What’s going on and what do you need to know?
It’s been a turbulent week. In the past few days, headlines have toggled between mounting concern around the Turkish Lira, the surprise weak performance announced by Tencent and, closer to home – confusion around land expropriation.
Unsurprisingly, the markets have reacted. Volatility in emerging market currencies, bond yields and equity markets has increased noticeably and it has become difficult to ascertain which element is having the biggest impact on global appetite for risk.
Investors are rightfully concerned about the longer-term impacts of all this. While we can fully understand the surge of emotions when faced with a barrage of headlines, we want to take this opportunity to remind investors to focus on longer-term objectives and to resist the urge to react in times of short-term volatility that is predominantly due to factors unrelated to your own investment holdings.
The most important thing to remember is to consider the things that are within your control and to stick to your financial plan for the long-term.
Of course, over the past few days as each of these events has unfolded, we have been in close contact with our underlying fund managers and we hope that the below will provide some context around each event.
Concerns with respect to the fluid events in Turkey revolve mainly around contagion effects on other emerging market currencies and assets, and the exposure to Turkish bank debt held by Western European domiciled financial institutions.
What do our fund managers say?
On contagion concerns – Daryll Owen, Fund Manager of the Nedgroup Investments Stable Fund: The countries with the highest current account deficits – “the fragile 5” – Brazil, Indonesia, India, South Africa (and Turkey), will be impacted most as global investors look to retreat to safe havens.
South Africa has the added misfortune of having the most overtraded currency in the world – 17% of SA’s GDP is traded every day in forex markets. So when risk is heightened, the ZAR becomes a useful hedge for long positions elsewhere.
We have structured our portfolios to defend against rising global geopolitical tension, be it from Turkey or elsewhere and we are monitoring the situation very closely.
Iain Power, Fund Manager of the Nedgroup Investments Balanced Fund and the Nedgroup Investments Managed Fund: The Turkish Lira has depreciated significantly over the last 10 years and in the last week has fallen 25% on a trade-weighted basis. At the same time yields on 10 year Turkish government bonds have risen from 18.2% to 20.5% reflecting the country’s difficult position. Significant economic imbalances have been building in the Turkish economy over the last decade which is in contrast to many other Emerging Markets and has left the Turkish economy’s external funding position increasingly exposed.
On the implications of a banking sector crisis, Iain Power continues Turkey’s vulnerabilities appear unique. The fragility in the banking sector looks more acute than most other Emerging Markets. The reluctance of the Turkish government to stem the fallout in their currency and accelerating inflation could result in a full-blown Turkish financial crisis with severe impact on their banking sector. Turkish banks have significant hard currency funding which could become problematic if the Turkish Lira continues to free-fall. The portfolio has no direct exposure to the problems in Turkey.
Tencent released their quarterly update this week, reporting weaker than expected growth numbers. This has exacerbated 2018 share price weakness. To put recent moves into perspective, the decline from the peak of HKD 474 on 23 January 2018 to close on 16 August 2018 at HKD 325, translates to a fall of 31%. The resultant impact on the Naspers share price, from a peak of R4090 on 21 November 2017 to 16 August 2018 at approx. R3150, was a loss of 23%.
In summary, Tencent reported the following negative factors: 1. Slower growth in online gaming, 2. Slower advertising revenue growth on news and video advertising, 3. New PBOC guidelines, which required wechat pay to move customer deposits to non-interest bearing accounts, impacted revenue growth in others segment, 4. Higher sales and marketing spend, 5. Lower net gains from other investee companies and higher impairment provision for certain investments.
What do our fund managers say?
Comment from Neil Brown, Fund Manager of the Nedgroup Investments Growth Fund: With slowing growth generally factored into our analysis, the only new information in the past few days relates to the big slowdown in the Chinese government approval of new Tencent Games and we expect these approvals to improve in the remainder of 2018. Tencent has now fallen below our valuation and we see upside in Naspers due to the good value of the rest of Naspers assets, known as the “Rump”.
Comment from Daryll Owen, Fund Manager of the Nedgroup Investments Stable Fund: Tencent will likely see gaming revenue weakness in the near term until there is further clarity around regulatory approval timeline. However, in the long run it remains the winner in a structurally growing Chinese gaming industry, with potential to gain incremental revenue in international markets. For this reason, we believe Tencent remains an attractive long-term investment, while in the local market, the discount via Naspers still remains attractive and we would use short-term weakness to accumulate shares.
Comment from Iain Power, Fund Manager of the Nedgroup Investments Balanced Fund and the Nedgroup Investments Managed Fund: The Tencent results announced this week, although disappointing, have not changed the company’s medium-term outlook. Certain specific factors resulted in revenue growth being lower than expectations. The Chinese government delayed the release of new mobile game titles due to potential violent content and the overall impact on social behaviour. We think these issues will ultimately be resolved with the regulator.
LAND EXPROPRIATION WITHOUT COMPENSATION (EWC)
On Wednesday 15 August 2018 Gwede Mantashe made statements in an interview with News24, regarding the magic number of 12 000 hectares. This has provoked additional concern surrounding the land EWC issue when there has actually been no further clarity provided. The lack of clarity is the problem and, as long as it is allowed to fester, we can expect business investment to be reserved.
What do our fund managers say?
Comment from Daryll Owen, Fund Manager of the Nedgroup Investments Stable Fund: It is worth noting that Mantashe was not citing a new idea. Instead, this is the Regulation of the Agricultural Land Holdings Bill which was published in 2016 by a previous minister. The Regulations Bill proposed that people should declare their nationality, race and gender, amongst other things and also put a 12 000 hectare limit on land per farm owner.
Furthermore, the ANC want to make sure this issue is fixed and they know now that there is a huge political risk to leaving it until post-elections. However, there is a risk that the 27 September deadline on the solution of Land Reform may be pushed out, as an outsourced company has to review all submissions and process them. Comment from Iain Power, Fund Manager of the Nedgroup Investments Balanced Fund and the Nedgroup Investments Managed Fund: The longer-term consequences of not urgently addressing the land issue will be severe, however painful it may be in the short term. We agree that it will be a fine balancing act, fulfilling the demand for broader land ownership whilst maintaining economic stability.
It is important to note that the framework for any amendments must still ensure economic stability and not endanger South Africa’s food production capacity. This implies that the framework around any amendments will be very specific and not open to interpretation. We believe the proposed constitutional amendment will likely clarify the powers that the State has under the current Constitution, rather than seeking to increase the State’s power to expropriate.
Comment from Neil Brown, Fund Manager of the Nedgroup Investments Growth Fund on the need to have a longer-term perspective on how to value companies within South Africa: For our valuations, after Cyril Ramaphosa’s December 2017 victory, we did not lower our expected SA government bond rate that is used as the discount rate for the basis for our company valuations. We believe that SA still has structural problems, which must be dealt with to enable SA to have a sustainable long-term GDP growth rate in excess of 2%.
In summary, we again urge investors to consider events with a longer-term perspective and if possible to take a considered, fundamental evaluation on the impact of any event on the prospects of investments held. As you can interpret from the comments above, this is what fund managers are doing on a daily basis when taking decisions on the positions within their portfolios. The recent market turbulence is a cause for concern, but to assess whether the recent news flow will have a lasting impact on individual assets, takes a lot more investigation and consumption of additional information. As always, our priority is to achieve excellent long-term performance for our investors and every decision we make is made with this commitment in mind.
Rob Johnson Head of Investments