Against heightened geopolitical tension and increased market volatility, the Allan Gray Equity Fund navigated a challenging first quarter of 2026, delivering a positive absolute return. Portfolio manager Jithen Pillay explains why maintaining a defensively positioned portfolio remains appropriate amid elevated uncertainty.
Geopolitical tension in the Middle East dominated market returns this quarter. After the MSCI World Index (World Index) and the FTSE/JSE All Share Index (ALSI) closed near all-time highs in 2025, both indices suffered negative returns in the first quarter of 2026, with the World Index down 3.6% in US dollars and the ALSI down 0.6% in rands. Even more pronounced was the volatility. Within the three-month period, the ALSI recorded 12 days with daily returns below -1% and another 14 days with daily returns above 1%. Given the heightened uncertainty, sentiment changed rapidly, at times on an intraday basis, in response to real-time statements from parties on the Middle East conflict.
At the time of writing (31 March 2026), it is difficult to predict with confidence the end state of the war or whether the ceasefire will hold. A low-road scenario would be a prolonged war with material destruction and/or blockades of infrastructure important to global trade. Iran, Saudi Arabia, Iraq, the United Arab Emirates, Kuwait and Qatar feature among the largest producers of oil and gas globally. The Strait of Hormuz is a critical chokepoint for these commodities, with approximately 20% of global oil volumes sailing through it. As these flows were disrupted, the oil price rose from around US$60 per barrel at the start of the year to more than US$100 per barrel at quarter-end. A 25% increase in the rand oil price, in the absence of lasting government relief, will add almost 2% to South Africa’s headline inflation rate, based solely on the official consumer price index weights of petrol and public transport fares in Statistics South Africa’s inflation basket. The eventual impact is likely to be higher as the oil price spike permeates through the broader economy, particularly if fuel availability becomes constrained.
The war is also not positive for South Africa’s terms of trade. We rely on imports to fulfil 80% of the country’s fuel needs (i.e. everything outside of Sasol Synfuels), which is reflected in the rand depreciating close to the R17-per-US-dollar barrier during the quarter. None of this is good news for South African consumers, and particularly for lower-income households whose disposable income was already constrained. At the other extreme, a swift end to the conflict could see trade flows resume quickly, with on-hand stockpiles cushioning any prolonged impact on inflation. This would likely see a strong recovery in asset prices. We believe positioning the Fund at either boundary is unwise, given the call it requires on inherently unpredictable state actors.
Given the volatility outlined above, the Allan Gray Equity Fund performed acceptably during the quarter in maintaining a positive absolute return. To quote the Fund’s Q4 2025 commentary: “Given current valuations, we are concerned about the prospects for absolute returns both globally and locally. Therefore, the Fund is positioned defensively to protect capital.” With the benefit of hindsight, this caution proved warranted. We remain concerned about the outlook for global and local growth, as well as deteriorating inflation forecasts. This would be less problematic if valuations were very low, but broadly this is not the case in the US and in some sectors of the ALSI. As such, the Fund maintains its offshore positioning close to the maximum limit, with an underweight to the US. Within the local component, the Fund’s largest equity positions are rand hedges and select domestically focused companies that we believe can grow earnings, even in a tougher macroeconomic environment.
We define risk as the probability of permanent capital loss, rather than failure to track a benchmark. This philosophy often leads the Fund to be more conservatively positioned. As a result, the Fund does well to keep up when overall markets are strong. However, most of the Fund’s outperformance is derived when markets are weak, leading to superior risk-adjusted returns through the cycle. A strong recovery in equity prices from here should see the Fund generate strong absolute returns, though likely below the benchmark return. However, a further sell-off in markets should see capital better protected, with strong relative returns as an added benefit. We believe such positioning is prudent given the heightened uncertainty.