Are we there yet?

By Nedgroup Investments

Omri Thomas is a Portfolio Manager at Abax Investments, the managers of the Nedgroup Investments Opportunity Fund.

Omri discusses the Fund’s performance over the quarter, its positioning going forward and why there are still opportunities in the market.

Performance update
Across all performance periods, the Opportunity Fund has recovered. A lot of the instruments that impacted the Fund last year have come through strongly and delivered for the Fund. Over the last year, the Fund delivered 36.7%. Despite its low equity component, compared to the average equity fund, the return was reasonable. It returned 11.5% for the quarter. The winners over the quarter included the Royal Bafokeng convertible shares contributing 4.07%, Naspers (0.69%), Sasol (0.68%), Eurostoxx 50 (0.364%) and British American Tobacco (0.56%). Over the one-year period, instruments that we think differentiate the Fund from other funds was the use of hybrid instruments within the Fund, either directly through investments, such as convertible bonds or preference shares. We also sometimes structure asymmetric return products like the Eurostoxx notes. If we look at the asset classes, we continue to see quite a lot of value in SA. Bonds are hovering between fair value and cheap in our view. SA property still offers decent returns. We’re still excited about the hybrid opportunities and you can still get decent value in SA equities. Most of the developed market asset classes are expensive, so there‘s a bit more uncertainty in global markets, which is a bit of a tail risk. The S&P is at record levels and that’s despite inflation pressure starting to build. There debate as to whether inflation pressure will come through, but the risks have increased.

Asset allocation
The SA equity portion has increased up to 47.4% as we see more opportunity here as opposed to developed markets and due to performance. We’ve decreased bonds slightly (10.3%) even though we started to see value in bonds, but remain concerned about the fiscal position in SA. Our bond duration is still fairly short. SA property is at 7.1% and we have started to take profit in select property companies and see value in the remaining shares that we hold. Convertibles and preference shares makeup the hybrid part of the portfolio. We increased this weighting to 10.6% mostly due to performance. The Royal Bafokeng convertible bond has done extremely well and was one of the top contributors to the Fund’s performance. We also added the SAPPI convertible bond, the Brait USD convertible bond and have a long held position in PSG preference shares. They have just announced a buy-out offer of all PSG preference shares at R81/share plus accrued dividends. Based on a trading price of R66/share, this is a good premium. Abax owns 30% of all the issued PSG preference shares, so should be a nice contributor to returns. We have quite a low exposure to offshore equities (5.2%) due to our concerns on valuations. Offshore bonds are SA names mainly offering us a yield spread above US treasuries, which when converted back to Rands is very decent. Cash is at about 3% and very little offshore property (0.3%).
Top 10 equities
Naspers remains our top equity holding (7.4%) followed by Royal Bafokeng convertible bond (7.2%). I’ve included Royal Bafokeng in our top equity positions as its share price is well above the strike price of the bond, so its performance will be directly impacted by the performance of Royal Bafokeng Platinum. In our view it is now a full equity. It has passed its conversion date, so we can convert and in fact have given notice on a big part of our position to convert into shares and to start reducing our position. Firstrand and Standard Bank are also in our top ten and are offering decent value with decent dividend yields at attractive ratings.

Naspers value unlock continues?
Naspers is still over 50% discount to what we see as the fair value. Over the last few years, management has started taking actions to try and unlock some of this value. They sold 2% of Tencent and used this to make more acquisitions and buy back some of their own shares. Prosus also bought back some of its own shares. They’ve just announced another sale of 2% of their Tencent shares. We would have liked them to use those proceeds to just buy back their shares, but will be using them to make further investments. They are trying to bolster the scale of the non-Tencent investments to hopefully unlock value through listing or selling or spinning off those assets into a separate company.

Hybrid exposure
Our hybrid exposure accounts for 20% of the Fund with investment notes making up almost 9.1%, convertible bonds at 8.7% and preference shares, which are mostly PSG, at 2%. The investment notes are spread over ten different notes and four different assets. A big part is on the Eurostoxx Index, which has had a nice recovery. Contrasted to the S&P, it was a very muted recovery, so you could expect this index to continue performing. The average yield to maturity of our basket of notes is 22%. In a yield-starved world, we think that’s a very attractive return. The average weighted duration is under a year to expiry. 8.5% of the 9% is expiring with the next year, so unless we replace it with new structured notes, that will reduce as a percentage of the portfolio. Expiry ranges from May 2021 to March 2026. Eight of the ten are above the strike price. The two below the strike price have a remaining duration of less than four years.

While global markets look expensive, SA continues to offer selective value. Banks have good capital levels, healthy provisions and attractive dividend yields. SA hybrids continue to offer attractive risk return pay-offs and we are still positive on Naspers and British American Tobacco. We continue to be cautious on the domestic economic outlook and bond duration remains low. Given the Rand strength, we’ve tried to maintain maximum FX exposure through the use of currency overlays. We are comfortable that our portfolio offers a good mix of growth and yielding assets, providing the portfolio with an attractive risk/return profile.