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INVESTMENT RESEARCH AND STRATEGY REPORTAUTUMN 2017

4.1. TACTICAL OVERVIEW

3. FINANCIAL MARKETS

4.3. PROPERTY COMMENTARY

4. TACTICAL PREFERENCES

4.2. EQUITY RESEARCH 4.4. PREFERENCE SHARES

4.5. FIXED INCOME 4.6. CASH MANAGEMENT OPTIONS

4.7. CURRENCIES

8. PERFORMANCE SUMMARY

5. DOMESTIC SOLUTIONS

6. OFFSHORE SOLUTIONS7. SPOTLIGHT ON: SUMMER

2017 SURVEY – THE VALUATION OF THE LOCAL MARKET

9. PREVIOUS PUBLICATIONS

1. INTRODUCTION 2. ECONOMIC REVIEW

Page | 2

1. INTRODUCTION

Introduction

Maintain an even keel for investment success“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.” – Warren Buffet.

One of our senior analysts, Henko Roos, explains in his article why investors should not make investment decisions based on their emotions – especially during times of increased political uncertainty. In these uncertain geopolitical times, this statement by Buffet rings as true today as it did when he made it during an interview in 2010. Being able to maintain an even keel and not overreacting to optimism or pessimism is critical for investment success. Our role as investment specialists and fiduciaries is to help provide you with the necessary information to make intelligent, unemotional investment decisions.

That is where the PSG Wealth Investment Research and Strategy Report comes in. The report outlines our high-level views of financial markets and our asset allocation decisions. Our analysts and contributors also reflect on some of the events that contributed to market instability in the first quarter of 2017. In this context we also consider the performances of our own investment solutions.

Lastly, take part in our autumn 2017 survey on political uncertainty and investing.

We hope you enjoy the read. Please feel free to send us any feedback you may have – we always look forward to hearing from you.

Regards

Adriaan Pask, PhD

PSG Wealth Chief Investment Officer

How to navigate this documentYou can navigate this document in two ways.

• Links on the cover page: Each tile acts as a link to the article mentioned in the specific tile.

• Links at the top of each page: Use each link 'Previous', 'Contents' or 'Next' to navigate between pages and the cover page.

https://www.surveymonkey.com/r/PoliticalUncertainty

Page | 3

2. ECONOMIC REVIEW

Economic review

The geopolitical uncertainties investors are faced with include Britain, which started its exit from the European Union (EU); anti-populist politics taking the lead in the Dutch elections; elections in France and Germany still looming; and President Donald Trump, who failed to reform healthcare in the US. On the domestic front, political uncertainty increased after the cabinet reshuffle and the removal of former Finance Minister Pravin Gordhan. These sovereign developments, along with events in 2016, still point to various uncertainties in macro-economics at home and abroad.

Britain starts its divorce from the EUAt the end of this quarter, British Prime Minister Theresa May notified the EU Council President, Donald Tusk, in a hand-delivered letter that Britain would quit the club it joined in 1973. “The United Kingdom is leaving the European Union,” May told parliament nine months after Britain shocked investors and world leaders by unexpectedly voting to quit the trade bloc. “This is a historic moment from which there can be no turning back,” May said.

The outcome of the negotiations will shape the future of Britain’s US$2.6 trillion economy, the world’s fifth biggest, and determine whether London can keep its place as one of the top two global financial centres.

For the EU, already reeling from successive crises over debt and refugees, the loss of Britain is the biggest blow yet following 60 years of effort to forge European unity in the wake of two world wars. Its leaders say they do not want to punish Britain. But with nationalist, anti-EU parties on the rise across Europe, they cannot afford to give London generous terms that might encourage other member states to break away.

May has promised to seek the greatest possible access to European markets but said Britain was not seeking membership of the ‘single market’ of 500 million people, as she understood there could be no ‘cherry picking’ of a free trade area based on unfettered movement of goods, services, capital and people.

Britain will aim to establish its own free trade deals with countries beyond Europe, and impose limits on immigration from the continent, May stated.

Except for the sterling falling against major currencies since the historic vote, the UK economy still grew in the aftermath of Brexit. Real economic growth accelerated to 2.9% y/y in the fourth quarter of 2016 from 2.3% in the third quarter, mainly due to a surge in exports and final consumption by households. The Bank of England (BoE), at the February 2017 Monetary

Geopolitical uncertainties on investors’ watch lists over the next few months

Eurozone indicators show a very solid start to the year

Cont

ributi

on to

ann

ual G

DP

grow

th

3

2

1

0

(1)

(2)

(3)2011

Government consumptionInvestmentsStocks and statistical discrepancies

2012 2013 2014 2015 2016

Household consumptionNet ExportsReal GDP

Source: S&P Global Ratings

Effective exchange rate EURO/USD (RHS)

115

110

105

100

95

90

85

Feb

14

Jun

14

Oct

14

Feb

15

Jun

15

Oct

15

Feb

16

Jun

16

Oct

16

Feb

17

1.5

1.4

1.3

1.2

1.1

1.0

0.9

0.8

0.7

0.6

Ind

ex

Rati

oSource: S&P Global Ratings

Economic indicators in UK still positive in Q4 2016

6

5

4

3

2

1

0

2014

- Q

3

2014

- Q

4

2015

- Q

1

2015

- Q

2

2015

- Q

3

2015

- Q

4

2016

- Q

1

2016

- Q

2

2016

- Q

3

2016

- Q

4

2017

- Q

1

2017

- Q

2

2017

- Q

3

2017

- Q

4

2018

- Q

1

2018

- Q

2

2018

- Q

3

2018

- Q

4

% c

hang

e Y/

Y

GDP CPI International financing


Policy Committee meeting, revised growth forecasts for 2017 and 2018 upwards to 2.0% and 1.6%, respectively.

However, the Chief European Economist at S&P Global Ratings, Jean-Michel Six, told investors at a conference in Johannesburg they expect the UK GDP to slow considerably in 2017 and 2018.

Meanwhile, consumer price inflation (CPI) reached an almost three-year high of 1.8% in January 2017, while core inflation (excluding energy and unprocessed food) remained unchanged at 1.5%. The BoE expects inflation to quicken substantially over the coming months and to breach the central bank’s target of 2% in the first half of 2018, due to the impact of sterling depreciation following the UK’s decision to leave the EU. The BoE left its current policy stance unchanged at 0.25% in February and March 2017.

Jan

11

Jul 1

1

Jan

12

Jul 1

2

Jan

13

Jul 1

3

Jan

14

Jul 1

4

Jan

15

Jul 1

5

Jan

16

Jul 1

6

Jan

17

60

55

50

45

40

Indi

ces

EZ PMI Composite EZ PMI Manufacturing EZ PMI Services


2010

2011

2012

2013

2014

2015

2016

2017

France Italy Spain

700

600

500

400

300

200

100

0

Bps


Page | 4Economic review

Economic growth gaining momentum in developed marketsEconomic recovery in the EU is viewed as resilient and gradually broadening across the region. Strong purchasing managers index (PMI) numbers have also been seen since November 2016, which indicates a consumer-led economic recovery taking place in the EU. The final Markit Eurozone Manufacturing PMI rose to a six-year high of 56.7 in April 2017, from 56.2 in March 2017. S&P Global Ratings expects economic growth of between 1.0% and 1.5% in the EU this year. And while Germany’s economy is speeding ahead and Germans are calling for the European Central Bank (ECB) to start tapering off their buyback of bonds each month, S&P believes a premature move by the ECB could jeopardise this recovery, and that the ECB will only start to taper off well into the second half of 2017 or only in 2018.

Top 10 economies as percentage of world GDP

1. United States of America 24.32%

2. China 14.84%

3. Japan 5.91%

4. Germany 4.54%

5. United Kingdom 3.85%

6. France 3.26%

7. India 2.83%

8. Italy 2.46%

9. Brazil 2.39%

10. Canada 2.09%

The 10 smallest economies as a percentage of world GDP

1. Columbia 0.39%

2. Philippines 0.39%

3. Malaysia 0.40%

4. Israel 0.40%

5. Hong Kong 0.42%

6. South Africa 0.42%

7. Egypt 0.45%

8. Venezuela 0.50%

9. Nigeria 0.65%

10. Argentina 0.79%

* Based on advanced and emerging market economies.

Source: World Bank as at 1 February 2017

Real global output growth and contributions from advanced and emerging market economies

5

4

3

2

1

0

-1

5

4

3

2

1

0

-1

2011 2012 2013 2014 2015 2016

Perc

enta

ge c

hang

e fr

om q

uart

er to

qua

rter

Perc

enta

ge p

oint

s

Advanced economies (right-hand scale) Emerging economies (right-hand scale)

Global growth

Source: South African Reserve Bank (SARB)

In its January 2017 World Economic Outlook Update, the International Monetary Fund (IMF) left its global growth forecasts for 2017 and 2018 unchanged at 3.4% and 3.6%, respectively.

Data shows the outlook for advanced economies improved somewhat over the last two years, reflecting stronger activity during the second half of 2016 as well as expected fiscal stimulus in the US. China seems to be stabilising and there are accelerations in growth within the BRIC nations, especially in Brazil and Russia. At this stage things look positive, but we do need to be aware of lessons learnt in 2016 around Brexit and the US presidential elections. However, economists believe that geopolitical changes, like policy mistakes and government issues, currently present risks which could derail this recovery. Only time will tell if populist movements in the EU will be victorious at the French election in May and the German national election in September.

An acceleration of inflation in some developed marketsInflation accelerated somewhat in the fourth quarter of 2016 and in the opening months of 2017 in some countries, as the international prices of crude oil, metals and mineral commodities increased. However, the World Bank believes underlying inflationary pressures remained fairly muted, especially in advanced economies. Monetary policy in advanced economies diverged further when the US policy interest rate was increased in December 2016 and again in March 2017, as the growth outlook in that country appears more robust. Monetary policy settings also differed among emerging market economies, with some central banks tightening policy due to weaker currencies while others eased policy, given subdued output growth and muted inflationary pressures.


Policy interest rates in selected advanced and emerging economies - a mixed picture

20

15

10

5

0

-5

2012 2013 2014 2015 2016 2017

Perc

ent

United States**

Brazil

India

* Russia and Turkey adopted new policy tools in September 2013 and January 2014, respectively. The old and new policy rates are shown on the same line in the figure.** Middle of range

Russia*

China

Mexico

South Africa

Turkey*

Euro area

Source: SARB

There has been an encouraging change in sentiment towards emerging markets (EMs)Data suggests that net capital flows towards EMs have increased in January 2017, although at a subdued pace.

The Institute of International Finance (IIF) estimates that non-resident portfolio flows to emerging markets rose to US$17.1 billion in February this year.

Their data shows that all four EM regions saw portfolio inflows in February, for the first time since June 2016.

Net capital flows as at February 2017 in EMs excluding China

EM9 (X China)120

100

80

60

40

20

0

01/0

4/20

10

01/0

8/20

10

01/1

2/20

10

01/0

4/20

11

01/0

8/20

11

01/1

2/20

11

01/0

4/20

12

01/0

8/20

12

01/1

2/20

12

01/0

4/20

13

01/0

8/20

13

01/1

2/20

13

01/0

4/20

14

01/0

8/20

14

01/1

2/20

14

01/0

4/20

15

01/0

8/20

15

01/1

2/20

15

01/0

4/20

16

01/0

8/20

16

01/1

2/20

16

Source: IIF

Net capital flows in South Africa

South Africa

01/0

4/20

10

01/0

8/20

10

01/1

2/20

10

01/0

4/20

11

01/0

8/20

11

01/1

2/20

11

01/0

4/20

12

01/0

8/20

12

01/1

2/20

12

01/0

4/20

13

01/0

8/20

13

01/1

2/20

13

01/0

4/20

14

01/0

8/20

14

01/1

2/20

14

01/0

4/20

15

01/0

8/20

15

01/1

2/20

15

01/0

4/20

16

01/0

8/20

16

01/1

2/20

16

10

8

6

4

2

0

-2

Source: IIF

Page | 6

On the domestic frontSouth Africa’s trade balance switched from a deficit of R11.22 billion in January to a surplus of R5.22 billion in February. According to the South African Reserve Bank (SARB), the smaller current account deficit was financed through net portfolio inflows, while direct and other investments registered outflows in the fourth quarter of 2016. South Africa’s gross gold and other foreign exchange reserves amounted to US$46.7 billion at the end of February 2017, and covered on average 5.2 months’ worth of imports of goods and services, and income payments in the fourth quarter of 2016.

According to the IIF, South Africa faces what could be a watershed year in 2017. In December, the ANC will elect a new leader, who will likely set the agenda for the party leading up to the general election in 2019. Growth should pick up as agriculture recovers, but no meaningful investment-led recovery is likely until 2018. According to the SARB, real economic growth slowed further and turned negative in the fourth quarter of 2016. The contraction at an annualised pace of 0.3% was in step with the current downward phase of the business cycle. For 2016 as a whole, real economic growth slowed to a mere 0.3% – the lowest annual growth rate since 2009. However, the increase in the composite leading business cycle indicator since May 2016 suggests improved economic activity in 2017. At its March meeting the SARB said it expected gross domestic product (GDP) growth to average: 1.2% in 2017 (January forecast: 0.4%), 1.7% in 2018 (January forecast: 1.1%) and 2% in 2019.

Within an environment of subdued output growth, the domestic economy struggled to create sufficient employment opportunities. In the third quarter of 2016, the seasonally adjusted unemployment rate increased to its highest level (27.1%) since the global financial crisis. The unemployment rate fell to 26.5% in the last three months of 2016. Wage settlements moderated slightly in 2016, and while growth in nominal unit labour cost accelerated to 5.7% in the fourth quarter of the year, it remained within the inflation target range.

Headline CPI has breached the upper limit of the inflation target range since September 2016 and accelerated to 6.8% in December, before moderating marginally in February 2017 to 6.3% y/y. At the end of March, the SARB kept its repo rate unchanged at 7% and the prime lending rate – the rate at which banks lend money to consumers – unchanged at 10.5%. At the January meeting, the Bank signalled that it could begin raising rates again if higher oil prices or a weaker rand caused inflation to remain outside the Bank’s 3% to 6% target range. Announcing the Bank’s decision on 22 March, Governor Lesetja Kganyago said steady oil prices and an improved inflation outlook informed the decision. He did, however, say political uncertainty was a risk to the rand exchange rate and thus inflation. The Bank now expects CPI inflation to average 5.9% y/y in 2017, from its 6.2% forecast in January; and to slow to 5.4% in 2018, against the January outlook of 5.5%. It expects an average of 5.5% in 2019.

Economic review

However, this was before President Jacob Zuma decided to replace former Finance Minister Pravin Gordhan during a cabinet reshuffle on 30 March, which was subsequently followed by a decision by S&P Global Ratings to downgrade the country’s sovereign foreign currency rating to junk (from BBB- to BB+).

While the rand recovered from the December 2015 so-called ‘Nenegate’ to about R12.20/$ at the start of 2017, the cabinet reshuffle at the end of March negatively influenced the local currency’s persistent strength. It weakened to about R13.80/$ at the end of the first quarter of 2017.

Real gross domestic product and expenditure - South Africa

12

10

8

6

4

2

0

-2

-4

-6

-8

-10

Perc

enta

ge c

hang

e fr

om q

uart

er to

qua

rter

2011 2012 2013 2014 2015 2016

Real gross domestic expenditure Real gross domestic product

Seasonally adjusted annualised rates

Source: SARB

It seems the only certainty at this stage is political uncertainty Political uncertainty includes uncertainty over whether Zuma will submit to all the calls for him to step down, uncertainty over the outcomes of upcoming elections in Europe, and uncertainty over when fiscal stimulus will lead to enhanced economic growth in the US. Investors need to remember that volatility is driven by sentiment, which often causes the mispricing of assets. This presents opportunities for active managers. No matter what the uncertainties, the PSG Wealth Solutions are diversified to help manage uncertainty.


Source: SARB

July

2012

January

2014

January

2015

January

2016

March

2016

March

2017

Last time repo rate was cut

Then-governor Gill Marcus dropped it by 50bps to 5%, the lowest level in at least 14 years

History of interest rate hikes

SARB has raised rates by 200bps since the start of 2014 to date

SARB has raised rates by 75bps since the start of 2015 to date

SARB raised repo rate by 50bps (6.75%)

SARB raised repo rate by 25bps (7%)

Repo rate left unchanged at 7% since March 2016 decision

Page | 8

3. FINANCIAL MARKETS

Long-term returns of most equities remain well above the expectations of inflation plus 7.00%. The exception is resources which came under pressure following a shift in Chinese policy – one moved from government spending towards a consumer-led economy.

Total returns as at 31 March 2017

Index Quarter-end value 1M 3M 6M 1Y 3Y 5Y

Loca

l equ

ities

ALSI 52 056.06 2.68% 3.78% 1.60% 2.53% 5.98% 12.49%

Industrials 76 744.17 4.19% 6.63% 1.63% 0.05% 10.00% 18.20%

Resources 18 401.03 2.91% 2.66% 1.43% 16.67% -12.51% -4.37%

Financials 40 260.92 -0.66% -1.08% 1.78% -1.81% 9.16% 15.01%

Listed property 627.61 0.11% 1.37% 2.64% 1.46% 14.48% 15.81%

Loca

l bon

ds

ALBI 546.6 0.40% 2.46% 2.82% 11.02% 7.45% 7.38%

ALBI 1-3 years 422.03 0.67% 2.58% 4.06% 9.40% 7.43% 6.72%

ALBI 3-7 years 525.7 0.82% 3.33% 4.44% 11.56% 8.65% 7.60%

ALBI 7-12 years 602.93 0.42% 2.61% 3.32% 10.99% 7.73% 7.43%

ALBI 12+ years 595.32 0.27% 2.18% 2.13% 11.46% 7.15% 7.66%

GOVI 544.66 0.44% 2.49% 2.86% 10.84% 7.44% 7.25%

OTHI 557.42 0.28% 2.38% 2.72% 11.41% 7.57% 8.16%

Loca

l cas

h

STeFI 3-month 353.63 0.60% 1.74% 3.55% 7.20% 6.43% 5.91%

Volatility Index 11.57 -10.45% -17.59% -12.94% -17.06% -5.89% -5.68%

Inte

rnat

iona

l equ

ities

S&P 500 2 362.72 0.12% 6.07% 10.12% 17.17% 10.37% 13.30%

Euro Stoxx 3 500.93 5.65% 6.82% 17.43% 20.14% 6.32% 10.38%

Nikkei 18 909.26 -1.10% -3.50% 14.95% 12.83% 8.44% 13.40%

Hang Seng 24 111.59 1.56% 9.60% 3.55% 16.05% 2.87% 3.24%

Dax 1 120.80 3.91% 7.47% 15.46% 22.53% 9.38% 12.86%

MSCI World 1 853.69 0.82% 5.85% 7.42% 12.47% 3.58% 8.26%

MSCI World ex US 1 793.34 2.08% 6.06% 5.31% 8.84% -2.23% 2.66%

FTSE 100 7 322.92 0.82% 2.52% 6.14% 18.59% 3.66% 5.39%

One-month financialsBanks and life assurers have largely been under pressure. These counters are exposed to local cyclical stocks that suffered the brunt of the recent political uncertainty.

One-month resourcesShows a strong recovery.

Five-year resourcesLong-term returns remain muted despite a recent rally in the sector.

Local bondsAlthough the performance in this sector was not great, the instruments held up reasonably well despite political volatility, indicating that much was priced in already as expected.

ALBI 3 - 7 yearsBond sectors generated in excess of 10% over the last 12 months, largely on the back of a more dovish MPC and interest rate outlook.

STeFi one-yearBarely generated inflation beating returns. After cost and taxes investors invested solely in cash which eroded the real value of their capital.

S&P 500 one-yearThe US remains one of the best performing regions for equity investments as investors seek the safety of developed markets that would lead the post-crisis recovery in a low yield environment.

Euro Stoxx one-yearEuropean shares showed a very strong recovery on the back of some depressed valuations.

Source: INET*Performance reported in Base Currency, Total Return

Financial markets

Page | 9Financial markets

SA asset class returns: 1-year performance SA asset class returns: 3-year performance

Year-to-date (YTD) returns in equities have been led by property stocks and bonds. However, bonds came under pressure in March due mainly to uncertainty on the domestic political front.

Locally listed property performed well in 2014 and 2015 (apart from December 2015). A minor recovery started in 2016, but performance in this sector has stagnated since May 2016.

SA asset class returns: 5-year performance SA equities: 1-year market cap returns

Importantly, over five years, all major asset classes outperformed cash. People often point to flat returns for the last three years, but in reality the average equity investor has grown their capital by around 75%. Equity returns don’t come in a straight line. Premium returns are earned for tolerating a bumpy ride. The so-called bumpy ride is seen in the 1-year graph which follows.

History has shown that over 1-year periods, equity returns can be highly volatile and unpredictable. Statistically, however, investors have a higher probability of achieving a higher long-term return if they invest when market stress and sentiment are poor.

116

114

112

110

108

106

104

102

100

98

96

94

04/2016 05/2016 06/2016 07/2016 08/2016 09/2016 10/2016 11/2016 12/2016 01/2017 02/2017 03/2017

FTSE/JSE All Share TR ZAR - 102.5

STeFI Call Deposit ZAR - 107.0

Beassa ALBI TR ZAR - 111.0

FTSE/JSE SA Listed Property TR ZAR - 101.5

152.5150.0147.5145.0142.5140.0137.5135.0132.5130.0127.5125.0122.5120.0117.5115.0112.5110.0107.5105.0102.5100.0

06/2014 09/2014 12/2014 03/2015 06/2015 09/2015 12/2015 03/2016 06/2016 09/2016 12/2016 03/2017

FTSE/JSE All Share TR ZAR - 119.0STeFI Call Deposit ZAR - 119.7

Beassa ALBI TR ZAR - 124.1FTSE/JSE SA Listed Property TR ZAR - 150.0

09/2012 03/2013 09/2013 03/2014 09/2014 03/2015 09/2015 03/2016 09/2016 03/2017

212.5

205.0

197.5

190.5

182.5

175.0

167.5

160.0

152.5

145.0

137.5

130.0

122.5

115.0

107.5

100.0

92.5

FTSE/JSE All Share TR ZAR - 180.2STeFI Call Deposit ZAR - 131.7

Beassa ALBI TR ZAR - 142.7FTSE/JSE SA Listed Property TR ZAR - 208.3

04/2016 05/2016 06/2016 07/2016 08/2016 09/2016 10/2016 11/2016 12/2016 01/2017 02/2017 03/2017

116

114

112

110

108

106

104

102

100

98

96

94

FTSE/JSE Top 40 TR ZAR - 100.7 FTSE/JSE Mid Cap TR ZAR - 108.0 FTSE/JSE Small Cap TR ZAR - 113.5

All graphs sourced from Morningstar Direct.

Page | 10

SA equities: 5-year market cap returns

Small caps have been a risky investment in a weak economy, but the liquidity premium on these counters remained intact over the long term as investors received a premium for holding these liquid counters.

SA equities: 1-year sector returns

Finally, resources started pulling their weight. Unfortunately, financials and industrials lagged at the same time.


The medium-term story for resources remains bleak.


Even over five years the story for resources remains muted. That’s why it’s important to diversify your portfolio.

Financial markets

220.0212.0205.0197.5190.0182.5175.0167.5160.0152.5145.0137.5130.0122.5115.0107.5100.0

92.509/2012 03/2013 09/2013 03/2014 09/2014 03/2015 09/2015 03/2016 09/2016 03/2017

FTSE/JSE Top 40 TR ZAR FTSE/JSE Small Cap TR - 187.8FTSE/JSE Mid Cap TR - 176.8

126.0124.0122.0120.0118.0116.0114.0112.0110.0108.0106.0104.0102.0100.0

98.096.094.092.090.0

04/2016 05/2016 06/2016 07/2016 08/2016 09/2016 10/2016 11/2016 12/2016 01/2017 02/2017 03/2017

FTSE/JSE Industrials Index TR ZAR

FTSE/JSE Resources Index TR ZAR - 98.2

FTSE/JSE Financials Index TR ZAR - 100.1

140.0135.0130.0125.5120.0115.0110.0105.0100.0

95.590.085.080.075.070.065.060.055.050.045.0

06/2014 09/2014 12/2014 03/2015 06/2015 09/2015 12/2015 03/2016 09/201606/2016 03/201712/2016

FTSE/JSE Industrials Index TR ZARFTSE/JSE Resources Index TR ZAR - 130.1

FTSE/JSE Financials Indez TR ZAR - 133.1

250240230220210200190180170160150140130120110100

9080706050

09/2012 03/2013 09/2013 03/2014 09/2014 03/2015 09/2015 03/2016 09/2016 03/2017

FTSE/JSE Industrials Index TR ZAR - 230.7

FTSE/JSE Financials index TR ZAR - 201.2

FTSE/JSE Resources Index TR ZAR - 80.0


Page | 11

SA equities: Sectors versus FTSE/JSE All Share Index (ALSI)*1-year rolling excess returns

SA equities versus global equities*Returns restated in USD

In US dollar terms the ALSI looks due for a rally. Over the last four years the ALSI has generated a US dollar return of 16bps per annum. Let’s hope this will tempt foreign investors. At the same time the MSCI All World Index has returned 9.08% per annum over the last five years, well ahead of global inflation plus 6%.

Especially if you consider how quickly things can turn around.

Financial markets

45.0

37.5

30.0

22.5

15.0

7.5

0.0

-7.5

-15.0

-22.5

-30.0

-37.5

-45.004 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03

2014 2015 2016 2017

FTSE/JSE Industrial Index TR ZARFTSE/JSE All Share TR ZAR

FTSE/JSE Resources Index TR ZARFTSE/JSE Financials Index TR ZAR

122

120

118

116

114

112

110

108

106

104

102

100

98

96

94

04/2016 05/2016 06/2016 07/2016 08/2016 09/2016 10/2016 11/2016 12/2016 01/2017 02/2017 03/2017

FTSE/JSE All Share TR ZAR - 112.5 FTSE All World TR USD - 115.8 FTSE Emerging TR USD - 118.0


Page | 12

4. TACTICAL PREFERENCES

Tactical preferences

Asset allocation preferences

Challenging economic conditions persist, but a lot of the negative sentiment has already been priced into the valuations of property. Given the poor sentiment, we may view this as an attractive entry point into selected securities.

Our current view on government bonds is neutral, while we assess pockets of risk and opportunity. If the rand strengthens beyond our base view we expect bonds are likely to rally and yields could decline.

Our view on this asset has improved as the interest rate cycle has turned. A slower pace of hikes is now expected. Cash should form part of a diversified portfolio.

There has been some recovery in the earnings in this sector. Some of these sectors are attractively priced.

Particularly in the US, stronger growth favours credit over government bonds, although there exists a caveat for high quality, investment grade exposure, and very selective buying.

The dollar has strengthened considerably in the past few months. Since July 2016 the USD has strengthened against the GBP by 8.64% and against the euro by 3.48%.

The sterling is still undervalued against major currencies. We be-lieve the sterling is currently the weakest major currency.

EMERGINGSouth Africa

DEVELOPED Global

USD

Cyclical

Residential

Government

Credit

GBP

EUR

Defensive CyclicalRetail

Defensive

ZAR

Gov

ernm

ent

Cre

dit

Reta

il

Residen

tial

CA

SHBO

ND

S

BONDS

CU

RRENC

Y

PRO

PERT

Y

PROPERTYEQUITY

EQUITY

Strategic asset allocation

Tactical asset allocation

Changes this month

Overweight:Tactical recommendation to hold more of the asset class than specified in the strategic asset allocation

Neutral:Tactical recommendation to hold the asset class in line with its weight in the strategic asset allocation

Underweight:Tactical recommendation to hold less of the asset class than specified in the strategic asset allocation

EMERGINGSouth Africa

DEVELOPED Global

USD

Cyclical

Residential

Government

Credit

GBP

EUR

Defensive CyclicalRetail

Defensive

ZAR

Gov

ernm

ent

Cre

dit

Reta

il

Residen

tial

CA

SHBO

ND

S

BONDS

CU

RRENC

Y

PRO

PERT

Y

PROPERTYEQUITY

EQUITY

Strategic asset allocation

Tactical asset allocation

Changes this month

Overweight:Tactical recommendation to hold more of the asset class than specified in the strategic asset allocation

Neutral:Tactical recommendation to hold the asset class in line with its weight in the strategic asset allocation

Underweight:Tactical recommendation to hold less of the asset class than specified in the strategic asset allocation

Bottom line• Our assessment shows that domestic equity is now roughly 24.6%

overvalued relative to its historic yield. Some pockets of the market are expensive and investors should expect continued volatility at current levels. That being said, skilled stock pickers should be able to find value in selected shares.

• Domestic listed property is overvalued by 24.5% relative to its historic earnings yield. In addition, we remain of the opinion that

the interest rate cycle will impact the strength and sentiment of the domestic economy, and the affordability of the property sector specifically. This will present headwinds for capital growth in the property sector. We expect property yields, which are calculated as a percentage of capital, to normalise on the back of downward pressure on capital values.

• Similarly, domestic bonds are, in general, also overvalued by more than 23.8% and will struggle if domestic interest rates normalise. There are always exceptions, but generally speaking bond yields seem stretched.

• Domestic cash is most likely generating a negative real return for investors, after fees and taxes. We remain of the view that although cash can play a strategic role in a portfolio, there is a material trade-off over the long term.

• Global equity is overvalued (22.6%) on a historic earnings basis, although the shift towards fiscal stimulus could support the asset class. In the US, further aims at deregulation will support corporate earnings, although the timing of fiscal support policies and potential deregulation is uncertain at this stage.

Page | 13

On the global frontGlobal bondsStill a risky asset with US Federal Reserve (Fed) hikes on the horizon and bond yields at levels of 1.50%. The US economy is strong with positive data being released on a daily basis. We expect Fed hikes to continue, placing pressure on bond capital values. The long-term yield on global bonds is 4.40%, and we see yields moving closer to 3.00% over the next 12 months.

Global propertyThis asset class looks relatively attractive in selected areas. Although interest rate hikes will not bode well for the prospects of this asset class.

Global equitiesThis is still a preferred asset class. We prefer an overweight position on the back of allocation surpluses that built up from other asset classes where we have underweight holdings. The ride is likely to be volatile, but the balance of probabilities favours the risk-adjusted return of equities more than for any other asset class.

Tactical overview

Global and domestic asset classes

80%

70%

60%

50%

40%

30%

20%

10%

0%

Global cash

% Premium(+)/Discount(-)

Global bonds

Global property

46.7%

66.8%

Global equities

Domestic cash

Domestic bonds

Domestic property

Domestic equities

Domestic industrials

Domestic resources

Domestic financials

Domestic bonds 1-3

Domestic bonds 3-7

Domestic bonds 7-12

Domestic bonds 12+

16.6%

22.6%

13.0%

23.8% 24.5% 24.6%

43.4%

10.9%

4.0%

34.2%30.3%

19.4%23.0%

*Current earnings yields versus long-term averages: Premiums and discountsSource: PSG Wealth research team

Total 5-year returns of major global indices

13.40%

Nikkei

13.30%

S&P 500

12.86%

DAX

10.38%

Euro Stoxx

5.39%

FTSE 100

3.24%

Hang Seng

4.1 TACTICAL OVERVIEW

Source: PSG Wealth research team

Page | 14

On the domestic frontGlobal and domestic asset classes

14

12

10

8

6

4

2

-

Global cash Global bonds

Global property

Global equities

Domestic cash

Domestic bonds

Domestic property

Domestic equities

Domestic industrials

Domestic resources

Domestic financials

Domestic bonds 1-3

Domestic bonds 3-7

Domestic bonds 7-12

Domestic bonds 12+

Average Current

3.2

4.4 4.44.9

8.2

11.8

8.2

6.86.3

6.9

8.0

11.611.4

11.712.0

9.29.4

7.97.67.7

6.2

3.6

5.1

6.2

9.0

7.1

3.83.7

1.51.7

*Current earnings yields versus long-term averagesSource: PSG Wealth research team

Domestic bondsPockets of attractive valuations polarised with more expensive risky counters. In general the forward multiple of the ALSI is broadly inline with longer-term yields. We think there are some material risks and opportunities in this sector.

This asset looks expensive relative to long-term yields. Although, long-term yields are probably slightly higher than what would be generally perceived as realistic. We feel this comparison leaves us with some margin of safety in the current environment where foreign investor sentiment is frequently tested to the extreme.

Domestic propertyDomestic listed property is overvalued by 24.5% relative to its historic

earnings yield. In addition, we remain of the opinion that the interest rate cycle will impact the strength and sentiment of the domestic economy, and the affordability of the property sector specifically. This will present headwinds for capital growth in the property sector. We expect property yields, which are calculated as a percentage of capital, to normalise on the back of downward pressure on capital values.

Domestic equitiesContains some expensive rand hedges. We think this area of the market is artificially inflated on the back of poor political sentiment and currency spot prices.

We have seen some adjustment on the multiple which re-rated following some earnings growth as expected. We maintain a neutral weighting.

Domestic industrialsThis area of the market is somewhat inflated as investors seek to minimise duration risk on the back of unsure monetary policy action.

Domestic financialsThe sector with the most opportunities. Banks and life insurers have been hit hard. We think this happened rather indiscriminately on the back of poor sentiment in the politcal sphere. Definitely some buying opportunities.

Domestic cashWill have to normalise over the long term. The economy is probably not strong enough to stomach a rate increase just yet, but rate normalisation is inevitable.

Tactical overview

Page | 15

4.2 EQUITY RESEARCH

Equity research

Domestic risk premiums likely to dominate investment decisionsUntil business confidence is restored at the domestic level, South Africa’s risk premiums will likely dominate investment decisions in the near future. This is especially likely given the unsure trajectory of sovereign progress following the cabinet reshuffle.

Emerging markets (EMs) posted decent returns until news broke of the recall of former Finance Minister Pravin Gordhan, at the end of March. The MSCI EM Index posted a strong return in US dollars for the first quarter of the year. This was mainly driven by an improvement in EM risk sentiment. EMs also outperformed developed markets (DMs) by 5.3% on the back of improved earnings expectations relative to developed markets. The FTSE/JSE All Share TR Index (ALSI TR) tracked the MSCI Emerging Market Index closely, until Gordhan was ordered to return from an international

roadshow. The markets reacted negatively to the news, which caused the R186 bond yield to spike to 8.87% after reaching a level of 8.32% earlier in the quarter. The rand, which was the best performing EM currency until 24 March, depreciated to R13.41 a dollar after reaching a level of R12.43 against the greenback. Despite this, the ALSI TR (in USD) still closed in the green with a return of 6.3% for the quarter. In local currency, the ALSI TR improved by 3.8% for the quarter. Our benchmark, the JSE Capped All Share TR Index, returned 3.28% for the same period.

A resurgence in rand hedge stocks assisted the performance of the benchmark, contributing 3.5% to index returns Naspers, given its weight in the index, was the single largest contributor. Richemont (up 16.8%), British American Tobacco (up 13.2%) and Mondi (up 14.5%) were the other main drivers. These stocks also provided the push for the consumer discretionary, consumer staples and materials sectors to lead sector performance during the first quarter of 2017. This was offset by a weak performance from the financial and healthcare sectors. This follows a deterioration in sentiment after poor trading guidance was reported by Netcare and Life Healthcare. FirstRand and Barclays were the primary drivers for the decline in the financial sector.

Index movers and sector attributors in Q1 2017Index movers

NPN CFR BTI MNP AGL SHP SLM BID REM NTC BVT BGA BIL SNH FSR Other

5%

4%

3%

2%

1%

0%

-1%

1.47%

1.25%

0.52%

0.26%0.19%

0.16%0.13% 0.09% -0.14% -0.14% -0.14%

-0.20%-0.26%

-0.28%-0.28% 0.65%

Sector attribution5%

4%

3%

2%

1%

0%

-1%

2.47%

0.89%

0.48%

0.08% 0.04% 0.00% -0.02% -0.04%-0.28%

-0.51% 0.17%

Cons

umer

di

scre

tiona

ry

Cons

umer

st

aple

s

Mat

eria

ls

Ener

gy

Real

est

ate

Tele

com

mun

i -ca

tion

serv

ices

Indu

stria

ls

Heal

thca

re

Info

rmati

on

tech

nolo

gy

Fina

ncia

ls

Oth

er

Source: Bloomberg

The FTSE/All Share Index versus the MSCI Emerging Market Index

Mar 16

25%

20%

15%

10%

5%

0%

-5%

-10%

Apr 16 May 16 Jun 16

MSCI Emerging Market Index Gross TR (USD) FTSE/JSE All Share Index TR (USD)

Jul 16 Aug 16 Sep 16 Oct 16 Nov 16 Dec 16 Jan 17 Feb 17 Mar 17

Source: Bloomberg

Page | 16Equity research

PSG Wealth domestic equity strategy for the second quarter of 2017South Africa’s idiosyncratic risks remain, especially after political uncertainty spiked towards the end of the quarter. While the weakened rand provided a push for the local bourse, which is heavy with rand hedge counters, additional political uncertainty interfered with our forecasts for earnings growth. We think the rand could come under further pressure should EMs sell off or sovereign risks increase. Conversely, an improvement in public governance could provide an upside to our expectations.

Multiples are in line with their long-term averages, and we expect returns to materialise primarily through growth in earnings and not through material changes in valuation multiples. Operating margins in most sectors could benefit from the improved use of capacity. A recovery in commodity prices should also translate into earnings growth. We forecast 15% growth in earnings per share (EPS) for the year ahead and a slight decline in the price-to-earnings (P/E) multiple.

Overall, our base case still targets an 8.6% return from the ALSI for the year ahead, assuming political risks will normalise and that we would have a stable exchange rate. This return was calculated on a sector level and

ALSI 12-month blended forward P/E

18

16

14

12

10

8

6

4

Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09

12m Blended Forward P/E Average 2 Standard deviations above/below (Excl.) 12m Blended Forward P/E (Excl.) Average (Excl.)

Dec 09 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 Dec 13 Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Dec 16

Source: Bloomberg

All valuations based on data as at 5 April 2017.

Proposed sector allocation

Overweight Slight OW Neutral Slight UW Underweight

Top 5

Consumer discretionary

Consumer staples

Financials

Healthcare

Industrials

IT

Telecoms

Source: Bloomberg

Current valuation levels

Weight Forward P/E (x)

P/NAV (x) P/Sales (x) Div Yld (%)

Top 5 37.50% 17.72 2.74 3.52 1.47

Consumer discretionary

7.00% 12.76 0.94 1.96 3.88

Consumer staples

6.80% 17.58 0.54 4.52 2.49

Energy 0.30% 7.43 2.07 1.22 1.44

Financials 18.90% 10.48 1.41 1.59 4.02

Healthcare 3.50% 14.96 1.92 2.66 2.2

Industrials 2.40% 11.86 0.51 1.54 3.25

Information technology

0.40% 11.33 0.31 1.51 2.25

Materials 11.40% 12.4 1.11 1.44 2.72

Real estate 6.90% 14.47 7.54 1.03 6.27

Telecom-munication services

4.80% 15.4 1.62 2.56 5.42

Source: Bloomberg

consolidated taking into account the investments’ weights in the index. The goal of this exercise is to highlight the sectors which we believe offer value and to inform the sector positioning of our portfolios.

On a P/E basis, the ALSI does not seem to offer value. The P/E ratio of the ALSI can be deceptive and might prove too simplistic to indicate potential return on its own. The actual valuation is concealed, due to the weight and current P/E multiples of rand hedge counters, which are dominant in the index. The graph above also excludes the impact of large rand hedge shares to reveal a P/E multiple that is in line with its long-term average. Investors should remember that the P/E multiples of the large rand hedge investments should be considered against prevailing low market interest rates in developed markets and not relative to their domestic peers.

The top five companies are Naspers and Richemont in the consumer discretionary sector, British American Tobacco in the consumer staples sector and Anglo and BHP Billiton in the materials sector. The top five companies currently contribute 37.5% to the value of the index and trade at a forward P/E ratio of 17.7 times. Removing the large rand hedges from their respective sectors reveals average P/E multiples which seem more acceptable.


We are slightly more conservative on expected market returnsOur calculations indicate we are slightly more conservative relative to consensus views or what our mean reversion analysis indicates. Although our expectation for the market’s return was confirmed, our analysis revealed substantial differences in expected returns at a sector level. Large distributions in expected returns are highlighted for the IT, telecoms, healthcare and consumer staples sectors. The IT and telecoms sectors were the only sectors where one of the measures highlighted a potential negative return.

Expected returns for the ALSI and its sectors for the rest of 2017

25%

20%

15%

10%

5%

0%

-5%

-10%

All s

hare

ex

clud

ing

ConsensusCo

nsum

er

disc

retio

nary

Cons

umer

st

aple

s

Fina

ncia

ls

Hea

lthca

re

Indu

stria

ls

Info

rmati

on

tech

nolo

gy

Tele

com

mun

icatio

n se

rvic

es

Mean reversion PSG Wealth

11%

9%

7%

5%

3%

1%

-1%

Source: Bloomberg

A quick note on methodology The returns of large rand hedge stocks were considered separately because their dominance in their sectors skewed the conclusion. When the return for the reversion was calculated, the mean metrics were weighted towards the most relevant technique per sector. The analysis was completed at a sector level and a positive or negative view on a sector will not necessarily apply to all investments in the sector. Larger investments in the sector will dominate its expected return.

• As a sanity check we calculated the expected return on the metrics mentioned below to confirm our conclusion:• sector returns based on a reversion to the long-term

mean based on: • price-to-net asset value ratio (P/NAV)• price-to-sales ratio (P/sales) • dividend yield• price-to-earnings ratio (P/E)

• consensus target price

All valuations based on data as at 5 April 2017.


The key strategic themes per sector which could influence the achievement of our target pricesWe have reduced our overweight position to the broader sector given an adjustment in return expectations. We also shifted our neutral view on Naspers and Richemont to underweight following share price movements and a change in our valuation methodology for Naspers.

Sentiment and movers in the consumer discretionary sector

Sector sentiment (q/q) Q1 2017

Sector EPS change -

Consensus target price change +

PSG Wealth sector guidance -

Sector performance +

Change in sector perception

travel and leisure -

industrial transportation -

general retailers +

Source: Bloomberg

11%

9%

7%

5%

3%

1%

NPN5.92%

CFR

5.00%

TRU

0.25% 0.10% 0.05% 0.04% 0.02% 0.01% -0.01% -0.01% -0.03% -0.07% -0.07% -0.16%

-0.01%-1.17%

ADH CSB MTA CLH SUR FBR WHL TFG SPG SUI IPL SNH Other-1%

Source: Bloomberg

Consumer staplesThis sector outperformed the Capped All Share Index by 5.60%. The share price of British American Tobacco (BAT) increased by 15.85% during the quarter and contributed 501 basis points to the overall sector’s performance. This follows the release of attractive results. The group continued to grow cigarette market share in its key markets, driven by good performance from its global drive brands. BAT also continued to grow cigarette volumes ahead of the industry. The group’s vapour business grew to the world’s largest outside of the US. BAT also made significant progress in obtaining the relevant shareholder and regulatory approvals to acquire the remaining 57.8% in Reynolds American Inc. Shoprite and Bidcorp contributed 167 and 88 basis points, respectively, to the performance of the sector. Spar was the biggest detractor to sector performance. Spar’s share price fell 12.25%

Consumer discretionaryThis sector outperformed the Capped All Share Index by 6.58%, with Naspers and Richemont acting as the main drivers for outperformance. The share price of Naspers increased by 15% for the quarter on the back of an improved earnings outlook. Tencent’s recent results revealed an expanding ecosystem, while mobile games maintained their dominant position. Potential is monetised across the media business, which continues to be supported by value-added services and more time spent on smartphones. The market still assigns a negative value to the rump investments in Naspers, despite recent transactions to unlock value, which supported an improved return on invested capital (ROIC) profile.

Richemont started the reporting season with a bang, with organic sales growth of 5%, well ahead of consensus estimates. This places Richemont in good stead, possibly for a recovery in top-line driven earnings. The share was up by 17% for the quarter. Steinhoff was the main detractor to this sector’s returns, declining by 10%. The restructuring of Steinhoff’s operations presents it with opportunities to grow earnings ahead of its European peers. Despite the better than anticipated growth, the share trades on lower forward P/E multiples than its peers.

The general retail sector remains highly competitive, with businesses likely to compromise margins to maintain market share given all the new market entrants. Volatile exchange rates will continue to impact the profits of retailers, due to the high percentage of imported merchandise. We expect an improvement in real wages as dissipating drought conditions offer some relief through lower inflation, which in turn could translate into more discretionary spending by consumers. Should inflation decline in 2017, then general retailers are likely to outperform food retailers. New regulations regarding credit affordability continue to weigh on credit sales. However, we believe this is already priced in and that retailers could benefit from amendments to affordability regulation.

Travel and leisure: Gaming operations are good quality investments with strong margins and healthy cash generation. This can be attributed to the defensive nature of the operations and the regulatory environment limiting competition. Gaming revenues, although resilient, are not immune to economic cycles. Gaming revenue in South Africa is expected to remain under pressure until economic conditions improve. Over the past couple of years demand for hotel rooms continued to grow, with little growth in hotel supply. Market occupancies are currently at 64% and we believe there is still room for improvement in the medium term.

Industrial transportation: The cyclical nature of businesses in this sector means that profitability is highly dependent on economic activity. Deterioration in global economic activity remains a key risk, with dominant players having diversified offshore. A weak rand constrains new vehicle sales, but support profits from their after-market sales (parts division). A weakness in the rand will have a greater impact on Imperial, due to its exposure to its vehicle import and distribution business.

over the past three months. Spar indicated in a December sales update that a slowdown in the building material businesses impacted the group’s South African operations, while the weakening of the sterling weighed on the group’s Irish operations.

The earnings of food producers remain dependent on the relationship between the prices of raw materials and the prices of products. Food producers are typically geared to the commodity inputs in their operations. Thus, any changes in items like maize, sugar and wheat would impact their profitability.

Tiger Brands and Pioneer have the highest sensitivity to soft commodity prices. Producers with strong brands should have the necessary pricing power to recover from higher input costs through price increases. Local consumer staples, however, struggle with a constrained consumer environment, which to some extent negated the benefit of higher food inflation.

Food producers’ results should benefit from the recovery in the South African maize crop. Normal weather patterns should further alleviate cost pressures of raw materials. The International Trade Admin Commission is currently reviewing import duty regimes, which is likely to result in a meaningful decrease in wheat prices. This will be favourable for the Tiger Brands milling business and AVI’s biscuit business. Elements of commoditisation are also present in the food distribution industry. As such, weak demand typically leads to an increase in competitive pressures and the erosion of margins. The food services market is a highly competitive and fragmented industry. Distributors in food services primarily redistribute other people’s products, leading to a limited scope for product differentiation. Increasing urbanisation, the rise of single-person households, the search for convenience and the increase in global tourism, should all provide a structural underpinning to the demand for food services.

We see value in selected food producers within the consumer staples sector, but feel that food retailers are fully valued. Despite the sector’s low risk characteristics, we maintain our underweight recommendation on this sector.

Sentiment and movers in the consumer staples sector


Sector EPS change +


PSG Wealth sector guidance =

Sector performance +

Change in sector perception +

Source: Bloomberg


Movers in the consumer staples sector

10%9%8%7%6%5%4%3%2%1%0%

-1%BTI

5.01%

SHP

1.67%

BID

0.88%

PFG

0.58%

CLS

0.57%

AVI

0.40%

TBS

0.26%

MSM

0.22%

PIK

0.18% 0.18%

ARL RCL

0.07%

OCE

-0.07%

CVH

-0.08%

TON

-0.11%

SPP

-0.75%

Other

-0.13%

Source: Bloomberg

Financials Political events which occurred at the end of the quarter negatively affected the performance of banks. This led to this sector underperforming the Capped All Share Index by 5.77%. Barclays Africa and FirstRand were the worst performers, declining by 17% and 13%, respectively. Sanlam added the most to the sector’s return after delivering solid results that beat estimates. Some of its competitors’ experienced worsening persistency, higher claims, and pressures on new business profitability. Discovery was another strong performer after its results showed strong underlying growth in its established business. However, its operations in the UK faced currency headwinds after Brexit. Its results also showed good momentum in its newer ventures, namely Discovery Insure and Ping-an Health. However, these new operations have not yet made a profitable contribution to the group. The share prices of Sanlam and Discovery increased by 7% and 12%, respectively, over the quarter.

Investment holding companies have significant exposure to this sector, in which their underlying investments operate. Remgro has a considerable exposure to the healthcare and financial sectors. Its investments in Mediclinic, FirstRand and RMBH make up about 55% of its investment portfolio. The company’s performance will be affected by material movements in these two sectors. The group’s recent results showed that Remgro’s performance was significantly affected by the share price movements of Mediclinic and Distell. We expect Remgro’s performance to be significantly influenced by the performance of the South African economy, given the weight of its domestic portfolio. Remgro was amongst the largest detractors from the sector, contributing 68 basis points to the decline in the sector. The share price declined by 7.6% during the quarter.

The Johannesburg Stock Exchange (JSE)’s performance was impacted by market volatility, competition and regulation. Increases in market volatility flowed through to volumes with an increase in volumes across most areas of the business. Due to stringent regulations and licensing requirements, barriers to entry remain relatively high, although competition is on the rise with the listing of a new exchange. Changes in regulation could pose hurdles for operations going forward and the local bourse will need to adapt to these changes. In order to support revenue streams, the JSE implemented a further 20% increase in fee reductions. This was possibly

larger than expected by the market, which explains the 18.81% decline in the share’s performance over the quarter.

For the banks, the end of the reporting season was followed by upward movements in market valuations as earnings generally came in ahead of consensus expectations. The results were resilient against a more challenging economic backdrop. However, given the ambiguous political situation, along with the consequent credit rating downgrades, prices and sentiment have come under significant pressure. The effect of these decisions is that the banks will have to pay for higher risk premiums when coming to market for new funding. This ultimately leads to margin erosion, which places pressure on profitability. With the consensus that local rates have peaked, another negative consequence is the additional risk to monetary policy expectations through the effect of currency weakness on inflation. Further increases in interest rates could lead to higher loan losses given the high level of indebtedness of the South African consumer. While higher interest rates would also increase risk in the corporate books, the recovery in commodity prices and return of normal weather conditions have relieved some stress in certain industries. Although the individual management teams have clearly communicated the potential political risks to the market, this is very difficult to forecast and remains a risk to valuations going forward.

We believe share price declines have captured some of these concerns, with the overall sector offering more value on a relative basis. With solid dividend yields, this sector also offers good opportunities for investors searching for yield. Given that most of the banks have capital ratios in excess of their internal targets, there is some leeway to absorb earnings pressure before dividends are put at risk. We will therefore increase our overweight position in financials.

Sentiment and movers in the financial sector


Sector EPS change +


PSG Wealth sector guidance +

Sector performance -

Change in sector perception -

Source: Bloomberg

3%

2%

1%

0%

-1%

-2%

-3%SLM

0.59%

DSY

0.36%

REI

0.27%

CPI

0.26%

PSG

0.21%

RMI

0.10%

AFH

-0.09%

CML

-0.15%

JSE

-0.20%

BAT

-0.24%

RMH

-0.33%

SBK

-0.41%

REM

-0.68%

BGA

-0.95%

FSR

-1.35%

Other

0.12%

Source: Bloomberg

HealthcareThe quarter under review saw muted growth in the private healthcare market. A larger than expected slowdown in the South African economy and an increase in active case management by medical aids away from hospital admissions, translated into below-consensus growth in paid patient days (PPD). This highlights the structural constraints to revenue growth for the local operations of healthcare providers. Accordingly, Life Healthcare and Netcare informed the market that their earnings will come in below expectations. This translated into an 18% and a 4% decline in the total return from Netcare and Life Healthcare, respectively.

The healthcare sector underperformed the Capped All Share Index by 10.36%, primarily due to poor performance from hospital counters. Netcare was the biggest detractor, contributing 347 basis points to the sector’s decline. This follows its disappointing trading update, indicating a 1% decline in PPD and lower occupancy levels of 63.3%. This is less that the 64.4% in the previous period, as well a lack of progress with the rent arrangement of its UK operations. Life Healthcare also indicated that the group expected a 0.9% to 1.2% decline in PPD and a reduction in occupancy levels to between 68% and 69% from 69.9% in the comparative period.

Investments in the healthcare industry are normally lower risk investments, due to the sector’s defensive nature and high barriers to entry. Positive structural drivers include an ageing population and increasing rates of diagnosis, particularly for lifestyle diseases. This, combined with capacity constraints in most government funded healthcare systems, should drive demand for private healthcare. However, over the past two years, healthcare counters have come under significant pressure. Static medical aid scheme memberships have led to slow growth in job opportunities in both the private and public sectors. The shift in the popularity of low-cost medical aid packages (Discovery KeyCare) and ongoing regulatory pressure also added headwinds to this sector. Changes in legislation remain a risk, both locally and abroad. Abroad, the recent implementation of the 20%-Thiqa co-payment in Dubai and the potential threat of a new tax on private patients in Zurich added to concerns. Locally, changing regulation (pending market inquiry into competition) could pose a risk to hospital pricing. However, any policy changes that could adversely affect prices, should not impact earnings in the short term, but could influence short-term sentiment.

Competition in the global pharmaceutical market remains fierce. Growth in this industry is underpinned by strong demand for healthcare and drugs in EMs. Legislative and regulatory changes introduced by the Department of Health (DoH), the South African Pharmacy Council (SAPC) and Medicines Control Council (MCC) could impact the turnover and margins of pharmaceutical companies. This could also impact their ability to obtain licences and to launch private labels, exclusively scheduled and complementary medicines. Pharmaceutical regulations and the use of increasingly strict quality standards have led to higher compliance costs across all territories. Low-cost Asian pharmaceutical companies are active in all major territories with many competing generics launched once patent of a molecule has expired. Shifts toward generic medicines could also erode


margins (the level of discount to that of the originator molecule sold in the market). Exchange rate volatility remains a risk, because most active pharmaceutical ingredients (API) are priced in US dollars. The weaker rand presents an attractive opportunity for exports of API and finished dosage formulations (FDF), which could offset some of the cost pressures experienced in other product categories.

We feel the material decline in share prices has created an attractive entry point for longer-term investors. Accordingly, we upgrade our view on this sector to overweight compared to the neutral stance in the previous quarter.

Sentiment and movers in the healthcare sector


Sector EPS change -

Consensus target price change -

PSG Wealth sector guidance +


Change in sector perception -

Source: Bloomberg

0.43%

1%

0%

-1%

-2%

-3%

-4%

-5%

-6%

-7%

-8%AIP ASC LHC APN MEI NTC Other

-0.29%

-0.86%

-1.30%

-1.59%

-3.47%

0.00%

Source: Bloomberg

IndustrialsIndustrials underperformed the Capped All Share Index for the quarter, primarily led by a 15% decline in the share price of Bidvest. Bidvest currently constitutes 35% of the sector’s weight. Bidvest’s results indicated that the company had done well to weather the muted domestic economic growth. Consumer confidence resulted in low headline earnings growth. In addition, the sector generally fell victim to many uncontrollable factors such as the Southern African drought and volatile EM currencies (the rand essentially strengthening against major currencies and then retracing gains at the end of March 2017). The sector was further weighed down by policy and political uncertainty. On a positive note, the strength in mining activity could support earnings. The sector continues to focus on cost reduction programmes and stringent working capital management to generate cash and reduce debt to ensure financial stability.

The mining and manufacturing sectors are expected to benefit from improved commodity prices. This translates into higher industry activity as the sector is heavily reliant on infrastructure expansion and mining activities, which are only expected to show meaningful improvement in the medium term. Management commentary generally highlighted that markets are beginning to stabilise. Supply/demand dynamics in industrial transportation remain fragile. Should macroeconomic factors improve, then many of the industrial players could be in a strong position to capitalise.

We maintain our underweight stance on the sector, but highlight that there is a material valuation differential between sector constituents. We recommend that investments in this sector should be considered individually.

Sentiment and movers in the industrial sector


Sector EPS change -




Change in sector perception +

Source: Bloomberg

KAP TRE MU RLO HDC BAW GND WB HCI RBX BLU GRF IVT CIL BVT Other

1.35%

0.99%

0.69%

0.37%

6%

5%

4%

3%

2%

1%

0%

-1%

0.64%

1.21%

Source: Bloomberg

Information Technology (IT)The IT sector underperformed the ALSI by 11.71%. Datatec added 1.37% to the sector’s performance while EOH Holdings contributed 9.81% of the sector’s decline. EOH’s share price ended the quarter 15.28% in the red. EOH released results in March which revealed good growth in revenue, aided by acquisitions. Services and software were the main revenue drivers. New solutions, services and products paired with developments into new territories were key factors in influencing the group’s performance. EOH has focused on expanding into the Middle East and the rest of Africa, as the local market seemed saturated. The group follows an aggressive acquisition strategy, which is a primary driver of growth.

Customer needs are changing from traditional software solutions to cloud, big data and security solutions. This places pressure on providers to stay ahead of market trends. This change in demand has intensified the need for firms to invest in innovation and infrastructure development. The global internet space is fiercely competitive with providers contending for increases in traffic and user engagement. Going forward, we anticipate that players in the IT space will need to allocate significant resources to stay abreast of changing market trends. Providers will need to differentiate their products and services from those of competitors to increase their market share.

We maintain our underweight stance towards this sector, but highlight corporate activity as a key risk towards our expectations for returns in this sector.

Sentiment and movers in the IT sector


Sector EPS change -

Consensus target price change -



Change in sector perception =

Source: Bloomberg

DTC EOH Other

1%

-1%

-3%

-5%

-7%

-9%

1.37%

-9.81%

0.01%

Source: Bloomberg

TelecommunicationsThe telecoms sector underperformed the ALSI by 3.46%. Telkom added 8 basis points to the sector, while Vodacom and MTN detracted 7 basis points and 19 basis points, respectively. MTN’s share price was down 3.3%, but flat on a total return basis.

Weak economic conditions and stringent regulatory environments were some of the factors which affected the top-line growth of telecoms providers. Exchange rate losses remained a headwind for the sector. MTN’s performance was significantly affected by volatile African currencies


paired with American dollar-denominated expenses. Amongst forex losses, the Nigerian fine and Towerco losses were major contributors to MTN’s reported headline loss.

Customer demand is moving from fixed-line business and voice revenue, to fibre-to-the-home (FTTH) and data services. The need to adapt to market trends places some providers like Telkom under structural pressure. Data remains a pillar to the revenue stream, but competition remains tough. Further pressure is placed on margins with networks that need to provide affordable data bundle packages and out-of-bundle rates. Digital services have significantly contributed to data growth in the sector. However, further development in this area is still possible.

The White Paper policy that the South African government intends to implement, may undermine historical investments and lead to lower barriers to entry. The Nigerian regulatory environment remains volatile, with stringent regulation that resulted in a significant number of contracts being disconnected. Capital expenditure is expected to remain high for all networks due to their focused spend on LTE rollouts, fibre infrastructure and the maintenance of existing tower structures. In-market consolidation or changes of ownership of major players could have a positive impact on the price dynamics of the sector.

Telkom reiterated its interest in Cell C, should the corporate action with Blue Telecoms not pass the required hurdles. The combination of Telkom Mobile and Cell C should result in a formidable number three player in the local market. Given the status quo, cost management will continue to be a key focus area for network providers, which will help mitigate the impact of competitive pricing strategies on operating margins.

As a consequence of the highly competitive market and tough trading environment, churn management, competitive rates and value-added services will remain key factors in maintaining market share.

Our spread of expected returns in the sector remains large. We will move to an overweight recommendation for the telecommunication sector. This is primarily informed by our valuation of MTN, which is the heavyweight in the sector. We highlight that a stabilisation of the Nigerian economy, which depends on improved oil prices, remains a key risk to our valuation.

Sentiment and movers in the telecommunication sector


Sector EPS change -


PSG Wealth sector guidance


Change in sector perception =

Source: Bloomberg

0.08% -0.07%

-0.19%

0.00%

0.5%

-0.5%TKG VOD MTN Other

Source: Bloomberg

Improved business confidence could improve South Africa’s risk premiumsGiven the uncertain trajectory of politics following the cabinet reshuffle, the volatility of local risk premiums is likely to dominate investment decisions until business/consumer confidence is restored. Changes in the perception of sovereign risk (positive and negative) and its flow through to exchange rates and interest rates, can also have a material impact on investment returns. With multiples slightly ahead of their long-term averages, we expect returns to materialise primarily through growth in earnings and not through a material change in valuation multiples. We forecast a 15% growth in earnings per share (EPS) for the year ahead and a decline in exit P/E multiples.

A failure to turn around confidence in the political landscape could provide support for rand hedge investments. However, we recognise more value in domestically focused investments relative to expensive defensives and rand hedge counters. More specifically, we highlight value in the financial sector and to a lesser extent in selected healthcare and consumer discretionary stocks. We remain underweight to consumer staples because we believe these counters are fully priced.

Page | 22

4.3 PROPERTY COMMENTARY

Property commentary

The sluggish economic environment continues to put pressure on the real estate sector, in particular office space. This was evident from the recent results published by listed property companies. Despite being the worst performer among the four traditional asset classes, the South African Listed Property Index (SAPY) still delivered a positive return of 1.37% for the quarter.

Growth across all four traditional asset classesspending combined with higher price increases by retailers to protect their profit margins. Sales promotions like Black Friday proved beneficial for retailers. The retail sector has seen demand shifting with consumers now focusing on the quality of shopping experiences and the need for an increase in leisure options to be included in what malls offer.

Cannibalisation has become a key issue in the market, with large newly developed malls eating into the performance of smaller surrounding retail establishments. Providers of retail space have also become more focused on the performance and turnover of retailers.

Lease periods have come under pressure in the industrial sector. This sector has also been marred by low growth in new rentals because a lack of business confidence has increased due to weak economic conditions.

The location of industrial property remains a key factor in securing leases. As a result of escalating rentals, tenants in the logistics and manufacturing sectors are moving towards the ownership of industrial properties.

Investment growth

2015-03

125.0

120.0

115.0

110.0

105.0

100.0

95.0

90.0

2015-09 2016-03 2016-09 2017-03

STeFI Call Deposit ZAR FTSE/JSE SA Listed Property Cap TR ZAR FTSE/JSE SA Listed Property TR ZARFTSE/JSE All Share TR ZAR Beassa ALBI TR ZAR

Source: Morningstar

Despite various headwinds, all four traditional asset classes ended the first quarter of 2017 on a positive note. Political uncertainty took centre stage, following the cabinet reshuffle and the axing of then-Finance Minister Pravin Gordhan. Despite disappointing trading updates from local retailers, revised lower gross domestic product (GDP) growth forecasts and a stronger rand weighing heavily on rand hedge counters, all four traditional asset classes ended the quarter on a positive note.

Domestic equity was the star performer returning 3.78% for the quarter, followed by domestic bonds (+2.49%) and cash (+1.69%). Despite being the worst performer local property still delivered a return of 1.37% for the quarter. This indicated a shift in risk appetite.During the quarter the South African Reserve Bank (SARB) also kept rates unchanged, citing the deterioration of the short-term inflation outlook and weak growth as reasons for the decision. SARB also lowered its 2017 GDP growth forecast to 1.1% from 1.2%.

Sluggish economic environment continues to put pressure on sector

Office space remains fragile due to a general oversupply in the market with muted demand, although demand for premium-grade green office space remains strong. Due to the highly competitive and weak market dynamics, it has become more expensive to attract and retain tenants through incentives.

Corporate consolidation remains a prevalent risk in this sector. Providers of office space are also starting to follow the market trend of serviced offices. This trend offers flexible lease arrangements because more corporates require their staff members to work remotely.

Large national retailers recently released results that showed a decline in volumes and sales growth. This was mainly due to constrained consumer

Reporting season

The reporting season and year came to an end with most companies reporting either half- or full- year results. Here are some of the highlights:

Company Market cap (Rm)

Reporting period

DPS growth

DPS forecast

Emira 7173.23 Interim -2.00% -2.00%

Fortress-A 55035.19 Interim 5.00% 5.00%

Fortress-B 55035.19 Interim 25.12% 25.00%

Growthpoint 74811.18 Interim 6.10% 4.90%

New Europe Property Investments

45704.3 Full Year 14.70% 15.00%

Resilient 46762.86 Interim 16.20% 15.00%-17.00%

Rockcastle 29877.86 Full Year 12.10% 21.00%

SA Corporate 13296.15 Interim 8.70% 6.00% - 8.00%

Capital & Counties 41925.33 Full Year 0.00% 0.00%*

Intu 64012.1 Full Year 2.19% 0.00%*

Hammerson 76582.4 Full Year 7.60% 4.17%*

*Bloomberg consensus estimates

Source: Bloomberg

Page | 23Property commentary

Lack of growth in local environment has increased appetite of locally listed companies to expand into offshore territories Central Eastern Europe (CEE) remains a favourite because this region is expected to report strong macro-economic fundamentals. Growthpoint ventured into CEE with its 26.9% stake in Globalworth Real Estate investments (Globalworth) for a total purchase price of €186.4m. Greenbay also confirmed that it will continue with its strategy to expand into Europe through the acquisition of material retail properties.

Consolidation also persisted within the property sector during this quarter. The merger of New Europe Property Investment (NEPI) and Rockcastle is expected to be completed by June 2017. This merger is expected to create the largest listed player in CEE. The merger will effectively consist of a share swap of 4.5 Rockcastle shares for every one NEPI share. Rockcastle will continue with its strategy of investing in direct properties and developments, via the proceeds from the sale of listed investments.

During the period, a number of disposals were concluded. Among these was Redefine International with its disposal of four German offices for a gross price of €106m. The assets were held in a joint venture with Menora Mivtachim Group (Menora), of which Redefine’s proportionate share amounts to 49%. Redefine International will use its share of net proceeds to further opportunities and reduce overall debt. Ascension said it concluded an agreement for the disposal of the property letting enterprise known as Island Centre to Buffshelfco for an aggregate of R115m. This disposal will allow Ascension to focus on its larger core buildings, which offer more sustainable growth.

A number of acquisitions occurred during the period, like Echo Polska Properties (EPP), who plans to acquire four retail properties in Poland for a total consideration of €166.57m, at an acquisition yield of about 7.5%. This transaction is expected to be concluded between 1 May and 30 September this year. The purchase will be funded with debt by issuing new shares and proceeds from asset recycling. The completion of the transaction is subject to certain conditional requirements, for example that EPP needs to obtain debt financing to the amount of 55% of the total purchase price.

Property companies that focus on the domestic market topped the charts in the first quarter. Arrowhead was the top performing stock with a return of 7.28%. The company released a solid set of results, which showed dividend growth of 9.85%. Next on the list of top performing stocks were Hyprop (+7.03%) and Fortress Income Fund B (+4.81%). NEPI’s share price, however, fell by 10.66% over the same period. Earlier this month, the group announced its intention to raise R1bn, double the initial amount on the back of great demand, via an accelerated book-build to finance its Croatian acquisition.

NEPI was the largest detractor for the first quarter of 2017 and contributed 92 basis points to the overall decline of the index. This was followed by Redefine and Rockcastle, who contributed a further 21 basis points and 20

basis points respectively to the index’s decline. The largest South African-based real estate company, Growthpoint, added 52 basis points to the index. This was followed by Hyprop and Resilient, who contributed 48 basis points and 27 basis points respectively.

Global listed properties started the quarter in the redThe FTSE/EPRAN/NAREIT Developed Rental Index ended the quarter on a negative note, with a net total return of -0.63% in US dollars. Singapore and Hong Kong were among the top performing listed real estate markets, with double-digit increases of 15.11% and 13.93% respectively. However, recent results have indicated that growth is slowing in Singapore. Increasing

Best and worst performers: underlying returns of the FTSE/JSE Capped Property Index (-0.59%)*

Arrowhead Properties

Hyprop Investments Ltd

Fortress Income Fund B Ltd

Fortress Income Fund A Ltd

Resilient REIT Ltd

Growthpoint Properties Ltd

Vukile Property Fund Ltd

Emira Property Ltd

Investec Property Fund Ltd

Capital & Regional PLC

Hammerson PLC

SA Corporate Real Estate Ltd

Attacq Ltd

MAS Real Estate Inc

FTSE/JSE Capped Property Index TR (Net)

Intu Properties PLC

Redefine Properties Ltd

Echo Polska Properties NV

Capital & Counties Properties

Liberty Two Degrees

Rockcastle Global Real Estate

Redefine International PLC

New Europe Property Investment

-10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10%

*1Q17 returns

Sources: PSG Wealth research team, Bloomberg

supply, soft tenant demand and increasing competition among landlords will continue to weigh on rent revisions in the medium term. Muted retail growth also places further pressure on rentals that mall owners can charge. Japan had the worst performing REITs, recording a drop of 3.84%, followed by France, with a decline of 2.89%.

Results from Europe were in line with or ahead of expectations. Larger retail shopping centres recorded good growth in rental growth and revisions, despite the adverse impact of terrorist attacks and poor weather conditions on retail sales in France. Political uncertainty in Europe also continues to impact share prices.

Page | 24Property commentary

Earnings in the Australian property market were in line with expectations. Returns were driven by a steady demand for and low supply of office space in Sydney. The retail sector saw a shift in performance from lower quality space in sub-regional centres, to dominant flagship shopping centres, as shoppers became more focused on the entertainment aspect and quality of their shopping experiences. Results indicate that continued growth in ecommerce will have an adverse impact on lower quality retail destinations.

Medium-term growth prospects of the global real estate market remain healthy, supported by long-term leases and solid fundamentals. The spread between listed real estate and government bonds has narrowed, placing upward pressure on cap rates (rental/property value).

Lacklustre economic conditions are expected to persist across all sectorsMuted demand, due to low confidence, is expected to place further pressure on rentals, while retaining and attracting new rentals will continue

to come at a price. The recent downgrade of South Africa’s sovereign credit rating to below investment grade is also expected to place further pressure on bonds. Given the historically strong correlation between local bonds and listed property, we expect local property prices to become depressed. REITs with foreign earnings will likely benefit from the weaker rand. Despite the underperformance of UK-focused REITs and an uncertain outlook for the British economy post Brexit, UK-focused REITs continue to experience a stable footfall, healthy occupancy rates, and steady rental renewals in the retail segment. Property development in the UK also remains robust. We will continue to monitor the liquidity risks of the domestic listed property sector, which remains a general concern. Where we are required by mandate to hold listed property, we prefer to hold counters with the following characteristics:

• low price-to-book values• low levels of debt/gearing and strong credit ratings• utilisation of structures that offer superior liquidity, like REITs• superior distribution growth track records.

Index movers who attributed to returns on the FTSE/JSE Capped Property Index (+0.59%)

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

-0.5%

-1.0%

-1.5%GRT

0.52%

0.48%

0.27%

0.27%

0.21%

0.14%0.09%

0.04% 0.03% -0.08%-0.11%

-0.14%

-0.20%

-0.21%

-0.92% 0.20%

HYP RES FFB FFA AWA VKE SAC IPF ITU RPL CCO ROC RDF NEP Other


Page | 25Preference shares

4.4 PREFERENCE SHARES

Generally speaking, the turnover for most preference shares hover around the 1.00% to 2.00% mark per month. This illustrates that these assets are generally not actively traded in the market.

Trade volumes remain thin, with the average monthly trades fluctuating between R0.07 million (Investec PLC) and R47.87 million (FirstRand).

STANDARD ABSA FIRSTRAND NEDBANK INV-LTD INV-BANK INV-PREF CAPITEC

VALUE SBPP ABSP FSRP NBKP INPR INLP INPPR CPIP

Price R89.10 R780.00 R85.10 R9.30 R76.50 R83.20 R102.00 R92.50

Yield as % of prime 77.00% 70.00% 75.56% 83.33% 77.78% 83.33% 95.00% 83.33%

Dividends Non-cum Non-cum Non-cum Non-cum Non-cum Non-cum Non-cum Non-cum

Accrued dividends R2.75 R24.97 R2.89 R0.33 R0.89 R0.96 R1.09 R2.64

Clean price R86.43 R755.03 R82.21 R8.97 R75.61 R82.24 R100.91 R89.86

LIQUIDITY SBPP ABSP FSRP NBKP INPR INLP INPPR CPIP

Market cap (Rm) R4 725m R3 857 m R3 830m R3 333m R2 464 m R1 285m R13m R168 m

Avg Monthly trade (Rm) R67.29 m R49.95 m R48.46m R52.35m R29.60m R15.39m R0.12 m R4.47 m

% of Market cap traded monthly 1.42% 1.30% 1.27% 1.57% 1.20% 1.20% 0.88% 2.65%

Effective yield as a % of prime 89.09% 92.71% 91.91% 92.91% 102.87% 101.33% 94.15% 92.73%

Effective yield 9.35% 9.73% 9.65% 9.76% 10.80% 10.64% 9.89% 9.74%

SASFIN DISCOVERY NETCARE PSG BRAIT STEINHOFF GRINDROD IMPERIAL INVICTA ASTRAPAK

VALUE SFNP DSBP NTCP PGFP BATP SHFF GNDP IPLP IVTP APKP

Price R82.00 R99.00 R85.50 R78.45 R - R78.00 R77.27 R78.70 R94.00 R98.25

Yield as % of prime 82.50% 100.00% 82.50% 83.33% 104.00% 82.50% 88.00% 82.50% 102.00% 88.89%

Dividends Non-cum Non-cum Cum Cum Cum Cum Cum Cum Cum Cum

Accrued dividends R2.28 R3.37 R1.78 R2.64 Redeemed R2.11 R2.96 R2.61 R1.58 R2.81

Clean price R79.72 R95.63 R83.72 R75.81 R - R75.89 R74.31 R76.09 R92.42 R95.44

LIQUIDITY SFNP DSBP NTCP PGFP BATP SHFF GNDP IPLP IVTP APKP

Market cap (Rm) R152 m R792 m R556 m R1 366 m R - R1 170 m R572 m R357 m R705m R147 m

Avg Monthly trade (Rm) R1.53m R11.16 m R35.45 m R22.17 m R - R12.60 m R10.71 m R19.58 m R7.07m R3.06m

% of Market cap traded monthly 1.01% 1.41% 6.38% 1.62% 0.00% 1.08% 1.87% 5.48% 1.00% 2.08%

Effective yield as a % of prime 103.49% 104.57% 98.54% 109.92% 0.00% 108.71% 118.43% 108.43% 110.37% 93.41%

Effective yield 10.87% 10.98% 10.35% 11.54% 0.00% 11.41% 12.43% 11.38% 11.59% 9.78%

Source: Grindrod Bank

Domestic preference shares characteristics: banks

Domestic preference shares characteristics: corporates

Effective yields are trading in a range of between 88.23% (Capitec) and 121.21% (Grindrod).

Effective yields are higher than those of longer-dated bonds, although the price reflects both a higher expected duration and default risk than what are inherent to bank and corporate credit.

The total preference shares in issue remain fairly low at just over R20 billion.

Current risks for preference sharesAlthough preference shares can be viewed as suitable income-generating investments for some high-net worth investors, and although prime-linked yields are set to increase as interest rates eventually normalise, we feel that there are some significant capital risks to this asset class.

The domestic economy is struggling, making further downgrades to South African sovereign ratings, local banks and state-owned enterprises that are guaranteed by the South African government increasingly likely. Large international institutional investors and passive investment funds in particular may be compelled to exit these markets after a downgrade. This will drive yields higher and will put capital values of preference shares under pressure. In addition, we don’t easily sacrifice liquidity, as it often places an investor in the position of price-taker when fundamental asset values are skewed disproportionally to what can be obtained in the open market.

Market capitalisation (Rm)

Standard - 4725ABSA - 3857Firstrand - 3830Nedbank - 3333Inv-Ltd - 2464Inv-Bank - 1285Inv-Pref - 13Capitec - 168Sasfin - 152

Discovery - 792Netcare - 556PSG - 1365Brait - 0Steinhoff - 1170Grindrod - 572Imperial - 357Invicta - 705Astrapak - 147


The FTSE/JSE Preference Share Index gained 1.80% in the first quarter of 2017

Page | 26Preference shares

Effective yield

Prime (10.5%)

14%

12%

10%

8%

6%

4%

2%

0%

SBPP ABSP FSRP NBKP INPR INLP INPPR CPIP SFNP DSBP NTCP PGFP BATP SHFF GNDP IPLP IVTP APKP

9.35

%

9.73

%

9.65

%

9.76

% 10.8

%

10.6

4%

9.89

%

9.74

% 10.8

7%

10.9

8%

10.3

5%

11.5

4%

11.4

1% 12.4

3%

11.3

8%

11.5

9%

9.78

%

BATP data not available at time of writing

Source: Grindrod Bank

BASEL III: Capital requirements

1H 2015 FY 2014 1H 2015 FY 2014 1H 2015 FY 2014 1H 2015 FY 2014 1H 2015 FY 2014

Standard Bank ABSA Bank FirstRand Nedbank Investec Bank

Tier 1 Capital 13,70% 12,90% 10,80% 11,40% 13,40% 14,50% 12,40% 11,90% 11,00% 11,20%

Total Capital 16,10% 15,50% 13,10% 13,70% 15,40% 16,40% 14,50% 14,60% 14,90% 14,90%

Returns on income-orientated asset classes

1-month 3-months 6-months 1-year

Beassa 1-3 Yr TR ZAR 0.7 3.0 4.5 9.4

Beassa 3-7 Yr TR ZAR 0.8 4.7 5.8 11.6

Beassa 7-12 Yr TR ZAR 0.4 5.6 6.3 11.0

FTSE/JSE Preference Share TR ZAR 1.7 1.8 3.9 14.8

FTSE/JSE SA Listed Property TR ZAR 0.1 4.2 5.5 1.5

Source: I-Net BFA

Page | 27Fixed income

4.5 FIXED INCOME

Over the first three months of 2017, the yield curve moved generally lowerOur data shows that long bonds on the All Bond Index (ALBI) generated an 11.46% return for the last 12 months. Even medium-dated bonds generated double-digit returns of 11.56% for 3 – 7 year bonds and 10.99% for 7 – 12 year bonds. The ALBI as a whole, with a duration of roughly seven years, generated an 11.02% return. The bond sector benefited from more dovish interest rate hike expectations on the domestic front.

The prime rate is still at the same level as eight years agoThe prime rate has stayed at the same level for the past 15 months – the same level as it was in August 2009, at 10.50%. At their meeting at the end of this quarter, the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) decided to leave the repo rate unchanged at 7.00%. We believe rate normalisation is inevitable over the medium term. Although rates are higher than what we experienced in the recent past, they still remain unsustainably low. Since inflation is only marginally breaching the upper target limit of 6% at this stage, we expect the MPC to follow a more accommodative stance given poor economic growth. However, if inflation breaches the 6% upper target limit by a material margin, we believe the MPC will proceed with small incremental rate increases.

Yield curve for last year

SA Old I-Net Yield Curve 31/03/2017 SA Old I-Net Yield Curve 31/03/2016

Difference Chart SA Old I-Net Yield Curve 31/03/2017 - SA Old I-Net Yield Curve 31/03/2016

10

9.5

9

8.5

8

7.5

1

0

-0.1

-0.2

-0.3

-0.4

-0.5

-0.6

-0.7

2 9 15 23 30

Source: I-Net Bridge

Prime rate increases since 2006

Year Day and month Prime rate

2017 30 March 10.50

24 January 10.50

2016 24 November 10.50

22 September 10.50

21 July 10.50

19 May 10.50

18 March 10.50

29 January 10.25

2015 20 November 9.75

24 July 9.50

2014 18 July 9.25

31 January 9.00

2012 20 July 8.50

2010 19 November 9.00

10 September 9.50

26 March 10.00

2009 14 August 10.50

29 May 11.00

4 May 12.00

25 March 13.00

6 February 14.00

2008 12 December 15.00

13 June 15.50

11 April 15.00

2007 7 December 14.50

12 October 14.00

17 August 13.50

8 July 13.00

2006 8 December 12.50

12 October 12.00

3 August 11.50

Source: South African Reserve Bank (SARB)

Yields of South African bonds as at 31 March 2017

12

10

8

6

4

2

0

2014-12-27 2017-09-22 2020-06-18 2023-03-15 2025-12-09 2028-09-04 2031-06-01 2034-02-25 2036-11-21

R203R203

R207 R208R2023

R186 R2030 R213 R2032


When the rising interest rate cycle does start to take effect, we naturally expect that it will have a negative impact on more flexible, negatively correlated fixed interest instruments like bonds, preference shares and property income assets. However, given our expectations that these moves will be small, protracted and reasonably anticipated, we don’t expect the impact of these individual hikes to contribute to excessive volatility in capital markets. However, the cost of capital will continue to rise as interest rates increase and bond yields will adjust accordingly. In addition, profile changes to sovereign debt will also impact the cost of capital negatively. We think most of the immediate effects of the recent downgrade are already reflected in asset prices.


Market caps of South African bonds as at 31 March 2017

Bond Yield Market Cap Maturity

R203 7.72 R45 784 184 783.24 2017/09/15 -26.4%

R204 7.93 R45 295 932 237.00 2018/12/21 -18.5%

R207 8.12 R56 836 736 993.03 2020/02/28 -18.1%

R208 8.28 R53 411 919 145.41 2021/03/31 -15.5%

R2 023 8.68 R63 012 473 918.47 2023/02/28 17.1%

R136 8.91 R198 340 529 761.91 2026/12/21 10.2%

R2 030 9.33 R87 379 240 329.30 2030/01/31 22.9%

R213 9.35 R83 470 272 666.34 2031/02/28 13.8%

R2 032 9.48 R64 593 685 092.79 2032/03/31 26.1%

R209 9.53 R63 405 537 992.53 2036/03/31 2.5%

R2 037 9.64 R87 893 839 529.09 2037/01/31 32.0%

R214 9.58 R60 615 348 623.26 2041/02/28 3.6%

R2 044 9.64 R73 561 412 239.81 2044/01/31 93.2%

R2 048 9.62 R123 052 479 159.58 2048/02/28 25.5%


Short-term performance

1-month 3-months 6-months 1-year

Beassa 1-3 Yr TR ZAR 0.7 3.0 4.5 9.4

Beassa 3-7 Yr TR ZAR 0.8 4.7 5.8 11.6

Beassa 7-12 Yr TR ZAR 0.4 5.6 6.3 11.0

FTSE/JSE Preference Share TR ZAR

1.7 1.8 3.9 14.8

FTSE/JSE SA Listed Property TR ZAR

0.1 4.2 5.5 1.5


Issued yields expressed as a percentage of prime are generally below the prime rate. However, some current effective yields (yield over clean price) are generally above prime at 10.50% due to lower prevailing clean prices.

Domestic equity earnings yield relative to domestic bond yields

1.30

1.20

1.10

1.00

0.90

0.80

0.70

0.60

0.50

0.40

0.30

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

Mean = 0.64St. Dev. = 0.16

!SDA (AJ203[EY]/ALIY) (0.572)


The graph above shows how domestic equities are relatively expensive at this stage.

Ten-year bond yield too low

Current Long term

US 10 year bond yield 2.4% 4%

Inflation differential 4.4% 4%

SA sovereign risk premium (CDS spread) 2.5% 2.5%

Suggested fair yield 9.3% 10.5%

Valuation and pricing adjustments

US 10 year bond yield 0.5%

Inflation differential (0.4%)

SA sovereign risk premium (CDS spread) 0%

Adjusted fair yield 9.4%


It would be wise to position investments for uncertaintyWe believe now is the time to place even greater focus on liquidity, quality and diversity. There are many unknowns in prevailing market conditions. Therefore, a degree of quality and manoeuvrability are essential components of an investment strategy. We will continue to assess the value and risks of investment opportunities as and when they present themselves, and adjust our solutions accordingly.

We are in favour of increasing our position in cash and short-dated sovereign debt given the conditions mentioned above. We maintain a somewhat more negative view on longer-dated nominal bonds.


4.6 CASH MANAGEMENT OPTIONS

We offer clients various cash management options, from investing in money market linked unit trusts (single and multi-managed), to custody cash accounts in securities portfolios.

Rate comparison (Net of fees)

8.5%

8%

7.5%

7%

6.5%

6.0%

5.5%

5%

4.5%

4%

3.5%

Feb

13

Mar

13

Apr

13

May

13

Jun

13

Jul 1

3

Aug

13

Sep

13

Oct

13

Nov

13

Dec

13

Jan

14

Feb

14

Mar

14

Apr

14

May

14

Jun

14

Jul 1

4

Aug

14

Sep

14

Oct

14

Nov

14

Dec

14

Jan

15

Feb

15

Mar

15

Apr

15

May

15

Jun

15

Jul 1

5

Aug

15

Sep

15

Oct

15

Nov

15

Dec

15

Jan

16

Feb

16

Mar

16

Apr

16

May

16

Jun

16

Jul 1

6

Aug

16

Sep

16

Oct

16

Nov

16

Dec

16

Jan

17

Feb

17

Mar

17

JSE Trustees Rate (Net)

ASISA MM Avg (Net)

AlexForbes MM Index (Net)

STeFI Call (Net)

PSGW EID (Net)

PSG Money Market (Net)

Investec CCM (Net)


Our multi-managed unit trust offering, the PSG Wealth Enhanced Interest Fund, has been a consistent performer.

The yield on the portfolio as at the end of March was 8.15%. The portfolio offers a term-deposit-type yield without comprising investor’s liquidity.

The effective after-cost yields for both the PSG Wealth Enhanced Interest Fund (8.15%) and the PSG Money Market Fund (7.49%) are currently well above the STeFI call rate (6.95%), even though this rate accelerated from the previous quarter’s number of 6.82%.

The average yield of the ASISA Money Market Fund peer group currently stands at 7.45%, while the JSE Custody cash yields are at 6.13%. This is a reasonable yield for investors who want to keep cash in their stockbroking accounts.

Cash plays a strategic role in the portfolio management processAlthough cash rates are only marginally positive in real terms, we feel that cash is playing an increasingly important role in the portfolio management process. Cash helps to reduce overall portfolio volatility. It also gives active managers access to funds so that they can take advantage of investment opportunities in equity markets as volatility increases. That being said, there is a material trade-off over the long term. Cash is not our wealth-building asset class of choice.

We strongly discourage clients from investing solely in cash in an attempt to time markets. By adopting such a strategy, a whole range of other unintended risks are introduced to longer-term wealth creation prospects. Both longevity risk and inflation risk could increase to excessive levels.

Page | 30

Rand/USD exchange rate spot price versus PPP

Jan

90

Jan

91

Jan

92

Jan

93

Jan

94

Jan

95

Jan

96

Jan

97

Jan

98

Jan

99

Jan

00

Jan

01

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Jan

13

Jan

14

Jan

15

Jan

16

Jan

17

18

16

14

12

10

8

6

4

2

0

-2

-4

USDZAR (CL) ASDZAR PPP +3 Std Dev +2 Std Dev +1 Std Dev -1 Std Dev -2 Std Dev -3 Std Dev


Rand/Euro exchange rate spot price versus PPP

20

18

16

14

12

10

8

6

4

2

0

-2

Jan

90

Jan

91

Jan

92

Jan

93

Jan

94

Jan

95

Jan

96

Jan

97

Jan

98

Jan

99

Jan

00

Jan

01

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Jan

10

Jan

11

Jan

12

Jan

13

Jan

14

Jan

15

Jan

16

Jan

17EURZAR (CL) EURZAR PPP +3 Std Dev +2 Std Dev +1 Std Dev -1 Std Dev -2 Std Dev -3 Std Dev


Currencies

4.7 CURRENCIES

The biggest short-term risk to return for South African investors is the rand, which is still trading at a material discount to purchasing power parity (PPP). Two key observations from this would be that:

1. The rand is trading well above the long-term PPP-level which seems excessive even if a sovereign downgrade occurs in 2017; and

2. The PPP-margin that the rand is trading at currently, statistically reduces the possibility of further weakness significantly.

Despite some material headwinds domestically in the first quarter of the year, we expect this trend (the strengthening of the rand) to steadily continue over the medium-term.

Page | 31

5. DOMESTIC SOLUTIONS

Domestic solutions

South African equities: armageddon or opportunity?A flood of negative news filled the web, airways and newspapers after credit rating agencies decided to downgrade South Africa’s sovereign foreign currency rating to junk status. The news focused on how South Africa’s global wealth was eroded over a few days, or how the down-grade was going to hit everyone’s pockets.

The last month that foreigners were net buyers of domestic equities (on a monthly basis) was in August 2015. For the next 19 consecutive months, until the end of March 2017, they were net sellers of equities to an average value of R10.79 billion per month, translating into a total value of R204.95 billion over the entire period.

However, over the same period, foreigners were regular buyers and sellers of local bonds, selling a total value of R1.55 billion over the 19-month period. Withdrawing R204 billion from our equities is by no means a small amount. There is also no certainty around how much they will sell in the future.

In November 1979, the late Sir John Templeton, founder of the Templeton Growth Fund, offered investors some good advice on buying and selling equities:

“If you want to buy the same thing that is popular with the investment security analyst, you can’t get a bargain. If you buy the same thing they buy you will get the same performance they get. If you are going to get superior performance, you’ve got to buy what other people are not buying or even what they are selling.”

In August 1958, he also said: “To buy when others are despondently selling and to sell when others are avidly buying requires the great-est fortitude and pays the greatest ultimate rewards.”

To say that foreigners are ‘despondently’ selling domestic equities and that local equities currently offer an attractive opportunity may not be com-pletely correct.

However, there should be no doubt that if the current trend continues, we will get closer to the point where ‘despondent selling’ will definitely be the case.

The latest rating agency decisionsThe first rating agency to make a move following the March cab-inet reshuffle by President Jacob Zuma, was S&P Global Ratings. S&P cut South Africa’s foreign currency rating from a BBB- invest-ment grade to a BB+ non-investment grade. This is the highest junk-score rating which South Africa received on 3 April 2017. S&P also warned that a deterioration of the nation’s fiscal and mac-ro-economic performance could lead to further reductions. Shortly after S&P another rating agency, Fitch downgraded South Africa’s foreign and local currency credit rating to sub-investment grade. Moody’s Research & Ratings said SA’s credit rating was on review after the cabinet reshuffle.

** The quotes from Sir John Templeton were sourced from the booklet ‘Sir John Tem-pleton, Throughout the Years’. It was published by Franklin Templeton Investments in honour of its founder and former chairperson. The introduction was written by Peter D. Jones, the President of Franklin Templeton Distributors, Inc.

It was no surprise to see this negative news flow and markets more or less priced in this bad news into assets. In the days following the down-grade news outlets reported how banking shares were dropping due to the downgrade. This was not unexpected, as the ratings of banks are linked to the country’s sovereign rating. All the major banks shed between 2% and 3% shortly after the opening of the market, continuing the stark sell-off that started when the news broke that President Jacob Zuma recalled Finance Minister Pravin Gordhan from an international investor roadshow. Share prices continued to fall after the President fired Minister Gordhan and

his Deputy, Mcebisi Jonas, a few days later in a cabinet reshuffle. Over the two weeks after the news, the banking index shed 14.7%.

Some say the news caused foreigners to withdraw money from our equity marketForeigners have been withdrawing billons of rands from our financial mar-kets for the past 19 months. However, the magnitude of the withdrawals may come as a surprise to some investors.

Net foreign transactions in South African bonds and equities

Mar

14

Apr

14

May

14

Jun

14

Jul 1

4

Aug

14

Sep

14

Oct

14

Nov

14

Dec

14

Jan

15

Feb

15

Mar

15

Apr

15

May

15

Jun

15

Jul 1

5

Aug

15

Sep

15

Oct

15

Nov

15

Dec

15

Jan

16

Feb

16

Mar

16

Apr

16

May

16

Jun

16

Jul 1

6

Aug

16

Sep

16

Oct

16

Nov

16

Dec

16

Jan

17

Feb

17

Mar

17

20

15

10

5

0

-5

-10

-15

-20

-25

Rand

(Bn)

Net foreign transactions in SA bonds (Rbn)

Net foreign transactions in SA equities (Rbn)


Page | 32Domestic solutions

Rating scale used by credit rating agencies

Source: Treasury

Current arguments against a higher equity exposureThe first argument is that equities are expensive. This issue has been raised at various previous events and has resulted in detailed research and discussions. This will not be repeated here. The table below shows that we have seen a noticeable improvement in valuations and that a further improvement can be expected.

Valuation of domestic equities over the past two years

1 year % changeP/E ratio

Index value Company earnings

31 March 2016 0.13% -14.54% 21.5

31 March 2017 -0.37% 10.10% 19.5

31 March 2018 (Expected) 0.00% 38.63% 14.1


The table indicates that the historic price earnings ratio (P/E) of the FTSE/JSE All Share Index (ALSI) stood at 21.5 on 31 March 2016. Due to the negative

change of 0.37% per year in the index value and the 10.10% per year im-provement in company earnings over the year till 31 March 2017, the P/E of the index declined to 19.5 times. On 31 March 2017, Bloomberg estimated that the 12-month weighted harmonic forward P/E was 14.0 (‘harmonic’ re-fers to a weighting methodology. The mean of a set of positive variables. Calculated by dividing the number of observations by the reciprocal of each number in the series). This implies that company analysts were expecting company earnings to grow 38.60% per year till the end of March 2018.

The calculation of the forward P/E assumes no change in the index value. If one relaxes this assumption and allow for a change in index value, then one can estimate a 1-year percentage change for the index based on different P/E ratios as at 31 March 2018. For example:

• If the P/E ratio stays at 19.5 then one can expect a 38.60% change in the index value.

• If the P/E ratio drops from 19.5 to 17.0, then one can expect a

21.00% change in the index value.

The second argument is that the current equity bull market is close to its end. An analysis of bull and bear market cycles since January 1960 until the end of March 2017 does not confirm this view.

South African equities: bull and bear markets: January 1960 to March 2017

Jan

60Ja

n 61

Jan

62Ja

n 63

Jan

64Ja

n 65

Jan

66Ja

n 67

Jan

68Ja

n 69

Jan

70Ja

n 71

Jan

72Ja

n 73

Jan

74Ja

n 75

Jan

76Ja

n 77

Jan

78Ja

n 79

Jan

80Ja

n 81

Jan

82Ja

n 83

Jan

84Ja

n 85

Jan

86Ja

n 87

Jan

88Ja

n 89

Jan

90Ja

n 91

Jan

92Ja

n 93

Jan

94Ja

n 95

Jan

96Ja

n 97

Jan

98Ja

n 99

Jan

00Ja

n 01

Jan

02Ja

n 03

Jan

04Ja

n 05

Jan

06Ja

n 07

Jan

08Ja

n 09

Jan

10Ja

n 11

Jan

12Ja

n 13

Jan

14Ja

n 15

Jan

16Ja

n 17

540.00520.00500.00480.00460.00440.00420.00400.00380.00360.00340.00320.00300.00280.00260.00240.00220.00200.00180.00160.00140.00120.00100.00

80.0060.0040.0020.00

0.00-20.00-40.00-60.00-80.00

-100.00

Bear markets

Cum

ulati

ve re

turn

s

Bull markets


Rating scale Rating description How banks will treat you

AAA Prime

All good banks want to lend you money at a very low interest

rate. They will offer you wine, tea, juice, anything you want

AA+

High gradeAll good banks want to lend you money at a low interest rate. They

will offer you tea and waterAA

AA-

A+

Upper medium grade

All good banks want to lend you money at a relatively low

interest rate. They will offer you only water

A

A-

BBB+

Lower medium grade

Most good banks want to lend you money at a normal interest rate. You will stand in a short

queue

BBB

BBB-

BB+

Non-investment grade speculative

A number of banks are still willing to lend you money, at a very high interest rate. No

special treatment and they want proof of assets for them to be sure you will be able

to pay them

BB

BB-

B+

Highly speculative

Unscrupulous lenders are willing to lend you money at very, very high interest rates. They take

your ID, TV, bed or other assets that you have so that they can

sell them if you don’t pay

B

B-

CCC+

Substantial risksCCC

CCC-

CCExtremely

speculative

C Default imminent

RD

In defaultSD

D

JUN

KIN

VES

TMEN

T G

RA

DE

Page | 33

Another piece of wisdom shared by Sir Templeton in February 1994 was that: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

The conditions for ‘pessimism’ are clearly visible in the red areas of the graph where the ALSI lost more than 20% of its value (the precondition for a bear market). The conditions for ‘euphoria’ are also visible in the sharp rise in index values at the top of each cycle.

None of these two conditions are currently visible in the latest cycle. That leaves us with ‘skepticism’ and ‘optimism’, of which ‘skepticism’ is reflected in the current news flows. However, active managers who are worth their salt can always find an opportunity during volatile times. As Templeton said: “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

Another way to reflect on the different cycles is to compare the duration and total return of each cycle with the average duration and average total return of all cycles. The current bull cycle started (from the point of maximum pessimism) 97 months ago, running from the end of February 2009 until today. This is the second longest bull cycle ever and does not compare very well to the average duration of 70 months for all the cycles. However, the total return of the current bull cycle is only 181.90% compared to the average total return of 327.80% of all the cycles. This is another indication that a condition of ‘euphoria’ is currently not present.

The above provides a strong indication that there could also be some good news in times of market stress, and not necessarily only bad news.

If you decide to live for the future, then you must look for those opportunities that are created in conditions of market stress to improve our future well-being. As such, you need to look past all the bad news and make decisions today that could benefit your future financial well-being. Domestic equities are without a doubt filled with such opportunities for investors with a long-term investment horizon.

The President of Franklin Templeton Distributors, Peter D. Jones, offered this piece of wisdom to modern investors in the foreword of Sir Templeton’s book:

“… no matter how your life progresses, two things about investing should never change. The first is that you should always seek the advice of a qualified financial advisor. The second is that there are timeless words of wisdom you should always remember when you invest.”

Domestic funds – performance and positioningPSG Wealth Domestic Equity Fund of Funds (FoF) and PSG Wealth Domestic Multi-Asset Funds of Funds (FoFs)Market conditions on both the global and domestic fronts remain extremely difficult for equity fund managers. Uncertainty around a worldwide

Domestic solutions

Durations and total returns of previous bull and bear markets

Cycle

1 2 3 4 5 6 7 8

Period: From Januray 60 April 69 March 74 October 80 September 87 April 98 May 02 June 08 Average

to March 69 February 74 September 80 August 87 March 98 April 02 May 08 Current

Correction (bear) mnths 15 30 29 20 6 4 11 9 15.5

% Corrected -35.8% -62.4% -51.4% -46.7% -43.9% -39.4% -32.9% -42.0% -44.3%

Recovery (bull) mnths 17 29 33 6 18 15 17 22 19.6

% Recovered 55.7% 177.5% 110.3% 94.5% 83.4% 65.3% 56.6% 73.9% 89.7%

Escalation (bull) mnths 79 0 17 56 104 30 44 75 50.6

% Escalated 261.1% 0.0% 131.7% 207.6% 194.9% 51.2% 170.7% 62.1% 134.9%

Total bull mnths 96 29 50 62 122 45 61 97 70.3

% Total bull market returns 462.3% 177.5% 387.4% 498.2% 440.9% 150.0% 324.0% 181.9% 327.8%


economic recovery and rising global interest rates result in continuous risk-on/risk-off trades. Sentiment is even worse on the domestic front with the increased political risk, and especially after South Africa was downgraded to non-investment grade by two ratings agencies – one at the end of the first quarter, the second at the start of the second quarter.

However, all three equity and asset allocation FoFs managed to outperform their benchmarks over the three-month, one-year and three-year investment periods ending March 2017.

Fund performance versus sector average

Name:3

Mon

ths

to

2017

/03/

31

Rank

1 Ye

ar t

o 20

17/0

3/31

Rank

3 Ye

ars

to

2017

/03/

31

Rank

PSG Wealth Creator FoF D 3.2 63 5.5 35 6.1 44

South African EQ General Sector Average

2.5 173 1.2 156 4.2 127

PSG Wealth Moderate FoF D 3.3 21 4.6 25 8.1 16

South African MA High Equity Sector Average

2.5 181 2.2 167 6.2 110

PSG Wealth Preserver FoF D 2.6 24 5.7 27 8.3 9

South African MA ow Equity Sector Average

2.1 144 4.1 133 6.6 93


The PSG Wealth equity and asset allocation FoFs are well diversified in terms of investment styles, asset classes and asset class sectors. However, prevailing market conditions are never favourable to all investment styles at all times. It is therefore not unusual to see one of the underlying managers underperforming the benchmark over the shorter measurement periods.

Sector allocation

Equity exposure of the PSG Wealth Creator FoF

Previous quarter Current quarter

PSG Wealth Creator FoF

PSG Wealth Creator FoF

Dom

estic

equ

ity

reso

urce

s

Resources 14.9 15.7

Financials 23.1 22.4

Industrials 43.5 41.3

Other equities -0.0 0.4

Equity hedges (+ Long/- Short) - -

Total domestic equities 81.5 79.8

Total foreign equities 15.2 14.9

Total equities 96.7 94.7


The composition of the PSG Wealth Creator FoF has changed slightly over the quarter, as the underlying managers reduced their exposure to industrials and financials and allocated more to resources shares. The underlying managers


of the PSG Wealth asset allocation FoFs have increased their exposure to resources and financials further, but this time they reduced their exposure

Asset allocation in PSG Wealth domestic solutions

Exposure of the PSG Wealth domestic asset allocation FoFsPrevious quarter Current quarter

PSG Wealth Preserver FoF PSG Wealth Moderate FoF PSG Wealth Preserver FoF PSG Wealth Moderate FoF

Dom

estic

Weight 100% 100% 100% 100%

Resources 2.0 6.4 2.4 7.5

Financials (excl. real estate) 5.0 9.9 5.5 11.6

Industrials 9.6 24.7 9.8 22.1

Other equities 0.3 0.1 0.3 0.1

Equity hedges( + Long/ - Short) -0.6 -0.8 -0.6 -0.7

Total equities (excl. real estate) 16.3 40.3 17.3 40.7

Real estate 3.5 5.3 3.9 5.3

Preference shares 0.4 0.2 0.4 0.2

Inflation linked bonds 5.7 1.4 5.4 1.4

Bonds 7+ yrs 12.1 10.2 13.0 10.5

Bonds 3 - 7 yrs 9.9 4.6 9.5 4.5

Bonds 1 - 3 yrs 6.3 1.8 6.5 1.9

Cash, derivatives and money market 24.4 11.4 22.2 11.2

Total non-equities (incl. real estate) 62.3 34.9 61.0 34.9

Fore

ign

Equities 17.4 23.4 16.9 22.7

Real estate 1.0 1.2 1.0 1.2

Bonds 1.3 0.1 1.7 0.3

Cash, derivatives and money market 1.6 -0.0 2.2 0.3

Total foreign 21.4 24.8 21.7 24.5

Tota

l

Total 100.0 100.0 100.0 100.0

Total equities 33.8 63.8 34.2 63.4

Total foreign 21.4 24.8 21.7 24.5


to industrials slightly. The underlying managers of the PSG Wealth Domestic Multi-Asset Funds of Funds (FoFs) have a sizeable exposure to non-equity

asset classes. The biggest change in these assets was a slight reduction in medium-term bonds (3 to 7 years) in favour of real estate.


PSG Wealth Fixed Interest FundsFund performance versus sector average

Name:

3 M

onth

s to

20

17/0

3/31

Rank

1 Ye

ar t

o 20

17/0

3/31

Rank

3 Ye

ars

to

2017

/03/

31

Rank

PSG Wealth Income FoF D 2.4 16 9.1 18 8.3 7

South African MA Income Sector Average

2.1 78 7.9 72 7.2 58

PSG Wealth Enhanced Interest D

2.0 2 8.2 1 7.1 1

South African IB Money Market Sector Average

1.9 33 7.7 29 6.8 26

PSG Wealth Preserver FoF D 2.6 24 5.7 27 8.3 9

South African MA ow Equity Sector Average

2.1 144 4.1 133 6.6 93


The PSG Wealth fixed interest funds managed to outperform their benchmarks over the three-month, one-year and three-year investment periods ending March 2017.

The managers in the PSG Wealth Income FoF have decreased their exposure to medium- and short-term bonds (3 to 7 and 1 to 3 years) in favour of long-term bonds (7+ years), cash and money market instruments. The higher cash levels will add some price stability to the funds and give the managers the opportunity to buy even more longer-dated instruments when interest rates start to decline.

Sector allocation

Non-equity exposure of the PSG Wealth domestic fixed interest FoFs

Previous quarter Current quarter

PSG Wealth Enhanced Interest Fund

PSG Wealth Income FoF

PSG Wealth Enhanced Interest Fund

PSG Wealth Income FoF

Dom

estic

non

-equ

ities

(inc

l rea

l est

ate)

Real estate - 3.3 - 3.7

Preference shares - 1.4 - 1.3

Inflation linked bonds - 3.3 - 3.1

Bonds 7+ yrs - 10.6 - 13.0

Bonds 3 - 7 yrs - 15.3 - 13.5

Bonds 1 - 3 yrs - 19.2 - 18.2

Cash, derivatives and money market 100.0 34.7 100.0 36.1

Total domestic non-equities (incl. real estate) 100.0 87.6 100.0 88.9

For

eign

non

-equ

ities

(inc

l re

al e

stat

e)

Real estate - 1.5 - 0.9

Bonds - 5.7 - 6.8

Other - - - -

Cash, derivatives and money market - 2.0 - 0.2

Total foreign non-equities (incl. real estate) - 10.6 - 7.9

Total non-equities (incl. real estate) 100.0 98.3 100.0 96.8


Page | 36

6. OFFSHORE SOLUTIONS

Offshore solutions

Opportunities abound for active managers in an uncertain world“The most important quality for an investor is temperament, not intellect.” – Warren Buffet

The increased positivity is driven mostly by non-US economies. This contrasts to 2016, when the US was basically the sole driver of increased growth expectations.

The global economic recovery is broadening, and BlackRock’s view is that there is room for consensus estimates to rise even higher as reflation gains traction.

As illustrated by the graph below, there has been an increase in inflation expectations in a number of key markets. Inflation has bounced in the UK, driven by a weak sterling, and it is creeping higher in the Eurozone, albeit from much lower levels.

Energy has driven much of the rebound, but inflation is also broadening as consumer price index (CPI) components increase.

US, UK and Eurozone inflation

Ann

ual i

nflati

on

0%

1%

2%

3%

4%

Eurozone

UK

US

2003 2005 2007 2009 2011 2013 2015 2017

*The chart uses trimmed mean inflation, which aims to provide a more accurate picture of underlying inflationary pressures. We take the official CPI basket for each country and each month, excluding the largest and smallest movers by price volatility.

Sources: BlackRock Investment Institute, Consensus Economics

Global recovery in corporate earnings

Luckily for global investors, markets are starting to catch up to these fast-changing undercurrents. This can be seen in the improvement of company earnings on a global scale, something which supports equities. The chart below shows the changes in corporate profit estimates.

Most major markets, including broad emerging markets (EMs), have seen a noticeable increase in the estimates of their 12-month forward corporate earnings.

Corporate earnings recovery: changes in corporate profit estimates for 2012 to 2017

Thre

e-m

onth

cha

nge

2012 2013 2014

Eurozone

Japan

US

Emerging markets

2015 2016 2017-10%

-5%

0%

5%

10%

*The lines show the three-month change in the aggregate 12-month forward earnings estimates. The data is based on the MSCI US, EMU, Japan and EM indexes.Sources: BlackRock Investment Institute, Consensus Economics

This earnings recovery is not just due to reflation. Cost discipline (resources), hopes for regulatory easing (financials) and innovation (tech) are all contributing to strong earnings expectations for 2017. Earnings momentum is particularly strong in Japan and EMs, while it is solid in Europe.

As noted in the latest BlackRock Global Investment Outlook report, volatility in equity markets is historically low, despite persistent political uncertainty. In fact, volatility looks unusually depressed across asset classes, with the exception of foreign exchange. Global reflation and ample liquidity have consistently trumped politics in recent years. Yet a lot is now brewing under the surface. Correlations between stocks and equity sectors, for example, have declined markedly in the US and Europe. Volatility is subject to sporadic outbursts that can surprise investors.

Political uncertainty versus equity volatility

January 2014 July 2014 January 2015 July 2015 January 2016

Policy uncertainty

Volatility

Brexit vote

US election

July 2016 March 2017

0

50

100

150

200

0

12.5

25

37.5

50

Unc

erta

inty

inde

x

Vola

tilit

y in

dex


One of the common traits that great investors share is their understanding of the instincts, emotions and tendencies of investment behaviour. Celebrated value investor and Warren Buffet’s mentor, Benjamin Graham famously quipped, “The investor’s chief problem – and even his worst enemy – is likely to be himself.” As noted in previous editions of this report, one of the biggest pitfalls to investors reaching their objectives is making investment decisions based on their own emotions. This is especially true during times of increased political uncertainty.

The best reason for South African investors to gain offshore exposure is diversification. It offers various benefits, and specifically, access to sectors and industries that are not available in South Africa. A key benefit for investors using strong global active managers, like those used within the global PSG Wealth Solutions, lies in their ability to navigate uncertain times and remove emotion from the investment decision-making process.

The last seven years have been an uphill battle for active managers, but a changing macro-economic backdrop suggests that active management could soon see a lift. On that note, this article will cover some of the key themes in global markets, and the opportunities presented by these themes for active managers to outperform.

Improved outlook for global growth and increasing inflation expectations for developed marketsVarious leading economic indicators show global economic growth is on the rise. The BlackRock Investment Institute’s Global Investment Outlook for Q2 2017 provides one such indicator, namely the ‘BlackRock GPS’. This indicator combines traditional economic indicators with big data signals like internet searches. The graph below points to a rise in the growth estimates of the G7 economies in the months ahead. (The G7 is an economic grouping consisting of Canada, France, Germany, Italy, Japan, the United Kingdom and the United States.)

BlackRock GPS versus G7 Consensus

January 2015

2.5%

Ann

ual G

DP

grow

th

2%

1.5%July 2015 January 2016 July 2016

G7 consensus

G7 GPS

March 2017


Page | 37Offshore solutions

In discussions with our global fund managers, many note that they are willing to look past rising political uncertainty in France and the US. They indicate that they will bet on what they view as an acceleration in activity and synchronised economic advances, across developed and emerging markets.

The move from monetary to fiscal policies Quantitative easing (QE), the most dramatic monetary intervention in the past decade, has caused an unprecedented growth in the balance sheets of global central banks. In short, QE involves central banks buying government bonds and other financial assets, held by commercial banks or other financial institutions, which causes the prices of these assets to rise and yields to adjust downwards. The additional liquidity and lower borrowing costs stimulate spending and aim to return inflation to its target. Additionally, QE encourages investments in assets with higher yields, like corporate bonds and equities. Over the last eight years, investors have become accustomed to the benefits of QE. However, more recently, there has been indications of a potential change in central bank policies, from monetary to fiscal stimulation. Central banks have indicated their intention to start normalising rates and tapering off QE as the recovery in the global economy continues to stabilise. This will, however, be done at a cautious rate and over a lengthy period, perhaps a decade. One of the major central banks, the US Federal Reserve (Fed), is currently the most advanced in its thinking of this topic. Data suggests the Fed will follow a passive and predictive path with minimal shocks to the markets, by letting debt run off when it matures.

The European Central Bank (ECB) is widely expected to continue QE into 2018, but to slowly start tapering asset purchases with the objective of gradually terminating the programme. As indicated by the following graph, the huge expansion of global balance sheets may be coming to an end soon.

Total central bank assets (% of GDP)

2007

0

20

40

60

80

100

120

140

10

20

30

40

50

60

70

2009 2011 2013 2015 2017 2019

Fulcrum Projection

PBoC (LHS)

ECB (LHS)

World (LHS)

Federal Reserve(LHS)

Bank of Japan (RHS)

Source: Financial Times

A further challenge to monetary policy could also come from the fiscal side. In the US, the Trump administration has indicated its intentions to focus on deregulation, tax reforms and infrastructure spending. Although it may be too soon to speculate on the exact scope of these plans, the intention to shift the focus to fiscal policies is clear. The gradual reduction of money supply, rate normalisation and fiscal stimulus create a changing macro-economic backdrop that should benefit active managers. Firstly, regional allocation should become more crucial as countries have different timelines for implementing the policy shifts. Secondly, sector allocation and bottom-up stock selection will prove valuable as these changes will have varying effects on companies based on the industries that they operate in and their balance sheet composition.

Convergence of emerging and developed market inflation ratesWe noted earlier that there has been a steady increase in inflation expectations for developed markets (DMs). The chart below illustrates that rising inflation rates in developed markets are converging with the falling inflation rates of EMs.

Convergence of EM and DM inflation rates

15

10

5

0

-5

1997 99 01 03 05

Emerging marketsDeveloped marketsSpread between EMs and DMs (percentage points)

07 09 11 13 15 17

*Consumer price inflation as annual % change

Source: JPMorgan

The gap is now at its lowest level in at least 20 years, due mainly to improving economic growth in DMs, which causes higher inflation in these markets. The recent strong performance of EM currencies, also keeps inflation stable in these countries. Traditionally, as the Fed increases interest rates, the US dollar strengthens and EMs are forced to raise rates to prevent their currencies from weakening. The falling inflation in EMs and rising inflation in DMs are adding to the appeal of EM investments. This causes an inflow of foreign funds into EMs and, in turn, protection against currency devaluations, despite the US’s tighter monetary policy.

The favourable population growth in EMs and a move towards consumption and higher value-added industries, like technology, should provide investors with opportunities. Investment risks in EMs are also reduced due to their lower inflation rates and less risks to their currencies. EMs represent about 11% of the global MSCI All Country World Index. This presents good quality active managers with opportunities to overweight EM exposure to capture the upside potential in these markets.

Conditions have improved for active managers to outperformOver the last seven years, passive management has benefited from huge tailwinds – low volatility, high correlations, slow growth and reduced fiscal spending. “All of which have worked against active management,” says Lisa Shalett, Head of Investment and Portfolio Strategies at Morgan Stanley Wealth Management. Similarly, low GDP growth has constrained company profits, making it difficult for stellar performers to stand out.

More recently, a number of macro-economic trends started to reverse, and in our view this changing environment can provide good active managers with opportunities to outperform. We have seen the early stages of a potential move from monetary to fiscal policy, mostly in the US, but there are clear indications that many other developed markets are poised to follow suit. Additionally, we have seen rising inflation expectations in developed markets, combined with declining inflation in EMs. GDP growth estimates for DMs have also steadily been improving. While political uncertainty has been high, volatility in stock markets has been relatively low. The positive news for global investors is that markets are catching up to these fast-changing dynamics and this is reflected in the upswing of global corporate earnings, which supports equities.

Historically, during periods of changing trends, active managers have had the best potential to find mispriced securities and outperform market indices, usually through accurate regional and sector allocation, as well as strong security selections. Against a changing backdrop, active managers may be able to add alpha in rising markets, while dampening volatility in down markets.

Global funds – performance and positioningThe PSG Wealth Global Preserver FoF USD had a very strong 12 months ending 31 March 2017, outperforming the GIFS USD Cautious sector average by 3.09% in USD. For the first quarter of 2017, the portfolio outperformed the sector by 0.11%. The PSG Wealth Global Preserver FoF GBP also delivered top quartile returns over the last 12 months, outperforming the GIFS GBP Cautious sector average by 10.18% in GBP. For the first quarter of 2017, the portfolio underperformed the sector by 0.33% in GBP. Both FoFs have been ranked in the top quartile of their respective global sectors since inception.

Over the first quarter of 2017, the PSG Wealth Global Moderate FoF outperformed the global sector average by 0.5% in USD. For the five years ending 31 March 2017, the portfolio outperformed the GIFS USD Moderate


Allocation sector average by 0.9% per annum and has been ranked in the second quartile of global peers since its inception.

The PSG Wealth Global Flexible FoF USD achieved strong returns for the 12 months ending 31 March 2017, delivering excess returns of 6.60% in USD above the GIFS USD Flexible Allocation sector average. For the first quarter of 2017, the fund outperformed the sector by 3.92%. The PSG Wealth Global Flexible FoF GBP also delivered top quartile returns over the last 12 months, outperforming the GIFS GBP Flexible Allocation sector by 15.66% in GBP. For the first quarter of 2017, the portfolio outperformed the sector by 2.96% in GBP. Both FoFs have been ranked in the top quartile of their global sectors since inception.

For the first quarter of 2017, the PSG Wealth Global Creator FoF outperformed the GIFS USD Global Large-Cap Blend sector average by 1.30% in USD. For the four years ending 31 March 2017, the portfolio outperformed the sector average by 2.21% per annum and has been ranked in the first quartile of global peers since its inception.

Performance of offshore solutions in USD

14%

12%

10%

8%

6%

4%

2%

0%

-2%3 Month

PSG Wealth Global Preserver Fof D USDPSG Wealth Global Flexible Fof D USD

PSG Wealth Global Moderate Fof D USDPSG Wealth Global Creator Fof D USD

6 Month 1 Year 2 Year 3 Year

Dots represent the return of the relevant sector average.

Sources: PSG Wealth research team, Morningstar

During the first quarter of 2017, we disinvested from the Firststate Global Listed Infrastructure and Sarasin Global Real Estate Funds within the PSG Wealth Global Preserver FoF USD and GBP. These funds were replaced with the Fidelity Global Multi Asset Income Fund and Blackrock Global Multi-Asset Income Fund. The changes were made to align the mandates of the underlying funds with the mandate of the PSG Wealth Global Preserver FoF. Both new portfolios have mandates focused on global income generation and capital preservation, experienced globally positioned investment teams and a record of consistent performance within global cautious allocation mandates. No other changes were made in any of the other PSG Wealth Global FoFs.

Within the PSG Wealth Global Preserver FoF, the change in underlying managers has resulted in a decrease in the overall equity allocation within the FoF by 6.3% (USD) and 6.4% (GBP) respectively. Both funds now have an equity allocation of 35%, which is in line with the proposed role of the portfolio in the PSG Wealth Global Fund Range. On a sector basis,

Look-through positioning of the PSG Wealth Global Fund Range

PSG Wealth Global Fund RangeAsset and sector allocation as at 31 March 2017

PSG Wealth Global Preserver FoF USD

PSG Wealth Global Preserver FoF GBP

PSG Wealth Global Moderate FoF

PSG Wealth Global Flexible FoF USD

PSG Wealth Global Flexible FoF GBP

PSG Wealth Global Creator FoF

Foreign Equities 35.2 35.7 54.9 84.0 85.1 94.7

Basic Materials 1.2 1.2 2.5 1.0 0.2 1.7

Communication Services

1.7 1.7 2.6 1.6 2.2 1.9

Consumer Cyclical 5.2 5.3 6.4 9.3 15.6 11.3

Consumer Defensive 4.4 4.5 5.2 14.1 10.3 13.3

Healthcare 6.7 6.8 6.6 16.5 14.5 16.8

Industrials 5.7 5.7 6.1 7.6 9.6 9.8

Technology 6.0 6.1 7.8 21.7 16.0 21.4

Energy 1.6 1.7 4.3 2.9 3.3 4.1

Financial Services 6.9 7.0 12.2 10.3 13.9 13.5

Utilities 1.1 1.1 1.1 0.1 0.9 0.8

Other/Undisclosed -5.3 -5.4 0.1 -1.2 -1.5 0.0

Foreign Property 2.0 2.0 1.1 5.6 5.7 1.8

Foreign Bonds 44.7 45.0 28.4 3.2 3.2 -

Foreign Other 2.8 2.8 6.9 0.1 0.1 0.2

Foreign Cash 15.3 14.5 8.7 7.1 5.9 3.4

Domestic Assets 0.0 0.0 0.0 - - -

PORTFOLIO TOTAL 100.0 100.0 100.0 100.0 100.0 100.0


the portfolio changes resulted in a significant decrease in the allocation to utilities, down 15.1% and 15.7% respectively. Allocation to the financial services and technology sectors increased by 2%. Foreign property allocation decreased by about 10% and the bond allocation increased by 28.9% and 29.2% respectively.


Regional allocation of Global Fund Range

PSG Wealth Global Fund Range Regional allocation as at 31 March 2016

PSG Wealth Global Preserver FoF USD

PSG Wealth Global Preserver FoF GBP

PSG Wealth Global Moderate FoF

PSG Wealth Global Flexible FoF USD

PSG Wealth Global Flexible FoF GBP

PSG Wealth Global Creator FoF

Americas 40.1 40.1 47.5 64.2 65.1 65.4

North America 39.0 39.0 46.1 63.4 64.2 64.7

Latin America 1.2 1.2 1.4 0.8 0.9 0.7

Greater Europe 41.2 41.2 32.2 24.5 25.8 26.2

United Kingdom 5.5 5.5 13.0 12.3 12.2 11.4

Europe Developed 34.0 34.0 17.2 10.8 13.4 14.2

Europe Emerging 0.6 0.6 0.7 1.0 0.1 0.1

Africa/Middle East 1.1 1.1 1.2 0.5 0.2 0.5

Greater Asia 18.7 18.7 20.4 11.3 9.1 8.4

Japan 8.2 8.2 9.5 3.3 2.2 3.9

Australasia 3.5 3.5 1.2 1.7 2.1 1.0

Asia Developed 4.2 4.2 5.1 3.8 2.5 1.4

Asia Emerging 2.9 2.9 4.5 2.6 2.3 2.1

Market Classification 100.0 100.0 100.0 100.0 100.0 100.0

% Developed Markets

94.4 94.4 93.2 95.5 96.6 97.1

% Emerging Markets 5.6 5.6 6.8 4.5 3.5 2.9

Source: Morningstar

Within the PSG Wealth Global Creator FoF the largest change during the quarter was the increase in the technology sector from 20.4% to 21.4% of the portfolio. The allocation to the consumer cyclical sector decreased in the last quarter by 0.9%. Global property again increased over the quarter, rising by 0.6% while cash decreased by 1%.

Over the first quarter of 2017, there was little movement in the allocation between EMs and DMs for most of the PSG Wealth Global FoFs. The only exception was the PSG Wealth Global Preserver, where the change in underlying managers saw EM exposure decrease from 7.5% to 5.6%. Additionally, the PSG Wealth Global Preserver FoF saw a large reduction in US allocation from 53.7% to 40.1%, while the European exposure increased from 21.3% to 41.2%. The PSG Wealth Global Creator FoF and PSG Wealth Global Flexible FoF continue holding overweight positions in developed markets (9% to 10%), which is due mostly to the preference for high quality stocks by a number of quality focused underlying managers.

Over the quarter changes made by underlying managers in the PSG Wealth Global Moderate FoF resulted in a decreased allocation to equities of 1.6%. On a sector basis, the allocation to financial services decreased by 0.9% and the allocation to communication services also decreased by 0.6%. Consumer defensive and technology increased by 0.4% and 0.3% respectively. As stated previously, many of the underlying managers used their cash positions to buy as opportunities arose in the market. The overall cash allocation of the FoF decreased by 4.7%. The total bond allocation of the FoF increased by 1%. Most managers remain short on duration,

and this is reflected in the relatively shorter-dated non-government bonds preferred by our underlying managers.

The allocation to global property (+0.9%), bonds (+1.6%) and cash (+1.1%) increased over the quarter in the PSG Wealth Global Flexible FoF. On a sector basis, there was a significant increase in the allocation to the technology sector in the USD FoF of 3.1%, while healthcare also increased by 1.8%. The allocation to financial services decreased by 2.2%.

Page | 40Spotlight on: Summer 2017 survey – The valuation of the local market

7. SPOTLIGHT ON: SUMMER 2017 SURVEY – THE VALUATION OF THE LOCAL MARKET

Top five stocks mask value on ALSIThe valuation of the top five market cap stocks on the FTSE/JSE All Share Index (ALSI) have been masking value elsewhere in the domestic market. An analysis of the FSTE/All Share Index (ALSI) shows that when these top five companies are excluded, then the forward price-to-earnings (P/E) ratio of the index returns to a level similar to the average P/E-level recorded over the past decade.

Valuations are not straightforward – current P/E could be misleadingThe rational approach to investing tactically in equity (as with all asset classes) is to adjust the position according to a fair assessment of opportunity and risk, increasing exposure when opportunities are presented, or lighting your stake when conditions are unfavourable.

One of the ways to gauge the relative opportunity or risk of equities is by comparing the price you pay relative to the profit they’re generating. This is done by monitoring the P/E ratio, which tracks the share price as a multiple of the most recent year’s earnings (profit).

Current and forward P/E ratios of ALSI

2006-12-29 2007-12-29 2008-12-29

40.00

35.00

30.00

25.00

20.00

15.00

10.00

5.00

0.00

2009-12-29 2010-12-29

Forward P/E

2011-12-29 2012-12-29 2013-12-29 2014-12-29 2015-12-29 2016-12-29

Current P/E

4 Apr 2017 P/E of

4 Apr 2017 P/E of


Earnings versus price of the ALSI

2006-12-29 2007-12-29 2008-12-29 2009-12-29 2010-12-29 2011-12-29 2012-12-29 2013-12-29 2014-12-29 2015-12-29 2016-12-29

Earnings Price

140%

120%

100%

80%

60%

40%

20%

0%

-20%

-40%

-60%


Forward P/E ratio of the ALSI (Bloomberg consensus)

Dec

06

Jun

07

Dec

07

Jun

08

Dec

08

Jun

09

Dec

09

Jun

10

Dec

10

Jun

11

Dec

11

Jun

12

Dec

12

Jun

13

Dec

13

Jun

14

Dec

14

Jun

15

Dec

15

Jun

16

Dec

16

18.00

16.00

14.00

12.00

10.00

8.00

6.00

4.00

Forward P/E Average +/- 2 S.D (Excl) Forward P/E (Excl) Average (Excl)

Sources: PSG Wealth research team, Bloomberg Consensus

While we recognise that valuation is often ineffective as an investment tool, it is the single most important determinant of long-term returns. Stocks on the ALSI look expensive if you use the current P/E ratios to measure value. The graph above shows that shares on the ALSI are currently trading at P/E ratios of around 19. In the last quarter of 2016, shares in the Top 40 Index were trading at P/E ratios of around 30. The last time P/E ratios were at such elevated levels was in 1994, after which share prices fell back significantly. They also approached these elevated levels in 2008 before another substantial retraction returned the market to normality.

Current P/E values seem expensive, because the P/Es have been inflated, largely on the back of an earnings collapse (seen in the graph below).

Local counters have also reacted to the slide in the local exchange rate. With a significant portion of the profits generated by the JSE’s biggest listings now coming from abroad, South African stock prices have been stimulated by the depreciating rand. However, when one uses the harmonic forward PE, which we believe is a more appropriate measure of current valuations, then the P/E for the ALSI is 14.12 times. This is still expensive compared to the long-term average P/E of 12.25. The analysis shows that the P/E for the ALSI is currently trading close to 2.5 standard deviations above its long-term average (see graph below).

Different values seen when using different P/E ratios

Current P/E Forward P/E Forward PE Long-term average

Current P/E excl top five

Forward P/E (excl top 5)

Forward P/E Long-term average

(excl)

18.74

14.1212.25

13.8712.58

11.31


Page | 41Spotlight on: Summer 2017 survey – The valuation of the local market

It is important to note the impact that large market cap companies have on P/E valuesAs stated above, the P/E for the ALSI is 14.12 when the forward P/E is used. However, when the top five companies with the largest market cap are excluded from the ALSI, then the forward P/E drops to 12.58. The top five companies (Richemont SA, British American Tobacco, BHP Billiton, Naspers and Anglo American) currently constitute almost 38% of the ALSI by weight. However, as the second pie chart indicates, they only account for 9% of the number of shares in the index.

Value of the top five market cap stocks on the ALSI (REDRAW IN CI)

All share Top 5 Weight Forward P/E Average Std dev. Std dev.away

Cie Financiére Richemont SA

8.1% 25.44 16.56 3.76 2.36

British Ameri-can Tobacco

3.5% 18.04 15.79 1.45 1.55

BHP Billiton PLC 6.7% 11.95 12.79 6.63 -0.13

Naspers Ltd 15.1% 29.75 22.42 8.62 0.85

Anglo Ameri-can PLC

4.1% 7.64 11.37 4.37 -0.85

37.5%

SABMiller is excluded from historic data for this analysis


Naspers alone accounts for about 15% of this index, trading at a forward P/E of almost 30. Richemont and BHP Billiton both contribute over 14% to the index and trade at forward P/Es of 25.44 and 11.95, respectively. Some of the top five companies are currently trading up to 8.62 standard deviations above their long-term averages.

P/E values of shares in the ALSI according to their weight*

< 8.2x

8.2x - 10.2x

10.2x - 12.2x

12.2x - 14.2x

14.2x - 16.2x

< 8.2x

8.2x - 10.2x

10.2x - 12.2x

12.2x - 14.2x

14.2x - 16.2x

16.2x - 18.2x

18.2x - 20.2x

20.2x - 22.2x

> 22.2x

16.2x - 18.2x

18.2x - 20.2x

20.2x - 22.2x

> 22.2x

26% 9%

< 8.2x

8.2x - 10.2x

10.2x - 12.2x

12.2x - 14.2x

14.2x - 16.2x

< 8.2x

8.2x - 10.2x

10.2x - 12.2x

12.2x - 14.2x

14.2x - 16.2x

16.2x - 18.2x

18.2x - 20.2x

20.2x - 22.2x

> 22.2x

16.2x - 18.2x

18.2x - 20.2x

20.2x - 22.2x

> 22.2x

26% 9%

*The grey counters trading at P/Es of 22 and higher currently constitute 26% of the ALSI.


Summer 2017 survey: The valuation of the local market

Question asked in Summer 2017 edition: Do you think the local equity market is:

Cheap 5.13%

Expensive 20.51%

More or less fairly valued 26.64%

Generally expensive, but cheap if you avoid a few of the most expensive stocks 33.33%

Other (send us your thoughts) 15.38%

Source: PSG Wealth research team survey in the Summer 2017 edition of the PSG Wealth Investment Research and Strategy Report.

Take part in our new survey on whether political uncertainty will deter you from investing by clicking here.

The results from each quarter’s questions will be discussed in the next edition of the report.

Most participants in the PSG Wealth Research and Strategy Report Summer 2017 survey felt that the local market was expensive. While 20.51% of respondents felt the market was expensive overall, the majority (33.33%) of respondents believe the market is generally expensive, but cheap if you avoid a few of the most expensive stocks. Almost a third of respondents (25.64%) felt the market was more or less fairly valued. Only 5.13% of respondents thought the market was cheap.

Bottom lineOver the long term, valuations tend to revert to the mean. Using historic P/E multiples, the JSE currently seems very expensive. However, a thorough analysis reveals that the valuation is in line with its long-term average, especially when heavyweight rand hedges are excluded. This is an indication that value is still available to diligent stock pickers.

Autumn 2017 survey: Political uncertainty and investingSouth Africa has faced many challenges in the past, both externally and internally induced. In various ways, these challenges may be perceived as having hindered the country from reaching its true potential. Growth may appear sub-par, especially when compared to our emerging market (EM) peers. The reasons offered for this are numerous – political uncertainty, restrictive labour legislation, a sovereign credit downgrade, a market dependent on commodity prices, and a generally distrustful relationship between Government and business. Despite this, some South African citizens are still wealthy and a number of companies are performing well despite challenging conditions. Challenging conditions are not stopping these individuals and companies from investing and growing their wealth, so why should it deter you?

Take part in our new survey by clicking here.

The number of shares in the ALSI and their P/E values**

**Only 9% of companies on the ALSI (the grey counters) are trading at P/Es of 22 and higher.



Page | 42PSG Wealth: Performance summary

8. PSG WEALTH: PERFORMANCE SUMMARY

Month Enhanced Interest

Income FoF Preserver FoF Moderate FoF Creator FoF Global Moderate FF

Global Creator FF

Global Moderate

Global Creator Global Flexible (USD)

Global Flexible (GBP)

Global Preserver (USD)

Global Preserver (GBP)

16-Apr 0.59 0.78 0.52 0.6 1.59 -1.47 -2.25 1.46 0.84 0.92 -0.47 0.58 -0.63

16-May 0.68 0.99 2.4 2.75 1.26 9.9 10.93 -0.58 0.47 0.14 0.37 0.02 0.39

16-Jun 0.62 0.83 -1.46 -2.81 -2.73 -9.43 -9.82 -1.96 -2.47 -0.3 6.2 1.66 7.84

16-Jul 0.68 0.82 0.54 0.97 1.76 -1.15 0.85 2.76 4.9 3.67 6.4 2.55 3.44

16-Aug 0.71 0.68 1.42 1.61 1.24 5.96 5.95 0.69 0.66 0.72 0.9 0.05 0.25

16-Sep 0.66 0.71 -0.67 -1.3 -0.57 -5.49 -5.5 0.09 -0.26 -0.08 0.36 0.41 1.19

16-Oct 0.65 0.42 -0.87 -2.1 -2.68 -3.57 -4.74 -1.21 -2.05 -2.32 3.38 -0.57 3.38

16-Nov 0.65 0.37 0.55 0.73 1.32 2.9 3.92 -0.2 0.79 0.85 -0.79 -1.13 -2.59

16-Dec 0.66 0.8 0.58 0.92 1.13 -0.44 -0.5 1.24 1.15 0.93 2.11 1.13 1.86

17-Jan 0.69 0.86 1.02 1.58 2.74 -0.71 0.58 1.51 2.82 2.79 1.17 0.58 -0.43

17-Feb 0.62 0.66 0.28 -0.03 -0.93 -1.37 0.18 1.59 3.31 3.73 3.89 2.12 2.62

17-Mar 0.64 0.82 1.29 1.74 1.4 3.33 3.87 0.81 1.4 0.45 0.53 -0.28 -0.26

MTD (5th) 0.09 0.11 0.58 0.96 1.17 2.69 2.64 -0.05 -0.23 -0.01 -0.03 0.07 0.11

YTD 1.96 2.36 2.6 3.31 3.21 1.18 4.66 3.96 7.71 7.09 5.66 2.43 1.91

1 Year 8.15 9.1 5.66 4.59 5.49 -2.95 1.8 6.27 11.92 11.94 26.47 7.3 18.01

2 Year 7.62 8.2 6.76 5.66 3.27 5.1 10.03 0.31 5.13 6.35 13.49 3.86 10.08

3 Year 7.14 8.3 8.27 8.07 6.08 9.07 13.76 0.67 5.07 5.04 14.66 3.57 10.19

5 Year 6.53 8.04 10.44 12.29 12.43 16.7 4.16 7.29 12.14 4.06 8.39

7 Year 8.21 10.21 12.01 12.34 7.06 9.19 3.96 6.56

*Performance has been annualised for periods longer than 12 months**Performance shown in base currency

Source: PSG Wealth research team data as at 31 March 2017

Page | 43

9. PREVIOUS PUBLICATIONS

Previous publications

MARCH 2017

MONTHLY INVESTMENT INSIGHTS

5 May 03 May19 Apr12 Apr05 Apr22 Mar15 Mar08 Mar01 Mar 15 Feb06 Feb 18 Jan11 Jan14 Dec07 Dec30 Nov16 Nov09 Nov02 Nov

April 2017March 2017February 2017January 2017November 2016October 2016September 2016August 2016July 2016

June 2016May 2016Apr 2016March 2016February 2016December 2015November 2015October 2015

Summer 2017 Spring 2016 Winter 2016Autumn 2016Summer 2016 Spring 2015

Distributions explainedS&P junk statusResearch providedFed hike inevitable?S&P 2 Dec reviewUS election Market PE’sLocal government elections Brexit vote Cash vs Long-term instrumentsS&P June 2016 ratingFed Dec 2015 interest rate hikeImpact of political moves on investments FoF fees small compared to gainsSARB hikes rates Weak PMI supports foreign diversification

March 2017 December 2016 September 2016July 2016April 2016January 2016October 2015July 2015

Daily

Research & Strategy Report Special reports Wealth Perspective

Weekly Monthly

26 Oct12 Oct05 Oct28 Sep14 Sep07 Sep31 Aug17 Aug10 Aug02 Aug27 Jul13 Jul06 Jul29 Jun22 Jun15 Jun 08 Jun01 Jun

25 May 18 May11 May04 May26 Apr 20 Apr 12 Apr 05 Apr 30 Mar23 Mar16 Mar09 Mar01 Mar23 Feb11 Dec20 Nov16 Nov

https://www.psg.co.za/files/diu/Daily-Investment-Update-05052017.pdf

https://www.psg.co.za/files/wealth/special-reports/Weekly-Investment-Update-03052017.pdf









https://www.psg.co.za/files/wealth/special-reports/PSG-Wealth-Special-Note-15122016.pdf









https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-April-2017.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-March-2017.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-February-2017.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-January-2017.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-November-2016.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-October-2016.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-September-2016.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-August-2016.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-July-2016.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-June-2016.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-May-2016.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-April-2016.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-March-2016.pdf

https://www.psg.co.za/news/wealth-perspective/2015/Q4/Investment-update-investor?utm_medium=Web+Article&utm_campaign=Wealth+Communication&utm_content=Investment-update&utm_source=Wealth+Perspective+Web&utm_term=Read+More

https://www.psg.co.za/files/wealth/special-reports/Weekly-Special-Report-20151207.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-November-2015.pdf

https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-October-2015.pdf

https://www.psg.co.za/files/communications/research-and-strategy/2017/Summer/Research-and-Strategy-Report-Summer-2017.pdf

https://www.psg.co.za/files/communications/research-and-strategy/2016/Spring/Research-and-Strategy-Report-Spring-2016.pdf

https://www.psg.co.za/files/communications/research-and-strategy/2016/Winter/Research-and-Strategy-Report-Winter-2016.pdf

https://www.psg.co.za/files/communications/research-and-strategy/2016/Autumn/Research-and-Strategy-Report.pdf

https://www.psg.co.za/files/communications/research-and-strategy/2016/Summer/Research-and-Strategy-Report.pdf?adviser+distibution

https://www.psg.co.za/files/communications/research-and-strategy/2015/Spring/Research-and-Strategy-Report-Q3-2015.pdf

https://goo.gl/1ZayvB

https://www.psg.co.za/files/communications/Downgrade-Webinar/Adriaan-Ratings-downgrade-and-other-investment-challenges-Where-to-from-here-full-version.pdf






https://www.psg.co.za/files/wealth/special-reports/PSG-Wealth-Monthly-Special-Note-August-2016.pdf


https://www.psg.co.za/files/mii/PSG-Wealth-Monthly-Investment-Insight-June-2016.pdf

https://www.psg.co.za/files/wealth/special-reports/Adhoc-Weekly-08062016.pdf






https://www.psg.co.za/news/wealth-perspective/2017/Q1-the-wealth-perspective?utm_medium=email&utm_campaign=wealth+communication&utm_content=the-wealth-perspective&utm_source=wealth+perspective+email&utm_term=banner

https://www.psg.co.za/news/wealth-perspective/2016/Q4-Investor

https://www.psg.co.za/news/wealth-perspective/2016/Q3-Investor

https://www.psg.co.za/news/wealth-perspective/2016/Q2-investor



https://www.psg.co.za/news/wealth-perspective/2015/Q3

https://www.psg.co.za/news/wealth-perspective/2015/Q2/client-version-investment-update




































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