportunities in the healthcare, insurance, industrial and telecommunication sectors, along with some of the large global consumer shares including British American Tobacco and Naspers. It also had a reasonable exposure to resource shares including diversified miners. Laurium remained constructive on bond valuations on the back of recent progress in reforms, and continued commitment to fiscal consolidation shown thus far by National Treasury. The investment manager continued to see value across the SA bond curve and would only look to reduce duration at lower yield levels. The real return building block, which is a conservative strategy and more focused on capital protection, returned 3.5% for the quarter and 15.0% for the year. These returns outperformed the inflation objective by a healthy margin. Absa Asset Management returned 4.0% for the quarter, but remained very conservatively positioned, given its concerns around equity valuations. However, the investment manager is finding opportunities in the local market, which appears attractive relative to developed markets that seem priced-for-perfection. The equity exposure at 30 June was 24%. Prescient delivered a return of 2.1% for the quarter. Property and nominal bonds were the strongest contributors to returns for the quarter, while equities detracted. The building block was restructured during the quarter to increase effective equity exposure to 30%, while trimming bond exposure to 10% and listed property to 5% to help fund the equity overweight. Local flexible bond building block The second quarter of 2021 was a very good quarter for local fixed income asset classes, as bond, ILB and property yields rallied strongly. Globally, there was some respite from the reflation theme that caused chaos in global bond markets last quarter. The US Fed reiterated what it believes to be a transitory rise in inflation, causing US, 10-year yields to decline by 30 basis points. While locally, it appears that the long-awaited structural economic reform programme has finally gained some traction with an opening up of the energy sector, partial privatisation in the state-owned enterprise sector, an affirmation of the judiciary’s independence and some hard lines drawn in the political factional battle within the ruling ANC. In addition, our trade balance continues to surge on higher commodity prices. Listed property led the way off its very depressed base, delivering 12.12%, nominal bonds (ALBI) rebounded strongly, returning 6.86%, inflation-linked bonds (IGOV) delivered 2.95%, while cash (STeFI) continued to plod along at 0.92% for the quarter. There was no change in the repo rate in the second quarter of 2021, which remains at an historical low of 3.5%. There was only one MPC meeting this quarter in May and its vote was 5-0 in favour of leaving the repo rate unchanged. The traded money market was not as sanguine and interestingly, the forward-rate agreement curve moved up meaningfully to price 1% of hikes in the next year and an additional 1% the following year. These are the most aggressive interest rate expectations by the market seen since the repo rate reached the lows last year. The three-month JIBAR rate was relatively anchored at 3.69%, as there is no immediate threat of interest rates rising, but the one-year interest rate rose an additional 16 basis points to close at 4.79%, which is more than 1% higher than the lows seen in October 2020. Based on these JIBAR rate levels, the total return for the STeFI composite index was 0.92% for the quarter. For the quarter, the building block yielded 8.2% compared to the ALBI’s 6.9%. Active asset allocation and duration decisions by the investment managers and revised positioning on the yield curve resulted in an outperformance of 1.4% of the ALBI. Measured over an appropriate investment term of three years, the building block yielded 7.5% compared to the ALBI’s 9.2%, underperforming largely due to the negative returns in the first quarter of 2020 at the start of the COVID-19 pandemic. For the five-year period, it yielded 8.9% compared to 9.2% generated by the ALBI. Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 7 of 10
Prescient had a large exposure to the 12-plus-years sector of the yield curve at the end of the quarter, with a 78.2% exposure, compared to the ALBI at 48.0%. Coronation, on the other hand, ended the quarter being overweight the 7-12-years sector (36.3% against the ALBI’s 17.8%) and the 12-plus-years sector was at 52.7%. The 1-3-years sector was the weakest-performing sector for the quarter (1.4%), while the 12-plus-years sector was the best-performing sector, returning 10.1%. The 3-7-years sector returned 2.1% and the 7-12-years sector returned 6.7%. The building block allocation to listed property (2.7%) boosted returns. The allocation to ILBs (7.9%), also detracted slightly from the relative returns of the building block, as this asset class delivered 3.0% for the quarter. At the end of the quarter, the building block had a duration position of 7.7 years compared to the ALBI of 6.5 years. Duration was increased by Prescient during the quarter. On aggregate, the building block was overweight the 12-plus-years sector and underweight all the other sectors. Local inflation-linked bond building block ILBs delivered another good quarter, buoyed by rising inflation and a decline in real yields. The total return from ILBs can be divided into two components – the monthly accrual and the mark-to-market of the capital value due to the move in the real yields. The first component of return was the monthly accrual from the yield on the bonds and the inflation uplift. This component of the total return was substantial at 2.5% this quarter, with a 1.7% from inflation uplift and around 0.8% from yield accrual. The second component of the return was determined by the move in real yields of the bonds. There were small gains here as real yields moved a marginal 9bps lower on average in the quarter, with the yield curve steepening in the process. This bull steepening of the curve generated capital gains of 0.50%. These components combined thus explain the index (IGOV) total return of 2.95%. For the quarter, the building block yielded 5.5% against the benchmark IGOV (2.95%). For the year, the building block yielded a return of 13.6%, compared to the benchmark of 14.8%. It had a modified duration of 9.0 years, which was slightly shorter than the IGOV at 9.4 years. The investment manager was overweight the 7-12-year underweight all the other sectors. Local cash building block For the quarter, the building block delivered a return of 1.1% compared to 0.9% for the STeFI benchmark. For the year, the building block delivered a return of 5.1% against the STeFI benchmark of 4.0%. It consistently met its objective of capital preservation, by maintaining positive returns on a one-year rolling basis. Both investment managers had a high exposure to floating-rate notes, which provided a fair degree of liquidity, while also providing above-benchmark yields. Commodities building block The building block returned negative 0.18% for the quarter, underperforming the STeFI’s 0.9% and returned 5.2% for the last year, outperforming the STeFI’s 4%. The building block positioning was again troubled by significant price volatility of many commodities and a substantially stronger rand. An example of this is copper, which was very bullish early in the second quarter of 2021. Too bullish for the Chinese, who aggressively sold copper from their strategic reserve to damp the speculative activity in the copper market. Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 8 of 10
Moderate hedge solution building block The moderate hedge solution returned 0.88% for the quarter, bringing the one-year return to 13.78% after the deduction of all fees. This solution is diversified across strategies and within strategies. While all strategies contributed to returns for the past quarter, the fixed income arbitrage component was the biggest contributor to returns for the year. The opportunity set for fixed income arbitrage remained favourable, as monetary policy expectation offered opportunity in the front end of the curve, while relative value spreads throughout the curve remained elevated and also offered opportunities. Aggressive hedge solution building block The equity allocation was further hurt by the exposure to resource shares. The RESI exposure and specifically the PGM basket were big drivers of returns in the past two years and the position remained unchanged. The aggressive hedge solution returned 0.02% for the quarter, bringing the one-year number to 16.88%. The 50%/50% Capped SWIX/STeFI returned 0.80% for the quarter and 15.5% for the last year. Portable alpha solution building block The portable alpha solution returned negative 0.22% for the quarter, bringing the one-year number to 34.14% after the deduction of fees. This compared to the Capped SWIX total return, which returned 0.63% for the quarter and 27.6% for the past year. Special opportunities building block The building block returned 0% for the first quarter and 7.6% for the year. The portfolio is fast approaching its six-year anniversary, generating annualised net returns of inflation plus 5.4% since inception, which was a pleasing result for investors. There is an academic debate whether the recent uptick in inflation globally indicates a longer-term trend, or if inflation will subside in the coming months once pandemic related disruptions to global supply chains normalise. Given that the majority of the building block’s interest-rate-sensitive securities are floating-rate notes, it should continue to perform in line with the inflation-plus mandate under both inflation regimes. The building block was valued at R975 million at the end of the second quarter which included a capital call and distribution from separate underlying portfolios. Work continues on uncovering specialist investment strategies that meet the portfolio’s inflation- plus 6 (before the deduction of fees) return objective, as the world economy emerges from the global pandemic. Global equity building block The global recovery continued to build momentum during the second quarter, driven by developed markets, where vaccine rollout is proving to be decisive in lifting pandemic restrictions. Forecasts for growth this year and next were revised up materially: the IMF is now forecasting global GDP to expand by 6% in 2021, up from its previous forecast of 5.2%; the OECD raised its growth expectation to 5.8% from 4.2%, the Federal Reserve upped its 2021 forecast for US growth to 7% (six months earlier it was predicting 4.2%), while the ECB is now expecting growth in the Euro Area of 4.6% in 2021, compared with its March forecast of 4%. At the same time, inflation has been much higher than earlier expectations. CPI reached 5% in the US in May, while the Fed’s preferred measure of inflation, core Personal Consumption Expenditure, reached 3.4%, which is its highest for almost three decades and well above the Fed’s 2% target. The policy response has been on a scale never seen before in peace time. President Biden’s spending plans, on top of his $1.9 trillion pandemic relief programme, call for more than $6 trillion of spending in infrastructure, healthcare, education, clean energy and the environment, while extending the social safety net and supporting jobs. If enacted in full, it would result in Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 9 of 10
annual fiscal deficits averaging more than $1 trillion, which is 5% of GDP, in the next decade, and is the highest sustained levels of spending since WWII. After a strong quarter and half year for markets, returns are likely to be harder to come by in the months ahead. Recovery is being discounted, at least in part. Nearly all safe-haven bonds offer negative real returns and, in the absence of deflation, are deeply unattractive, even more so if inflation takes hold. The uncertainty and risks surrounding this exceptional economic cycle point to periods of volatility ahead. However, the risks should be kept in perspective. Inflation expectations remain reasonably well anchored. Financial conditions are very easy, and liquidity is abundant. Short-term setbacks are likely but the conditions for a sustained fall in risk asset classes are not evident. Further progress in equity markets and other risk asset classes is therefore likely. Against this backdrop, the global equity building block returned 4.0% in the quarter, outperforming its MSCI AC World index, which returned 3.8% in the same period. For the year, the building block returned 18.6%, outperforming the benchmark return of 16.6%. Growth stocks continued to drive markets in the quarter, which was reflected in our underlying investment manager returns. Jennison was the largest contributor to returns, mainly due to its stock selection within the Consumer Products and Retail sector, which forms a large component of their overall book. Our value style investment managers were the main detractors from returns in the quarter. Robeco’s value strategy was the biggest relative detractor, coming from its stock selection within the IT Hardware sector. Global property building block Global property continued to recover from the fallout experienced in 2020, as the pace of the vaccine rollout and re-opening of more sectors exceeded initial forecasts. Against this backdrop, the global property building block returned 4.5% (in rand terms), marginally above its benchmark, which returned 4.3 % for the same period. Global fixed income building block In contrast to global equities, global bonds endured another tough quarter, as US bond yields rose and breached 1.7% on concerns over possibly higher inflation in the next year. These concerns have in turn led to a number of market participants believing that the US Fed will begin tapering its bond buying programme. Against this backdrop, the global bond building block returned negative 1.8% (in rand terms), outperforming its benchmark, which returned negative 2.7 % for the same period. Conclusion We are confident that our portfolios are well positioned and have factored the potential future returns as well as the underlying market and economic conditions. Our portfolios are suitably diversified across asset classes and strategies, and we will continue to manage the portfolios in a prudent manner. Moment of portfolio facts & figures | FAW Enhanced Range quarterly commentary | June 2021 Page 10 of 10
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