The poor sentiment towards equity markets at the end of 2018 reversed sharply in the first quarter of 2019, with the JSE appreciating 8% and the MSCI World Index 12%. The 65% net share exposure held at the start of the quarter allowed the Fund to benefit from these equity market movements.
Regulation 28 of the Pension Funds Act limits the Balanced Fund’s share exposure to a maximum of 75%. The Fund’s share exposure indicates where we see the risk/return profile of equities currently: a moderately favourable balance. The relatively weak returns from JSE equities over the past four years have allowed many companies to grow into their valuations. The median price-to-earnings (PE) multiple of the top 100 companies has fallen from 17.0 in 2015 to 13.6 today. This is a rough indication of an improved opportunity set and aligns with our bottom-up research where we are finding more companies trading at or below our estimates of fair value. Broadly we think the JSE is trading at about fair value. Using history as a guide, these valuations suggest investors can expect returns over the next five years of about 4% above inflation – not a dripping roast, but a good opportunity for those with a long-term horizon. We look to add to the underlying market return through careful stock selection and alpha generation.
The year-to-date move in the JSE was a story of very distinct parts: The resources sector appreciated 18% driven by Anglo American, BHP Billiton (BHP) and the platinum sector. While the weak economy and deteriorating sentiment towards South Africa caused the retail sector to fall 14%. In between, the banks registered marginal declines. We are currently focusing the bulk of our research efforts on the domestic cyclical sector. To date, we have not bought large positions, outside Woolworths, as the valuations are not yet exceptional given the risks. In a similar vein, the property sector has had a difficult 18 months, returning a negative 18% from its peak. Despite the lower valuations, we have not bought any large positions as the excesses of a 20-year bull market are not undone in just over a year.
Unfortunately, we held no Anglo American and only a small position in BHP, missing the stellar returns of the past year. Iron ore accounts for the bulk of these two companies’ earnings, a commodity we have been wrongly cautious about for some time. Brazilian miner Vale’s recent tailings dam failure has driven the iron ore price higher still, as it has been forced to cut production by approximately 40 million tonnes. We reassess our positions constantly but, based on our long-term commodity price assumptions, we don’t find value in Anglo or BHP. Glencore, a diversified mining company, is a top 10 holding for the Fund. However, given Glencore’s nil exposure to iron ore, it has been a relative underperformer in the mining sector.
Orbis has had a difficult start to 2019 with its funds generally lagging the sharp recovery in international markets. Half of the Allan Gray Balanced Fund’s international exposure (excluding Africa ex-SA) is invested in the Orbis Global Balanced Fund, while the remainder is in a mix of the Orbis Equity and Optimal Funds. The Orbis Funds are generally underweight the US equity market, which has detracted from the relative performance. The US market has driven global equity returns over the past 10 years and valuations are looking very stretched. Historically, if you invested in the US market at these valuations, you lost money over a five-year time horizon. This is confirmed by Orbis’ bottom-up research.
When managing the Allan Gray Balanced Fund, we continuously search for undervalued assets and strive to avoid overvalued assets. These are particularly exciting times as the nervousness around South Africa could grant us the opportunity to buy some very undervalued assets. We are working to assess these opportunities.
The Fund’s largest purchases were MultiChoice and British American Tobacco while the most significant sales in the quarter were Sasol and Nedbank.