The ETF Monthly Review: August 2019

IN THIS ISSUE:

What happened in the markets in July?

• Fitch Ratings, Moody’s and Business Unity South Africa issue credit warnings on SA
• The South African Reserve Bank and the US Fed cut interest rates
• China and the US trade relations sour further

Our favourite ETFs

• Domestic equities: Satrix SA Quality ETF
• Foreign equities: Satrix MSCI World ETF and Satrix MSCI Emerging Markets
• Bonds and cash: NewFunds TRACI 3 Month (short term); Satrix ILBI ETF, Stanlib Global Bond ETF and Ashburton World Government Bond ETF (long term)
• Dividend/income funds: Stanlib SA Property ETF and Sygnia Itrix Global Property ETF
• Commodities: Standard Bank Africa Rhodium ETF

What’s happened in the markets?

Financial markets were subdued in July. The equally weighted portfolio of JSE-listed ETFs shed 0.8% while the Intellidex portfolio gained a pedestrian 0.46% (+10.38% year-to-date, YTD).

Local assets came under pressure as sentiment towards SA deteriorated further amid concerns of a worsening fiscus outlook, heightened political risk underpinned by factional battles within the ANC and no implementation of reforms. Moody’s, the only major ratings agency that still grades South African debt higher than junk, warned that National Treasury’s plan to double financial support for Eskom was “credit negative”. Similar sentiment was echoed by Fitch Ratings which downgraded its outlook for SA. These and other negative events somewhat overshadowed the sentiment-positive repo rate cut by the South Africa Reserve Bank. Local equities suffered the most. The all share index regressed 2.37% with the underperformance noticeably pervasive across all sectors and somewhat pronounced among SA-facing sectors such as financials. Bonds softened marginally. Commodities, particularly the platinum group of metals, performed relatively well.

Growth in international markets slowed as US-China trade tensions escalated and fears of global economic slowdown increased. However, most asset classes delivered positive returns. The MSCI World index jumped 1.2%, thanks to growth in developed markets which more than offset losses from most emerging markets. Global government bond indices posted modest gains.

Local markets: June performance

The average return on local-equity ETFs was -2.88%. The top five performers were commodity ETFs led by Standard Bank Africa Rhodium (+6.96%), Standard Bank Africa Platinum (+6.26%) and Absa NewPlat (+5.82%). Standard Bank Africa Rhodium is now up a staggering 45.85% so far this year.

The Satrix FINI 15 and NewFunds S&P GIVI South Africa Financial ETFs were the laggards with losses of 8.86% and 8.37% respectively. Resources funds, which topped the performance table in June, were among July’s worst performers. Satrix Resi shed 6.49% (YTD: +8.51%) while the NewFunds S&P Givi South Africa Resources ETF fell 5.78% (YTD: +3.82%).

International markets: June performance

JSE ETFs tracking international equities and bonds fared better than their counterparts that track domestic stocks. Cloud Atlas Africa Real Estate ETF, which tracks property stocks in Africa excluding SA, had the best performance with a return of 17.32%. The fund is now up 11.08% this year. Stanlib S&P 500 Info Tech Index Feeder came second with a return of 6.58% (year-to-date: +32.3%). Cloud Atlas AMI Big50 ex-SA ETF, was the worst performer with a loss of 10.4% followed by Sygnia EU (-2.8%) and Sygnia UK (-2.5%).

The performance of international assets was shaped by numerous factors including a rate cut cycle which is in motion for many economies, US-China trade relations, Brexit and economic data from some major economies. The US Federal Reserve followed many other central bankers and delivered a widely expected interest rate cut on the last day of July.

The European Central Bank gave strong hints that an easing package is on the way. The EU concluded nominations of its leaders for many of the top jobs in Brussels. Perhaps the most consequential outcome for investors was the nomination of Christine Lagarde to take over from Mario Draghi as ECB leader at the start of November. Lagarde is largely viewed as dovish and hence is expected maintain the accommodative stance on monetary policy.

In the UK, the appointment of Borris Johnson as British prime minister saw the pound coming under pressure as investors fret over the likelihood of a no-deal Brexit. The US economy grew an annualised 2.1% in the second quarter of 2019, ahead of an expected 1.8%, following a 3.1% uptick in 2019Q1. Contrarily, China’s GDP growth in the second quarter slowed to 6.2%, its lowest growth since 1992.

Final thoughts

We are seeing the following key themes playing out in the markets: slow economic growth; low inflation; and lower interest rates. For SA, sentiment remains on the ropes because of the following factors:

• Extremely low economic growth with limited hope for positive per capita GDP growth, compounded by global growth issues and risk narratives;
• The sharp weakening of the rand;
• A sense that no reform is occurring, and politics and political egos are trumping rational and necessary policy making;
• A view that the government is not doing anything in response to the crises of low growth and rising unemployment;

• The view that prescribed assets (using pensions to fund public debt), national health insurance and land reform etc all skew risks to the downside;

• Increasing despair at the lack of action over Eskom; and
• A Moody’s downgrade of SA’s credit rating looking more and more likely

Given this backdrop, local assets are likely to be under pressure in the coming months. On the international markets, asset prices are likely to be supported by accommodative monetary policies. However, we expect to see some volatility being driven by the trade tensions between the US and China. This outlook argues for a balanced portfolio with local and offshore assets. Tactically, investors can go overweight in dividend-focused ETFs, quality ETFs and foreign ETFs.

Bond and cash funds

Bonds should find their way into a well-diversified portfolio due to their risk-diversification attributes. If you are investing for a very short period, usually less than a year, then the NewFunds TRACI 3 Month (0.63%) is a natural choice because it is least sensitive to sudden adverse interest rate movements. You can also park your funds in a money market fund if you’ve a lump sum that you wish to put down as a deposit for big-ticket item purchases like a house or car while you shop around. It’s a better option than putting money in a current account that does not earn real interest.

For a longer investment horizon, protecting your investment against inflation is paramount. We maintain our choice of the Satrix ILBI ETF (-68% and +319%), which has the lowest expense ratio in this category. Furthermore, nominal bonds add a unique risk-return dimension that differs from inflation-linked bonds and improves overall portfolio performance.