Ashburton investments: Global perspectives - issue one

ISSUE ONE

Winds of change A different direction provides access to more

FOCUS ON AFRICA The real African opportunity FOCUS ON INDIA Beyond the headlines FOCUS ON CURRENCIES Shifting currency sands

NOV 2013

“The stocks we like are inevitably being driven by the unstoppable forces of urbanisation, strong demographics and increased disposable income”. p12 PAUL CLARK,

Fund Manager, Ashburton Investments (South Africa)

[ ConTRIBUTORS ]

Tristan Hanson is Head of Asset Allocation for Ashburton Investments (International) and is responsible for multi-asset strategy and related research. Tristan joined Ashburton in 2008 and has 11 years’ experience in the investment industry.

Prior to Ashburton, he worked as a Strategist for JP Morgan Cazenove for seven years. He holds a Masters’ in Public Administration in International Development from Harvard University’s Kennedy School of Government. He also holds a BA (Hons) in Economics from Durham University. Tristan attained the Securities Institute Diploma in 2000.

Cover photography: Corbis – sailing on the Nile River

2

Global Perspectives

PaOlo Senatore is the Chief Investment Officer of the South African long-only funds at Ashburton Investments (South Africa).

Paolo has 16 years’ industry experience and began his career in 1995 when he joined RMB gaining exposure to a number of areas within the bank. By 1997, he had joined London & Dominion Trust, wholly-owned by RMB, and the foundation of the RMB Private Bank Portfolio Management operations. There he gained experience in private client portfolio management and was responsible for the development of the institutional business.

Paolo holds an MSc in Mechanical Engineering from the University of the Witwatersrand.

Jonathan Schiessl is Head of Equities

for Ashburton Investments (International), responsible for the Chindia Equity Fund and India Equity Opportunities Fund. Jonathan joined Ashburton in 2000 and has 16 years’ experience in the investment industry. Prior to working at Ashburton, he worked for Bank Julius Baer and other financial institutions in London. He has a Social Science (Hons) degree, specialising in Economics, from the University of Hertfordshire.

Contents

Insight – Thought Leadership – Market Views

p4 Welcome

Introduction Head of Ashburton Investments Boshoff Grobler introduces the first issue of Global Perspectives.

p7 Global Outlook

Questions & Answers

The macro economic issues facing the world’s financial markets and how these could affect asset classes and investments going forward.

p 12 Focus on Africa

The Real African Opportunity

The equity opportunities to be found right across this vastly diverse continent.

p 16

p 18 Focus on India

Beyond the Headlines

The newspapers may suggest that India’s economic prospects remain gloomy, but beyond the headlines lie a great many investment opportunities.

p 22 Focus on Currencies

Shifting Currency Sands

The US dollar continues to dominate the currency market but the balance of power may be starting to shift.

p 25 Focus on Currencies

The Next Phase for Bond Markets

What next for the bond markets after five years of unfolding economic and financial conditions, not to mention a programme of unprecedented Quantitative Easing.

Focus on Africa

Debt Funding in Africa: The Investment Opportunity

With demand far outstripping supply, debt funding in Africa is an inherent opportunity for institutional investors.

Nico Els is a Fund Manager at Ashburton

Investments (South Africa) and is a member of Ashburton’s primary and secondary Asset Allocation committee. He has 20 years’ experience in fixed income, starting in 1992 with SMK Securities on the bond floor of the JSE as a Fixed Income Sales Representative. In 2006, Nico joined RMB and helped to establish a FICC proprietary desk, with his main focus on G10 interest rates and currencies.

He worked in London for three years and gained valuable knowledge of global macro trading strategies, portfolio construction as well as risk management. Nico holds a BCom (Hons) in Investment Management and completed his JSE Membership Examination.

Paul Clark is a Fund Manager at Ashburton

Investments (South Africa). He joined Ashburton South Africa in 2012 to set up and manage an Africa Fund for the FirstRand Group. Paul started his investment career with Standard Corporate and Merchant Bank’s Asset Management division where he served as a Research Analyst and Specialist Unit Trust Fund Manager for two years. He subsequently joined HSBC Equities South Africa as an Equities Analyst for five years. Paul then joined the African Alliance Group in 2004 as Head of Research and was instrumental in the launch of the Africa Pioneer Fund in June 2007. Paul holds a BEng degree in Chemical Engineering from the University of Stellenbosch as well as a BCom degree in Accounting from the University of the Witwatersrand. Paul is a Chartered Financial Analyst (CFA) charterholder.

Riyadh Bhyat is a member of the Product Development team at Ashburton Investments (South Africa) focusing on Credit Funds and involved in Ashburton’s Private Equity business.

Riyadh joined Ashburton in 2013 and is currently driving the development of Co-Investment funds across sectors. Riyadh began his career at Rand Merchant Bank, serving as a transactor in the Debt Capital Markets division for five years where he was responsible for equity-linked funding instruments.

He holds a B.Sc Hons in Actuarial Science from the University of the Witwatersrand, is a Fellow of the Institute of Actuaries, and has an MBA with distinction from the University of Oxford, Christ Church, where he was a Saїd Scholar.

www.ashburtoninvestments.com

3

Welcome

Access to more: More markets, more opportunities Boshoff Grobler

Head of Ashburton Investments

Welcome

to this, the first issue of Ashburton Investments’ Global Perspectives magazine.

F

or those of you familiar with Perspective magazine, Global Perspectives is intended to capture the essence of the recent changes we have made to our business.

It is an appropriate opportunity for me to reflect on why we have chosen to create this new business, and share our excitement and enthusiasm for the Ashburton Investments brand.

Ashburton Investments already has $10.6 billion in assets under management, representing the coming together of a number of offerings within the FirstRand Group (FirstRand).

With an asset base of $87 billion as of 30 June 2013, FirstRand has a strong balance sheet and a track record of creating new businesses that challenge conventional thinking and bring new propositions to customers. Ashburton Investments represents FirstRand’s strategy to grow in the investment management space.

We are a new player but come to market with not only 30 years of expertise and excellence as Ashburton Jersey, but also the backing of FirstRand’s balance sheet and reputation for meeting people’s needs with innovative offerings. We believe that the time is right for a new type of investment management, investment management motivated by the needs of the investor and whose products are tailored to the client’s requirements.

4

Global Perspectives

“The only real difference is that you will be offered access to more: more markets, more opportunities, more products, more ways of managing your money and more ways of managing risk.”

“We believe that the time is right for a new type of investment management, investment management motivated by the needs of the investor and whose products are tailored to the client’s requirements.”

By accessing the capabilities of the existing franchises within FirstRand we can bring new investment and asset classes to retail and institutional investors offering a far wider investment choice than currently exists, with more sources of both return and yield.

For existing clients your engagement with us will be very much a case of business as usual. We have simply taken our well-established and recognised Jersey capabilities of multi-asset investing, specialist emerging markets equity and global equity products, and supplemented these with our South African strengths.

Your investments will be managed just as they are now and completely separately and independently from the banking businesses to avoid any potential conflicts of interest and maintain client confidentiality.

The only real difference is that you will be offered access to more: more markets, more opportunities, more products, more ways of managing your money and more ways of managing risk. In short, more ways to meet your unique and individual needs.

In this first issue of Global Perspectives Tristan Hanson, Head of Asset Allocation at Ashburton Investments (International), and Paolo Senatore, Chief Investment Officer of the South African long-only funds, provide their views on what is likely to shape global economics going forward. Paul Clark, Fund Manager, Ashburton Investments (South Africa), proves that the African investment story is about so much more than resources and commodities, and Jonathan Schiessl, Head of Equities at Ashburton Investments (International) finds real opportunities defying the current political and economic mood in India. Nico Els, Fund Manager, Ashburton Investments (South Africa), discusses Quantitative Easing and how it has created the ‘new normal’, while Paolo Senatore and Riyadh Bhyat, Ashburton Investments (South Africa), review the landscape in terms of currency and credit, respectively.

The thought leadership, knowledge and expertise within these pages are merely indicative of the Ashburton Investment offering. With Ashburton Investments now positioned as FirstRand’s investment management platform we believe we are building the investment proposition that our investors have told us they want.

We may very well be a new business, albeit with an admirable history, but we believe that the combination of pedigree, reputation and performance from Jersey

and the scale, financial acumen, and experience from South Africa is a powerful one. And one that, by providing access to more sources of yield, more sources of return and more opportunities, has the potential to produce a level of return to fulfil all our investors’ needs.

Global Perspectives magazine will be published three times a year and we hope to bring you insightful articles addressing topics which are pertinent to investors across the globe. Enjoy the read. /

Boshoff Grobler

www.ashburtoninvestments.com

5

Global Outlook

Tristan Hanson

Paolo Senatore

Global outlook

Questions & Answers For this, the first issue of Global Perspectives, Ashburton Investments (International) Head of Asset Allocation, Tristan Hanson, and Chief Investment Officer of the South African long-only funds, Paolo Senatore, provide their views on the macro economic issues facing the world’s financial markets and the potential ramifications these might have on asset classes and investments going forward.

6

Global Perspectives

W

hat are the main global issues facing the markets?

TH: In our view, macroeconomic conditions are generally improving and global economic growth should accelerate in 2014, as growth picks up in the US and Europe.

If this view proves to be correct, the main issue facing markets over the next two to three years is likely to be the prospect of a less accommodative monetary policy in the US and how this might impact financial markets.

So far, we’ve already had the first ripples with regards to the prospects of the Federal Reserve (Fed) starting to pare back its quantitative easing (QE) programme in the form of smaller incremental bond purchases by the central bank. QE is likely to end during 2014. Then attention will shift to the issue of interest rate hikes. Currently, we expect the Fed to begin to lift short-term interest rates during the first half of 2015.

With investors around the world having

www.ashburtoninvestments.com

7

Global Outlook

become comfortable with zero interest rates in the world’s largest economies, the eventual onset of a tightening cycle will be a prime focus for investors.

The outlook for Chinese growth will also be a key factor in determining asset class returns, given its much increased importance to the global economy over the years. We expect trend growth to continue slowing in China, perhaps to 5 or 6% by the end of the decade. While this is slower than what China achieved in the previous 30 years, it would still represent strong growth by most countries’ standards. We are not forecasting a financial crisis in China, although the risks have risen in recent years.

There is far more optimism about the euro area these days – a stark contrast to periods in 2011 and 2012 when fear was rife that the currency union could disintegrate. Whether this improvement can be sustained over the next couple of years will have a strong bearing on investment returns, not just in Europe but globally. A fair amount of rebalancing has been achieved by the periphery countries in terms of unit labour costs or current account balances, but economic conditions remain depressed.

Things look stable currently but the risk of political crisis or a negative shock to growth could precipitate renewed concerns.

More generally, debt levels around the world remain extremely high despite the efforts of deleveraging. As a result, we live in a world driven by asset prices and leverage. Another significant decline in global asset prices could result in severe balance sheet destruction and another collapse in global demand, leading to severe recession. The direction of asset prices therefore has considerable influence on economic growth.

All that being said, however, I think the world is less vulnerable than it has been for close to ten years. Being an optimist I believe we are on the cusp of stronger cyclical growth in the global economy as many of the financial risks have diminished somewhat from where they were.

What is the potential impact of reduced QE in the US? PS: The near-term effect of an end to zero interest rates is certainly keeping the markets on alert.

We also think this has global implications, like Africa and other parts of the developing world, in terms of how the bond markets will trade.

It is difficult to know the pace at which this will play out (QE tapering), but it’s certainly dependant on the sustainability of US growth.

The impact of potential higher interest rates driven by QE tapering talk and the economic

8

Global Perspectives

The unstoppable growth of China’s middle class.

growth that’s already occurring in the US is starting to be seen in the form of bond markets trading higher in emerging markets. In South Africa, for example, while short-term rates haven’t moved, bond yields on ten year paper have moved from 6% to around 7.7%.

What is the impact of China’s relatively slower growth on the rest of the world?

PS: China has in the past been a very important driver of aggregate economic growth across many developing regions. The fact that the structure of China’s economy has changed (and will continue to evolve) from being export and commoditiesdriven to having a greater focus on the consumer, continues to excite investors. Certainly we’re seeing a re-focus of the infrastructure spend which we have become accustomed to in China in recent years. Instead, the domestic consumer will play a greater role especially in terms of its impact on the financial, property and retail sectors over there.

TH: It is fair to say China is experiencing something of a structural slowdown and that trend growth is declining. However, I think we need to put this in the context of the rest of the world. In this, China’s growth should still out-pace other developing nations and also the US and Europe. It is just that we have become used to the double digit GDP growth of the past few decades. A slowdown is inevitable on a relative basis as we’re currently running at around 7 to 7.5% growth for the year.

Over the coming years, this figure could consolidate to around 6% and possibly down to 5%. So it’s still good growth, but not as fast and aggressive as in previous years. And I think related to that is the fact that the composition of that growth is likely to shift and to probably be less commodity intensive than has previously been the case and more consumer sector driven, as Paolo eludes to.

“Markets like India, South Africa, and Turkey (those running twin deficits) and countries with a high debt to GDP ratio may find it difficult to achieve potential growth rates if foreign inflows do not occur.”

How does this shift towards the consumer sector affect the outlook for commodities?

PS: I think that’s an important point Tristan makes because we expect demand levels for commodities to flatten as fewer capital-intensive projects are initiated. This view that the commodities cycle will level out going forward obviously impacts those commodity producing countries and many of which are in the emerging world.

W

Turkey is an emerging market running twin deficits.

hat are your views on commodities as an investment?

Base metals such as copper have strengthened in recent weeks.

PS: There has been a slight strengthening of hard commodities like base metals such as copper in recent weeks, presumably on the back of supportive comments about the growth of the global economy.

We expect the US economy to come through next year with reasonable growth, as we’ve both mentioned. It is a large economy of course, but this needs to be put in the same context as another huge economy like China, changing from being an infrastructure-based economy to being more led by consumption. So the net result we think will be a fairly flattish commodity cycle and that would impact on currencies that depend on the commodity cycle such as the South African Rand. The Rand is well correlated for example to the metals commodity cycle, and if we expect that to be fairly flat then you can’t expect that to be especially supportive of a Rand or an appreciating Rand.

TH: We have avoided commodities in the recent past, and though we expect global growth will strengthen, in general terms we’re not hugely enthusiastic about commodities, especially the likes of gold where we expect weakness to continue as the macro environment improves.

Turning to oil, we have had a longterm view that oil price will remain higher for longer; not necessarily as a result of stronger than expected demand, but because the cost of supply is going up over time. Optimists may point to the shale oil boom in the US, which has certainly boosted supply, but even so, the technology remains expensive so a reasonably high oil price is required.

In addition, deep offshore wells represent expensive extraction. As for OPEC countries, they now require a higher oil price to balance budgets.

www.ashburtoninvestments.com

9

Global Outlook The Eurozone crisis – nearing a resolution?

TH: The Eurozone crisis, which has driven market volatility in recent years, is another big issue [on top of China and US/QE tapering] that will determine the direction of markets. The OMT [Outright Monetary Transactions] programme introduced by the European Central Bank was successful in taking the pressure off bond markets.

I’d say it is possible that the worst is over in terms of the current crisis, but we’re also morphing into a world where the risks are mainly political and not economic. Even though a number of weak economies are starting to recover, there remains a danger of some sort of political accident derailing that recovery.

How is Ashburton positioned in terms of asset allocation?

What about opportunities in the fixed income space?

TH: From our perspective, equities will continue to provide the best returns over the medium term of the major asset classes. If we are right, in the belief that the cyclical recovery is coming through, then that supports equities as well and price trends are favourable. We certainly still favour equities versus fixed income.

There is always the risk that equities may suffer from bouts of volatility should negative shocks occur, but over time they should outperform.

TH: Looking within fixed income, high yield is probably the best place to be, in our view. While the spread you get is not especially wide, it is wide enough and we should be able to generate mid-single digit returns from that sector of fixed income.

For government bonds, you are generally looking at very low returns.

Within emerging market debt there are some opportunities on a selective basis and we hold positions in Mexico, for instance.

PS: If I could pick on one theme within assets it would be the re-emergence of

PS: To add to that, one market where we have seen challenges for emerging market

The rand remains under threat from the US dollar.

10

developing/emerging markets. Emerging markets are starting to look more interesting once again but we need to keep a focus on what might happen in an environment where US rates are rising. Under this environment we will continue to see pressure on emerging market sovereign bond yields.

The outlook for emerging market equities is still quite positive, but not as aggressive or as obvious as it might have been in the past. Markets like India, South Africa, and Turkey (those running twin deficits) and countries with a high debt to GDP ratio may find it difficult to achieve potential growth rates if foreign inflows do not occur. In this regard, those economies may struggle to gain momentum and could lag. If that’s the case, equities in those emerging markets could come under pressure.

Global Perspectives

debt is in South Africa. While we are not expecting any interest rate increases over the short-term, we are seeing the longer end of the yield curve move higher. From current levels we could see yields on South African sovereign bonds rise by a further 50 to 75 basis points over the year for bonds of ten years’ duration. The bond market has the potential to be a volatile asset class, and we expect further weakness in this asset class as the year progresses.

What currencies do you favour?

TH: In light of an expected reduction in monetary policy accommodation, between the major currencies we have a preference for the US dollar over the medium term.

We think US growth is going to outpace growth in the rest of the developed world and believe the Federal Reserve is going to start shifting to a slightly tighter monetary policy so that should be favourable for the US dollar. It is also inexpensive in valuation terms. The Japanese yen would probably be the weakest out of the major currencies because Japan’s central bank is easing policy aggressively.

With reference to emerging market currencies, for the first ten years of this century we saw generalised US dollar weakness and a concurrent strengthening of emerging market currencies. Looking forward, I think that much of that particular trend is played out and you’re going to see probably more diversion between emerging market currency performance, and perhaps not a generalised trend of appreciation.

Egyptian carpet looms – an example of investment opportunities our African team are exploring.

A

re there any other regions or asset classes which you think have the potential to generate superior returns in the future?

PS: Yes, although it may not be on the radar of your average investor. One of the investment themes we like is Africa and African-listed equities. We’re fairly bullish on the African story in general and there are a number of countries within Africa that are obtaining growth rates on the 5% mark with a nice infrastructure tilt too, which has led us to become fairly bullish on the African story.

When you enter the African market it becomes a different scenario with regards to how you access information about local firms. It’s not obviously an easy market

to invest in because your availability of research is very limited, so it really necessitates a need for feet on the ground and a much more intense research process by the fund manager to make an informed view on a specific corporate. The fund manager won’t be able to rely on the typical resources available to them within the other more developed economies. It’s a different ball game in terms of making investments which is exactly where Ashburton’s local knowledge and strengths really come into play. /

www.ashburtoninvestments.com

11

Photography: Sven Torfinn/Panos, construction workers on the Kigali skyline.

Focus on Africa

12

Global Perspectives

The real African opportunity For many, investing in Africa is all about South Africa and the associated resource and commodity story, but for Paul Clark, Fund Manager, Ashburton Investments (South Africa), if you are prepared to dig a bit deeper, there are equity opportunities to be found right across this vastly diverse continent.

S

Paul Clark Fund Manager, Ashburton Investments (South Africa) hunts down equity opportunities in Africa.

outh Africa is admittedly the largest economy in Africa and as such an obvious focus for investors.

And while Africa’s growth in recent years is often linked to commodities, according to McKinsey, during the strong commodity price boom from 2002 to 2007 only 24% of the change in Africa’s real GDP growth can be attributed to resources. Clearly the majority of growth can be found elsewhere. Investing in African equities as an asset class, particularly outside the more established

South African equity market, is often described as ‘frontier market’ investing. And while it may not be for the faint hearted, you are essentially investing in early-stage emerging growth economies with a comparable element of risk as there would be from investing in Latin America or Southeast Asia. In reality, from the on the ground research we conduct, the risk premium attached to African companies is more often than not wildly overstated.

www.ashburtoninvestments.com

13

Focus on Africa Strong growth prospects Since the beginning of this year, the Ashburton African equities team has visited a great many companies across the continent, to find those which we believe to be good value stocks with strong growth prospects and excellent management teams.

We focus on companies where we think the current share price isn’t a true reflection of future growth expectations.

We don’t focus on particular sectors or themes, preferring instead to look at the company first and identify at what stage of development the sector they operate in is and whether that represents a significant opportunity for growth.

The stocks we like are inevitably being driven by the unstoppable forces of urbanisation, strong demographics and increased disposable income. And while this is widely reported as the current African trend, the 50+ countries in our investment universe are all at different stages in this journey. That said, while it’s important to acknowledge that they are not all the same, they are not all unique either. A few share similar characteristics, patterns and trends which we take into careful consideration as part of our investment assessment.

Stock selection At Ashburton we adopt a bottom-up stock selection investment philosophy, sourcing undervalued companies with strong investment potential to significantly reduce any risk. The companies we invest in are those we know to be trustworthy, knowledgeable, and respected in the marketplace. We get to know the management teams and enough about the macro and political climate they operate in to make investing no more of a risk than in any other emerging market. We stress test their business plans to determine whether they have the appropriate strategies in place to meet increased demand and whether in doing so they can optimise efficiencies. We believe these to be key considerations and paramount over the macro drivers of the domestic economy and changeable political winds.

A perfect example of this, and one of our favourite companies, is an Egyptian carpet manufacturer who sells domestically and in the Middle East, but also globally through retail giants such as Wal-Mart.

The political situation in Egypt may be a very long way from stable but a company

14

Global Perspectives

“We continue to favour undervalued listed African equities across a variety of sectors.”

Infrastructure in Lusaka, Zambia.

like this, in reaching such a diverse global market, has adopted a very robust strategy against both political and currency volatility.

Carefully considering quality companies on their own merit, conducting the due diligence, meeting the managers and recognising the potential all help mitigate some of the portfolio risks inherent in investing in developing markets and industries.

E

ia pt gy

ns

il

ar kc

ts pe

.

24%

FROM 2002 – 2007 only 24% of africa’s real GDP can be attributed to resources

Infrastructure ambitions ARM Cement is another exciting opportunity we researched when on the ground in Kenya. Cement demand in East Africa is growing strongly with significant growth in residential developments.

Future demand in the region will flow from oil reserve discoveries in Uganda and Northern Kenya, which will necessitate significant infrastructure spend on new ports and railways to support trade routes.

On a recent visit to the Zambian capital, Lusaka, we saw row upon row of new houses and flats, as well as small business parks, built entirely from cement bricks – confirming that this trend is not confined to one region.

We also favour Nigerian banks, where once again we believe growth will be driven by infrastructure spend particularly in the power sector. Although more widely associated with oil exports, Nigeria now enjoys a thriving financial sector fuelled by expanding domestic consumption.

These are all examples of how when investing in African-listed equities we have looked at the burgeoning themes of urbanisation, demographics and consumer demand and assessed exactly where on the continent we might achieve the best returns. However, more importantly, we have looked in minute detail at exactly how the companies we

like will benefit from these high growth areas. We’ve determined whether, in our view, there is an upside to what we consider to be ‘fair value’ in the share price. We know that our investors want solid returns, and while the macro and political environment can be an important driver, our value-based investment process depends entirely upon looking at companies from the ground up.

Less volatility In addition to the well-managed and under-valued local companies we favour, we believe there is another upside to African equities. The volatility of equity returns from African companies (excluding South African) compares favourably with those trading on the S&P 500 index. Our research indicates Fig 1: Annualised risk and returns

Annualised Return

25% 20%

Egypt

15%

Africa ex SA

10% Frontier

5%

S&P 500

0% 10%

South Africa

Emerging

Nigeria Developed

15%

20%

Annualised Risk

25%

30%

35%

Source: Bloomberg, Ashburton estimates

Fig 2: GDP growth rates

Advanced Economies

Africa ex SA

that while the volatility is comparable, the returns from African investments are, over time, superior (see fig. 1).

And we are further encouraged by recent International Monetary Fund figures (see fig. 2) which indicate superior growth rates for Africa compared to the developed world over the next few years. This, we would suggest, highlights the rapid economic progress the majority of the continent will make even if you take South Africa’s resource-rich economy out of the equation.

Diversification Diversification is a much over-used investment term often with little reference to reality. It often refers to asset class selection as a means of protecting an investor’s portfolio against market fluctuations, but, as has been seen in the last 12 months, certain asset classes have conspired together rather than offset each other, and generally to the investor’s detriment (see fig. 3).

At Ashburton we would argue that the way we approach selecting undervalued African companies, and you need only look at the examples mentioned above, brings with it some very tangible diversification benefits.

There is enormous divergence in Africa’s contrasting economies and their individual strengths, whether driven by commodities or economic drivers such as urbanisation and a thriving middle class.

Undervalued equities

SSA ex SA

8 7 6 5 4 3 2 1 0

2013

2014

2015

2016

2017

2018

Source: IMF October 2013

Fig 3: Correlation data

Africa* World GEM Frontier S&P 500 Egypt Nigeria South Africa

Africa* World GEM Frontier S&P 500 Egypt Nigeria South Africa 1 0.27 1 0.32 0.83 1 0.50 0.37 0.37 1 0.19 0.95 0.72 0.32 1 0.77 0.26 0.33 0.44 0.19 1 0.57 0.04 0.04 0.26 0.02 0.14 1 0.22 0.79 0.87 0.28 0.67 0.22 0.02 1

Perfect correlation is 1.0 – anything less than 0.5 is uncorrelated * Excluding South Africa

Source: Bloomberg, Ashburton estimates

As value investors, we continue to favour undervalued listed African equities across a variety of sectors, believing that, relative to other emerging markets globally, African equities can provide long-term growth.

A situation which we are confident can only improve as commerce in Africa matures.

From our on the ground research it’s becoming ever clearer that Africans are at long last investing in Africa. A number of cross border trade disputes have been resolved providing better access to more, previously hard to find, opportunities with greater protection for investors’ interests.

For anyone with even a limited grasp of Africa’s complex makeup it should hardly be surprising that the investment opportunity extends way beyond South Africa and commodities. What may be surprising, however, is the sheer diversity of the opportunity together with the depth and breadth of undervalued listed African equities across the continent with the potential to deliver considerable returns. /

www.ashburtoninvestments.com

15

Focus on Africa

Debt funding in Africa: the investment opportunity Unlike Africa’s abundant natural resources, funding is scarce across the continent – and demand far outstrips supply. Riyadh Bhyat, Ashburton Investments (South Africa), examines why this funding gap exists, and outlines the inherent opportunities for institutional investors.

A

RiyaDH BHYAT is a member of the Product Development team focussing on Credit Funds and Private Equity business.

s has been extremely well documented by the global and trade press, Africa’s economic growth looks set to accelerate as the continent invests in infrastructure and consumer spending rises. Of course, referring to the 54 countries that comprise Africa with such a broad brush is not entirely accurate – the economic circumstances of these countries vary dramatically, as do their drivers for growth. Nevertheless, there is a shared need between African nations for investment to fuel growth.

In fact, the majority of African nations report that the largest impediment to growth is access to financing, as shown below in Fig. 1.

Fig 1: Most problematic factors for doing business in SSA

20 16

8

Poor public health

Government instability

FX regulations

Crime and theft

Restrictiev labour regulations

Tax regulation

Policy instability

Poor work ethic

Inflation

Inefficient govt bureacracy Uneducated workforce

Tax rates

Corruption

0

Inadequate infrastructure

4 Access to financing

% of respondents

12

Source: World Economic Forum, RMB Where to Invest in Africa 2013/14

So why is funding so scarce on the continent and what are the implications and opportunities for investors?

The answer to this question lies in understanding the nuances and challenges of the local market conditions from a lender’s perspective. Just as in any other part of the world, lenders in Africa either expect cash flow or assets as security against a loan.

In turn, the lender has to make sure that those cash flows can be verified or that those assets exist, where the client says they exist.

The lender will also require trustworthy financials/asset valuations and want to consult reliable asset/name/address/lien registers in order to be sufficiently confident to put their cash at risk.

While in developed markets it is taken for granted that there is an established ecosystem of processes around enforceability of property rights, which in turn supports a functioning system of lending, this is not always the case in Africa. In Nigeria, for example, there is an opaque system of registering security over property known as “stamping”, which is difficult to navigate

16

Global Perspectives

without local experience and understanding and can act to limit the availability of financing sources.

Other aspects of the African market that lead to a relatively low appetite to lend include volatility and the difficulty of achieving diversification. Since the continent is still heavily dependent on commodity exports this leaves it open to fluctuating commodity prices which are dependent on external factors and open to large and unpredictable changes. If for example, China were to have a hard landing, Africa would certainly feel the consequences of that drop in demand. Understandably, this is a concern for lenders.

In terms of diversification, given that Africa is made up of such a dynamic patchwork of countries, lenders must consider the tradeoff between cost and concentration risk when deciding whether to operate in some or many of the 50+ diverse markets.

To be able to adequately diversify lenders have to be able to understand each of the individual markets and legal jurisdictions, but this comes with costs – both “school fees” and operational costs in supporting a presence across many countries. Without sufficient geographical reach, lenders will find themselves with undiversified portfolios, which are even more vulnerable to the effects of volatility.

Successful providers of funding therefore tend to be institutions that have the skills, resources and experience to effectively enter markets and understand (and mitigate against) risks. These institutions include: large banks, private equity houses and non-conventional entrants, such as mobile phone providers.

These providers of long term funding to the continent are also increasingly coming from other emerging markets (as shown in fig. 2 below) – 50% of African Foreign Direct Investment (“FDI”) is now provided by emerging market investors: Fig 2: Provision of FDI into Africa Table 1: Provision of FDI into Africa

Country % Of FDI in 2003 % of FDI in 2010 India 1% 14% China 1% 10% North America 31% 8% United Kingdom 12% 11% France 10% 8% Source: Africa’s Growth Story, Acha Leke & Mutsa Chironga

Assessing the impact Given the challenges of lending in Africa, it comes as no surprise that there are a limited number of participating institutions. And those which are willing to lend usually have very demanding

terms, such as onerous covenants or exacting security arrangements. A larger risk premium is demanded, as can be seen in the significant increase in the average margin over 3m Libor on African syndicated loans, as shown below in Fig. 3.

Fig 3: margin over OVER 3m Libor African FIG 2:Average AVERAGE MARGIN 3Mon LIBOR ONsyndicated AFRICAN loans SYNDICATED LOANS Africa average margin (bps)

400 350 300 250 200 150 100 1997

1999

2001

2003

2005

2007

2009

2011

2013

Source: Thomson Reuters African Loan update, 7 June 2013

At present, the majority of willing lenders are offshore institutions. This is largely because Africa has not yet gone through a significant capital formation process, such as that seen in China over the last 20 years, which means that the continent’s ability to fund itself is limited. According to Thomson Reuters, the top ten banks in Africa account for circa 78% of syndicated loan funding (see Fig. 4), making the market relatively uncompetitive and allowing for high risk-adjusted returns to earned.

TABLE 2: AFRICA MANDATED LEAD ARRANGE LEAGUE Fig 4: Africa Mandated Lead Arrange league table (Q1 – Q3TABLE 2013) (Q1 – Q3 2013)

Prorated Volume ($m)

Market share (%)

Cumulative market share (%)

1457

14

14

Standard Chartered

942

9

24

Citi

940

9

33

4

Standard Bank

823

8

41

5

BNP Paribas

669

7

48

6

Societe Generate

642

6

54

7

First Bank of Nigeria

622

6

60

8

ING

618

6

66

9

Nedbank

609

6

72

10

Natixis

602

6

78

11-14

SMBC, HSBC, GTB, BTMU

2221

22

100

$10145

100%

100%

Rank

Bank

1

FirstRand Bank

2 3

TOTAL

(the largest syndicated lender in Africa) to open up the possibility of a co-investment fund and allow investors to gain exposure to African loans. An arrangement of this sort achieves many of the goals for successfully investing in Africa: diversifying at low cost, leveraging experience and local partnerships and tapping into the skills to recognise, mitigate and structure around local risks.

Source: Thomson Reuters, African Loan Market Association, 8 October 2013

These top banks are therefore carving out niches and gaining significant experience in and understanding of the local markets.

For institutional investors looking to leverage the opportunities for debt investment into the continent, what will be key is to make the most of local knowledge, and work with organisations such as this, that have a good track record and expertise in Africa. Africa is a complicated, large, and diversified marketplace, and garnering returns from the loan market requires genuine local insight.

Experienced funders understand the nuances of the market – legally, administratively, and inter-personally – and have built up relationships and trust with local partners. While such banks have not traditionally opened up their investments to third parties Ashburton is working closely with Rand Merchant Bank

FirstRand structure

Onwards and upwards With growth rates in Africa now hard to ignore; the continent’s significant demographic advantage over Asian economies; the way that mobile technology is revolutionising banking and the provision of finance across the continent; and the fact that Africa is also largely uncorrelated with the performance of developed world markets, Africa is only advancing.

African exposure is becoming not just attractive but essential for sophisticated investors. /

www.ashburtoninvestments.com

17

Focus on India

Beyond the headlines

When you read the newspapers, India’s economic prospects may seem decidedly gloomy, but Jonathan Schiessl, Head of Equities at Ashburton Investments (International), argues that there are a great many opportunities in India for investors prepared to dig deeper and look beyond the headlines.

18

Global Perspectives

Jonathan Schiessl

A

Head of Equities at Ashburton Investments (International), looks beyond the headlines for real growth in India.

nyone travelling in India only a few short years ago couldn’t help but notice signs saying “Now it’s our turn”, or newspaper adverts celebrating “incredible India”. At the time the country seemed destined to finally realise its potential and take its rightful place among the world’s economic and political giants.

Yet today India feels like it has gone from hero to zero and cover stories abound in The Economist and Financial Times asking what went wrong. But is the story really that simple? Whilst the headline economic data and political system has undoubtedly deteriorated since 2010, many parts of corporate India have been quietly going from strength to strength. We think it’s important to highlight that amongst the general doom and gloom, we’ve found plenty of Indian companies run by top quality management offering fantastic growth opportunities, even in this environment.

First and foremost, we’d like to stress that it is our core belief that growth and wealth in India is predominantly created by individuals and the corporate sector, and not government. Therefore, we have tended to focus on domestic businesses that are subject to minimal interference by government. This reduces the influence of rent seekers and increases our confidence in sustainable management quality and business longevity.

It would, of course, be all too easy to focus on the titans of corporate India. We could highlight companies such as Tata Motors with its resurgent Jaguar Land Rover division, or the technology outsourcing giant TCS. But we thought it more insightful to look at predominantly domestic companies, especially those who have been operating in this apparent disastrous macro and political environment. So we’re focusing on two businesses that most will never have heard of, yet are emerging giants in their respective industries. Both are held in the Ashburton India Equity Opportunities Fund which is currently for expert investors only.

www.ashburtoninvestments.com

19

Focus on India

Fig 1: Eicher Motors vs. The Sensex

Godrej

(rebased from beginning 2010, % move)

Sensex

600 500 400 300 200 100 0

04/01/2011

-100 04/01/2010

04/01/2011

04/01/2012 04/01/2012

04/01/2013 04/01/2013 Source: Bloomberg

Fig 2: Net flows into the South African equity and bond markets (million)

Premium motorcycle replacement demand Royal Enfield sales

FY11

FY12

FY13

743,708 743,715 795,911 54,475 76,697 120,678

FY14E

FY15E

1,161,398 1,606,435 Source SIAM, Axis Capital

20

Global Perspectives

Strategic dominance Both companies are largely consumerfacing and follow a relatively simple approach: identify a market segment or opportunity and dominate through a variety of strategies. The first company we highlight is Eicher Motors, a domestic commercial vehicle manufacturer also doing rather well in the premium motorcycle sector.

We then look at Godrej Industries, the holding company of one of India’s oldest and most respected family dynasties that operates predominantly in India, but increasingly in other emerging economies.

Eicher Motors began selling imported tractors in 1948. Over the next five decades the company has grown, diversified, acquired, consolidated and expanded into the group it is today. It has two main divisions – Royal Enfield (a premium motorcycle business) and a commercial vehicle business joint-ventured with Sweden’s Volvo Group. Looking at

Fig 1, the stock price of Eicher has vastly outperformed the Sensex Index since the beginning of 2010.

Royal Enfield is one of the world’s oldest motorcycle brands, making motorcycles in the UK from 1909. We won’t dwell on the history here but most of the UK motorcycle industry had disappeared by the 1970s, killed off by Japanese competition and a lack of innovation. Enfield Motorcycles, however, were available in India from 1949, and produced domestically from 1955.

When production ceased in the UK in 1970, production in India continued. In 1990 Enfield India entered into a strategic alliance with the Eicher Group, before the two entities fully merged in 1994.Today all Royal Enfield motorbikes are manufactured in India where all R&D is also conducted. This premium heritage brand is predominantly an Indian story, playing into the rising aspirations of a growing middle class.

Strong replacement demand for premium motorcycles and a growing market share offer a massive opportunity for Eicher (see fig. 2) – despite a four times increase in production there is still a waiting list of almost six months. They enjoy a near monopoly in their market sector, but retain an obsession with product quality and pricing and spend heavily on maintaining and growing their brand. A new plant with the latest technology should further double their capacity to almost 250,000 units by the end of this fiscal year. The company has also just started directly marketing its new bike, the Continental GT, in the UK, to rave reviews.

Joint venture The second and equally compelling chapter of the Eicher story is their Commercial Vehicle (CV) business. The company has long played in various sectors of this market, but the game-changer, in our view, was the far-reaching agreement and joint venture (JV) signed with Volvo. Named VE Commercial Vehicles, the JV has been operational since 2008. It provides Volvo with market access through an established brand to the Indian CV market, and provides Eicher with the latest technology from one of the world’s largest commercial vehicle makers. In addition, the introduction of a new engine factory will help the JV face off increasing competition domestically, and allow the Indian business to become a global hub for the manufacture of medium-sized engines.

Despite the recent economic slowdown in India, Eicher has been increasing its market share. We expect this trend to continue as the JV focuses on product

quality and improving reliability, expanding its after sales network and diversifying its product range.

A trusted brand Our second example, Godrej Industries, can trace its heritage back to 1897. One of India’s most trusted brands, Godrej enjoys the patronage of around 500 million Indians every day. The Godrej group has interests in real estate, consumer goods, appliances, and agricultural applications as well as chemicals. At the heart of this whole empire the Godrej family continue to play an active management and ownership role. It is their reputation for probity in everything they do that sets them apart from many other familyowned businesses in India. Whilst the stock price has outperformed the Sensex since the beginning of 2010 (see fig. 3), being one of India’s most famous and oldest companies means the story is relatively well known to investors and so the potential for outperformance is arguably limited compared to Eicher.

What is less well appreciated is that since 2001 the company has grown its market capitalisation by 45% compound annual growth rate (CAGR) driven by a 30% CAGR in consolidated earnings. In 2010-11 management forecast a further 10x growth by 2020 which on the current trajectory; growth of 27% from 2011-2013, appears to be on track.

The company is a holding company with its biggest single stake being 22% of the separately listed Godrej Consumer Products (GCPL). GCPL has a dominant market position in India and selected international geographies (10% of revenues come from Africa and 7% from Latin America), with a strategy to grow into the three focused categories of household care, hair care and

personal wash across Asia, Africa and South America. It is a highly innovative company with strong cross pollination in different territories – for example it recently launched a paper format mosquito repellent – “Good Knight Fast Card”.

Low capital intensity However, what really excites us about this company is Godrej Agrovet, its 64% owned agricultural business. Agrovet is India’s leading agricultural player in animal feed and palm oil plantations. This is a low capital intensity business with high barriers to entry.

It also has a 49% stake in a JV with US multinational Tyson Foods selling chicken and frozen foods. It is the largest player with 10% market share in the organised animal feed business (poultry, cattle and aqua), with the organised market representing only 10% of the total potential market today.

This trend is changing fast as retail in India becomes more organised. The company has stated that this business will ultimately seek a separate listing, and could be worth as much as US$1billion (Godrej Industries market capitalisation is currently US$1.5bn).

We have deliberately focused on both Godrej Industries and Eicher Motors as pretty successful companies operating in an economy that is widely regarded as hitting the buffers, albeit hopefully temporarily. As part of our strategy we continue to find plenty of fascinating companies in India today with compelling investment opportunities for those willing to dig a little bit deeper and be prepared to put up with periods of inevitable volatility.

India’s political and economic status may have deteriorated but in the hunt for enhanced returns, a great many opportunities can be found by looking beyond the headlines. /

Fig 3: Godrej Industries vs. The Sensex

Godrej

(rebased from beginning 2010, % move)

Sensex

100 80 60 40 20 0 -20

04/01/2011

04/01/2012

04/01/2013

04/01/2011

04/01/2012

04/01/2013

-40 04/01/2010

Source: Bloomberg

www.ashburtoninvestments.com

21

Focus on currencies and fixed income

Shifting currency sands Paolo Senatore, Chief Investment Officer of the South African long-only funds, on the US dollar’s dominance of the currency market, the effect this has had on, amongst others, the South African rand and how the sands are very definitely shifting.

22

Global Perspectives

A

PaOlo Senatore Chief Investment Officer of the South African long-only funds, on commodities and asset classes with the potential to generate superior returns.

s the world reserve currency, the US dollar (USD) has inevitably dominated the currency markets for decades. Today more than 60 percent of all foreign currency reserves are in US dollars so the ripples from the US Federal Reserve’s somewhat changeable announcements on Quantitative Easing (QE), and the recent dispute over budgets and President Obama’s healthcare reforms have been felt the world over.

As was the intention, QE has indeed led to a greater availability of credit in developed markets, but this has not been offset by localised demand. Instead the excess liquidity has been directed into emerging markets having an adverse effect on, amongst other financial measures, currency exchange rates.

And although the US political stalemate in October was inevitably resolved before what would have been the first ever US debt default, the bickering, according to global market research firm IHS, cost the country $300m a day in lost output. Though bad news for the US, albeit of its own making, other currencies have in general benefitted from US in-fighting. The South African rand, for example, has rallied a little against the dollar in recent weeks, bringing welcome relief from a six month period of rapid devaluation.

Currency fluctuations in reaction to American market behaviours and financial developments are, of course, nothing new but it is worth stepping back and putting into historical context and perspective exactly why this should be. Using the rand as an example we can pretty accurately track peaks and troughs against global, but particularly American, economic developments; which helps both explain the generally weakening rand and provides a directional view of the rand for the foreseeable future.

Fig.1 below illustrates the rand/USD relationship to the S&P500 index. Throughout the nineties, and between 2003 and 2008, the US dollar reigned allpowerful. These periods of currency strength coincided with the internet revolution and a period of what turned out to be excessive credit extension.

In both instances global markets appreciated strongly, only to collapse when the internet bubble burst and the sub-prime financial crisis came to the surface. From the early nineties right up until 2001 the rand depreciated from 2.5 to 13.7 to the dollar only to then appreciate from 13.7 to 6 to the dollar following the market correction.

Steady depreciation The period of synchronised global growth from 2003 to 2008 saw the rand steadily depreciate again from 6 to 8.3 to the dollar before the equity market sub-prime financial crisis market selloff. The rand then depreciated yet further, reaching 11.6 to the dollar at the peak of the equity market selloff in October 2008. As in 2001, after the panic selling in the equity and bond markets had subsided, global money began to flow back into emerging markets which had been, by and large, unaffected by the subprime crisis. In response to the emerging market cash injection the rand strengthened once more against the dollar, attaining a level of 6.6 in April 2011.

Since then, the rand has been in depreciation mode as investment changed direction once again; this time moving back into developed economies.

Fig 1: S&P 500 and ZAR USD

1700

14

1400

12

1200

10

1000

8

800

6

600 4 3.5

400 350

3 -2.5

300 ‘90 ‘91 ‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13

Source: I-Net

www.ashburtoninvestments.com

23

Focus on currencies and fixed income Why then the rapid depreciation of the rand in 2013? We can readily identify three underlying causes: 1. Slowing South African GDP growth rates compared to those in the rest of the developed world 2. A deterioration of South African national accounts 3. A decline in foreign inward investment.

Fig.2 below documents the change in GDP from 2005 to present and includes forecasts for 2013 and 2014. The table illustrates that during the period 2005 to 2007, the South African economy grew at more than 5%. Excluding the recession of 2009, the South African GDP growth rate has been declining and is forecast to grow at a modest 1.9% in 2013. By contrast, since its recession in 2009, the US economy has grown at around 2% and is forecast to improve by a further 2.7% in 2014. It is likely, therefore, that over the next 18 months the acceleration in US GDP growth will attract investors; thereby potentially strengthening the dollar relative to many other currencies.

Fig 2: Gross Domestic Product (GDP)

2005 2006 2007 2008 2009 2010 2011 2012 2013f 2014f USA* 3.1 2.7 1.9 -0.3 -3.1 2.4 1.8 2.2 1.9 2.7 RSA** 5.3 5.6 5.5 3.6 -1.5 3.1 3.5 2.5 1.9 3.0 Source: *Bloomberg, in-house forecasts. ** SA Reserve Bank, in-house forecasts

The South African current-account balance (exports less imports) and fiscal balance (income from taxes less government expenditure) are tabled below prior and subsequent to the sub-prime banking crisis. Given the elevated growth rates prior to the sub-prime crisis, the current-account deficit ballooned to 7% of GDP as a consequence of increased consumption. The main difference between then and now is that at least the economy was enjoying rapid growth and a demonstrable fiscal surplus. After the 2008 sub-prime crisis, however, with the rapid slowdown in private-sector expenditure, the government came to the rescue and began spending. The public sector expanded rapidly, salary increases came in well above inflation and consumer spending boosted the economy.

Unfortunately, since 2008/09 the government has been spending well in excess of tax revenues. It is notable that for the 2012/13 fiscal year the combined current and fiscal deficits now comprise 11.5% of GDP, nearly three times the 2005/06 total deficit (see fig. 3).

The third factor to consider is net foreign investment into the South African equity and bond markets which from fig. 4 below can be seen to be in a state of general decline. There is an anomaly in the R92billion inflow into the bond market last year when South Africa became part of the World Government Bond Index.

Fig 3:Account balances as a percentage of GDP

2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13

Current

-3.5

-5.3

-7.0

-7.2

-4.0

-2.8

-3.4

-6.3

Fiscal -0.5 1.2 1.7 1.0 -6.5 -4.4 -3.9 -5.2 Total -4.0 -4.1 -5.3 -6.2 -10.5 -7.2 -7.3 -11.5 Source: SA Reserve Bank

Going forward, it is likely that despite brief periods of rand strength, the currency will weaken against the dollar for several years to come. South Africa’s GDP is forecast to contract markedly this year to 1.9% and possibly achieve sub-par growth next year, while US GDP is forecast to accelerate to 2.7% in 2014. Furthermore, the South African fiscal and current-account deficits remain vulnerable to disappointing revenue collection and lower commodity prices.

Fig 4: Net flows into the South African equity and bond markets (million)

2009 Equity 74,686 Bond 27,301 Total 101,987

2010 35,976 55,900 91,876

2011 -18,866 48,404 29,538

2012 2013 to date -3,252 18,078 92,388* 1,106 89,136 19,184

Source: I-Net Bridge.*SA incorporated into the World Government Bond Index, as at 11 October 2013

24

Global Perspectives

With this current economic backdrop, South Africa does not rank highly as an investment destination – a situation somewhat exacerbated by the current union rivalry and labour unrest plaguing the mining and agricultural sectors of the economy.

Taking all these factors into consideration, it is our view that the currency remains susceptible to weakness until the economy improves, the current account and fiscal deficits narrow, and the labour issues are resolved.

It is worth noting, however, that while the US Dollar still reigns supreme as the world reserve currency, the sands are definitely shifting. Although its meteoric rise has slowed in recent months, the Chinese economy is still projected to challenge the US economy, in size at least, by 2016. The Chinese have recently agreed with Japan to use their own currencies in bilateral trade and alongside Russia have expressed intent to break the control that the US dollar has over international trade.

Chinese Stock Exchange, Shanghai.

The BRICS (Brazil, Russia, India, China and South Africa) have made a similar pact to trade in their own currencies. The US Dollar may face further headwinds from the International Monetary Fund, which has written a paper advocating a new global reserve system that no longer relies on the dollar as the single major reserve currency.

America’s crown is unlikely to be toppled overnight and until it does, currency movements are likely to continue to be most directly affected by its economic developments. It may well be that further down the line global currencies are benchmarked against the Renminbi or even the “Bancor” – the name of a potential future global currency suggested in an IMF paper, but for now the US Dollar remains dominant and our position is that the rand is likely to remain vulnerable to further weakness. /

Focus on currencies and fixed income

The next phase for bond markets

As the global recovery continues, albeit stutteringly, Nico Els, Fund Manager at Ashburton Investment (South Africa), looks at prospects for the bond markets: evaluating how five years of unfolding global economic and financial conditions have led to an environment now known as “the new normal”, as well as the consequences of Quantitative Easing “tapering”.

M

Nico Els Fund Manager at Ashburton Investments (South Africa) examines the prospects for the bond markets in an environment now recognised as ‘the new normal’.

ost developed countries’ bond markets have a strong correlation to the US, so for the purposes of this article I will focus on the US but draw out the implications for the South African bond market.

The foundations for “the new normal” were laid during the

rapid expansion of the noughties that preceded the crash.

There was a boom in personal consumption: 75 % of US GDP came from personal consumption, and both unemployment and interest rates were low.

So far so normal in an expansionary phase.

www.ashburtoninvestments.com

25

Focus on currencies and fixed income

Where things diverged was in the rise, and then rise again, in house prices. This ‘wealth’ effect, a general feeling of well-being, led consumers to borrow much more money from the banks than might be considered usual in that stage of the economic cycle.

This feeding frenzy of consumption had a dramatic effect on US personal savings. Averaging 10% of disposable income from 1950 to 1985, this figure then dropped to about 6% in 1985-2004 before plummeting still further to an all-time low of 2.3%.

The arguably inevitable consequences were therefore a lot worse than in previous recessions, as households tried to tackle their own debt. When many subsequently failed, the banks had little option but to foreclose.

During the boom period, the Federal Funds interest rate had risen from 1 to 5.25%, inflation jumped from 1.5 to 5.6%, and ten year bond yields went from 3 to 5.4%.

In an attempt to manage the crisis, the Federal Reserve aggressively cut its Funds rate to 0.25%. Inflation went into negative figures, down to -2%, and ten year yields collapsed to 1.4%, an all-time low.

Massive bond buying spree The Fed soon realised that the slashing of rates failed to rescue the situation; inflation continued to fall, people shied away from investing in the economy and there was a sharp and significant drop in economic activity. As a response the Fed introduced QE in 2008, with a massive bond buying spree. The intention was two-fold: i) to push interest rates as low as possible to provide struggling mortgage borrowers with some breathing space and ii) to stimulate the growth by buying up bonds in the belief that sellers would re-invest the money back into the economy.

The sums the Fed injected have been vast. The first round was worth $1.4tr. QE2 (the second round) introduced another $0.6tr and QE3 is still pumping in $85bn a month. The Fed’s balance sheet has expanded by a massive $3.6tr in total.

Then in May 2013, Bernanke revealed that he was considering QE “tapering”. He warned the markets that the Fed could start reducing these monthly investments, stopping entirely by mid 2014.

The effect was immediate. The markets reacted very nervously with bond yields shooting up from 1.4 to 3%.

And it is this reaction which is widely regarded as the start of the “next phase for bond markets”.

From the South African perspective Bernanke’s announcement was particularly damaging. Interest rates sky-rocketed and ten year government bonds rose from 6 to 8% in under a month.

The largely unforeseen flaw in the US QE approach is that much of the QE capital didn’t in reality find its way back into the US economy but, in the hunt for higher yields, into worldwide investments instead, and particularly into emerging bond markets.

So those countries that had benefited most from the easy money will be most vulnerable when QE is withdrawn. South Africa has benefited from record inflows of 90bn Rand ($9bn) in 2012 alone.

Fast forward to today’s “new normal” with almost synchronised global recovery but interest rates and inflation still abnormally low. Most of the G10 countries are starting to show signs of improvements. Our view is that global growth will increase from 2.8% in 2013 to 3.7% in 2014. The US will go from 1.7% in 2013 to 2.7% in 2014, and the Euro area will grow from 0.3 to 1%.

Germany’s growth on its own should rise from 0.5 to 1%, and the UK from 1.4 to 2.5%. China, we believe, will stabilise with growth slowing from 7.7 to 7.5%, allaying to some extent any fears of a hard landing.

It may still be too early to say but hopefully the worst is behind us. Slowly but surely the economic measures, in terms of fiscal stimuli, have helped: time has benefited the US consumer and employment figures in the US are on the rise.

However, this recovery differs from normal in part because of the output gap: potential GDP growth minus actual GDP growth.

Growth over the last five years or so has been way below potential.

There remains significant spare capacity in the worldwide economy which is keeping inflation lower than you’d normally expect with this sort of stimuli; a disparity which is unlikely to be resolved for a few years yet.

“Investors might therefore be wise to approach fixed income with caution, given an expected gradual global recovery.”

26

Global Perspectives

Our view is that global growth will increase from

% 2.8 in 2013

to

% 3.7 in 2014

et re St W all

“With our one year return forecast for bonds close to 2% below that of cash, bonds as an asset class do not look attractive.”

markets will find it increasingly difficult to believe the Fed’s forward guidance. Concerns are already being voiced about shock interest rate rises. One contributing factor is continued uncertainty over the effect of the withdrawal of the US Federal Reserve’s Quantitative Easing (QE) programme, and its effect on interest rate levels and inflation. QE hasn’t been a feature of previous recoveries.

The current volatility in global fixed income markets is, as we have seen, a product of uncertainty over the withdrawal of QE3.

And it is likely that as soon as the economy picks up, Bernanke will start to taper QE which could lead to higher mortgage rates.

Mortgage rates moving too high too quickly risks a slowdown in economic activity, at which point QE will have to be reinstated.

It’s a cyclical process for which there is no obvious quick fix, but it’s likely to take several months for the economy to stabilise sufficiently to dispense with QE altogether. Until then market volatility will remain high.

The Ashburton view is that US bond yields will drift up with the weak recovery, leading to a capital loss. Ten year rates stand at 2.65% but it is our view that these will rise to between 2.75 and 3% by the end of the year, and then to 3.25% in 12 month’s time, and perhaps Continued volatility even 5% by the end of 2016.

In the meantime, emerging market countries The US fiscal drag is also leading to a differently such as South Africa, which benefited from shaped recovery. The need for the US to control massive foreign inflows, are exposed. its budget deficit will restrict GDP going forward.

37% of government bonds are now held $ tr The Government must either raise taxes and by foreign investors; a high and concerning The US ipsum federal reserve’s keep them high, or spend less, which will have number indeed.

Lorem dolor sit amit balance sheet hasmundi. expanded sic transit gloria a similar knock-on effect on the consumer.

South Africa is a member of the “fragile by $3.6tr in total In previous recessions when consumers have five” – a group of emerging market countries struggled to keep their heads above water or with twin deficits (both current account and other issues have slowed the economy, the Government budget balance deficits) that are therefore most vulnerable to the would have stepped in to take up the slack. In the “new normal” effects of foreign inflows and outflows. Turkey, India, Indonesia and with the Government effectively maxed-out, it could well fall Brazil complete the group. South Africa’s rates have a very strong to the consumer to up the economy’s fortunes. correlation with those in the US – a coefficient of 0.86 – so as US Meanwhile, Chairman Bernanke is still struggling with volatility rates rise, so will South Africa’s. Add in the country’s twin deficits in the bond markets, unleashed it must be said by his own and current labour issues, and the future looks challenging. announcements on QE tapering. World bond markets remain SA ten year Government bonds are currently 7.35%, and concerned about interest rates rising more quickly than Bernanke we anticipate them rising to 8.5% in 12 months’ time. So with would like. This will be challenging for the Fed Chairman as our one year return forecast for bonds close to 2% below he needs continued low mortgage rates to aid the recovery. that of cash, bonds as an asset class do not look attractive.

The repo rate of the South African Reserve Bank is currently Significant headwinds at 5%. The market is pricing in hikes of 100 basis points in 12 months’ time, and a further 100 basis points in the following Bernanke has provided forward guidance that the Reserve’s 12 month period. At Ashburton we believe that this rate would Funds interest rate will rise very gradually, and is only likely remain unchanged for an extended period, before gradually rising to reach 4% (regarded as “neutral” by the Fed) in 2018/2019. from the first half of 2015. The rand is the “dark horse” in this view.

In previous upswings it’s taken just five to seven quarters to Should the rand weaken substantially from current levels and arrive at neutral. Another differentiator is the US economy, remain elevated, the SARB would be forced to hike rates sooner which is still likely to face significant headwinds. According than our base case view. to US Federal Reserve Chairman Ben Bernanke these include Investors might therefore be wise to approach fixed “the slow recovery of the housing sector, continued fiscal drag, income with caution, given an expected gradual global recovery. and perhaps continued effects from the financial crisis”.

Sovereign bond performance is likely to be constrained by a slow However, if the economy continues to improve, consumer upward drift in yields, so consequently Ashburton is underweight confidence will rise, unemployment figures will drop, and the the asset class. /

3.6

www.ashburtoninvestments.com

27

A part of the FirstRand Group Ashburton Investments is the investment management business of the FirstRand Group, one of Africa’s largest financial services companies. It represents a new franchise in the FirstRand portfolio of leading financial services businesses, alongside but separate to RMB, FNB and WesBank.

Local expertise and international reach Our assets under management exceed R110 billion ($13.25 billion), and we have international reach with offices in South Africa, the United Kingdom, Channel Islands, United Arab Emirates and India.

Core to Ashburton Investments’ proposition of giving investors access to more is its ability to leverage the skills, platforms and product origination capabilities within the Group.

Contact information South Africa

Channel Islands

Johannesburg (head office)

Ashburton (Jersey) Limited 17 Hilary Street, St Helier, Jersey, JE4 8SJ, Channel Islands Tel: +44 (0) 1534 512000

Merchant Place, 1 Fredman Drive, Sandton, 2196 Tel: +27 (0) 11 282 8800

Cape Town The Pavilion, 155 Campground Road, Newlands, 7700 Tel: +27 (0) 21 670 3800

Durban 10-12 Cranbrook Crescent, La Lucia Office Park, La Lucia Ridge, 4051 Tel: +27 (0) 31 560 7800 Email: enquiries@ashburton.com Website: www.ashburtoninvestments.com

United Kingdom Austin Friars House, 2-6 Austin Friars, London, EC2N 2HD, United Kingdom Tel: +44 (0) 207 939 1844

United Arab Emirates

We are about solid foundations and new frontiers

C/O FirstRand Bank, Level 1, Gargash Building (next to Times Square), Sheikh Zayed Road, Dubai, United Arab Emirates Tel +97 (0) 14 371 3600

Issued by Ashburton (Jersey) Limited (“Ashburton”) which has its Registered Office at 17 Hilary Street, St Helier, Jersey JE4 8SJ, Channel Islands and which is regulated by the Jersey Financial Services Commission and also authorised as a Foreign Financial Services Provider in South Africa in accordance with Section 8 of the Financial Advisory & Intermediary Services Act 2002 (FSP number 42500). The views expressed in this document represent the collective views of the Ashburton investments team and its external advisers, which will change with altering market conditions. It is for information purposes only and must not be regarded as a prospectus for any security, financial product or transaction. Ashburton does not in any way represent, recommend or propose that the securities and/or financial or investment products or services that may be referred to in this document are appropriate and/or suitable for a particular investment objective or financial situation or needs. This document does not constitute advice in respect of any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever. While all care has been taken by Ashburton in the preparation of the information contained in this document, Ashburton does not make any representations or give any warranties as to the correctness, accuracy or completeness, nor does Ashburton assume liability for loss arising from errors in the information irrespective of whether there has been any negligence by Ashburton, its affiliates or any other employees of Ashburton, and whether such losses be direct or consequential.

Ashburton and its affiliates disclaim any liability for any direct, indirect or consequential damage or losses that may be sustained from using or relying on the information contained herein. The value of investments, and the income from them, can go down as well as up, is not guaranteed, and you could receive back less than you invested. This could also happen as a result of changes in the rate of currency exchange, particularly where overseas securities are held. Past performance is not necessarily a guide to future performance. If you undertake investment business with a non-UK firm, you will be excluded from the benefit of the rules and regulations made under the UK’s Financial Services and Markets Act 2000, including the UK Financial Services Compensation Scheme. Approved for issue in the UK by FirstRand Bank Limited (London Branch), a branch of FirstRand Bank Limited, whose Registered office is at Austin Friars House, 2-6 Austin Friars, London EC2N 2HD. FirstRand Bank Limited is authorised and regulated by the South African Reserve Bank. Authorised by the Prudential Regulation Authority. Subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. Approved for issue in South Africa, by Ashburton Fund Managers (Proprietary) Limited which is a licensed Financial Services Provider (“FSP”) in terms of section 8 of the Financial Advisory and Intermediary Services Act, 37 of 2002 (“FAIS Act”), with FSP number 40169, regulated by the Financial Services Board.